FM-Ch.1 Van Hone

The Role of Financial
Management
Chapter 1
After studying Chapter 1, you
should be able to:
1. Explain why the role of the financial manager today is so important.
2. Describe "financial management" in terms of the three major decision
areas that confront the financial manager.
3. Identify the goal of the firm and understand why shareholders' wealth
maximization is preferred over other goals.
4. Understand the potential problems arising when management of the
corporation and ownership are separated (i.e., agency problems).
5. Demonstrate an understanding of corporate governance.
6. Discuss the issues underlying social responsibility of the firm.
7. Understand the basic responsibilities of financial managers and the
differences between a "treasurer" and a "controller."
Why should I care about
Financial Management ?
• Prepare for the workplace of tomorrow.
• Broadening expectations of financial knowledge
and skills.
• Use and understand financial terminology and
concepts in team communication.
• Developing cross-functional capabilities.
• Critical thinking.
The Role of
Financial Management
• What is Financial Management?

• The Goal of the Firm
• Corporate Governance
• Organization of the Financial
Management Function
What is Financial
Management?
Concerns the acquisition,

financing, and management of
assets with some overall goal
in mind.
Investment Decisions
Most important of the three
decisions.
• What is the optimal firm size?
• What specific assets should be
acquired?
• What assets (if any) should be
reduced or eliminated?
Financing Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).
• What is the best type of financing?
• What is the best financing mix?
• What is the best dividend policy (e.g.,
dividend-payout ratio)?
• How will the funds be physically acquired?
Asset Management Decisions
• How do we manage existing assets

efficiently?
• Financial Manager has varying degrees of
operating responsibility over assets.
• Greater emphasis on current asset
management than fixed asset management.
What is the Goal of
the Firm?
Maximization of
Shareholder Wealth!
Value creation occurs when we

maximize the share price for
current shareholders.
Corporate Social Responsibility
Discussion
Class Discussion: What role should CSR

and/or sustainability have on living the
“goal of the firm”?
Corporate Social Responsibility (CSR): A business
outlook that acknowledges a firm’s responsibilities to
its stakeholders and the natural environment.
Sustainability: Meeting the needs of the present without
compromising the ability of future generations to meet
their own needs.
What Goals do some
Firms have?
• “Creating superior shareholder value is our top priority.” Associated
Banc-Corp 2006 Annual Report.
• “The desire to increase shareholder value is what drives our actions.”
Phillips 2006 Annual Report.
• “FedEx’s main responsibility is to create shareholder value.” FedEx
Corporation, SEC Form Def 14A for the period ending 9/25/2006.
• “… the Board of Directors plays a central role in the Company’s
corporate governance system; it has the power (and the duty) to
direct Company business, pursuing and fulfilling its primary and
ultimate objective of creating shareholder value.” Pirelli & C. S.p.A.
Milan Annual Report 2006.
Shortcomings of Alternative
Perspectives
Profit Maximization
•Maximizing a firm’s earnings after taxes.
Problems
• Could increase current profits while harming firm
(e.g., defer maintenance, issue common stock to
buy T-bills, etc.).
• Ignores changes in the risk level of the firm.
Shortcomings of Alternative
Perspectives
Earnings per Share Maximization
•Maximizing earnings after taxes divided
by shares outstanding.
Problems
• Does not specify timing or duration of expected
returns.
• Ignores changes in the risk level of the firm.
• Calls for a zero payout dividend policy.
Strengths of Shareholder Wealth
Maximization
• Takes account of: current and future
profits and EPS; the timing, duration, and
risk of profits and EPS; dividend policy;
and all other relevant factors.
• Thus, share price serves as a barometer for
business performance.
The Modern Corporation
Modern Corporation
Shareholders Management
There exists a SEPARATION between

owners and managers.
Role of Management
Management acts as an agent
for the owners (shareholders)
of the firm.
• An agent is an individual
authorized by another person,
called the principal, to act in the
latter’s behalf.
Agency Theory
•Jensen and Meckling developed a

theory of the firm based on
agency theory.
• Agency Theory is a branch of
economics relating to the behavior of
principals and their agents.
Agency Theory
•Principals must provide incentives

so that management acts in the
principals’ best interests and then
monitor results.
• Incentives include, stock options,
perquisites, and bonuses.
Corporate
Social Responsibility
• Wealth maximization does not preclude the
firm from being socially responsible at the
corporate level.
• Assume we view the firm as producing both
private and social goods.
• Then shareholder wealth maximization
remains the appropriate goal in governing
the firm.
Corporate Governance
• Corporate governance: represents the
system by which corporations are managed
and controlled.
• Includes shareholders, board of directors,
and senior management.
• Then shareholder wealth maximization
remains the appropriate goal in governing
the firm.
Board of Directors
• Typical responsibilities:
• Set company-wide policy;
• Advise the CEO and other senior executives;
• Hire, fire, and set the compensation of the CEO;
• Review and approve strategy, significant investments,
and acquisitions; and
• Oversee operating plans, capital budgets, and financial
reports to common shareholders.
• CEO/Chairman roles commonly same person in US,
but separate in Britain (US moving in this direction).
Sarbanes-Oxley Act of 2002
• Sarbanes-Oxley Act of 2002 (SOX): addresses corporate
governance, auditing and accounting, executive compensation,
and enhanced and timely disclosure of corporate information.
• Imposes new penalties for violations of securities laws.
• Established the Public Company Accounting Oversight
Board (PCAOB) to adopt auditing, quality control, ethics,
disclosure standards for public companies and their
auditors, and policing authority.
• Generally increasing the standards for corporate
governance.
Organization of the Financial
Management Function
Board of Directors
President
(Chief Executive Officer)
Executive Vice Executive Vice Executive Vice

President President President
(Operations) (Finance - CFO) (Marketing)
Organization of the Financial
Management Function
EVP of Finance
Vice President (Treasurer) Controller
•Capital Investment •Cost Accounting
•Cash Management •Cost Management
•Commercial/investment banking •Data Processing
relationships •General Ledger
•Credit Management •Government Reporting
•Dividend Disbursement •Internal Control
•Financial Analysis/Planning •Preparing Financial Statements
•Investor Relations •Preparing Budgets
•Mergers and Acquisitions •Preparing Forecasts
•Pension Management
•Insurance/Risk Management
•Tax Analysis/Planning

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The Role of Financial

• What is Financial Management?

Concerns the acquisition,

• How do we manage existing assets

Value creation occurs when we

Class Discussion: What role should CSR

There exists a SEPARATION between

•Jensen and Meckling developed a

•Principals must provide incentives

Executive Vice Executive Vice Executive Vice

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