Solution Manual For Corporate Finance 7th Canadian Edition By Ross – Westerfield
ISBN-10: 0071339574, ISBN-13: 978-0071339575
Chapter 1: Introduction to Corporate Finance
- An argument can be made either way. At the one extreme, we could argue that in a market economy, all of these things are priced. There is thus an optimal level of, for example, unethical and /or illegal behaviour, and the framework of stock valuation explicitly includes these. At the other extreme, we could argue that these are non–economic phenomena and are best handled through the political process.
Most studies find that socially responsible investment practices do not impact portfolio returns and risk consistently. Major Canadian institutional investors pay careful attention to corporate social responsibility in selecting investments but place financial considerations first.
A classic (and highly relevant) thought question that illustrates this debate goes something like this: “A firm has estimated that the cost of improving the safety of one of its products is $30 million. However, the firm believes that improving the safety of the product will only save $20 million in product liability claims. What should the firm do?’’
1.2 In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone else’s best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm.
1.3 We would expect agency problems to be less severe in other countries, primarily due to the relatively small percentage of individual ownership. Fewer individual owners should reduce the number of diverse opinions concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree of agreement between owners and managers on decisions concerning risky projects. In addition, institutions may be better able to implement effective monitoring mechanisms on managers than can individual owners, based on the institutions’ deeper resources and experiences with their own management. The increase in institutional ownership of stock in the United States and the growing activism of these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more efficient market for corporate control.
1.4 Canadian financial institutions include chartered banks and other depository institutions––trust companies and credit unions as well as nondepository institutions––investment dealers, insurance companies, pension funds and mutual funds.
Financial markets can be classified as either money markets or capital markets. Short–term debt securities are bought and sold in money markets. Capital markets are the markets for long–term debt and shares of stock, for example the TSE.
1.5 Canadian Financial Markets, like all markets, are experiencing rapid globalization. The toolkit of available financial management techniques has expanded in response to a need to control volatility risk and to track complex dealing in many countries. Computer technology improvements make new financial engineering applications practical and create opportunities to combine different types of financial institutions. Financial institutions pressure authorities to deregulate in a process called the regulatory dialectic.
These trends have made financial management in Canada much more complex and technical. In the face of increased global competition, the payoff for good financial management is great with finance becoming important in corporate strategic planning.