Coorporate issuers Flashcards
Market factors are
shareholder engagement, shareholder activism and competition and markets
Stronger corporate governance
can have many benefits including; operational efficiency, improved control, better operating and financial performance and lower default risk and cost of debt.
A pull on liquidity is when
> disbursements are paid too quickly or trade credit availability is limited
making payments too early; reduced credit lines from suppliers due to late payments; limits of short-term lines of credit; low liquidity positions
Perquisite consumption refers to
> the level of spending that company executives are allowed to legally spend including on such things as company cars and hospitality.
Higher perquisite consumption will increase equity agency costs.
The pecking order theory suggests
> that managers will prefer to raise capital using the method which revels the least information about the internal operations of the company.
this usually means using internally generated capital first.
issue equity when they believe that it is overvalued by the market. As such investors may take the decision to issue equity as being a negative signal
Higher levels of information asymmetry between managers and investors places investors at greater risk. As such
both providers of debt capital and providers of equity capital will expect higher returns than otherwis
Freemium pricing
allows a certain level of usage or functionality of goods and services without charge
> growth strategy
Penetration pricing
is an approach which uses discounted pricing to gain market penetration
> growth strategy
An aggregator is a type of marketplace
where a company remarkets products such as the computer games under its own branding.
Limited partners cannot replace the
general partner
eu corporations pay
corporate tax + income tax
All of the profits and losses of a general partnership are
collectively shared by the general partners. If one partner is unable to pay their share of the debt, then the remaining partners remain fully liable collectively for the debt.
In a two-tier structure
the management board run the company but are supervised by the supervisory board.
the supervisory board is mainly comprised of non-executive directors whilst the management board is composed of executive directors.
A one-tier board
is comprised of both executive and non-executive directors.
responsibility of the board of directors
Ensuring the effectiveness of the company’s audit and control systems
Ensuring leadership continuity through succession planning
Income is paid to debt holders pre corporation tax but paid to equity holders post corporation tax.
It is senior management that is responsible for implementation of strategy. The Board will, however, oversee the execution of the strategy.
Use the market values if given a choice between market value and par value of debt and equity
The target structure and the optimal structure may be the same, but
> the market values are constantly varying and other factors such as the cost of issuing securities mean that this is often not the case.
companies will keep them within a range.
MM I with corporate taxes states that the
market value of a leveraged company is equal to the value of an unleveraged company plus the value of the debt tax shield.
MM II without corporate taxes states that the
cost of equity is a linear function of the company’s debt to equity ratio.
MM II with corporate taxes states that the cost of equity
is a linear function of the company’s debt-to-equity ratio with an adjustment for the tax rate.
Project NPV with real options
= NPV (based on DCF [discounted cash flow] alone) – Cost of options + Value of options. Calculate the NPV based on expected cash flows.
Sole Proprietorship (Sole trader)
- No legal identity – considered to be an extension of the owner
- Owner-operated business
- Owner retains all returns and assumes all the risk
- Profits from business taxed as personal income
- Operational simplicity and flexibility
- Financed informally through personal means
- Business growth is limited by owner’s ability to finance and personal risk appetite
- Typically, pass-through businesses (for tax)
- Business not taxed at entity level
- Profit / losses passed to sole trader who is taxed personally
- Access to capital limited by sole trader’s ability to raise finance
General Partnership
No legal identity – partnership agreement sets ownership
* Owner/Partner-operated business
* Partners share all risk and business liability
* Partners share all return, with profits taxed as personal income
* Contribution of capital and expertise by partners
* Business growth is limited by partner resourcing capabilities and risk appetite
Limited Partnership
- There must be at least one General Partner (GP) and a number of Limited
Partners (LPs) - No legal identity – partnership agreement sets ownership
- GP operates the business and has unlimited liability
- LPs have limited liability and have no control over business operations
- All partners share the returns, with profits taxed as personal income
- Contribution of capital and expertise by partners
- Business growth is limited by GP/LP financing capabilities and risk appetite and
GP competence and integrity in running the business - Typically, pass-through businesses (for tax)
