CHAPTER 1 The Role and Environment of Managerial Finance 21financial institution
An intermediary that channels
the savings of individuals,
businesses, and governments
into loans or investments.
Hint Think about how
inefficient it would be if each
individual saver had to
negotiate with each potential
user of savings. Institutions
make the process very efficient
by becoming intermediaries
between savers and users.
LG5executive compensation in the future. Contributing to this publicity is the SEC
requirement that publicly traded companies disclose to shareholders and others
both the amount of compensation to their highest paid executives and the
method used to determine it. At the same time, new compensation plans that bet-
ter link managers’ performance with regard to shareholder wealth to their com-
pensation are expected to be developed and implemented.
Unconstrained, managers may have other goals in addition to share price
maximization, but much of the evidence suggests that share price maximiza-
tion—the focus of this book—is the primary goal of most firms.Review Questions
1–11 For what three basic reasons is profit maximization inconsistent with
wealth maximization?
1–12 What is risk?Why must risk as well as return be considered by the finan-
cial manager who is evaluating a decision alternative or action?
1–13 What is the goal of the firm and therefore of all managers and employees?
Discuss how one measures achievement of this goal.
1–14 What is economic value added (EVA®)?How is it used?
1–15 Describe the role of corporate ethics policies and guidelines, and discuss
the relationship that is believed to exist between ethics and share price.
1–16 How do market forces, both shareholder activism and the threat of
takeover, act to prevent or minimize the agency problem?
1–17 Define agency costs,and explain why firms incur them. How can manage-
ment structure management compensationto minimize agency problems?
What is the current view with regard to the execution of many compensa-
tion plans?1.4 Financial Institutions and Markets
Most successful firms have ongoing needs for funds. They can obtain funds from
external sources in three ways. One is through a financial institutionthat accepts
savings and transfers them to those that need funds. Another is through financial
markets,organized forums in which the suppliers and demanders of various types
of funds can make transactions. A third is through private placement.Because of
the unstructured nature of private placements, here we focus primarily on finan-
cial institutions and financial markets.Financial Institutions
Financial institutionsserve as intermediaries by channeling the savings of individ-
uals, businesses, and governments into loans or investments. Many financial
institutions directly or indirectly pay savers interest on deposited funds; others
provide services for a fee (for example, checking accounts for which customers
pay service charges). Some financial institutions accept customers’ savings
deposits and lend this money to other customers or to firms; others invest