ross4eChap01sm - Chapter 1 Introduction to Corporate...

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Chapter 1: Introduction to Corporate Finance 1.1 From the set-of-contracts viewpoint, the goal of the corporate firm is to maximize the shareholders’ wealth in the firm. However, at times, corporations appear to pursue managerial goals at the expense of shareholders--such as maximization of personal wealth ( high salaries, company perks), corporate wealth, growth and company size. Not- for-profit organizations frequently pursue social or political missions, so many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are offered at the lowest possible cost to society. Other goals are to be efficient and effective in providing the services. A better approach might be to observe that even a not-for-profit business has a need for surplus to finance growth. Thus, one answer is that the appropriate goal is to maximize the value of the surplus. 1.2 An argument can be made either way. At the one extreme, we could argue that in a market economy, all of these things are priced. There is thus an optimal level of, for example, unethical and /or illegal behaviour, and the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these are non-economic phenomena and are best handled through the political process. Recent studies appear to indicate that value may be reduced because the corporation fails to invest in profitable investments that do no meet the new social responsible criteria. A classic (and highly relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do?’’ 1.3 In the corporate form of ownership, the shareholders are the owners of the firm. The
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