Firms, the Stock Market, and Corporate Governance
Firms, the Stock Market, and Corporate Governance ARE 1150
Popular in Principles of Agriculture & Resource Economics
Popular in Agricultural & Resource Econ
This 4 page Class Notes was uploaded by Caitrín Hall on Thursday April 28, 2016. The Class Notes belongs to ARE 1150 at University of Connecticut taught by Emma Bojinova in Spring 2016. Since its upload, it has received 34 views. For similar materials see Principles of Agriculture & Resource Economics in Agricultural & Resource Econ at University of Connecticut.
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Date Created: 04/28/16
Chapter 8 Firms, The Stock Market, and Corporate Governments 8.1 Types of Firms Sole proprietorship – a firm owned by a single individual; not organized as a corp. Partnership – a firm owned jointly by 2 or more persons; not organized as a corp. Corporation – a legal form of business that provides owners with protection from losing more than their investment should the business fail Unlimited liability means there is no legal distinction between the personal assets of the owners of the firm and the assets of the firm Asset – anything of value owned by a person or a firm General incorporation laws – allow firms to be organized as corporations Limited liability – the legal provision that shields owners from a corporation from losing more than they have invested in the firm Corporations Earn the Majority of Revenue and Profits Profit is the difference between revenue and the total cost to a firm of producing the goods and services it offers for sale How Important Are Small Businesses to the US Economy? Vital Provide entrepreneurs with a vehicle for bringing a new product to the market 8.2 The Structure of Corporations and the Principle-Agent Problem Corporate governance – the way in which a corporation is structured and the effect that structure has on the corporation’s behavior Corporate Structure and Corporate Governance o Shareholders are the owners of a corporation’s stock and own the firm but do not manage the firm directly; instead they elect a board of electors to represent their interests o The board of directors appoints a chief executive officer who runs day-to-day operations; sometimes also appoints other members of top management, such as the chief financial officer o At other times, the CEO appoint other member of top management o Members of top management on the board of directors are inside directors o Members of the board of directors who do not have a direct management role in the firm are outside directors; intended to act as checks on the decisions of top managers Separation of ownership from control – a situation in a corporation in which the top management, rather than the shareholders, control day-to-day operations Principal-agent problem – a problem caused by an agent pursuing his own interests rather than the interests of the principal who hired him` 8.3 How Firms Raise Funds As the owner of a small business, you can raise the funds for an expansion in 3 ways: 1. Reinvest profits back into your firm; “retained earnings” are profits that are reinvested in firm rather than taken out and paid to the firm’s owners 2. Recruit additional owners to invest in the firm to increase financial capital 3. Borrow funds from relatives, friends, or a bank Sources of External Funds It is the role of an economy’s financial system to transfer funds from savers to borrowers either directly or indirectly Indirect finance – a flow of funds from savers to borrowers through financial intermediaries such as banks. Intermediaries raise funds from saves to lend to firms. o Savers ex: individual funds o Intermediary ex: banks o Borrowers ex: firms Direct finance – a flow of funds from savers to firms through financial markets o Usually takes the form of borrowers selling lenders financial securities such as stocks and bonds o Bond – a financial security that represents a promise to repay a fixed amount of funds o The principal, or face value, of a bond is the final payments of the loan amount at maturity, or the end of its term o Coupon payment – an interest payment on a bond o Interest rate – the cost of borrowing funds, usually expressed as a percentage of the amount borrowed o The coupon rate is the interest rate on the bond $60/$1000 = 0.06, 6% coupon rate o The higher the default risk on a bond, the higher the interest rate o Stock – a financial security that represents partial ownership of a firm o Dividends – payments by a corporation to its shareholders o Investors receive a capital gain when a firm’s share price rises Stock and Bond Markets Provide Capital—and Information Stock and bond markets can take place in buildings known as exchanges or linked by computers comprising the over-the-counter market, most of which is the NASDAQ Changes in the value of a firm’s stock and bonds offer important information for a firm’s managers and for investors Why Do Stock Prices Fluctuate So Much? The value of a stock market index is set equal to 100 in a particular year (base year) The performance of the U.S. stock market is often measured by market indexes, which hare averages of stock prices 8.4 Using Financial Statements to Evaluate a Corporation Liability – anything owned by a person or a firm Income statement – a financial statement that sums up a firm’s revenues, costs, and profit over a period of time Getting to Accounting Profit Accounting profit – a firm’s net income, measured as revenue minus operating expense and taxes paid Explicit cost – a cost that involves spending money Implicit cost – a nonmonetary opportunity cost Economists use the term nominal rate of return to refer to the minimum amount that investors must earn on the funds they invest in a firm, expressed as a percentage of the amount investor Economic profit – a firm’s revenues minus all of its implicit and explicit costs Subtracting the value of a firm’s liabilities from the value of its assets = net worth Balance sheet – a financial statement that sums up a firm’s financial position on a particular day, usually the end of a quarter or year o Value of left side must always equal value of right side o Stockholders’ equity = net worth of firm
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