Chapter 11
An Overview Of Long-Term
Financing
Professor John Zietlow
MBA 621
Chapter 11 Overview
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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
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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)
2001
--
2000
$ 247
Common stock, par value $0.20 per share
shares authorized: 4,687,500,000
shares issued: (2001: 1,913,513,218;
2000: 1,893,940,595)
$14,248
12,400
Retained earnings
Treasury stock, at cost
Shares (2001: 190 mm; 2000: 131 mm)
Employee trust benefits, at cost
Accumulatd gains & losses not affecting RE
30,142
23,784
(20,114)
-(662)
(13,800)
(1,712)
(295)
Total stockholders’ equity
$23,614
$20,624
Preferred stock, par value $0.01 per share
shares authorized: 150,000,000
shares issued: 2,546,011
Rights Of Common Stockholders
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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
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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
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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)
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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
Short-term debt
Commercial paper1
Short-term loans
Long-term debt: Current maturities
Total
Long-term debt (In US Dollars)
Debentures:
Maturities
6.22%
2027
6.5%
2028
7%
2025
7%
2045
7.125%
2096
7.5%
2013
8.375%
2019
Notes: 6.3% average
2001-2014
MTN program: 5.8% avg 2001-2014
Other: 6.8% average
2001-2012
$ 4,809
1,564
4,815
$11,118
Amount
$ 500
700
600
150
850
550
750
2,772
3,620
828
$11,320
Foreign Currency & Total L-T Debt Of IBM
Dollar Value of Foreign Currency Debt 2
Euros (4.4%)
2002-2005
Japanese yen (1.1%)
2002-2014
Canadian dollars (5.8%)
2002-2005
Swiss francs (4.0%)
2002-2003
Other (6.1%)
2002-2014
Less: Net unamortized discount
Less: Current maturities
Total Long-Term Debt
$ 3,042
$ 4,749
441
151
726
$20,429
47
4,815
$15,963
Notes: 1 The weighted-average interest rates for commercial paper was
1.9% on December 31, 2001.
2 Values translated into dollars using exchange rate in force on
December 31, 2001. Average interest rates in parentheses.
Source: IBM website (www.ibm.com/annualreport)
Basic Choices In Long-Term Financing
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Corporations are almost always net “dis-savers”; they
consume more capital (savings) than they generate
– Their capital investments exceed their retained earnings
– Thus ongoing need to fund financial deficit by tapping external
sources of capital
Individual corporations (and corporate sector) face four key
decision variables each year:
– How much capital is needed for investment, other purposes?
– How much capital to raise externally vs internally?
– Should external funds be raised on capital markets or via
financial intermediaries?
– Fraction of external capital raised as debt versus equity?
Internal financing roughly equal to cash flow from operations
minus cash dividends
– Amount not fixed: firm can vary dividends & capital structure
Sources Of Funds For Non-Financial U.S.
Corporations, 1980-2000
Sources = Uses ($Billion)
Capital expenditures
Internal Sources
Profit after tax
- Dividends
+ Depreciation
Total internal sources
External Sources
Incrse non-mkt liabilities
?
Net raised in markets
Net new equity issues
Net debt issues
Net ext = Financial deficit
Internal funding as % total
Financial deficit as % total
Fincl market funds % total
Net equity issues % total
2000
1,535
1,021
1999
1,503
907
1996
1,051
685
1990
538
430
1980
387
262
410
(264)
667
887
372
(248)
622
806
310
(201)
506
678
141
(118)
371
432
116
(45)
159
207
387
301
-153
447
648
58
42
19
-10
404
338
-143
482
697
54
46
20
-10
313
80
-70
149
373
65
35
8
-7
120
64
-63
127
106
80
20
12
-12
139
83
10
73
180
54
46
21
3
Banks Are The World’s Largest
Corporations—But Only By Assets
Bank Name
Mizuho Holdings
Citigroup
Deutsche Bank
Bank of Tokyo-Mitsubishi
J.P. Morgan Chase
HSBC Holdings
Hypovereinsbank
UBS
BNP Paribas
Country
Total Assets
($US Billions)
Global Asset
Ranking
Japan
$1,304,342
1
US
902,210
2
Germany
882,541
3
Japan
716,934
4
US
715,348
5
Britain
674,381
7
Germany
672,692
8
Switzerland
671,118
9
France
651,590
10
External Financing Patterns For G-7
Countries: Averages For 1984-1991
Country
United States
External financing as a
percent of total financing
23%
Japan
56
Germany
33
France
35
Italy
33
United Kingdom
49
Canada
42
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
Net debt issuance,
% of total external
Net equity issuance,
% of total external
134%
-34%
Japan
85
15
Germany
87
13
France
39
61
Italy
65
35
United Kingdom
72
28
Canada
72
28
Country
United States
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
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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
# Offerings
Value $US Billions
Total Debt & Equity 1
14,070
$3,902
U.S Issuers Worldwide 1
9,721
$2,790
Global Debt
12,099
$3,600
Global Long-Term
Straight Debt 2
8,934
$3,198
Global Equity
1,724
$209
1 Totals
do not include privatizations or sovereign debt offerings.
2 Excluding Mortgage- and asset-backed securities or U.S. municipal bonds.
Number & Value ($US Billions) Of U.S. Public
Security Offerings, 2002
Security Type
# Offerings
Value $US Bn
Long-Term Debt
5,942
$2,231
Short-Term Debt
3,162
$395
High-Yield Debt
255
$58
Mortgage-Backed Securities
980
$768
Tax-Exempt Municipal Bonds
13,132
$337
Convertible Debt & Preferred
137
$60
Nonconvertible Preferred
112
$17
Common Stock (Includ IPOs)
540
$104
Initial Public Offerings
97
$27
Law And Finance-Legal Systems And The
Size Of National Capital Markets
Countries/Legal
Systems
External
Cap/GDP
Private
Debt/GDP
Domestic Shareholder
Firms/Pop
Rights
English common
law countries
0.60
0.68
35.45
3.39
French civil law
countries
0.21
0.45
10.00
1.76
German civil law
countries
0.46
0.97
16.79
2.00
Scandinavian law
countries
0.30
0.57
27.26
2.50
All countries
0.44
0.59
21.59
2.44
Ownership Structure And Corporate
Governance In Continental Europe
Value of Global Mergers & Acquisitions,
1991-2002 ($US Billions)
4000
3500
3000
2500
2000
1500
1000
500
0
1990
1991
1992
1993
1994
1995
U.S. targets
1996
1997
1998
Non-U.S. targets
1999
2000
2001
2002
Pension Funds
And Capital
Markets
Pension Funds
And Capital
Markets (Cont)