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SNIPPETS OF HISTORY

Now let`s lighten up a little. In this material we are going to describe how financial decisions are made today. But financial markets also have an interesting history. Look at the accompanying box, which lays out bits of this history, starting in prehistoric times, when the growth of bacteria anticipated the mathematics of compound interest, and continuing nearly to the present.

Summary

What are the advantages and disadvantages of the most common forms of business organization? Which forms are most suitable to different types of businesses?

Businesses may be organized as proprietorships, partnerships, or corporations. A corporation is legally distinct from its owners. Therefore, the shareholders who own a corporation enjoy limited liability for its obligations. Ownership and management of corporations are usually separate, which means that the firm`s operations need not be disrupted by changes in ownership. On the other hand, corporations are subject to double taxation. Larger companies, for which the separation of ownership and management is more important, tend to be organized as corporations.

What are the major business functions and decisions for which the firm`s financial managers are responsible?

The overall task of financial management can be broken down into (1) the investment, or capital budgeting, decision and (2) the financing decision. In other words, the firm has to decide (1) how much to invest and what assets to invest in and (2) how to raise the necessary cash. The objective is to increase the value of the shareholders` stake in the firm. The financial manager acts as the intermediary between the firm and financial markets, where companies raise funds by issuing securities directly to investors, and where investors can trade already-issued securities among themselves. The financial manager also may raise funds by borrowing from financial intermediaries like banks or insurance companies. The financial intermediaries in turn raise funds, often in small amounts, from individual households.

In small companies there is often only one financial executive. However, the larger corporation usually has both a treasurer and a controller. The treasurer`s job is to obtain and manage the company`s financing. By contrast, the controller`s job is one of inspecting to see that the money is used correctly. Large firms may also appoint a chief financial officer, or CFO.

Why does it make sense for corporations to maximize their market values?

Value maximization is usually taken to be the goal of the firm. Such a strategy maximizes shareholders` wealth, thereby enabling shareholders to pursue their personal goals. However, value maximization does not imply a disregard for ethical decision making, in part because the firm`s reputation as an employer and business partner depends on its past actions.

Why may conflicts of interest arise in large organizations? How can corporations provide incentives for everyone to work toward a common end?

Agency problems imply that managers may have interests that differ from those of the firm. These problems are kept in check by compensation plans that link the well-being of employees to that of the firm, by monitoring of management by the board of directors, security holders, and creditors, and by the threat of takeover.