- Business not taxed at entity level
- Profit / losses passed to partners who are taxed personally
- Access to capital limited by partner’s ability to raise finance
Investment fund established as a Limited Partnership
The Fund - (Limited Partnership)
Fund Manager- (GP)
Investor /client - (LP)
Corporations
- A corporation is an evolved model of a limited partnership
- Known as a limited liability company (LLC) or just limited company
- In the US a corporation and an LLC are not the same
- In a US LLC, tax is at the personal level
- In a US corporation, tax is at the personal level and corporate level
Public for-profit
Private for-profit
Nonprofit
- Separate legal identity
- Owner-operator separation allows for greater, more diverse resourcing with some risk control
- Business liability is shared across multiple, limited liability owners with claims to return and financial risk of their equity investment
- Shareholder tax disadvantage in countries with double taxation
- Dividends taxed as personal income
- Unbounded access to capital and unlimited business potential
Non profit
- Formed with a specific purpose, e.g. promoting a public
benefit or charitable mission - Have a board and can have paid employees
- No shareholders and no dividends
- Typically exempt from tax
- Any profits must be use the promote the mission
Public for-profit
- Have profit motive and specific purpose at inception
- Usually listed on a stock exchange
- In some countries (UK and Australia) having more than
50 shareholders causes the corporation to be categorized
as public whether or not it is listed on a stock exchange
Private for-profit
- Have profit motive and specific purpose at inception
- Not listed on a stock exchange
Investment fund established as a Corporation
The Fund (Corporation)
pays
Fund Manager (Separate company)
Fund Board of Directors
elected by shareholders hire fund maanger
Public companies
- Mostly, public companies have their shares listed and traded on an exchange
- Change of ownership is often quick and easy to achieve
- However, it can take some time if it involves a large order in a less liquid stock
- Each trade has the potential to move the price of the stock
- Freely traded shares, not held by insiders, strategic investors or sponsors, are
called the issuer’s “free float”
Private companies
- Private companies do not trade on exchanges
- There is no price transparency
- Trading of shares can be difficult and sometimes not allowed
- So why buy shares in a private company?
- Potential returns can be very high since investors join when the company is new
- This also means that investment risks are high
Share issuance
- After listing, public companies may raise large amount in the capital markets by issuing additional shares to many investors
- In contrast, private companies finance much smaller amounts in the primary market with far fewer investors who have much longer holding periods
- Investors in private companies normally do this through a private placement
- Terms are outlined in a private placement memorandum
- Investment may be restricted to accredited investors, also termed eligible or professional investors
Registration and Disclosure Requirements
- Public companies are required to register with a regulatory authority and are subject to greater compliance and reporting requirements
- In the US public companies must file financial information to the SEC on a quarterly
basis through a system known as EDGAR (Electronic Data Gathering, Analysis and Retrieval) - In the Europe Union, listed companies must disclose semi-annually
- Public companies must also disclose stock transactions made by officers and directors
- Private companies are not subject to such tight regulatory oversight and do not have an obligation to report information to the public
Going Public From Private
- Initial Public Offering
- Companies must meet certain requirements required by the exchange
- They are assisted by investment banks who underwrite the issue and pass cash raised to the issuer
- Once the IPO is completed, the company is public and its share trade on the exchange
- Direct listing
- No investment bank/underwriter involvement
- No new capital is raised
- The company simply lists on the exchange and shares are sold by existing investors
- Acquisition
- A larger public company acquires a smaller company and the small company forms part of the listed company
Going Public From Private
- Special Purpose Acquisition Company (SPAC)
- A shell company (a.k.a. a ‘blank check’ company)
- Set up solely to acquire an unspecified private company in the future
- Raises capital through an IPO
- Proceeds placed in a trust account and are used for acquisition or returned back to
investors - Publicly listed and often specialize in a particular industry
- Have a shelf life, such as 18 months, to complete the deal or return the funds
- Often investors will have some indication of what company the SPAC will acquire
- Based on the backgrounds of the SPAC executives, or
- Comments such individuals have made in the media
- Once acquisition of a private company has happened, the company becomes public
Life cycle stage Start up
Revenues
Cash flow
Business risk
Financing need
Financing difficulty
Low to none
Negative
High
