Unit 1:

Corporate Finance and

Corporate Governance (3)

Asst. Prof. Tek Bahadur Madai

Kailali Multiple Campus
 Outline of the Chapter

• 1.1. Forms of business organizations

• 1.2. Investment and financing decisions
• 1.3. Financial markets and institutions
• 1.3.1. Financial institutions
• 1.3.2. Financial market
• 1.4. Corporate Governance
• 1.4.1. Defining corporate governance
• 1.4.2. Importance of Corporate Governance
• 1.4.3. Roles and responsibilities of CEO, Directors, and Chairman;
• 1.4.4. Corporate Governance Practice in Nepal
 Forms of business organizations

• How the company should be structured will be one of your first considerations as a
business owner.
• The arrangement of ownership you choose will have long-term effects.
• Every firm must establish a legal structure that outlines the members' obligations
and rights with regard to the ownership, control, personal liability, lifespan, and
financial structure of the organization.
In making a choice, you will want to take into account the following:
• Your vision regarding the size and nature of your business.
• The level of control you wish to have.
• The level of “structure” you are willing to deal with.
• Risk of legal action for the company.
• Tax implications of the different organizational structures.
• Expected profit (or loss) of the business.
• Whether or not you need to re-invest earnings into the business.
 Forms of business organizations

I. Sole Proprietorship
II. Partnerships
III. Limited Liability Companies or Corporations
Sole Proprietorship
• As sole proprietorships, small enterprises predominantly begin. These
businesses are owned by a single person, typically the person in charge
of managing the company's daily operations.
• All of a business's assets and any earnings are owned by a sole
proprietorship. Additionally, they take full responsibility for all of their
obligations and debts.
• You are one with the company in the eyes of the law and the general
public.
 Benefits of Being a Sole Proprietor

 The most straightforward and affordable type of ownership to organize.

 Sole owners have total authority and are free to act whatever they like within the
bounds of the law.
 The owner's personal tax return receives the business's profits immediately.
 If desired, it is simple to shut down the business.
Problems with a Sole Proprietorship
 All debts owed to the business are legally the sole proprietor's responsibility and
are subject to infinite liability.
 Both their personal and commercial assets are in risk.
 May be at a disadvantage in raising funds and are often limited to using funds
from personal savings or consumer loans.
 High-caliber workers or those who are motivated by the chance to hold a stake
in the company may be difficult to recruit.
 Partnerships

• A partnership is when two or more persons each hold a portion of a single company.
• The law does not discriminate between a corporation and its owners, similar to proprietorships.
• A written partnership agreement should be in place between the partners, outlining how decisions will be made,
earnings will be split, conflicts will be settled, new participants will be accepted to the partnership, how partners can be
bought out, and how the partnership will be dissolved if necessary.
Advantages of a Partnership
• Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.
• With more than one owner, the ability to raise funds may be increased.
• The profits from the business flow directly through to the partners’ personal tax return.
• Prospective employees may be attracted to the business if given the incentive to become a partner.
• The business usually will benefit from partners who have complementary skills.
Disadvantages of a Partnership
• Partners are jointly and individually liable for the actions of the other partners.
• Profits must be shared with others.
• Since decisions are shared, disagreements can occur.
• Some employee benefits are not deductible from business income on tax returns.
• The partnership may have a limited life; it may end upon the withdrawal or death of a partner.
 Types of Partnerships
1. General partnership
• Partners distribute profit or loss shares and management and accountability responsibilities in
accordance with their internal agreement.
• Unless otherwise specified in a formal agreement, equal shares are presumed.
2. Limited partnership and partnership with limited liability
• The term "limited" refers to the majority of the partners' limited responsibility (to the degree of
their investment) and limited influence over management choices, which typically attracts investors
for short-term projects or for purchasing capital assets.
• The operation of retail or service enterprises does not frequently employ this type of ownership.
• A limited partnership must be formed in a more formal and complicated manner than a general
partnership.
3. Joint venture
• Acts like a general partnership, but is clearly for a limited period of time or a single project.
• If the partners in a joint venture repeat the activity, they will be recognized as an ongoing
partnership and will have to file as such, and distribute accumulated partnership assets upon
dissolution of the entity.
 Corporations
• A corporation is a type of legal body established by shareholders, investors, or other private parties
with the intention of making a profit.
• Corporations are permitted to sign contracts, bring and defend legal actions involving their own
property, pay federal and state taxes, and take out loans from financial institutions.
Advantages of a Corporation
• Shareholders have limited liability for the corporation’s debts or judgments against the corporation.
• Generally, shareholders can only be held accountable for their investment in stock of the company.
(Note however, that officers can be held personally liable for their actions, such as the failure to
withhold and pay employment taxes.
• Corporations can raise additional funds through the sale of stock.
• A Corporation may deduct the cost of benefits it provides to officers and employees.
Disadvantages of a Corporation
• The process of incorporation requires more time and money than other forms of organization.
• Corporations are monitored by federal, state and some local agencies, and as a result may have more
paperwork to comply with regulations.
• Incorporating may result in higher overall taxes. Dividends paid to shareholders are not deductible
from business income; thus this income can be taxed twice.
 Investment and financing decisions

