Section 14 Flashcards
What can Agency cost of equity tell us?
it can be a signal of low profitability; can reduce effort of the manager (and thus affect value of firm)
What can the agency cost of debt do?
induce risk shifting and inefficient project choice (thus reducing value of firm)
define free cash flow?
cash flow in excess of that required to fund all projects that have positive net present values.
Describe the theory developed that explains the benefits of debt in reducing agency costs of free cash flow:
how to motivate managers to disgorce cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies
What does debt do to managers in regards to their ability to squander funds?
debt, and its periodic payments, reduces managers ability to squander funds on pet projects and “empire building”
what is the lazy manager problem?
managers in stable firms with lots of free cash flow and without much product market competition may become lazy and complacent
what does raising leverage do on managers in the lazy managers problem?
puts a lot of pressure on them to perform and make operations more efficient
what do most leverage increasing transactions do after the fact to common stock prices, and which transactions are they?
stock repurchases, exchange of debt or preferred for common, debt for preferred : result in significantly positive increases in common stock prices.
most leverage reducing transactions do what to common stock prices, and what are those transactions?
sale of common, exchange of common for debt/preferred, preffered for debt, call of convertible bonds, convertible preferred forcing conversion into common: result in significant decreases in stock prices
from 1973 to 1970’s crude oil prices did what..?
increased tenfold
what agency conflicts can excessive leverage produce?
risk shifting; managers have incentives to loot company prior to bankruptcy
inefficiently managed firms are targets for…?
corporate raiders
what is the market for corporate control?
the market for the right to control the management of corporate resources
name the types of takeovers:
mergers, hostile and friendly tender offers, proxy contests, leveraged buyouts
what is a merger?
bidder negotiates an agreement with target management on the terms of the offer for the target and then submits the proposed agreement to a vote with shareholders
what is a tender offer?
bidder makes an offer directly to shareholders to buy some or all of the stock of the target firm
what is a “Friendly” tender offer?
offers that are supported by target management
what is a “hostile” tender offer?
refers to offers which are opposed by target managements
what is a proxy contest?
dissident shareholder group attempts through a vote of shareholders to obtain control of the board of directors
what are leveraged buyouts?
buyouts of shareholders equity, heavily financed with debt by a group that frequently includes incumbent management
why are defensive strategies against hostile takeovers controversial?
they pose a conflict of interest for target management because they impose significant welfare losses on managers
how can defensive strategies against hostile takeovers help target shareholders during a control contest?
litigation and other blocking actions may provide necessary time for the management of the firm to “shop” the target and negotiate competing bids
what are some defensive measures against control contests?
litigation by target management, greenmail, poison pill
define litigation by target management:
litigation against a hostile suitor based on charges of securities fraud, antitrust violations, and violations of state or federal tender offer regulations
define greenmail:
targeted block stock repurchase - occurs when target management ends hostile takeover threat by repurchasing at a premium the hostile suitor’s block of target stock
define poison pills
first introduced in 1982 and describes a family of shareholder rights agreements that, when triggered by an event such as a tender offer for control: provide target shareholders with rights to purchase additional shares or sell shares to the target at very attractive prices; makes hostile acquisitions exorbitantly expensive in most cases since the bidder has to buy much more shares
what were some factors in the high level of takeover activity in the 1980’s?
changes in antitrust regulations, and deregulation
describe the changes in antirturst regulations that led to takeovers in the 80’s?
antritrust regulators object less to vertical combinations. Even horizontal mergers between industry leaders were completely taboo before the 1980’s and are often allowed now
Describe the deregulation that caused the takeover activity in the 1980’s
many of the mergers, takeovers, and restructuring over the last ten years have occurred in industries that recently were deregulated (transpiration, airlines, financial services, broadcasting, and oil/gas)
returns to shareholders of acquiring companies are..?
typically low or even negative.
returns to bidders and targets of takeovers…?
shareholders of target clearly benefit from takeovers because of high premiums
Moeller et all (2005) showed that from 1991 to 2001, acquiring firms shareholders lost..?
$216 billion
