The basic goal: to create stockholder value

1
CHAPTER 1An Overview of Financial Management

• The basic goal to create stock-holder value
• Agency relationships
• 1. Stockholders versus managers
• 2. Stockholders versus creditors

2
What is an agency relationship?

• An agency relationship arises whenever one or
  more individuals, called principals, (1) hires
  another individual or organization, called an
  agent, to perform some service and (2) then
  delegates decision-making authority to that agent.

3
If you are the only employee, and only your money
is invested in the business, would any
agencyproblems exist?

• No agency problem would exist. A potential
  agency problem arises whenever the manager of a
  firm owns less than 100 percent of the firms
  common stock, or the firm borrows. You own 100
  percent of the firm.

4
If you expanded and hired additional people to
help you, might that give rise to agency problems?

• An agency relationship could exist between you
  and your employees if you, the principal, hired
  the employees to perform some service and
  delegated some decision-making authority to them.

5
If you needed additional capital to buy computer
inventory or to develop software, might that lead
to agency problems?

• Acquiring outside capital could lead to agency
  problems.

6
Would it matter if the new capital came in the
form of an unsecured bank loan, a bank loan
secured by your inventory of computers, or from
new stockholders?

• Agency problems are less for secured than for
  unsecured debt, and different between
  stockholders and creditors.

7
There are 2 potential agency conflicts

• Conflicts between stockholders and managers.
• Conflicts between stockholders and creditors.

8
Would potential agency problems increase or
decrease if you expanded operations to other
campuses?
Increase. You could not physically be at all
locations at the same time. Consequently, you
would have to delegate decision-making authority
to others.
9
If you were a bank lending officer looking at the
situation, what actions might make a loan
feasible?

• Creditors can protect themselves by (1) having
  the loan secured and (2) placing restrictive
  covenants in debt agreements. They can also
  charge a higher than normal interest rate to
  compensate for risk.

10
As the founder-owner-president of the company,
what actions might mitigate your agency problems
if you expanded beyond your home campus?

• 1. Structuring compensation packages to attract
  and retain able managers whose interests are
  aligned with yours.

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• 2. Threat of firing.
• 3. Increase monitoring costs by making frequent
  visits to off campus locations.

12
Would going public in an IPO increase or decrease
agency problems?
By going public through an IPO, your firm would
bring in new shareholders. This would increase
agency problems, especially if you sell most of
your stock and buy a yacht. You could minimize
potential agency problems by staying on as CEO
and running the company.
13
Why might you want to (1) inflate your reported
earnings or (2) use off balance sheet financing
to make your financial position look stronger?

• A manager might inflate a firm's reported
  earnings or make its debt appear to be lower if
  he or she wanted the firm to look good
  temporarily. For example just prior to
  exercising stock options or raising more debt.

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What are the potential consequences of inflating
earnings or hiding debt?

• If the firm is publicly traded, the stock price
  will probably drop once it is revealed that fraud
  has taken place. If private, banks may be
  unwilling to lend to it, and investors may be
  unwilling to invest more money.

15
What kind of compensation program might you use
to minimize agency problems?

• Reasonable annual salary to meet living
  expenses
• Cash (or stock) bonus
• Options to buy stock or actual shares of stock to
  reward long-term performance
• Tie bonus/options to EVA

16
Is it easy for someone with technical skills and
no understanding of financial management to move
higher and higher in management?

• No. Investors are forcing managers to focus on
  value maximization. Successful firms (those who
  maximize shareholder value) will not continue to
  promote individuals who lack an understanding of
  financial management.

17
Why might someone interviewing for an entry level
job have a better shot at getting a good job if
he or she had a good grasp of financial
management?

• Managers want to hire people who can make
  decisions with the broader goal of corporate
  value maximization in mind because investors are
  forcing top managers to focus on value
  maximization.

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• Students who understand this focus have a major
  advantage in the job market. This applies both
  to the initial job, and the career path that
  follows.