from the PREFACE

This text offers fundamental tenets that will help you develop financial intuition to use throughout your career. Our principles of finance provide an integrated view of the most important financial concepts, which you can apply to all your financial decisions. This intuition is critical because the field of finance continues to evolve at a dizzying pace. Changes in the economic environment and in the practice of finance occur daily. Consider stock price movements over the last several years, Ponzi schemes run by Bernard Madoff, Allen Stanford, and Scott Rothstein, as well as corporate scandals at Enron, ImClone, Tyco, and WorldCom. A sound understanding of basic concepts is the best way to prepare for such a rapidly changing field.

After developing your financial intuition, Corporate Financial Management shows you how to apply it to the financial world. For example, the first principle, the Principle of Self-Interested Behavior, is the most basic. Without this principle, we cannot explain financial behavior. Regrettably, some people misapply this principle. In your career, you are likely to face illegal “opportunities” to make literally millions of dollars by, for example, insider trading. Our Principle of Self-Interested Behavior explicitly excludes such behavior: individuals should obey the rules and regulations to ensure legal—and ethically sound—behavior. There is nothing wrong with pursuing self-interested behavior—provided you play by the rules. Recent scandals demonstrate the importance of corporate governance, and highlight the relevance of our chapter on agency theory, which is based on the Principle of Self-Interested Behavior.

covered in prerequisite courses. Also, although an understanding of mathematics is necessary, we facilitate the learning process by providing simple examples and analogies. By providing both verbal/logical and mathematical descriptions, we hope to enlist each student’s “learning strength,” as well as have the descriptions reinforce one another. Finally, this book has been written with the intent that it will become a useful future reference tool for students as they move through their business careers. The explanations, information, applications, minicases, and problem sets provide a valuable reference source for material not covered in class; and the chapter summaries highlight the important dimensions and concepts connected with each topic.

The applications in this text come from the real business world—many pulled from today’s headlines—and are designed to illustrate how financial principles are useful and immediately applicable. We tell you about executive stock options at McDonalds, financing decisions by firms such as PepsiCo, American Airlines, and CBS, and investment decisions made by firms such as Boeing and Disney.

Whether it is a manager evaluating a capital budgeting project, a chief executive officer studying a merger, a corporate treasurer deciding what type of security to issue, an investment banker determining the structure of a new security, a bond trader deciding which bonds to buy, or a stock portfolio manager deciding which stocks to sell, it is their grasp of financial concepts and their ability to apply them in any situation that distinguishes the successful people.

INTENDED AUDIENCE

Corporate Financial Management was written for use in corporate finance and financial management courses in MBA and undergraduate programs. There is an abundance of material, so the book can be used in introductory as well as advanced classes, and become a reference source for future classes and throughout your career. Corporate Financial Management is distinguished in several specific ways, including its careful integration of recent developments in financial analysis and practice (including agency theory, asymmetric information, and contingent claims analysis) into a corporate finance text; its bridging the gap between theory and practice through its coauthorship team; and its student-friendly presentations of new, and also established, topics.

We assume a familiarity with the standard prerequisites in business/management programs: college-level algebra, financial accounting, microeconomics, and statistics. Although we assume xvi students have this background, we provide reminders of basic definitions and concepts that were covered in prerequisite courses. Also, although an understanding of mathematics is necessary, we
facilitate the learning process by providing simple examples and analogies. By providing both verbal/logical and mathematical descriptions, we hope to enlist each student’s “learning strength,” as well as have the descriptions reinforce one another.

Finally, this book has been written with the intent that it will become a useful future reference tool for students as they move through their business careers. The explanations, information, applications, minicases, and problem sets provide a valuable reference source for material not covered in class; and the chapter summaries highlight the important dimensions and concepts connected with each topic.

IMPORTANT IMPROVEMENTS AND DISTINCTIVE FEATURES IN THE FOURTH EDITION
The fourth edition reflects feedback from users, changes within the financial world, and the issues students encounter today:

• BRIDGING THE GAP BETWEEN THEORY AND PRACTICE. This book is unique in that our author team includes real-world practitioner perspective. John Finnerty has spent the last 30 years working as a practitioner in the world of finance. Among other positions, he has been a partner with PricewaterhouseCoopers, worked in investment banking for Morgan Stanley, and served as CFO of The College Saving Bank. John’s first-hand experience brings the real world of business into this book—and into your classroom. In addition, John Stowe provides a professional institution perspective, having been Head of Curriculum Development for the CFA Institute.

• THE IMPORTANCE OF RESEARCH. The things we teach you in this book are based on an extensive body of research done by many professors over many years. The end-of-chapter bibliographies cite important contributions to our understanding of finance. Of course, like every field, there is always more to learn, so we indicate in the text what is known, what is believed, and what is still being debated.

• PROBLEM SETS. Problems are organized into three different levels of difficulty, from basic to advanced, to help faculty and students determine more efficiently appropriate material to review. Level A problems are basic. They review the chapter material and can be answered by direct reference to the text material. Level B problems also relate fairly closely to the material in the chapter but are somewhat more complex. Level C problems are advanced extensions of material presented in the chapter. The level C problems are designed to challenge the students with complex situations, puzzles, or the examination of more subtle implications of the material in the chapter. Occasionally, problems are drawn from material in earlier chapters to reinforce the retention of important concepts. Solutions to selected problems can be found online at www.wohlpublishing.com/emery.

