Conceptual_Review - FIN 3403: Business Finance Dr. Banko...

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FIN3403 Exam 1 Conceptual Review Spring 2011 1 FIN 3403: Business Finance Exam 1 Dr. Banko Conceptual Review Spring 2011 Chapter 1: Forms of business organizations and advantages and disadvantages I. Alternative forms of organization (3 Main Forms followed by a few others) a. Sole Proprietorship i. Advantages: 1. Ease of formation 2. Minimal regulation 3. Lack of corporate taxation ii. Disadvantages: 1. Unlimited Liability 2. Difficulty of raising capital 3. Limited life b. Partnership: unincorporated business owned by two or more persons i. See proprietorship for advantages & disadvantages ii. An additional disadvantage is that it is difficult to transfer ownership if one or more partners decide they want out. c. Corporation: Legal entity created by a state i. Advantages 1. Unlimited Life 2. Limited Liability 3. Easily transferred ownership 4. Ease of raising capital ii. Disadvantages: 1. Double taxation 2. Relative difficulty of setting up and complying with regulations d. Other forms: i. Limited Partnership: general partners with unlimited liability and limited partners with limited liability. ii. Limited Liability Partnership, Aka LLC, or Limited Liability Company: All partners have limited liability, but the organization does not face the tax treatment of corporations Agency Relationships: a. Agency problems arise when the interests of a principal and his/her agent are not the same. In a corporation, there is an agency relationship between managers and stockholders since the management is responsible for day to day decisions. The manager may be inclined to act in his own interest despite the fact that he is the agent of the shareholders (owners) of the firm. Any time the interests of a manager and the party he is supposed to represent (i.e. stockholders) conflict, an agency problem arises.
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FIN3403 Exam 1 Conceptual Review Spring 2011 2 MANAGERS AND STOCKHOLDERS i. Agency problems 1. Managers want perks but stockholders don’t want to pay for them a. Corporate car, jet, etc… b. Big fat expense account 2. Investors like projects that are riskier than those managers would like given the diversification of investors and the lack of diversification of managers a. Investors hold stocks in a diversified portfolio but managers don’t have a diversified portfolio of jobs. ii. Solving agency issues between MANAGERS & STOCKHOLDERS 1. Managerial Compensation: pay managers with stock or performance based bonuses to encourage them to maximize stock price 2. Direct Intervention: Institutional investors, given the relatively large number of shares, and thus votes, they hold, have the power to lobby the managers of a firm or to kick them out and hire new management (Proxy Fight) 3. Takeover threat: Low stock valuation due to poor management makes a firm an attractive takeover target. In this case managers would most likely be fired or demoted and are thus encouraged to maximize stock price to avoid this occurring. STOCKHOLDERS AND BONDHOLDERS (Creditors)
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Conceptual_Review - FIN 3403: Business Finance Dr. Banko...

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