Introduction to Corporate Finance

1: The Scope of Corporate Finance

profit on loan originations while passing on the risk of subprime mortgages to other investors? Did a lack

of due diligence by rating agencies cause them to fail to warn investors of the risks of exotic mortgage-

backed securities and credit default swaps? Should financial institutions like American International

Group (AIG) pay bonuses to managers even after receiving billions in governmental bailout dollars?

The last time ethical concerns received as much attention in the media was after the Enron collapse

in late 2001. In response to a series of (mostly US) corporate scandals, the Australian Securities Exchange

(ASX) adopted rules for companies listed on its exchange that asked companies to provide extensive

documentation about the internal controls they had to protect investors from fraud. If a company decided

not to comply with some of the rules – such as ensuring that the external organisation auditing the company

books was not also a consultant to the company – then the company had to explain why it was not following

the rules, and the ASX had to be satisfied with the explanation. It is interesting to note that one response to

the global financial crisis of 2007–11 and its subsequent securities markets effects has been the enactment

of new laws in many countries placing limits on the risks that financial institutions can take.

More and more companies are now directly addressing the issue of ethics by establishing corporate

ethics policies and guidelines and by requiring employee compliance with them. Frequently, employees

are required to sign a formal pledge to uphold the company’s ethics policies. Such policies typically apply

to employee actions in dealing with all corporate stakeholders, including the public at large. Ethical

behaviour is therefore viewed as both necessary and perfectly consistent with achieving the company’s goal of

maximising shareholder wealth.

CONCEPT REVIEW QUESTIONS 1-4

8 What are agency costs? Why do these tend to increase in severity as a company grows larger?

9 What are the relative advantages and disadvantages of using sophisticated management

compensation packages to align the interests of managers and shareholders?

10 Why are ethics important in corporate finance? What is the likely consequence of unethical

behaviour by financial managers?

Vern LoForti, VP, CFO,

and Corporate Secretary,

InfoSonics

‘Sarbanes—Oxley has

certainly impacted our

company in many ways

from operations all the

way to the board.’

See the entire interview on

the CourseMate website.

COURSEMATE

SMART VIdEO

Source: Cengage Learning

SUMMARY

■ When making financial decisions, managers

should seek to create value for the company’s

owners, its shareholders. The most important

way to do this is to take actions that generate

benefits in excess of costs, which should

generate wealth for the company’s owners.

■ Finance graduates must interact with

professionals trained in all other business

disciplines. The five most important career

paths for finance professionals are in corporate

finance, commercial banking, investment

banking, money management and consulting.

■ Corporate finance activities can be grouped

into five basic functions: the financing function,

the financial management function, the capital

budgeting function, the risk management

function and the corporate governance

function.

LO1.1

LO1.2