Long-Term Financing

Professor XXXXXCourse Name / Number

2

Common Stock and Long-Term Debt

• Common stockholders are residual claimants– No claim to earnings or assets until all senior

claims are paid in full– High risk, but historically also high return

Long-Term Financing

Debt capital represents a legally enforceable claim

Equity capital

3

Common Stock

Par value Denomination. Little economic relevance today

Shares authorized, outstandin

g, and issued

Maximum number of shares that can be issued

Additional paid-in capital

Amount received in excess of par value when corporation initially sold stock

4

Common Stock

Market capitalizati

on

Market price/share x number shares outstanding

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

5

Book Value Of Stockholders’ Equity In IBM

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

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

6

Rights Of Common Stockholders

Voting rights of common stockholders can be exercised in person or by proxy.

Most US corporations have majority voting. Each share gives one vote for

each director’s position.

Cumulative voting gives minority shareholders greater chance of electing

one or more directors.

Shareholders do not have a legal right to receive dividends.

7

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 preferred stock held mostly by corporations.

Promises a fixed annual dividend payment, but not legally enforceable; firms cannot pay common stock dividends if

preferred stock in arrears.

Preferred stockholders usually do not have voting rights.Venture capitalists an exception: they have control rights

and receive board of directors seats.

8

Methods Of Classifying Long-Term Debt

Maturity

Short-term: Bills

Intermediate-term: Notes

Long-term: BondsOnly long-term debt is part of a

corporation’s capitalization

SeniorityRank in priority of claims to assets and cash flow. Senior versus subordinated

debt

Interest payment method

Floating or fixed rate debt

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Methods Of Classifying Long-Term Debt

Callability

Firms could retire and reissue debt if interest rates fall.

Most US corporate debt is callable by firm.

Security

Is debt secured by explicit collateral?

Mortgages: secured by real estate

Equipment trust receipts:secured by transportation equipment

Debentures: no explicit collateral

10

Methods Of Classifying Long-Term Debt

Method of principal

repayment

Bullet loans: principal repaid in a lump sum at maturity

Amortized loans: equal periodic principal and interest payments

Security versus loan

product

Capital market instruments:bonds, notes, bills are securities

Syndicated bank loans the most important loan products

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Short-Term and Long-Term US Dollar Debt of IBM

Short-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

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

12

Foreign Currency and Total Long-Term 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)

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Basic Choices In Long-Term Financing

Corporations 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 as debt vs. equity?Internal financing: cash flow from operations minus cash dividends

Amount not fixed: firm can vary dividends and capital structure

Corporations are almost always net dissavers.

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Sources Of Funds For Non-Financial U.S. Corporations

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

Source: Federal Reserve System data, reported in Statistical Abstract of the United States, various issues.

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

Bank Name CountryTotal

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 10Source: “Fortune Global 500: The World’s Largest Corporations”, Fortune (July 23, 2001)

16

External 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 (December 1995).

17

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 (December 1995).

18

Annual Global Securities Issuance: Patterns

Securities 1990 - 2000 2001 2002

Issued on public capital markets

$20 trillion$4.07 trillion

$3.9 trillion

Private placement $3-4 trillion$500 billion

$417 billion

U.S. issuers account for two-thirds of total public issue volume.

Debt issues are over three-fourths of US total every year.Equity issues play small financing role everywhere.

Source: Investment Dealers’ Digest, various early January issues, 1991-2003.

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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 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.Source: Investment Dealers’ Digest, January 6, 2003.

20

U.S. Public Security Offerings, 2002

Security Type # Offerings Value $US Billion

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 (Including IPOs)

540 $104

Initial Public Offerings 97 $27Source: Investment Dealers’ Digest, January 6, 2003.

21

Law And Finance-Legal SystemsCountries/Legal Systems

External Cap/GDP

Private Debt/GD

P

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

Source: Rafael LaPorta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, “Legal Determinants of External Finance”, Journal of Finance 52 (July 1997), pp. 1131-1150

22

Ownership Structure And Corporate Governance In Continental Europe

Source: ‘Lean, Mean and European; A Survey of European Business,” The Economist (April 29, 2001), p.12

23

Global Mergers and Acquisitions, 1991-2002 (US Dollar 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

Source: Judy Radler Cohen, “M&A: Hoping for Recovery,” Investment Dealer’s Digest (January 14, 2002), pp. 29-43, and previous IDD issues

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Pension Funds And Capital Markets

Source: The Economist (May 20, 2000), p.127

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Pension Funds And Capital Markets

Source: The Economist (February 3, 2001), p.54

Long-term financing instruments: common and preferred stock, debt

Financial deficit: difference between firm’s total funding needs and internally

generated cash flows

Financial intermediaries are institutions that raise funds by selling claims on themselves

Volume of security issues surged eight-fold in 11 years

Long-Term Financing