>Finance>FinanceCreated 7/1/1996
Go to Brad De
Long's Home Page
http://www.j-bradford-delong.net/Intro_Finance/BAonethirty15.html
Basics:
Enormous variety of financing instruments
International Paper's debt securities (and equity) at the end of 1993:
Asset
Amount (millions)
9.4% to 9.7% notes due 1995-2002
$400
7 5/8% notes due 2004, 2023
$398
6 1/8% notes due 2003
$199
6 7/8% notes due 2023
$197
Assorted medium-term notes due 1994-2006
$549
9 1/8% French franc notes due 1994
$95
5 1/8% debentures due 2012
$78
5 1/4% euro-convertible subordinated debentures due 2002
$199
Environmental and industrial development bonds
$747
Commercial paper
$516
Other franc borrowoing
$95
German mark borrowing
$214
Equity Book Value
Issued common shares (at par)
$127
Additional capital
$1704
Retained earnings
$4553
Treasury shares (at cost)
-$159
Net common equity
$6225
Why so much innovation? Taxes and financial regulations are very important causes; a belief that wide investor choice is good for its own sake. But in a pure CAPM world there would be much, much, much less variety of securities.
Patterns of corporate financing.
Heavy reliance on internal financing. Does this mean that securities markets are overrated? Almost surely not...
Debt-to-market ratios vary between 11% and 36% across industrial economies.
Corporate governance
Dispersal of ownership; free-rider problem; managerial displacement via voting-with-the-feet and takeover threat; managerial displacement via directors' coup;
agency problems created by separation of ownership and control offset by (i) rights issues provided to top managers (less than perfect); (ii) fear of lawsuits; (iii) threat of takeover.
alternative systems--bank representatives on boards of directors; large voting blocks; universal banking; "keiretsu"
General Motors --> 100% of shares widely held
Daimler-Benz --> 32% "widely held"; 28% Deutsche Bank (U.S. banks forbidden to hold equity in non-financial corporations) (Deutsche Bank votes 42% "deposit rights");14% Kuwait; 25% Mercedes Auto Holdings.
You can't mount a takeover of Daimler-Benz; then again, you don't have to wait for a takeover artist in order to realize value...
sharks vs. watchers; sharks are good if skills are scarce, and you want those with managerial assessment skills prowling around; watchers are good if ultimate investors are pretty good at judging watchers
Connections with eastern european reform
Japan with its keiretsu follows the German form...
Summary:
Finance is mostly a "marketing" problem; company tries to split cash flows into different streams that will appeal to different investors with different tastes, wealth levels, and tax rates.
Another look: internal funds as most important; mix of outside financing chagnes from year to year; net equity issues in the 1980s stronglynegtaive: people leveraged up.
Inbox Software EquityAccount:
|
|
Initial |
After two years |
After three years |
|
Stock at par |
$50,000 |
$50,000 |
$150,000 |
|
Other contributions |
$1,950,000 |
$1,950,000 |
$6,850,000 |
|
Retained earnings |
|
$120,000 |
$370,000 |
|
|
$2,000,000 |
$2,120,000 |
$7,370,000 |
Issuing Securities
First Meriam venture partners invests one million in round one venture capital... Marvin Enterprises:
Started with $100,000; which was spent; then went looking for VC and sold a 50% stake for $1,000,000
|
|
Assets |
Liabilities + Net Worth |
|
|
Cash |
$1 |
$1 |
1m shares Venture Capital Equity |
|
"Intangible" |
$1 |
$1 |
1 m shares Founders' Equity |
|
|
|
|
|
|
|
$2 |
$2 |
|
Round 2 of venture capital; sell a 4/14 = 28.5% stake in the company for $4,000,000
|
|
Assets |
Liabilities + Net Worth |
|
|
Cash from new equity |
$4 |
$4 |
0.8 m shares 2nd Stage Equity @ $5/share |
|
Fixed assets |
$1 |
$5 |
1 m shares 1st Stage Equity |
|
"Intangible" |
$9 |
$5 |
1 m shares Founders' Equity |
|
|
$14 |
$14 |
|
Venture capital--a low probability of success, but the prospect of a big win...
Initial Public Offering
Register with the SEC; SEC approval; prospectus "Red herring"; registrar; transfer agent; underwriters; substantial administrative costs; underpricing IPO's.
Marvin sells 500,000 primary shares (for the company) and 400,000 secondary shares (from VCs and from founders)
|
|
Assets |
Liabilities + Net Worth |
|
|
|
|
$72 |
0.9 m shares IPO |
|
Cashfrom new equity |
$37.5 |
$48 |
0.6 2nd Stage Equity |
|
Fixed assets |
$5 |
$80 |
1.0 1st Stage Equity |
|
"Intangible" |
$221.5 |
$64 |
0.8 Founders' Equity |
|
|
$264 |
$264 |
|
"Contentment at selling an article for one-third of its subsequent value is a rarity"
General Cash Offers by existing companies; SEC registration; "shelf" registration; market reaction to new stock issues-- 1/3 of value soaked up in stock price decline
Should you worry about dilution?
Quangle's profitability:
|
Book net worth |
$100,000 |
|
|
Number of shares |
1000 |
|
|
Book value per share |
$100 |
|
|
Net earnings |
$8000 |
|
|
EPS |
$8 |
|
|
PE |
10 |
|
|
Price |
$80 per share |
|
|
Total market value |
$80,000 |
|
By selling shares at less than market value, does the firm "dilute" its shareholders equity? You should see by now that this is the wrong question to ask. Suppose that Quangle has a 10% earnings-per-dollar invested opportunity open to it. Sells 100 shares at a price of $80 a share and puts the money to work at 10%--and is fine. Suppose that Quangle has a 20%-plus-one-dollar investment opportunity--and sells 200 shares at a price of $100 -less-half-a-penny a share
|
Book net worth |
$100,000 |
$108,000 |
$119,999 |
|
Number of shares |
1000 |
1100 |
1200 |
|
Book value per share |
$100 |
$98.18 |
$99.999 |
|
Net earnings |
$8000 |
$8,800 |
$12,000 |
|
EPS |
$8 |
$8 |
$10 |
|
PE |
10 |
10 |
10 |
|
Price |
$80 per share |
$80 per share |
$100 per share |
|
Total market value |
$80,000 |
$88,000 |
$120,000 |
It's silly to tie what you do to book value.
Summary:
Larger is cheaper--bunch security issues, for transaction costs are considerable
There are no issue costs for retained earnings
Private placements are well suited for the small, risky, unusual, and complex
Watch out for underpricing--the lion's share of costs come from underpricing
New issues may depress price (and so should be coreographed to be information-free)
shelf registration for large firms that don't need to be warranteed by IBs
