Topics in Corporate Finance

These flashcards cover key concepts and definitions related to corporate finance topics, focusing on information asymmetry, IPO processes, financing structures, and capital estimation challenges.

What is information asymmetry in corporate finance?

It occurs when one party in a transaction has superior information compared to the other, typically referring to managers having an advantage over external investors.

What is adverse selection?

It arises before a transaction, where lower-quality firms seek external finance, making it hard for investors to distinguish between good and bad firms.

What is moral hazard?

It occurs after a transaction when borrowers may take actions that benefit themselves at the expense of lenders once they have secured funding.

What is the Pecking Order Theory?

It states that firms prefer to finance first with internal funds, then debt, and lastly equity to mitigate information asymmetry.

What are the four key IPO puzzles in corporate finance?

Systematic underpricing, cyclicality of IPO volume, high flotation costs, and poor long-run performance.

Why does systematic underpricing occur during IPOs?

It occurs because firms must incentivize uninformed investors to participate, compensating for asymmetric information.

What is the winner's curse in IPO allocations?

It explains why uninformed investors often end up with poor IPO allocations when informed investors dominate oversubscribed offerings.

What are SPACs?

Special Purpose Acquisition Companies that raise capital through an IPO and later merge with private firms, offering a shortcut to public markets.

What is a seasoned equity offering (SEO)?

An additional capital-raising method post-IPO that can involve cash offers or rights offers to existing shareholders.

What are the challenges in estimating the cost of capital using the CAPM?

Difficulties include observable risk-free rates, varying market risk premiums, and the dependence of beta estimates on historical data and leverage.

How can firms reduce their cost of capital?

By enhancing share liquidity, improving transparency, stabilizing dividends, managing capital structure effectively, and strengthening corporate governance.

What are SAFE notes?

Debt/equity hybrid instruments used in venture capital that allow flexible conversion into equity.

What is the typical annual return expected by venture investors?

High Internal Rates of Return (IRRs) typically ranging between 20% to 40%.