Long-term Financing

Introduction to Long-Term Financing

  • Overview of long-term financing and its importance in corporate finance.

  • Understanding the basic features of securities.

Basic Features of Securities

  • Types of securities: Includes equity (stocks) and debt (bonds).

  • Key differences between equity and debt.

    • Equity: Ownership stake in the company, potential for capital appreciation, dividends at the board's discretion.

    • Debt: Loan to the company with interest payments, no ownership stake, tax-deductible interest.

  • Historical trends in corporate finance.

Common Stock Features

  • Definition: Refers to stock without preference for dividends or bankruptcy payouts.

  • Shareholder Rights:

    • Voting rights: Typically "one share, one vote".

    • Voting Mechanisms:

      • Straight voting: Each share equals one vote per candidate.

      • Cumulative voting: Total votes equal to shares owned multiplied by the number of directors to elect.

Example of Voting Mechanics

  • Straight Voting Example:

    • Kim (20 shares) and Park (100 shares) both vote, Park is likely to elect all directors.

  • Cumulative Voting Example (6 directors):

    • Kim casts 20 votes and Park casts 100 votes; Kim can impact election if accumulating at least 101 votes.

Korean Context

  • Shareholders with over 3% ownership can request cumulative voting.

  • Only 3.9% of firms with over 1 trillion won in assets allow cumulative voting.

  • Staggered elections where a fraction of directors are elected each year.

Violations of Voting Principles

  • Dual-Class Stocks: Around 6% of U.S. firms have different voting rights, leading to possible shareholder imbalance.

  • Pyramid Ownership Structures: Common in Asia/Europe, complicates voting rights.

  • Other Rights of Shareholders:

    • Share in asset liquidation, vote in major decisions, and share proportionally in dividends.

Value of Equity

  • Types of Shares:

    • Authorized shares: Shares issued under incorporation agreement.

    • Outstanding shares: Shares held by investors.

    • Treasury shares: Shares repurchased by the firm.

  • Book Value of Common Stock:

    • Calculation includes capital surplus, par value, and retained earnings.

Market Values vs. Book Values

  • Market Value of Equity: Reflects future expected dividends; calculation depends on shares outstanding and current market price.

  • Book Value of Equity: Historical measure based on past transactions; less relevant for current shareholder value.

Preferred Stock Features

  • Definition: Equity claim that requires dividend payment before common stockholders.

  • Characteristics:

    • Fixed dividends, no voting rights (unless unpaid), and equal claim in bankruptcy.

  • Firms use preferred stock to avoid the bankruptcy consequences associated with unpaid debt.

Long-Term Debt Features

  • Definition: Debt does not confer ownership or voting power.

  • Tax-deductible interest payments.

  • Legal recourse in case of unpaid interest or principal.

  • Debt Contracts Features:

    • Face value, market price, coupon payments, and maturity.

Classifications of Debt

  • Types: Long-term debt (maturity > 1 year), bonds, notes, debentures, secured and unsecured debt.

  • Callable Debt: Can be repurchased at a predetermined price.

  • Indenture agreement: Outlines terms between a firm and its lenders.

Patterns of Corporate Financing

  • Trends show internal cash flow dominating as a source of funding U.S. firms.

  • Overview of cash flow uses: capital spending and working capital.

  • From 2003 to 2013, average financing in Korean firms indicated reliance on bank borrowing.

Recent Trends in Capital Structure

  • Debt Ratio (D/E): Calculated based on company financing choices; recent average for U.S. non-financial firms below 50%.

  • Determinants of debt ratios: external financial choices, profitability, and retained earnings.

  • Market vs. Book Value: Financial analysts prefer market values, while treasurers may favor book values due to stability.