Chapter 1 Introduction to Corporate Finance

proxy fight. A proxy is the authority to vote someone else's stock. A proxy fight develops when a group solicits proxies in order to replace the existing board and thereby replace existing management.

An important mechanism by which unhappy stockholders can replace existing management is

1. Partnerships are usually inexpensive and easy to form. Written documents are required in complicated arrangements. Business licenses and filing fees may be necessary. 2. General partners have unlimited liability for all debts. The liability of limited partners is usually limited to the contribution each has made to the partnership. If one general partner is unable to meet his or her commitment, the shortfall must be made up by the other general partners. 3. The general partnership is terminated when a general partner dies or withdraws (but this is not so for a limited partner). It is difficult for a partnership to transfer ownership without dissolving. Usually all general partners must agree. However, limited partners may sell their interest in a business. 4. It is difficult for a partnership to raise large amounts of cash. Equity contributions are usually limited to a partner's ability and desire to contribute to the partnership. Many companies, such as Apple Computer, start life as a proprietorship or partnership, but at some point they choose to convert to corporate form. 5. Income from a partnership is taxed as personal income to the partners. 6. Management control resides with the general partners. Usually a majority vote is required on important matters, such as the amount of profit to be retained in the business.

Here are some things that are important when considering a partnership:

1. The sole proprietorship is the cheapest business to form. No formal charter is required, and few government regulations must be satisfied for most industries. 2. A sole proprietorship pays no corporate income taxes. All profits of the business are taxed as individual income. 3. The sole proprietorship has unlimited liability for business debts and obligations. No distinction is made between personal and business assets. 4. The life of the sole proprietorship is limited by the life of the sole proprietor. 5. Because the only money invested in the firm is the proprietor's, the equity money that can be raised by the sole proprietor is limited to the proprietor's personal wealth.

Here are some factors that are important in considering a sole proprietorship

the shareholders (the owners), the directors, and the corporation officers (the top management).

In its simplest form, the corporation comprises three sets of distinct interests:

value will be created.

Over time, if the cash paid to shareholders and bondholders (F) is greater than the cash raised in the financial markets

(1) general partnerships and (2) limited partnerships.

Partnerships fall into two categories:

1. Name of the corporation. 2. Intended life of the corporation (it may be forever). 3. Business purpose. 4. Number of shares of stock that the corporation is authorized to issue, with a statement of limitations and rights of different classes of shares. 5. Nature of the rights granted to shareholders. 6. Number of members of the initial board of directors.

Starting a corporation is more complicated than starting a proprietorship or partnership. The incorporators must prepare articles of incorporation and a set of bylaws. The articles of incorporation must include the following:

agency problem

Such a relationship exists whenever someone (the principal) hires another (the agent) to represent his or her interests. For example, you might hire someone (an agent) to sell a car that you own while you are away at school. In all such relationships there is a possibility of a conflict of interest between the principal and the agent. Such a conflict is called an

extends the disclosure requirements of the 1933 Act to securities trading in markets after they have been issued. the 1934 Act deals with the important issue of insider trading. Illegal insider trading occurs when any person who has acquired nonpublic, special information (i.e., inside information) buys or sells securities based upon that information

The 1934 Act

requires a corporation to file a registration statement with the Securities and Exchange Commission (SEC) that must be made available to every buyer of a new security. The intent of the registration statement is to provide potential stockholders with all the necessary information to make a reasonable decision.

The Securities Act of 1933 requires what?

to maximize the current value per share of the existing stock.

The goal of financial management is

an agency relationship

The relationship between stockholders and management is called

The federal government taxes corporate income (the states do as well). This tax is in addition to the personal income tax that shareholders pay on dividend income they receive. This is double taxation for shareholders when compared to taxation on proprietorships and partnerships.

There is, however, one great disadvantage to incorporation.

capital budgeting

We use the term _______ _______ to describe the process of making and managing expenditures on long-lived assets.

is a distinct legal entity. As such, a corporation can have a name and enjoy many of the legal powers of natural persons. For example, corporations can acquire and exchange property. Corporations can enter contracts and may sue and be sued. For jurisdictional purposes the corporation is a citizen of its state of incorporation (it cannot vote, however).

What is a corporation?

all partners agree to provide some fraction of the work and cash and to share the profits and losses. Each partner is liable for all of the debts of the partnership. A partnership agreement specifies the nature of the arrangement. The partnership agreement may be an oral agreement or a formal document setting forth the understanding.

What is a general partnership

permit the liability of some of the partners to be limited to the amount of cash each has contributed to the partnership. Limited partnerships usually require that (1) at least one partner be a general partner and (2) the limited partners do not participate in managing the business

What is a limited partnership

First, how closely are management goals aligned with stockholder goals? This question relates, at least in part, to the way managers are compensated. Second, can managers be replaced if they do not pursue stockholder goals? This Management will frequently have a significant economic incentive to increase share value for two reasons. First, managerial compensation, particularly at the top, is usually tied to financial performance in general and often to share value in particular. For

Whether managers will, in fact, act in the best interests of stockholders depends on two factors

Stakeholders

course. Employees, customers, suppliers, and even the government all have a financial interest in the firm. Taken together, these various groups are called

protect investors from corporate abuses. For example, one section of Sarbox prohibits personal loans from a company to its officers, such as the ones that were received by WorldCom CEO Bernie Ebbers.One of the key sections of Sarbox took effect on November 15, 2004. Section 404 requires, among other things, that each company's annual report must have an assessment of the company's internal control structure and financial reporting. The auditor must then evaluate and attest to management's assessment of these issues. Sarbox also creates the Public Companies Accounting Oversight Board (PCAOB) to establish new audit guidelines and ethical standards. It requires public companies' audit committees of corporate boards to include only independent, outside directors to oversee the annual audits and disclose if the committees have a financial expert the officers of the corporation must review and sign the annual reports. They must explicitly declare that the annual report does not contain any false statements or material omissions; that the financial statements fairly represent the financial results; and that they are responsible for all internal controls.

the Sarbanes-Oxley Act in 2002. The act, better known as "Sarbox," is intended to

to operate and be taxed like a partnership but retain limited liability for owners, so an LLC is essentially a hybrid of partnership and corporation. Although states have differing definitions for LLCs, the more important scorekeeper is the Internal Revenue Service (IRS). The IRS will consider an LLC a corporation, thereby subjecting it to double taxation, unless it meets certain specific criteria. In essence, an LLC cannot be too corporationlike, or it will be treated as one by the IRS.

the limited liability company (LLC). The goal of this entity is