Investment Decision
• Spending money on assets that would provide the organization with the maximum return over a chosen time
period is the primary idea behind an investment choice.
• Choosing what to acquire will ultimately determine how much value the business will realize. The
organization must strike a balance between its short- and long-term objectives in order to accomplish this.
• A corporation needs money to pay its expenses in the very near future, but if it keeps all of its cash, it won't
be able to develop in the future since it won't be investing in anything.
• A strictly long-term viewpoint is at the other extreme of the spectrum. If a firm invests all of its funds, it will
have the best long-term development possibilities; yet, if it doesn't have enough cash on hand, it won't be
able to pay its debts and will soon have to close.
• Therefore, it is important for businesses to achieve the correct balance between long- and short-term
investments.
The investments must meet three main criteria:
1. It must maximize the value of the firm after considering the amount of risk the company is comfortable with
(risk aversion).
2. It must be financed appropriately.
3. If there is no investment opportunity, the cash must be returned to the shareholder in order to maximize
shareholder value.
 Investment and financing decisions

Financing decision
• In some manner, a corporation must make money to cover all of its expenses. The finance
division will have to determine how to fund them in order to pay for them.
• An investment can be financed in one of two ways: using corporate funds, or by obtaining
funding from outside sources.
• Every one has benefits and drawbacks. There are two methods to obtain funding from
outside investors: by taking on debt or by offering stock. Acquiring debt is the same as
acquiring a loan.
• The cost of borrowing is the interest that is due on the loan repayment.
• Selling equity generally means selling a piece of your business. For instance, a corporation
may opt to sell itself to the general public as opposed to private investors when it goes public.
• Selling stocks—representing ownership of a tiny portion of the company—is a requirement
for going public. The business is promoting itself to the public in exchange for money.
• Every venture may be financed using business funds or money from outside investors.
• The best method to fund the investment is decided upon during the financing decision-
making process.
 Financial Institution (FI)
Concept:
• The financial institutions are the financial intermediaries who facilitate in transferring of capital
from savers to users.
• These are the companies engaged in the business of dealing with financial and monetary
transactions such as deposits, loans, investments, and currency exchange.
• The function of the financial institution is to collect capital from various savers and use that
capital to make loans and other investments in their own name.
Figure: Financial intermediaries
Suppliers of fund
Financial Users of fund
intermediaries