Proof of concept
Very high
Life cycle stage Growth
Revenues
Cash flow
Business risk
Financing need
Financing difficulty
Increasing
Increasing
Moderate
ScALE
V high to high
Life cycle stage Maturity
Revenues
Cash flow
Business risk
Financing need
Financing difficulty
Positive &
Predictable
Positive &
Predictable
Low
Business as usual
Moderate to low
Life cycle stage Decline
Revenues
Cash flow
Business risk
Financing need
Financing difficulty
Deteriorating
Deteriorating
Increasing
Shortfalls
Increasing
Shareholders
Indefinite term
Unlimited potential return
Maximum loss – initial investment
Higher investment risk
Aim is to maximise firm value
Debtholders
Defined term
Capped return
Maximum loss – initial investment
Lower investment risk
Aim is for timely repayment
Lenders
- Company has a binding contract with lenders (debtholders)
- Claims fully paid before any payments to owners (shareholders)
- Company must have the funds to make interest payments
- Legal recourse
- Interest payments are generally tax-deductible
- Cheaper source of funding for the company and less risk for investors
- If the value of the firm falls below the book value of debt,
debtholders experience losses - Potential loss is invested amount but upside is capped
Owners
- Have a residual interest after all creditors have been paid
- No legal recourse
- Dividends paid out of net income but are discretionary
- Equity is a more permanent source of capital
- Have the right to vote
- Potential loss is invested amount but unlimited upside
Bondholders
- Assess the likelihood of timely repayment of debt. As such, they:
- Assess the issuer’s cash flows and collateral/security
- Evaluate issuer creditworthiness and willingness to pay its debt
- Estimate the probability of default and the loss given default
- Downside risk increases as a company takes on more debt
- Bond investors receive priority in times of financial distress
- Can often force the company to liquidate its assets and return cash to bond
investors
Issuer perspective
Equity
Capital cost
Attractiveness
Investment risk
Investment interest
Higher
Creates dilution, may be only option when issuer cash flows
are absent or unpredictable
Lower, holders cannot force liquidation
Max (Net assets – Liabilities)
Issuer perspective
Debt
Capital cost
Attractiveness
Investment risk
Investment interest
Lower
Preferred when issuer cash flows are predictable
Higher, adds leverage
Debt repayment
Equity v Debt – Conflicts of Interest
- Potential conflicts exist between shareholders and bondholders
- Equity investors prefer management to invest in projects that have greater risk and return
- At the extreme, shareholders would like the company to increase dividend payments and share repurchases with debt proceeds
- Bondholders receive no upside from a company investing in risky projects
- Returns are capped to the par value plus coupons
- Bondholders often rely on covenants to protect them against actions by management that compromise the safety of their investment
Corporate governance practices
- The corporate governance systems adopted around the world typically reflect the influence of shareholder theory or stakeholder theory to a varying extent:
Shareholder Theory
* Most important responsibility of a company’ s managers is to maximise shareholder returns
Stakeholder Theory
* Broadens a company’s focus beyond the focus of shareholders to include customers, suppliers, employees and others that have an interest in the company
- Stakeholder theory gives more prominence to Environmental, Social and Governance considerations by making them an explicit objective for the Board of
Directors and management
Shareholders
Owners of the company entitled to the net value of the company and are the most subordinate of capital providers
* Shareholder focus is typically growth in profitability that maximizes equity value
* Have the ability to vote
* Controlling vs. Minority shareholders
Creditors
- Most commonly bondholders and banks lending money to the company
- No voting rights
- May use covenants to restrict the activities of the borrower
- Company’s ability to generate cash flows is primary source of repayment
- Creditors prefer stability in the company’s operations
- Private debtholders have greater access to company management with lower information asymmetry than public debtholders
Managers and Employees
- Compensated through salary, bonuses and equity-based compensation and therefore motivated to maximize the value of their remuneration while protecting their employment position
- Employees provide labor and skills (human capital)
Board of Directors
- Elected by shareholders to protect the shareholders’ interests, provide strategic direction, monitor and manage company performance
- Boards often have inside directors (e.g. founders) and independent directors(no material company relationship)
- One-tier board: Consist of a single board of directors containing executive and non-executive directors
- Two-tier board: Supervisory Board (mainly non-executives) overseas the Management (Executive) Board
Customers
- Customer expects a company’s product or services to satisfy their needs given the price paid and often require ongoing support from a company
- Customer satisfaction and sales revenue/profit are often highly correlated!
