Introduction: Stock Markets, Investments and Corporate Financial Decision Making

The text is aimed at examining the interplay between stock markets, investments, and corporate financial decision making.A large firm is typically financed by a combination of equity finance, which is raised by issuing shares or stocks as certificates of ownership in the company, and debt finance, or borrowing, which is created by issuing bonds (an “I Owe You”) that obliges the company to return the borrowed amount (the principle) at some designated date together with interest payments over the loan. Such a large firm is likely incorporated as a legal entity under the Corporation Law of the state. One implication of incorporation is that the firm's shareholders as owners of the company have limited liability (responsibility) for the firm's behaviour. By submitting itself to the rules of a stock exchange, the firm's shares and bonds can be listed for trading on the exchange. This means that a firm can raise funds by issuing equity and debt (which we refer to as a primary market) and thereafter have its stocks and bonds traded second-hand between sellers and new buyers (in what we refer to as a secondary market, but which more generally is referred to as the stock market, whose prices are reported daily in the news). The holders of bonds and stocks in a firm are naturally seeking the highest returns on their investments for a given level of risk. Such investors' expectation of return, reciprocally, may be viewed as identifying the firm's cost of financial capital. So firms must seek to invest in projects and ventures that satisfy the risk–return expectations of their sources of finance — as both equity and debt. From such a perspective, we can say that (i) the investment activities of large firms and (ii) the investment activities in their bonds and stocks that take place in stock and other financial markets, are different sides of the same investment coin, connected by the cost of financial capital…