• The institutions which are involved in transferring capital from savers to users are called financial
intermediaries.
• Financial intermediaries encompass a broad range of business operations within the financial
services sector including commercial banks, insurance companies, brokerage firms, and
investment dealers.
 Types of Financial Institutions
Financial Institutions can be divided into two types. They are:
1. Depository Institutions
2. Non- Depository Institutions
 Financial Institution (FI)
Depository Institutions:
• Depository Institutions accept and manage deposits and make loans.
• This types of institutions are divided into commercial banks, development banks and other deposit
taking institutions like credit union.
a. Commercial Banks: Commercial banks are those financial institutions, which help in pooling the
savings of surplus units and arrange their productive uses. They basically accept the deposits from
individuals and institutions, which are repayable on demand. These deposits from individuals and
institutions are invested to satisfy the short-term financing requirement of business and industry.
b. Development Banks: Development banks are those which have been set up mainly to provide
infrastructure facilities for the industrial growth of the country. They provide financial assistance
for both public and private sector industries. The objectives of the development banks are to
promote industrial growth, to develop backward areas, to create more employment opportunities,
to generate more exports and encourage import substitution etc.
 Financial Institution (FI)
. Savings institutions: Saving institutions sometimes called thrift institutions
are another type of financial institution that serves a local community. They
take the deposits of local residents and lend the money back in the form of
consumer loans, mortgages, and small business loans. Savings institutions
include savings and loan institutions, savings banks etc.

d. Credit Unions: Credit unions are cooperative associations where large

numbers of people are voluntarily associated for savings and borrowing
purposes. These individuals are the members of credit unions as they make
share investment along with deposits. The saving generated from these
members is used to lend the members of the union only.
 Financial Institution (FI)
Non-depository Institutions:
• Non-depository types of financial institutions are not banks in real sense.
• They make contractual arrangement and investment in securities to satisfy the needs and preferences
of investors.
• The non-depository institutions include insurance companies, pension funds and mutual funds.
a. Insurance Companies: Insurance companies are the contractual saving institutions which collect
periodic premium from insured party and in return agree to compensate against the risk of loss of life
and properties.
b. Pension Funds: Pension funds are financial institutions which accept saving to provide pension and
other kinds of retirement benefits to the employees of government units and other corporations.
Pension funds are basically funded by corporation and government units for their employees, which
make a periodic deposit to the pension fund and the fund provides benefits to associated employees
on the retirement. The pension funds basically invest in stocks, bonds and other type of long-term
securities including real estate.
 Financial Institution (FI)
. Mutual Funds: A mutual fund is a type of financial vehicle made up of a pool of
money collected from many investors to invest in securities like stocks, bonds, money market
instruments, and other assets. Mutual funds give small or individual investors access to
diversified, professionally managed portfolios at a low price.
d. Finance companies: Finance company is a non depository financial institution since it does not
accept the deposit. It collects the fund through the issuance of short-term securities, especially
commercial paper other short term securities. It provides loans to people or businesses and
supplies credit for the purchase of consumer goods and services by purchasing the time-sales
contracts of merchants or by granting small loans directly to consumers.
e. Securities firms: Securities firms include investment banks, investment companies, and
brokerage firms. They help company in issuing securities such as stocks and debt securities and
investors in buying and selling the securities. They also help creating, marketing, and managing
investment portfolios.
 Financial Institution (FI)
Role of Financial Institutions:
• Financial institutions play a pivotal role in every economy.
• They are regulated by a central government organization for banking and non-
banking financial institutions.
• These institutions help in bridging the gap between idle savings and investment and
its borrowers i.e. from net savers to net borrowers.
a. Regulation of Monetary Supply
b. Banking Services
c. Insurance Services
d. Capital Formation
e. Investment Advice
 The following are the list of banks in Nepal, licensed by
Nepal Rastra Bank:
NRB has classified the banking sectors into four category:
1. Commercial Banks (Class ‘A’ Banks)
2. Development Banks (Class ‘B’ Banks)
3. Finance Companies (Class ‘C’ Banks)
4. Micro Credits Development Banks (Class ‘D’ Banks)
List of Banks and Financial Institutions (As of Jestha, 2080)

Financial Institutions Numbers

• Class: "A" (Commercial Banks) 21
• Class: "B" (Development Banks) 17
• Class: "C" (Finance Companies) 17
• Class: "D" (Micro Finance Financial Institutions) 63
• Other Institutions 15
• Infrastructure Development Bank 1
• Non Life Insurance companies 14
• Life Insurance companies 14
• Cooperatives 34512
 Financial Markets: Concept (1/4)

