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What is Corporate Finance?

Corporate Finance is the area of finance that deals with the financial decisions of firms; the main goal of corporate finance is to maximize corporate value. The term corporate finance applies to the financial decisions taken inside the firm in terms of investments, financing and corporate governance. It also applies to the activities of investment banking that deal with firm transactions such as mergers, acquisitions, initial public offerings or leveraged buy outs among others.

Within the firm, corporate finance deals mostly with capital budgeting decisions and financing decisions. Capital budgeting decisions refer to the selection of which investment projects should be undertaken. These decisions should take into account the expected cash flows of the projects, but also their risk and the amount of flexibility and embedded strategic options that they entail. Corporate Finance provides with the tools to analyze such elements in the context of an investment decision. Financing decisions are related to the liability structure of the firm. Firms´ capital structure can affect taxation, bankruptcy risk, the perception of the market and the incentives within the firm. In this sense capital structure can be optimized to maximize shareholders´ value. Corporate Finance also deals with the payout policy of the firm.

Corporate Finance also deals with the transactions that are traditionally in the sphere of investment banking. Among them the area of mergers and acquisitions deals with transactions that involve changes in the nature and control of the firm. Leveraged buy outs and private equity in general are also areas of interest within corporate finance. Although Banking in general is often considered an area on its own it is closely related to corporate finance.

Finally corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. While the study of corporate governance involves several areas of law and economics it has been traditionally considered associated with corporate finance given its association with the agency problems that are the core of many corporate finance problems. The study of executive compensation and the provision of incentives inside the firm are also often analyzed as a subset of corporate governance.