Corporate governance, capital structure, and business model analysis concepts tested on CFA Level 1 corporate issuers.
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- What is the agency problem in corporate finance?
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A conflict of interest between managers (agents) and shareholders (principals) arising from the separation of management and ownership.- Name the primary responsibilities of a board of directors.
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Hiring/firing senior management, approving strategy, ensuring financial reporting integrity, and protecting shareholder interests.- What is a shareholder's basic legal right in a corporation?
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The right to vote on matters such as board elections, executive compensation, and major corporate actions, plus the right to receive dividends.- Distinguish between the shareholder model and stakeholder model of governance.
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Shareholder model prioritizes maximizing shareholder value; stakeholder model considers all parties (employees, customers, suppliers, community).- What is the primary function of an audit committee?
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To oversee the integrity of financial reporting, audit processes, and internal controls; serves as liaison between board and auditors.- What does a compensation committee do?
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Reviews and approves executive compensation packages to ensure they align management incentives with shareholder interests.- Define the capital structure of a firm.
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The mix of debt and equity financing used by a company to fund its assets and operations.- What is the difference between book value of debt and market value of debt?
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Book value is the debt amount on the balance sheet; market value reflects the current market price of the debt securities in the marketplace.- Define the cost of equity.
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The required rate of return that investors demand on equity investments, reflecting the risk of the firm's cash flows.- What is the cost of debt?
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The rate of interest (coupon) a company must pay on its debt obligations; typically measured as the yield to maturity on the firm's bonds.- What does WACC stand for and what does it measure?
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Weighted Average Cost of Capital; the average rate of return a firm must pay to finance its assets, weighted by the proportion of debt and equity.- State Modigliani-Miller Proposition I with taxes.
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The value of a levered firm exceeds the value of an unlevered firm by the present value of the tax shield from debt (interest is tax-deductible).- What is the pecking order theory of capital structure?
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Firms prefer internal equity (retained earnings) first, then debt, then external equity, because asymmetric information makes external financing more costly.- Define financial leverage.
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The use of debt financing to amplify the return on equity; measures the proportion of debt in a firm's capital structure.- Define operating leverage.
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The extent to which a firm uses fixed costs in its operations; higher fixed costs mean greater percentage change in operating income from a given change in sales.
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