- Tend to be less concerned with, and affected by, a company’s financial performance
Governments
- Seek to protect the interests of the general public and ensure the well-being of their nations’ economies
- Companies have a significant impact on an economy’s output, employment and social welfare
- Regulators have an interest that applicable laws are adhered to
- Major source of tax revenue to a government
Suppliers
Primary interest in being paid in a timely manner
* Suppliers often seek to build long-term transparent and fair relationships with the companies for the benefit of both parties
* Concerned with the company’s cash flows generating abilities to meet its obligations
Introduction to Environmental, Social, and Governance Issues
- Environmental and social issues were treated as negative externalities (costs which are not borne by the company or investors) – ESG aims to internalise these costs
- The concept of considering the environmental, social and governance factors in the investment process
- The inclusion of governance factors in investment analysis has been in place for some time but the practice of considering environmental and social issues has
evolved more slowly - ESG factors were once regarded as intangible or qualitative information but this has moved on to become tangible and decision-useful information due to increased corporate disclosures and refinements in the identification and analysis of ESG factors
Environmental issues
Climate change and carbon emissions
Air and water pollution
Biodiversity
Deforestation
Energy efficiency
Waste management
Water scarcity
Social issues
Customer satisfaction and product responsibility
Data security and privacy
Gender and diversity
Occupational health & safety
Treatment of workers
Community relations & charitable activities
Human rights
Labor standards
Governance issues
Board composition (independence & diversity)
Audit committee structure
Bribery and corruption
Executive compensation
Shareholder rights
Lobbying & political contributions
Whistleblowing schemes
Three catalysts for ESG Growth
- Increased material impact of ESG factors
- Environmental disasters
- Social controversies
- Governance deficiencies
- The interest of younger clients in the environmental and social impact of
investments has grown - Government stakeholder’s prioritization of climate change and social policies
Environmental Factors
- Environmental factors that are material in investment analysis include: Natural resource management, pollution prevention, water conservation, energy efficiency
and reduced emissions - Climate change risk can be identified as:
- Physical risk: Such as the risk of extreme weather damage to assets (commonly insurable or diversifiable)
- Transition risk: Risks associated with the change to a low carbon economy (may result in stranded assets e.g. oil reserves no longer economically viable)
- Adverse material environmental effects can result from factors such as reputational damage, legal claims, regulatory fines or environmental clean-up
costs
Social Factors
- Social factors relate to the impact of an organisation’s actions on:
- Employees e.g. employee turnover, health and safety, diversity
- Human capital
- Customers e.g. data privacy
- Communities e.g. community relations
- Managing social risk can reduce organisational costs, for example by increasing employee productivity, reducing litigation actions and reducing reputational damage
Governance Factors
- Governance factors include issues such as:
- Company ownership and voting
- Board composition and skills
- Executive remuneration
- Board level management of long term risk and sustainability
Assessment of how ESG-related risks and opportunities impact a company’s cash flows
- Identify material ESG effects and quantify them in financial terms
- Major, long term ESG effects will usually have greatest effect on equity
- Fixed income investors are mainly impacted by adverse ESG events which affect the ability to make interest and principal payments
- The maturity of an adverse ESG event is important e.g. consider the long-term risk that a fossil fuel reserve becomes a stranded asset - mainly affecting longer term debt vs shorter term debt
