Corporate finance: fundamentals of value and price

This book of Corporate Finance tries to systemically integrate firms’ approach on the market, on which the fundamentals of value depend, with that of investors in the financial markets on which prices depend. The book of Corporate Finance is built on the basis of four strong beliefs. First, the main aim of the firm is to maximize the equity value over time, and then for current and future shareholders. Then this aim must always be considered in the long run where pursuing the shareholders’ value creation implies and requires satisfying of other stakeholders as well. It is in a perspective of short run that we may have distortions of the shareholder value theory able to attribute to it the blame for the incorrect behaviour of managers. Indeed, the maximization of the equity value in the long run is different and, most relevant, commonly in contrast with the maximization of the equity value in the short run. Therefore, the problem is not the shareholder-oriented capitalism but the distortion due to the short-termism of some managers. Second, finance has a fundamental role in the structured growth process of the firm. Corporate finance goes far beyond the narrow boundaries as defined in the past by influencing directly and in relevant way the most important strategic and operating choices of the firm. Today for the firm is not possible to image to make well business without to make well finance as well. Since the aim of the firm is to maximize the equity value in order to grow in a structured way, a good financial manager must always think in terms of value creation. It requires a deep knowledge of the firm’s business and the behaviour of all its actors (customers, suppliers, employees, competitors, etc.), to invest capital with profit, as well as a deep knowledge of financial markets and investors’ behaviour about risk and expected return, to raise capital to be invested in the business. Third, fundamental analysis of the firm is a relevant part of the corporate finance and it is the starting point for financial managers, financial analysts, investors, financial advisors, and bankers, to well-understand the current state of the firm’s health, where it comes from and where it is going. In this contest, the fundamental analysis of the firm is based on the Economic and Financial Dynamic Analysis (EFDA) of the firm. It is more than the simple financial analysis commonly based on the financial statements and then focused on the past performance of the firm. The EFDA is not an accounting analysis and it must be never confused with the analysis of the accuracy of numbers on the basis of the accounting principles. The EFDA is based on economic and financial aggregates (operating and net income, invested capital and capital structure, free cash-flows to the firm and to equity) able to show clearly, simple and intuitively the effective economic and financial dynamic of the firm over time by considering both the past and the future connected in a single and unique evolution path. In this dynamic perspective, the focus is on evolution over time of the economic and financial items rather than on their static analysis with regard to a specific moment. Indeed each single number must be analysed in a systemic way with regard all other numbers on the basis of their dynamic evolution over time. Indeed, the main aim of the EFDA is to support the decision-making process by evaluating the firm’s ability to create and to maximize the equity value over time through the systemic, constant, and continuous measurement of the effects of the strategic and operating decisions of CEO and managers on the economic and financial dynamic of the firm with regard to the past and the future. Specifically, the EFDA supports the decision-making process by measuring and evaluating i) ex ante, the expected effects of the strategic and operational decisions on the expected economic and financial dynamic of the firm and then on its ability to create and to maximize value, and ii) ex post, the real effects of the strategic and operational decisions made on the actual economic and financial dynamic of the firm and then on the effective value created. Since the main aim of the firm is to create value, the future time is more relevant to the past time. Therefore, the EFDA is based more on the expected future dynamic rather than the past. The past analysis is relevant to well-understand the performance effectively realized by the firm in order mainly to evaluate the accuracy and reliability of the assumptions on which the expected value of economic and financial items is made in the expected dynamic. Fourth, the firm’s ability to create and to maximize the equity value must be measured by considering jointly the fundamental analysis of the firm, based on the Economic and Financial Dynamic Analysis (EFDA), with the dynamic of financial markets. Indeed, the firm valuation is one of the most relevant fields in which the fundamentals of value based on the firm’s analysis meet the fundamental of asset pricing based on financial market analysis about risk and expected return. In this sense, the baseline equation of value creation states that the firm creates value if and only if the return on capital invested in the business exceeds the cost of capital raised in the financial market. Consequently, the maximization of the firm’s equity value is based on two variables: 1) return on invested capital, where its maximization requires a deep knowledge of real markets and the business model of the firm and 2) cost of capital, where its minimization requires a deep knowledge of the financial markets and the behaviour of investors with regard to the risk and expected return. I believe that in the field of Corporate Finance theory and practice must be considered jointly. Then the book is defined by thinking of master's degree and doctoral students as well as financial managers, financial analysts and advisors, investors and bankers. The approach used in the book is based on a rigorous quantitative analysis. All equations used, although they can be frightening at first reading, they always have a direct application and their main aim is to help the decision-making process both at strategic and operating level in order to maximize the firm’s equity value. To avoid weighing down the text no citations have been inserted except as deemed necessary (and if any of these are missing, I apologize in advance). All the texts and papers from which I drew are indicated in the bibliography at the end of the book and also in this case I hope I have not forgotten anyone.