• QUESTIONS. These are in addition to the problem sets. The questions are intended to be answered without calculations. As with the problems, to help faculty and students, the questions are divided by level of difficulty into two groups. The first group of questions should be answerable by direct reference to the chapter. Questions in the second group require more thought because they are more complex, more subtle, or, occasionally, sneaky.

• AGENCY THEORY. Our treatment of agency theory goes well beyond that of other books. We are the only text that has a separate chapter on agency theory and principal-agent problems, to our knowledge. In addition, we weave the concepts into the very fabric of our text, and explicitly show how the important insights from this material can be used to solve many practical problems throughout the rest of the book.

• CORPORATE GOVERNANCE. Corporate governance issues are examined in the context of agency theory. For example, we describe some of the manager-stockholder conflicts that contributed to the downfalls of firms like Enron and the venerable 233-year-old Barings Bank.

• CAPITAL MARKET EFFICIENCY. Stock market movement, especially in the last two decades, has caused people to question the efficiency of the capital markets. The text has been updated throughout to reflect these issues. Despite many questions, the principle of market efficiency is an important concept. The principle gives us the best starting point for analysis, as shown by Modigliani and Miller. Further, it reminds us to look for information that can be contained in market prices. It also reminds us that, to the extent markets are efficient, we can be price takers and focus on our comparative advantage. Deviations from market efficiency, which happen occasionally in financial markets and frequently in nonfinancial markets, provide opportunities for corporate and personal gain.

• CALCULATORS AND EXCEL. We facilitate the use of both calculators and spreadsheets. Calculator boxes illustrating computations appear throughout the text. Problems especially suited for being solved by Excel are identified and grouped at the ends of Level B and Level C end-of-chapter problem sets. • CURRENCY. The examples, tables, and figures have been updated, and reflect current laws, regulations, and data.

• REAL OPTIONS. Real options are a critical source of value, particularly in capital budgeting. We use the term option in its broadest sense: any right without an obligation attached to it. This definition allows us to apply the important insights of option theory to a wide variety of topics and provides a natural entrée into real options. For example, in addition to capital budgeting, we use option concepts in agency theory and capital structure, among many others. We believe options analysis is one of the most valuable technologies available in finance.

• MINICASES. A Minicase has been included at the end of almost every chapter as a direct application of the material in that chapter.

• BULLETED SUMMARIES. The chapter summaries are given in bulleted, rather than narrative, format to facilitate student review.

• FOCUS ON PRINCIPLES. These boxes set the stage in the beginning of each chapter by highlighting how particular finance principles apply to the chapter material. They highlight such things as looking for capital budgeting projects that offer a valuable new idea or use a firm’s comparative advantage, and seeing the value of real options in a capital budgeting project. The Focus on Principles boxes also help students develop and apply financial intuition.

• KEY TERMS. Important words and phrases are bolded the first time they appear and included in the glossary.

• PRINCIPLES OF FINANCE. In Chapter 2, we describe the 12 principles of finance that provide the foundation for learning finance.

• EXAMPLES. Numerous examples are included in each chapter. They illustrate the concepts as well as the computational details needed to apply the concepts. Good numerical examples are a critical learning device.

• NUMBERED EQUATIONS. Important equations are numbered when they appear in the text.

• EQUATION SUMMARIES. Following each chapter is an equation summary that reprints all of the numbered equations in the chapter. Students can use these to study, and many professors expressed the importance of these summaries for their classroom instruction. The equation summaries are also provided electronically on the website.

• INTERNATIONALIZATION. It is imperative that today’s companies incorporate into their decision making the specific constraints and additional market imperfections introduced by operating in an international economy. The principles of finance do not stop at the border— the concepts and principles developed in this book readily apply to international transactions.

With this in mind, we treat the international aspects of finance throughout the book as both a point of view and a particular market environment in which the firm operates.

THIS BOOK’S OVERRIDING GOAL
We wrote Corporate Financial Management with an overriding goal of modernizing the teaching of finance. In particular, we believe the revolution in financial research involving asymmetric information, options, and agency theory should be brought into the classroom. Since the first edition was written, the Nobel prize in economics has offered substantial validation for our view:
eight of the latest fourteen prizes have involved this revolution in financial research. This book can enrich the teaching of finance by weaving these important research advances into the very fabric of the traditional financial management course.

Certainly these research advances are very important—but they are also fascinating. They are immediately applicable and relevant to the real world, as we have witnessed with scandals at Enron, ImClone, Tyco, and WorldCom. Our book offers the excitement of this profoundly important material directly to the student. These concepts, integrated throughout, can and should be understood within the context of finance.

The other business/management disciplines have enthusiastically embraced the idea of a corporation as a set of stakeholders. Beyond accounting, areas such as organizational behavior, strategic management, business law, marketing, and production continue to integrate the implications of agency theory, options, and asymmetric information into their views of the organizational world. This makes the principal-agent framework a natural way for integrating the business/ management areas. Therefore, this book offers the chance for the core finance class to play a central role in the curriculum.

 


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