Corporate finance is an area of finance that deals with the sources of funding, and the capital structure of businesses, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value.See Corporate Finance: First Principles, Aswath Damodaran, New York University's Stern School of Business
Correspondingly, corporate finance comprises two main sub-disciplines. Capital budgeting is concerned with the setting of criteria about which value-adding projects should receive investment funding, and whether to finance that investment with equity or debt capital. Working capital management is the management of the company's monetary funds that deal with the short-term operating balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).
The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate a company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms "corporate finance" and "corporate financier" may be associated with transactions in which capital is raised in order to create, develop, grow, or acquire businesses.
Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. Financial management overlaps with the financial function of the accounting profession. However, financial accounting is the reporting of historical financial information, while financial management is concerned with the deployment of capital resources to increase a firm's value to the shareholders.
History
Corporate finance for the pre-industrial world began to emerge in the Italian city-states and the low countries of Europe from the 15th century.
The Dutch East India Company (also known by the abbreviation "VOC" in Dutch) was the first publicly listed company ever to pay regular dividends.Freedman, Roy S.: Introduction to Financial Technology. (Academic Press, 2006, )DK Publishing (Dorling Kindersley): The Business Book (Big Ideas Simply Explained). (DK Publishing, 2014, )Huston, Jeffrey L.: The Declaration of Dependence: Dividends in the Twenty-First Century. (Archway Publishing, 2015, ) The VOC was also the first recorded joint-stock company to get a fixed capital stock. Public markets for investment securities developed in the Dutch Republic during the 17th century.Ferguson, Niall (2002). Empire: The Rise and Demise of the British World Order and the Lessons for Global Power, p. 15. "Moreover, their company [the Dutch East India Company] was a permanent joint-stock company, unlike the English company, which did not become permanent until 1650."Smith, B. Mark: A History of the Global Stock Market: From Ancient Rome to Silicon Valley. (University of Chicago Press, 2003, ), p. 17. As Mark Smith (2003) notes, "the first joint-stock companies had actually been created in England in the sixteenth century. These early joint-stock firms, however, possessed only temporary charters from the government, in some cases for one voyage only. (One example was the Muscovy Company, chartered in England in 1533 for trade with Russia; another, chartered the same year, was a company with the intriguing title Guinea Adventurers.) The Dutch East India Company was the first joint-stock company to have a permanent charter."Clarke, Thomas; Branson, Douglas: The SAGE Handbook of Corporate Governance. (SAGE Publications Ltd., 2012 ), p. 431. "The EIC first issued permanent shares in 1657 (Harris, 2005: 45)."
By the early 1800s, London acted as a center of corporate finance for companies around the world, which innovated new forms of lending and investment; see . The twentieth century brought the rise of managerial capitalism and common stock finance, with share capital raised through listings, in preference to other sources of capital.
Modern corporate finance, alongside investment management, developed in the second half of the 20th century, particularly driven by innovations in theory and practice in the United States and Britain. Here, see the later sections of History of banking in the United States and of History of private equity and venture capital.
Outline
The primary goal of Corporate Finance is to maximize or to continually increase shareholder value (see Fisher separation theorem).
Here, the three main questions that financial managers addresses are: what long-term investments should we make? What methods should we employ to finance the investment? How do we manage our day-to-day financial activities? These three questions lead to the primary areas of concern in corporate finance: capital budgeting, capital structure, and working capital management. This then requires that managers find an appropriate balance between: investments in "projects" that increase the firm's long term profitability; and paying excess cash in the form of dividends to shareholders; short term considerations, such as paying back creditor-related debt, will also feature.
Choosing between investment projects will thus be based upon several inter-related criteria. (1) Corporate management seeks to maximize the value of the firm by investing in projects which yield a positive net present value when valued using an appropriate discount rate - "hurdle rate" - in consideration of risk. (2) These projects must also be financed appropriately. (3) If no growth is possible by the company and excess cash surplus is not needed to the firm, then financial theory suggests that management should return some or all of the excess cash to shareholders (i.e., distribution via dividends).
