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ECON 2560 (71)
Chapter 14

Chapter 14 ECON 2560

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University of Guelph
ECON 2560
Tahsin Mehdi

Chapter 14 ECON 2560 Introduction to Corporate Financing & Governance Capital Structure: A firm’s mix of debt & equity financing CREATING VALUE W/ FINANCING DECISIONS  Competition in financial markets is more intense than in most product markets  In product markets companies can regularly find competitive advantage that allow positive NPV investments  In an efficient capital market all securities are fairly priced given the info available to investors  In this case, the sale of securities at their market price can never be a positive NPV transaction  This means it’s harder to make or lose money by smart r stupid financing strategies COMMON STOCK Issued Shares: Shares that have been issued by the company Outstanding Shares: Shares that have been issued by the company & are held by investors Authorized Share Capital: Max # of shares that the company is permitted to issue as specified in the firms articles of incorporation Par Value: Value of security shown on certificate Additional Paid-in Capital: Difference between issue price and par value of stock (also called capital surplus) Retained Earnings: Earnings not paid out as dividends Book Value VS. Market Value  Markey value is usually greater than book value partly b/c inflation has driven the value of many assets above what they originally cost Dividends  Shareholders hope to receive a series of dividends on their investment  BUT the company isn’t obligated to pay any dividends and the decision is up to board of directors  B/c dividends are discretionary they aren’t considered to be a business expense  Companies CANT deduct dividend payments when they calculate their taxable income Ownership of the Corporation  A corporation is owned by common shareholders while a large portion of stock is held directly by individual investors and unincorporated businesses  Shareholders have control over the company’s affairs and occasionally company will need shareholder approval before they take certain action  The board usually consists of the company’s top management as well as non-executive directors who aren’t employed by the firm Voting Procedures Majority Voting: Voting System in which each director is voted on separately  Most company shareholders elect directors by this system  Shareholders can cast 1 vote for each share they own Cumulative Voting: Voting system in which all the votes 1 shareholder Is allowed to cast can be cast for 1 candidate for the board of directors  Shareholders can either vote in person or appoint a proxy to vote Proxy Contest: Takeover attempt in which outsiders compete w/ management for shareholder votes  Cards are stacked against outsiders b/c the insiders can get the firm to pay all the costs of presenting their case & obtaining votes  In some special cases such as important corporate decisions (including mergers, selling firm assets etc.) the votes of most of the minority shareholders must be received  Sometimes powerful minority shareholders can successfully prevent takeover decisions made by the company’s management or majority shareholders Classes of Stock  Many companies issue just 1 class of common stock  Sometimes a firm may have 2 or more classes outstanding, which differ in their right to vote or receive dividends  Common shares without fill voting rights are called restricted shares  There are various types of restricted shares  Restricted shares w/ no votes = non-voting shares  If they have less votes per share than another class of common shares = subordinate voting  Canadian securities regulators are making it harder for firms to convert an existing common share class into 2 share classes w/ different voting rights  In order to convert, most of the minority shareholders must approve  Stock exchanges will not list a new class of non-voting or subordinate voting shares unless the shares have the right to participate in takeover bids (coattail provision) Corporate Governance in Canada & Elsewhere  In many large corporations, shareholders own the company but don’t manage it  The separation between ownership & management in major Canadian corporations creates a potential conflict between shareholders & managers To mitigate this conflict…  Shareholders elect a board of directors which then appoints, oversees and sometimes fires managers  Managers remuneration is tied to their performance  Poorly performing companies are taken over & the management is replaced by a new team  A few years ago, Ontario introduced legislation to improve corporate governance & disclosure practices under an enactment known as Bill C-198 ( Canada’s Sarbanes-Oxley)  Intended to foster principles of corporate governance & provide for a healthy ethical business environment  Rules of corp. governance may differ across countries PREFERRED STOCK Preferred Stock: Stock that takes priority over common stock in regard to dividends  For most companies preferred stock is much less important than common stock  BUT it can be useful for financing in mergers and certain other special situations  Like debt, most preferred stock promises a series of fixed payments to the investor and with relatively rare exceptions preferred dividends aren’t paid in full & on time  No common stock dividends can be paid until all preferred dividends are paid  Like common stock, preferred stock usually does not have a final repayment  Preferred stock rarely confers full voting privileges  This is an advantage for firms hat want to raise new money without sharing control of the firm with the new shareholders  Companies can’t deduct preferred dividends when they calculate taxable income BUT dividend income is generally not taxed when received by Canadian corporations & is taxed at reduced rates by received by individuals who are eligible to a dividend tax credit  The government of Canada has made it harder for banks to buy preferred stock from other corporations Floating-rate Preferred: Preferred stock paying dividends that vary w/ short-term interest rates  The dividend rate could be tied to the prime rate of interest Net worth: Book value of common shareholder’s equity + preferred stock CORPORATE DEBT  When companies borrow money they promise to make regular interest payments & to repay the principle amount  Corporations have limited liability  The promise to repay debt is not always kept  If company is in trouble has the right to default on debt and hand over company’s assets to lenders  The company will choose bankruptcy only if the value of the assets is less than the amount of the debt Debt Come in Many Forms Major distinguishing characteristics… Interest Rate  The interest payment, or coupon, on most long-term loans is fixed at the time of issue E.g. If a 1000 bond is issued w/ a coupon of 10%, the firm continues to pay $1000 a year regardless of how interest rates change  Some
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