Professor John Zietlow MBA 621 An Overview Of Long-Term Financing Chapter 11

Chapter 11 Overview 11.1The Basic Instruments of Long-Term Financing –Common & Preferred Stock –Long-Term Debt 11.2The Basic Choices in Long-Term Financing –The Need to Fund a Financial Deficit –The Choice Between Internal Versus External Financing 11.3Financial 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 11.4The Expanding Role of Securities Markets –The Growth of Securities Issues Worldwide –The Worldwide Surge in Mergers and Acquisitions 11.5Corporate 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

Short-Term & Long-Term $US Debt of IBM

Foreign Currency & Total L-T Debt Of IBM Notes: 1 The weighted-average interest rates for commercial paper was 1.9% on December 31, Values translated into dollars using exchange rate in force on December 31, Average interest rates in parentheses. Source: IBM website (

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,

Banks Are The World’s Largest Corporations—But Only By Assets Bank NameCountry Total Assets ($US Billions) Global Asset Ranking Mizuho HoldingsJapan$1,304,3421 CitigroupUS902,2102 Deutsche BankGermany882,5413 Bank of Tokyo-MitsubishiJapan716,9344 J.P. Morgan ChaseUS715,3485 HSBC HoldingsBritain674,3817 HypovereinsbankGermany672,6928 UBSSwitzerland671,1189 BNP ParibasFrance651,59010

External Financing Patterns For G-7 Countries: Averages For 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 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 And Value Of Worldwide Security Issues In 2002 Security Type# OfferingsValue $US Billions Total Debt & Equity 1 14,070$3,902 U.S Issuers Worldwide 1 9,721$2,790 Global Debt12,099$3,600 Global Long-Term Straight Debt 2 8,934$3,198 Global Equity1,724$209 1 Totals do not include privatizations or sovereign debt offerings. 2 Excluding Mortgage- and asset-backed securities or U.S. municipal bonds.

Number & Value ($US Billions) Of U.S. Public Security Offerings, 2002 Security Type# OfferingsValue $US Bn Long-Term Debt5,942$2,231 Short-Term Debt3,162$395 High-Yield Debt255$58 Mortgage-Backed Securities980$768 Tax-Exempt Municipal Bonds13,132$337 Convertible Debt & Preferred137$60 Nonconvertible Preferred112$17 Common Stock (Includ IPOs)540$104 Initial Public Offerings97$27

Law And Finance-Legal Systems And The Size Of National Capital Markets Countries/Legal Systems External Cap/GDP Private Debt/GDP Domestic Firms/Pop Shareholder Rights English common law countries French civil law countries German civil law countries Scandinavian law countries All countries

Ownership Structure And Corporate Governance In Continental Europe

Value of Global Mergers & Acquisitions, ($US Billions)

Pension Funds And Capital Markets

Pension Funds And Capital Markets (Cont)