Concept of Financial Market:

• The assets can be classified as real assets and financial assets.
• Real assets include land and building, plant and machinery, equipment,
furniture and fixture, vehicles, and so on.
• Financial assets include common stock, preferred stock, debentures or bond,
Treasury bill, certificate of deposit, bankers’ acceptance, municipal bond,
mutual fund etc.
• The markets for buying and selling of financial assets are called financial
markets.
• They are the mechanism that exists to facilitate the exchange of financial
assets, providing the liquidity of financial assets.
 Financial Markets: Concept (2/4)

• Financial markets transfer funds from those who have excess funds to those who
need funds. Financial markets facilitate the flow of savings generated from one sector
of the economy to another, where there is a demand for funds.
• They enable individual to obtain a loan, businesses to finance assets and government
to finance their expenditures.
• In financial markets, the businesses raise funds by issuing securities or by borrowing
from banks and other financial institutions.
• Financial markets help in bringing lenders and borrowers of funds together with the
help of financial intermediaries. The main participants in the financial markets are
households, corporations and the government.
• These participants stand as the suppliers and demanders of the funds in the financial
markets.
 Financial Markets: Concept (3/4)

Generally, the following securities are traded in the financial market.

i. Stock Market ( common stocks, preferred stocks)
ii. Bond Market (corporate bond, government bond)
iii. Commodities Market (oil, precious stones, and gold. ):
• A specific market is created for such resources because their price is unpredictable.
• There is a commodity futures market where in agreement to buy and sell of
commodities at predetermined price of items at a given future time is made.
Iv. Derivatives Market (option, swaps, forwards and futures )
• A derivatives market involves the trading of derivatives or contracts whose value is based
on the market value of the asset underlying it.
• It refers to the market where derivatives like option, swaps, forwards and futures are
traded. The trading activities are done at the stated price in future.
 Financial Markets: Concept (4/4)

Role of Financial Markets

Financial markets play many important roles to the economy of the
country. They provide a market that bridges the gap between borrowers
and lenders. The Financial markets also allow efficient risk sharing among
investors.
The roles of financial market are as follows:
• Facilitate Price discovery.
• Provide liquidity to financial assets.
• Reduce the cost of transactions.
• Channel for Mobilizing Savings.
 Types of Financial Markets

Classification by Nature of Claim

i. Debt markat
ii. Equity market
Classification by Maturity of Claim
iii. Money market
iv. Capital market
Classification by Seasoning of Claim
v. Primary market
vi. Secondary market
Classification by Organizational Structure
vii. Organized stock exchange
viii. Ovet the counter (OTC) market
ix. Derivative market
 Corporate Governance
• Corporate Governance refers to the way a corporation is governed. It is the technique by which
companies are directed and managed. It means carrying the business as per the stakeholders’
desires.
• Corporate governance is the combination of rules, processes or laws by which businesses are
operated, regulated or controlled.
• Corporate governance essentially involves balancing the interests of a company's
many stakeholders, such as shareholders, senior management executives, customers, suppliers,
financiers, the government, and the community.
• It is actually conducted by the board of Directors and the concerned committees for the company’s
stakeholder’s benefit. It is all about balancing individual and societal goals, as well as, economic and
social goals.
• The board of directors is responsible for creating the framework for corporate governance that best
aligns business conduct with objectives.
• Specific processes that can be outlined in corporate governance include action plans, performance
measurement, disclosure practices, executive compensation decisions, dividend policies,
procedures for reconciling conflicts of interest and explicit or implicit contracts between the
company and stakeholders.
 Corporate Governance
Principles of corporate governance
• The basic principles of corporate governance are accountability, transparency, fairness, and responsibility.
• All shareholders should be treated equally and fairly. Part of this is making sure shareholders are aware of
their rights and how to exercise them.
• Legal, contractual and social obligations to non-shareholder stakeholders must be upheld. This includes
always communicating pertinent information to employees, investors, vendors and members of the
community.
• The board of directors must maintain a commitment to ensure accountability, fairness,
diversity and transparency within corporate governance. Board members must also possess the adequate
skills necessary to review management practices.
• Organizations should define a code of conduct for board members and executives, only appointing new
individuals if they meet that standard.
• All corporate governance policies and procedures should be transparent or disclosed to relevant
stakeholders.
 Corporate Governance
Benefits of Corporate Governance
• Good corporate governance ensures corporate success and economic growth.
• Strong corporate governance maintains investors’ confidence, as a result of which,
company can raise capital efficiently and effectively.
• It lowers the capital cost.
• There is a positive impact on the share price.
• It provides proper inducement to the owners as well as managers to achieve objectives
that are in interests of the shareholders and the organization.
• Good corporate governance also minimizes wastages, corruption, risks and
mismanagement.
• It helps in brand formation and development.
• It ensures organization in managed in a manner that fits the best interests of all.
Roles and responsibilities of CEO, Directors, and Chairman;

