Corporate Finance: An Introduction

Citation

Anderson, W. (2009), "Corporate Finance: An Introduction", Pacific Accounting Review, Vol. 21 No. 2, pp. 186-188. https://doi.org/10.1108/par.2009.21.2.186.1

This recently published book sets out to be an introductory text in corporate finance. It certainly covers the necessary ground for such a text, presenting the basics of value and capital budgeting, risk and return, market efficiency and imperfect markets, the applications and pitfalls of capital budgeting, financial statement analysis and the use of pro‐forma statements, capital structure, and equity payout policy. In addition, its final part provides good coverage of extension topics such as capital structure dynamics, corporate governance, international finance, and options and risk management.

After a preliminary chapter of overview, the book gets underway with a Part One titled “Value and Capital Budgeting”. As we are still at the text's front end, markets are perfect and risk is neutral. As one would expect, the basics of the time value of money are introduced. The Part's first chapter starts with a description of what constitutes a return on an investment, and quickly relates it to the concept of the future values of sums and then present values. Over this simple ground, Welch certainly moves at a cracking pace. Within just a few pages he moves onto fractional time periods, and solving for interest rates before defining the discount rate as the “cost of capital” and going on to discuss net present value.

Part One contains five further chapters, which move briskly over the ground of perpetuities and annuities (Chapter 3), the relative merits of NPV and IRR as capital budgeting tools (Chapter 4), time‐varying rates of return and the yield curve (Chapter 5) and the basics of risk, risk premiums, defaults and company ratings in Chapter 6.

Well, that was Part One, the first of eight. The pace does not let up. Part Two is about risk and return in a perfect market under risk aversion. In Part Three, markets become imperfect, while Part Four deals with real‐world applications. From here on out, the effect of market imperfections are incorporated into every topic.

Welch's text is well structured. Each part has a yellow‐paged précis of learning objectives, and also a subheading that lets a student know where the part's contents stand on the continuum stretching between a simplified world of models and the much messier, much more complex world where commerce is actually practised. There is a progression through the book from simple to complex. At the chapter level, too, there is a similar progression from an easy first view to advanced ideas.

However, Welch's approach to structure is more sophisticated than just that. It is closely aligned to how a savvy student, operating under time constraints, is likely to go about studying course material. One starts by reading a chapter's précis of learning objectives, and then switches to the end to read the chapter summary, which Welch provides as a set of neatly bulleted points. The student's third move is then to skim through the chapter's subheadings and its sidebars. After all of that, the reading of the text commences, with a finger on the page to force the mind to concentrate, line by line.

This was tested out on a student, currently midway through an MBA finance course, who was given Welch's book to look at for an hour. She found the chapter format just right for ease of absorption. Of particular note to her was the insertion, at the end of each subsection, of sets of self‐test questions titled, “Solve Now!” This has an immediate reinforcement function, facilitating a running check on how much has been understood. This is further sped up by the availability of the answers at a glance, immediately after the chapter summary and its attendant glossary of key terms. In addition, the subsections furnish a series of grey boxes labelled “Important” in red to placard vital concepts for further reinforcement. The only aspect of Welch's format which grated with this student was the tendency for the material laid out in side‐bars to be witty and quirky commentary on terms rather than the immediate definition of them she would have preferred.

Another interesting feature to be found listed in the contents of many chapters is a section with a standard wording in red italics, “How Bad Are Mistakes?” The idea behind this is to give students a perception of whether errors of various sorts are major or minor. And if all of the above has not been enough, chapter appendices extend the material into more complex territory – in some instances this is in quite large measure. Chapter 5 in particular, has an excellent appendix on bonds which encompasses forward interest rates, duration and duration hedging, continuous compounding, and a section on coupon stripping.

Welch's book comes with access to online course materials at MyFinanceLab. This also provides extension problems that can be submitted and assessed online. Of particular note is MyFinanceLab's capacity for generating individualised study plans for students based on their performance in the online practice tests associated with each chapter.

The book is also forthright in what it has to offer. Aside from the usual preliminary acknowledgements, it has 13 pages of punchy prose that pitch its case as to why you should read it, point by point. First among these points is the strength, already mentioned, of the connection between modelling, with its simplifications, and the actual world, where models may turn out to be inaccurate or break down, as mentioned earlier. In a time of recession brought partially attributable to the excesses of financial practitioners and an only recently‐perceived inadequacy of orthodox financial thinking, this is a desirable trait. A second, grabbing this reviewer's attention, is an up‐to‐the‐minute perspective of capital structure. Welch argues here that control rights are important alongside cash flow rights; and that the value of a firm should include the usually overlooked item of nonfinancial debt (trade credit and unpaid tax), which may increase the value of liabilities as much as 50 percent. In further unpacking the elements of capital structure, Welch proposes a model of project value that takes into account, along with the usual inputs, the impact of market distortions and the cost of mitigating them (Figure 18.5, p. 691). The book also has an excellent chapter on corporate governance

The book can also be fun to read. The author piques students' interest with interesting historical titbits, which he parcels up as anecdotes boxed in yellow. These tend to be off‐beat. We learn, for instance, that the US Government lease on Guantanamo Bay in Cuba is a perpetuity of 2,000 pesos in gold that the Cubans have repudiated. Some anecdotes solicit application of the tools under discussion nearby in the text. An interest rate problem set in the ancient Mesopotamian Hammurabi Code accompanies the introduction to the time value of money, while an NPV problem posed by a 13th Century mathematician, Leonardo of Piza is put under the reader's nose a little bit later. My favourite is non‐computational and a little more modern, titled “Fiduciary Responsibility, or the Fox Guarding the Henhouse”. It relates to negotiations preceding the appointment of Jamie Dimon as CEO of J.P. Morgan in December 2005. These anecdotes can be quickly located because they feature in the book's table of contents.

The book contains three excellent appendices, the first of which provides a basic mathematical and statistical background with practice questions. The other two are glossaries: one of terms used in the book, and the other a specialised list of bonds and rates jargon including CMO (collateralized mortgage obligation). Missing however is any mention of CDO, which is similar in nature, though with more general application. But inside the front cover there is a table of common symbols and notation, which is matched inside the back cover with a page index of key equations. For anyone who has spent time leafing through a large text looking for an equation they have noted but cannot easily relocate, this inclusion is a very definite bonus.

This book is written in easily readable English, with flair and wit. However, the pace and the depth of delivery would make it a fairly tough text for an undergraduate with no great background in mathematics. But, as an introductory text, it would be excellent for graduate students engaging for the first time with the finance discipline.