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Chapter 11. An Overview Of Long-Term Financing. Del Hawley FIN 634. Fall 2003. Chapter 11 Overview. 11.1 The Basic Instruments of Long-Term Financing Common & Preferred Stock Long-Term Debt 11.2 The Basic Choices in Long-Term Financing The Need to Fund a Financial Deficit
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Chapter 11 An Overview Of Long-Term Financing Del HawleyFIN 634 Fall 2003
Chapter 11 Overview • 11.1 The Basic Instruments of Long-Term Financing • Common & Preferred Stock • Long-Term Debt • 11.2 The Basic Choices in Long-Term Financing • The Need to Fund a Financial Deficit • The Choice Between Internal Versus External Financing • 11.3 Financial Intermediaries’ Role in Corporate Finance • What is a Financial Intermediary (FI) and What Does it Do? • The Role of FIs in American Corporate Finance • The Role of FIs in non-U.S. Corporate Finance • 11.4 The Expanding Role of Securities Markets • The Growth of Securities Issues Worldwide • The Worldwide Surge in Mergers and Acquisitions • 11.5 Corporate Governance and Corporate Finance
Characteristics of Common Stock • Basic terminology of common stock (refer to IBM data) • Par value: denomination; little economic relevance today • Shares authorized, outstanding, & issued: shareholders specify maximum amount of shares that can be issued • Additional paid-in capital: amount received in excess of par value when corporation initially sold stock. • Market value: market price/share x number shares O/S • Treasury stock: stock purchased on open market by corporation. Usually purchased for stock options. • Stock split: two-for-one split issues one new share for each already held. Done to reduce per share price. • Common stockholders are residual claimants • They have no claim to earnings or assets until all senior claims are paid in full. • High risk, but historically also high return
Book Value Of Stockholders’ Equity In IBM As Of December 31, 2001 (In $ millions)
Rights Of Common Stockholders • Voting rights of C/S can be exercised in person or by proxy • Assigning proxy means giving someone else (usually mgt) the right to vote your shares at a stockholders’ meeting • Can change your mind; most recent proxy has voting right • proxy fight: when a dissident group solicits proxies in order to challenge management. Mgt usually wins. • Most US corporations have majority voting • This gives each share one vote for each director’s position (one vote for each of ten board seats) • Cumulative voting gives minority S/Hs greater chance of electing one or more directors • Can vote all ten votes for a single director. • S/Hs do not have a legal right to receive dividends • Dividends paid only at BOD discretion, and only if all creditor claims are current.
Characteristics of Preferred Stock • Preferred stock is an equity claim, though fixed in amount • Claim on assets and cash flow senior to common stock • As equity security, dividend payments are not tax deductible for the corporation and are subject to personal income tax. • For tax reasons, straight P/S held mostly by corporations • Venture capitalists use convertible P/S almost exclusively • Promises a fixed annual dividend payment, expressed as dollar amount or percent, but not legally enforceable • However, firm cannot pay C/S dividends if P/S in arrears • In liquidation, P/S claim paid before C/S receive anything • Preferred stockholders usually do not have voting rights • Venture capitalists an exception: they have very strong control rights and receive BOD seats
Methods Of Classifying Long-Term Debt • Maturity: Only long-term debt is part of a corporation’s capitalization (“permanent capital”) • Short, Intermediate, and long-term debt often called bills, notes, and bonds, respectively. • Seniority: Rank in priority of claims to assets & cash flow • Senior versus subordinated debt • Security: Is debt secured by explicit collateral? • Mortgages are secured by real estate; transportation equipment secured by equipment trust receipts • Most corporations issue debentures; no explicit collateral • Callability: Most US corporate debt is callable by firm • Allows firm to retire & reissue debt if interest rates fall • Must compensate investors with call premium and higher interest rate on bonds
Methods Of Classifying L-T Debt (Continued) • Interest payment method: Floating or fixed rate debt • Most US bonds pay fixed coupon interest payments • Virtually all bank loans are floating rate debt, based on prime rate or LIBOR (London Inter-Bank Offered Rate) • Method of principal repayment: Bullet vs amortized loans • Most corporate bonds are bullet loans: principal repaid in a lump sum at maturity • Sinking fund purchases reduce default risk by reducing amount O/S over bond issue’s life • Most personal loans (homes, cars), some corporate debts are amortized: equal periodic principal & interest payments • Security versus loan product: Is debt securitized? • Capital market instruments--bonds, notes, bills--are securities (commercial paper is economically, but not legally) • Syndicated bank loans the most important loan products
Basic Choices In Long-Term Financing • Corporations are almost always net “dis-savers”; they consume more capital (savings) than they generate • Their capital investments exceed their retained earnings • Thus ongoing need to fund financial deficit by tapping external sources of capital • Individual corporations (and corporate sector) face four key decision variables each year: • How much capital is needed for investment, other purposes? • How much capital to raise externally vs internally? • Should external funds be raised on capital markets or via financial intermediaries? • Fraction of external capital raised as debt versus equity? • Internal financing roughly equal to cash flow from operations minus cash dividends • Amount not fixed: firm can vary dividends & capital structure
Sources Of Funds For Non-Financial U.S. Corporations, 1980-2000
External Financing Patterns For G-7 Countries: Averages For 1984-1991 Source: Rajan and Zingales, “What do We Know About Capital Structure: Some Evidence from International Data,” Journal of Finance 50 (1995).
Composition Of Net External Financing, G-7 Countries: Average 1984-1991 Source: Rajan and Zingales, “What do We Know About Capital Structure: Some Evidence from International Data,” Journal of Finance 50 (1995).
Annual Global Securities Issuance: Patterns • Record $4.07 Trillion Securities Issued On Public Capital Markets Worldwide During 2001 and $3.9 trillion in 2002 • Compared to only $504 bn in 1990 • Over $500bn More In Private Placements ($417bn in 2002) • Almost $20 Trillion Total Public Offers During 1990s • Another $3-4 trillion in private placements • Rule 144A issues very popular with US, non-US issuers • Each Year, US Issuers Account For Two-Thirds Of Total Public Issue Volume, Most Private Issues • Over 70% of public issues in 2001and 2002; • Debt Issues Are Over Three-Fourths Of US Total Every Year • Account for 91% and 94% of issues in 2001 and 2002 • Equity Issues Play Small Financing Role Everywhere
Number & Value ($US Billions) Of U.S. Public Security Offerings, 2002
Value of Global Mergers & Acquisitions, 1991-2002 ($US Billions)