• Every public company shall have a board of directors consisting

of a minimum of three and a maximum of eleven directors.
• Any one director selected by the directors from amongst
themselves shall be the Chairperson of the board of directors.
 Responsibilities and duties of directors (as per company act 2063)
(1) No director or of a company shall do anything to derive personal benefit through the
company or in the course of conducting business of the company.
(2) If any person has derived personal benefit in the course of business of the company in
contravention of Sub-section (1), the company shall recover the amount involved in the
matter from such director as if such amount were a loan.
(3) Any person appointed as a director of a public company shall, prior to assuming the
duties of his/her office, take an oath of secrecy and honesty in a format as prescribed.
(4) Every director and officer of a company shall, in discharging their duties, act honestly and
in good faith, having regard to the interest and benefit of the company, and exercise such
care, caution, wisdom, diligence and efficiency as a reasonable and prudent person
exercises.
(5) The company may recover damages for any loss or damage caused too the company from
a director who does any act with ulterior motive, causing such loss or damage to the
company, in contravention of Sub-section (4).
(6) It shall be the duty of every director to comply with this Act, memorandum of
association, articles of association of the company and the consensus agreement.
 Responsibilities and duties of CEO

• The highest-ranking executive in a corporation is the chief executive officer (CEO).

• Generally speaking, a chief executive officer's principal duties include making significant business
decisions, overseeing a company's overall operations and financial resources, and serving as the
primary liaison between the board of directors and corporate operations.
• The chief executive officer frequently represents the business in public.
CEO's Roles and Responsibilities
A CEO's role varies from one company to another depending on the company's size, culture, and
corporate structure.
• Oversee the strategic direction of an organization.
• Implement changes and proposed plans.
• Engage in media obligations and public relations.
• Interact with other leadership executives.
• Maintain accountability with the board.
• Monitor company performance.
• Setting precedence for the working culture and environment.
 Roles and responsibilities of Chairman
The chairman is responsible for the leadership of the board and ensuring its effectiveness in all
aspects of its role, including the good governance of the company and the effective operation of
its committees.
• Leading, chairing and overseeing the performance of the Board and playing a pivotal role in the
creation of the conditions necessary for overall Board and individual director effectiveness, both
inside and outside the boardroom.
• Ensuring effective communication with the association members and to chair general meetings.
• Promoting and overseeing the highest standards of corporate governance within the Board and
the Group.
• Leading the board in discussions of proposals put forward by the executive team including on
strategy, risk management, governance, capital, financial reporting and M&A activity.
• Setting an agenda for the board, which is focused on strategic matters, forward looking and
evaluates and oversees the group’s businesses;
• Making sure the board follows the reserved matter timetable.
 Corporate Governance Practice in Nepal
• Corporate governance is the system of rules, practices and
processes by which a company is directed and controlled.
Principles folowed:
• Setting the division of responsibilities among management,
regulatory and enforcement agencies.
• Defining the role of stakeholders.
• Establishing the rights of shareholders.
• Defining the responsibilities of the board
• Deciding the extent and importance of disclosure and
transparency.
Thank You