The first two criteria concern "capital budgeting", the planning of value-adding, long-term corporate financial projects relating to investments funded through and affecting the firm's capital structure, and where management must allocate the firm's limited resources between competing opportunities ("projects"). See: Campbell R. Harvey (1997). Investment Decisions and Capital Budgeting (); Don M. Chance. (ND). The Investment Decision of the Corporation Capital budgeting is thus also concerned with the setting of criteria about which projects should receive investment funding to increase the value of the firm, and whether to finance that investment with equity or debt capital.Myers, Stewart C. "Interactions of corporate financing and investment decisions—implications for capital budgeting." The Journal of finance 29.1 (1974): 1-25. Investments should be made on the basis of value-added to the future of the corporation. Projects that increase a firm's value may include a wide variety of different types of investments, including but not limited to, expansion policies, or mergers and acquisitions.
The third criterion relates to dividend policy. In general, managers of growth companies (i.e. firms that earn high rates of return on invested capital) will use most of the firm's capital resources and surplus cash on investments and projects so the company can continue to expand its business operations into the future. When companies reach maturity levels within their industry (i.e. companies that earn approximately average or lower returns on invested capital), managers of these companies will use surplus cash to payout dividends to shareholders. Thus, when no growth or expansion is likely, and excess cash surplus exists and is not needed, then management is expected to pay out some or all of those surplus earnings in the form of cash dividends or to repurchase the company's stock through a share buyback program.
Capital structure
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately.The Financing Decision of the Corporation , Prof. Don M. Chance; Capital Structure, Prof. Aswath Damodaran The sources of financing are, generically, capital self-generated by the firm and capital from external funders, obtained by issuing new debt and equity (and hybrid- or convertible securities). However, as above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix will impact the valuation of the firm, and a considered decision The design of the capital structure, Ch 35. in Vernimmen et al. is required here. See Balance sheet, WACC. Finally, there is much theoretical discussion as to other considerations that management might weigh.
Sources of capital
Corporations, as outlined, may rely on borrowed funds (debt capital or credit) as sources of investment to sustain ongoing business operations or to fund future growth. Debt comes in several forms, such as through bank loans, notes payable, or bonds issued to the public. Bonds require the corporation to make regular interest payments (interest expenses) on the borrowed capital until the debt reaches its maturity date, therein the firm must pay back the obligation in full. (An exception is zero-coupon bonds - or "zeros"). Debt payments can also be made in the form of a sinking fund provision, whereby the corporation pays annual installments of the borrowed debt above regular interest charges. Corporations that issue callable bonds are entitled to pay back the obligation in full whenever the company feels it is in their best interest to pay off the debt payments. If interest expenses cannot be made by the corporation through cash payments, the firm may also use collateral assets as a form of repaying their debt obligations (or through the process of liquidation). Especially re debt funded corporations, see Bankruptcy and Financial distress. Under some treatments (especially for valuation) leases are regarded as debt: the payments are set; they are tax deductible; failing to make them results in the loss of the asset.Aswath Damodaran (2009). Leases, Debt and Value
Corporations can alternatively sell shares of the company to investors to raise capital. Investors, or shareholders, expect that there will be an upward trend in the value of the company (shares appreciate in value) over time, making their investment a profitable purchase. As outlined: Shareholder value is increased when corporations invest equity capital and other funds into projects (or investments) that earn a positive rate of return for the owners. Investors then prefer to buy shares of stock in companies that will consistently earn a positive rate of return on capital (on equity) in the future, thus increasing the market value of the stock of that corporation. Shareholder value may also be increased when corporations pay out excess cash surplus (funds that are not needed for business) in the form of dividends. Internal financing is often constituted of retained earnings, i.e., those remaining after dividends; this provides, per some measures, the cheapest form of funding.
Preferred stock. is a specialized form of financing which combines properties of common stock and debt instruments, and may then be considered a hybrid security. Preferreds are senior (i.e. higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company).Drinkard, T., A Primer On Preferred Stocks., Investopedia Preferred stock is usually Nonvoting, i.e. carries no voting rights,"Preferred Stock ... generally carries no voting rights unless scheduled dividends have been omitted." – Quantum Online but may carry a dividend and may have priority over common stock in the payment of dividends and upon liquidation.