Professor John ZietlowMBA 621

Professor John ZietlowMBA 621

An Overview Of Long-Term Financing

An Overview Of Long-Term Financing

Chapter 11Chapter 11

Chapter 11 OverviewChapter 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 StockCharacteristics 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)

Book Value Of Stockholders’ Equity In IBM As Of December 31, 2001 (In $ millions)

2001 2000

Preferred stock, par value $0.01 per share -- $ 247

shares authorized: 150,000,000

shares issued: 2,546,011

Common stock, par value $0.20 per share

$14,248

12,400

shares authorized: 4,687,500,000

shares issued: (2001: 1,913,513,218; 2000: 1,893,940,595)

Retained earnings

30,142

23,784

Treasury stock, at cost Shares (2001: 190 mm; 2000: 131 mm)

(20,114)

(13,800)

Employee trust benefits, at cost -- (1,712)

Accumulatd gains & losses not affecting RE (662) (295)

Total stockholders’ equity

$23,614

$20,624

Rights Of Common StockholdersRights 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 StockCharacteristics 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 DebtMethods 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)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 IBMShort-Term & Long-Term $US Debt of IBMShort-term debt

Commercial paper1 $ 4,809 Short-term loans 1,564 Long-term debt: Current maturities 4,815 Total $11,118

Long-term debt (In US Dollars) Debentures: Maturities Amount

6.22% 2027 $ 500 6.5% 2028 700 7% 2025 600 7% 2045 150 7.125% 2096 850 7.5% 2013 550 8.375% 2019 750

Notes: 6.3% average 2001-2014 2,772 MTN program: 5.8% avg 2001-2014 3,620 Other: 6.8% average 2001-2012 828

$11,320

Foreign Currency & Total L-T Debt Of IBMForeign Currency & Total L-T Debt Of IBM

Dollar Value of Foreign Currency Debt 2 Euros (4.4%) 2002-2005 $ 3,042 Japanese yen (1.1%) 2002-2014 $ 4,749 Canadian dollars (5.8%) 2002-2005 441 Swiss francs (4.0%) 2002-2003 151 Other (6.1%) 2002-2014 726 $20,429 Less: Net unamortized discount 47 Less: Current maturities 4,815 Total Long-Term Debt $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 onDecember 31, 2001. Average interest rates in parentheses.

Source: IBM website (www.ibm.com/annualreport)

Basic Choices In Long-Term FinancingBasic 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

Sources Of Funds For Non-Financial U.S. Corporations, 1980-2000

2000 1999 1996 1990 1980

Sources = Uses ($Billion) 1,535 1,503 1,051 538 387 Capital expenditures 1,021 907 685 430 262

Internal Sources

Profit after tax 410 372 310 141 116 - Dividends (264) (248) (201) (118) (45)

+ Depreciation 667 622 506 371 159 Total internal sources 887 806 678 432 207

External Sources

?Incrse non-mkt liabilities 387 404 313 120 139 Net raised in markets 301 338 80 64 83

Net new equity issues -153 -143 -70 -63 10 Net debt issues 447 482 149 127 73 Net ext = Financial deficit 648 697 373 106 180

Internal funding as % total 58 54 65 80 54 Financial deficit as % total 42 46 35 20 46

Fincl market funds % total 19 20 8 12 21

Net equity issues % total -10 -10 -7 -12 3

Banks Are The World’s Largest Corporations—But Only By Assets

Banks Are The World’s Largest Corporations—But Only By Assets

Bank Name Country

Total Assets

($US Billions)

Global Asset

Ranking

Mizuho Holdings Japan $1,304,342 1

Citigroup US 902,210 2

Deutsche Bank Germany 882,541 3

Bank of Tokyo-Mitsubishi Japan 716,934 4

J.P. Morgan Chase US 715,348 5

HSBC Holdings Britain 674,381 7

Hypovereinsbank Germany 672,692 8

UBS Switzerland 671,118 9

BNP Paribas France 651,590 10

External Financing Patterns For G-7 Countries: Averages For 1984-1991External Financing Patterns For G-7 Countries: Averages For 1984-1991

Country

External financing as a percent of total financing

United States

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

Composition Of Net External Financing, G-7 Countries: Average 1984-1991

Country

Net debt issuance, % of total external

Net equity issuance, % of total external

United States

134%

-34%

Japan

85

15

Germany

87

13

France

39

61

Italy

65

35

United Kingdom

72

28

Canada

72

28

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: PatternsAnnual 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

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

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

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

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

Ownership Structure And Corporate Governance In Continental Europe

Value of Global Mergers & Acquisitions, 1991-2002 ($US Billions)

Value of Global Mergers & Acquisitions, 1991-2002 ($US Billions)

0

500

1000

1500

2000

2500

3000

3500

4000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

U.S. targets Non-U.S. targets

Pension Funds And Capital

Markets

Pension Funds And Capital

Markets

Pension Funds And Capital

Markets (Cont)

Pension Funds And Capital

Markets (Cont)