Corporate Issuers — Study Notes

CFA® Level I topic weight 6–9% · how companies govern, invest and finance themselves

Governance & stakeholders

Organizational forms: sole proprietorships and partnerships carry unlimited (or partially limited) owner liability; corporations separate legal personality, give shareholders limited liability, and split ownership from control — which creates the governance problem. Public companies face listing and disclosure obligations private companies avoid.
Principal–agent conflicts: managers vs shareholders (empire building, perks, entrenchment), controlling vs minority shareholders, and shareholders vs creditors (risk-shifting into volatile projects once debt is priced). Mechanisms that mitigate: independent boards, audit and compensation committees, incentive alignment, takeover pressure, and creditor covenants.
Board structure: exam-favored details include board independence, separation of chair and CEO, staggered vs annually elected boards (staggered boards entrench), and the audit committee’s independence requirement.
ESG in analysis: environmental, social and governance factors enter through materiality — e.g., stranded-asset risk, labor practices, board quality. Approaches range from negative screening to integration into forecasts and discount rates.
Business models: a coherent statement of who the customer is, what is sold, how it is priced and how the firm captures margin — questions test identifying revenue-model types (subscription, platform, franchising) and their working-capital implications.

Capital allocation

NPV: discount incremental after-tax cash flows at the project’s required return; accept when NPV > 0. NPV measures the expected addition to shareholder wealth and is the theoretically correct criterion.
IRR: the discount rate making NPV zero; accept when IRR > required return. IRR can mislead with non-conventional cash flows (multiple IRRs) and assumes reinvestment at the IRR itself.
NPV vs IRR conflicts: mutually exclusive projects of different scale or cash-flow timing can rank differently — follow NPV. Payback period ignores time value and post-payback cash flows; it measures liquidity, not value.
Common pitfalls in practice: including sunk costs, ignoring opportunity costs and cannibalization, and treating financing costs as project cash flows (they belong in the discount rate).

Cost of capital & capital structure

WACC = w_d·r_d(1 − t) + w_p·r_p + w_e·r_e, using target market-value weights and the marginal (current) cost of each source — not historical coupon rates. Only debt gets the tax shield.
Cost of equity: commonly CAPM — r_e = R_f + β(market risk premium) — or bond-yield-plus-risk-premium as a sanity check. Cost of preferred is r_p = D_p ÷ price.
Modigliani–Miller: with no taxes and frictionless markets, capital structure is irrelevant to firm value; with corporate taxes, the debt tax shield adds value, pushing toward debt. The trade-off theory balances tax shields against expected costs of financial distress; the pecking order says firms prefer internal funds, then debt, then equity as a last resort.
Payout basics: dividends and share repurchases return capital to owners; a repurchase at market price leaves remaining shareholders’ wealth unchanged but raises EPS when funded from idle cash (fewer shares).

Leverage & working capital

Operating leverage (DOL): fixed operating costs magnify how %Δ sales becomes %Δ operating income. Financial leverage (DFL) layers fixed financing costs on top; total leverage DTL = DOL × DFL. Higher fixed costs mean higher breakeven and more volatile earnings in both directions.
Breakeven quantity = (fixed operating + fixed financing costs) ÷ (price − variable cost per unit); the operating breakeven drops the financing costs.
Cash conversion cycle = days of inventory on hand + days sales outstanding − days payables outstanding. A shorter cycle ties up less cash; lengthening DPO helps the firm but strains suppliers.
Liquidity management: primary sources are cash flows, marketable securities and credit lines; secondary sources (asset sales, renegotiation) signal stress. Compare the current and quick ratios and drag/pull effects on liquidity (uncollectible receivables, early payments).

Common traps

Using the historical (coupon) cost of debt in WACC — use the marginal cost the firm would pay today, after tax.
Ranking mutually exclusive projects by IRR — scale and timing differences make IRR rankings unreliable; NPV decides.
Counting sunk costs in project cash flows — only incremental future cash flows count; include opportunity costs and side effects instead.
Confusing the direction of the cash conversion cycle — more payables days shortens the cycle; more inventory or receivables days lengthens it.
Treating high operating leverage as unambiguously good — it magnifies downturns exactly as it magnifies growth.

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