EXP 482 Corporate Financial Policy Clifford W. Smith, Jr. Winter 2007 Handout 5 * Covers readings on course outline through Barclay/Smith (1996)

Financial Architecture  Leverage  Bond covenants  Public vs. private debt  Maturity  Priority  Conversion rights  Call provisions

 Larger issues usually public ―fixed registration fees ―under-diversification of private lenders  The riskier the debt, the more likely that it will be private ―easier to renegotiate ―usually contains more, and more specific, contract provisions Private vs Public Debt

Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt

Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt

Baa (Private) Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA S BAA Baa (Public) Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt

Baa (Private) Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA S BAA Baa (Public) Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt

Investment Opportunity Set Assets in Place Growth Opportunities Cost of Longer Maturity Low High (Underinvestment) Predicted Maturity Long Short

Investment Opportunity Set Assets in Place Growth Opportunities Cost of Low Priority Low High Fixed Claims (Creditor Conflicts)

Investment Opportunity Set Assets in Place Growth Opportunities Cost of Low Priority Low High Fixed Claims (Creditor Conflicts) Concentration of Lower Greater Priority Classes

Benchmarking Impact on Private Debt Impact on Maturity Impact on Priority Concentration Growth Options (Merck)GreaterShorterGreater Credence Goods (Eastern)GreaterShorterGreater Product Warranties (Yugo)GreaterShorterGreater Future Product Support (Yugo/Wang)GreaterShorterGreater Supplier Financing (Campeau)GreaterShorterGreater Firm SizeLessLongerLess Closely Held FirmGreaterShorterGreater RegulationLessLonger? Tax Credits ——Less Marginal Corporate Tax Rate —— — Marginal Personal Tax Rate — — — Abnormal EarningsGreater ShorterGreater

Deregulation and Debt Maturity Leverage and Debt Maturity in the Telecommunications industry

Investment Opportunity Set Financial Architecture Leverage High Low Maturity Long Short Priority(Table 5)Diffuse Concentrated Conversional RightsLow High Leasing(Table 4)High Low Compensation Level of Pay Low High Conditional Pay Low High Assets in Place Growth Opportunities