Corporate Finances - Comprehensive Study Notes
Corporate Finances
Key Terms
Security: A share, participation, or other interest in property or an enterprise of the issuer, or an obligation of the issuer.
Equity Security: A security representing ownership interest in an enterprise, often referred to as a share.
Equity Capital: Capital received by a corporation in exchange for the issuance of stock.
Debt Security: A security representing an obligation of the corporate issuer; commonly known as a bond.
Debt Capital: Money received by a corporation in exchange for issuing debt securities.
Bondholder and Dividend
Bondholder: An individual or entity to whom a debt is owed by a corporation.
Dividend: A distribution of corporate profits to shareholders.
Types of Stock
Common Stock: Ordinary stock of a corporation with no special privileges.
Preferred Stock: Stock in a corporation that carries specific rights and privileges.
Equity Securities Glossary
Authorized Shares: Shares authorized for issuance specified in the corporation's articles of incorporation.
Common Stock: Shares that possess voting rights, the right to receive distributions (if declared), and the right to share proportionately in net assets upon liquidation of the corporation.
Convertible Preferred Stock: Preferred stock that can be converted into other stock of the corporation, typically common stock.
Cumulative Preferred Stock: Preferred stock with dividends that accumulate if not paid due to the corporation’s financial status and must be paid prior to any distribution to common shareholders.
Outstanding Shares: Shares that are authorized, issued, and held by shareholders, entitling them to voting, liquidation, and dividend rights.
Participating Preferred Stock: Preferred stock whose holders can receive guaranteed dividends and, if available, share in any additional dividends after common shareholder distributions.
Par Value: The minimum amount at which a share of stock may be issued; this is the nominal or face value assigned to a security.
Redeemable Preferred Stock: Preferred stock that can be required to be resold to the corporation upon demand or during a call by the corporation.
Sinking Fund: A reserve account earmarked for the redemption of stock or for retiring bonds.
Treasury Shares: Shares reacquired by the corporation, considered authorized and issued but not outstanding.
Watered Stock: Shares issued for less than par value.
Comparison of Common and Preferred Stock
Voting Rights:
Common Stock: Usually one vote per share.
Preferred Stock: May or may not have voting rights; specified in articles, with voting rights being rare.
Distribution Rights:
Common Stock: No guaranteed distributions; distributions declared at the discretion of the board, requiring corporate solvent status.
Preferred Stock: Distributions can be cumulative, and they may also have a participating feature for additional dividends.
Liquidation Rights:
Common Stock: Shareholders receive assets after creditors and preferred shareholders have been paid.
Preferred Stock: Shareholders receive assets after creditors but before common shareholders.
Conversion Rights:
Common Stock: No conversion rights.
Preferred Stock: May have the right to convert their preferred shares into other types of shares.
Redemption Rights:
Common Stock: No redemption rights.
Preferred Stock: Shareholders may be compelled to sell back to the corporation.
Debt Securities Glossary
Bonds: Debt instruments secured by collateral that creditors can access if the corporation defaults.
Convertible Debt Security: Debt security that can be converted into equity securities (shares) of the corporation.
Debentures: Long-term debts that are unsecured; creditors must sue to recover in a default scenario.
Debt Securities: Documentation evidencing a corporation’s debt to a party, who is a creditor without voting rights.
Junk Bond: A bond with a higher risk of default offering higher yield compared to more secure bonds.
Mortgage Bonds/Notes: Documents by a corporation pledging real estate as collateral for debt repayment.
Redeemable Debt Security: Can be paid off or redeemed before its maturity date.
Security Agreement: A document chronicling the pledge of corporate personal property as collateral for a debt.
Subordinated Debt Security: Debt ranked lower in repayment order compared to other debts that have priority.
Comparison of Equity and Debt Securities
Equity Securities (Stock):
Shareholders own the corporation, entitled to vote and receive distributions (if earnings permit).
Issuance of shares provides cash for the corporation but dilutes the power of existing shareholders.
Debt Securities (Bonds):
Bondholders are external creditors with a right to repayment.
Issuance of bonds provides cash without diluting the power of existing shareholders, but bonds must be repaid.
Distribution in Insolvency:
Equity: No distributions are given to shareholders if the corporation is insolvent.
Debt: Bondholders may still receive interest and principal payments regardless of corporation's solvency.
Tax Implications:
Corporations cannot deduct shareholder distributions from taxes; they pay taxes on earnings.
They can deduct interest on debt securities to reduce taxable income.
Liquidation Order:
Equity: Shareholders receive assets only after creditors and bondholders are paid.
Debt: Bondholders are prioritized over shareholders in asset distribution during liquidation.
Green Bonds and Social Bonds
Corporations are increasingly issuing green bonds to fund eco-friendly projects like clean transportation, pollution prevention, and energy efficiency in response to investor demand.
Green and social bonds reflect the emphasis on sustainable investing and Environmental-Social-Governance (ESG) issues that shareholders are calling for.
Taxation of Corporations
Corporations are recognized as separate entities by the state and thus are liable for taxes like any other individual. They are subject to federal taxes, as well as potentially state and local taxation.
Double Taxation: This refers to the taxation of corporate income at two stages: once at the corporate level and again at the shareholder level when profits are distributed.
Inversions
Corporate inversions occur when a U.S. company reincorporates following a transaction with a foreign company to benefit from lower tax rates in that foreign country.
2017 Tax Reform
The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate to a flat 21% from a former maximum of 35%.
The reform introduced a modified or hybrid territorial tax system applicable to U.S. corporations.
2017 Tax Reform Continuance
Companies face a one-time mandatory repatriation tax on overseas profits: 15.5% for cash and 8% for noncash assets, payable regardless of repatriation action. The tax can be spread across eight years.
Foreign income earned after 2018 is exempt from U.S. tax due to the new territorial tax system. Corporations can deduct 100% of dividends from related foreign companies if they own at least 10%, subject to specific holding periods.
Key Features of Corporate Finances
To raise capital, corporations issue stock (equity securities) representing ownership interest or bonds (debt securities) representing loans.
Share issuance must follow regulations set forth in corporate articles of incorporation.
Par Value: The minimum price for which shares can be sold, applicable to issued shares. If no par value is established, shares may be sold for any amount determined by the corporation’s directors.
Corporations may establish multiple classes of stock, where common stock typically provides voting rights, distribution rights, and liquidation rights.
Preferred stock often confers additional rights such as cumulative dividends, conversion, or redemption privileges.
Debt securities can be either secured or unsecured; the terms affect the recovery process in the event of default.
Interest payments on bonds are deductible, while dividends are not, contributing to the corporation's double taxation scenario.