Capital Structure and Security Issuance
Capital structure notes are available in Word format here. The PowerPoint slides are available here. (2/1/99) Included in these notes are notes on Modigliani and Miller, when capital structure does matter, and conflicts between various stakeholder groups. There is also an explanation of why WACC is rarely the correct discount rate.
Tying the idea of capital structure back to the view of a firm as a nexus of contracts is important. We have spoken often of the wide array of securities available and the reasons why each exist (for example to reduce "fighting" between various stakeholders). An academic view of this idea can be found in Gilson and Warner's paper on junk bond financing. (2/4/99)
For questions on the costs of issuing new securities (which may be useful in several 488 cases Hint hint!), a starting point is the Lee, Lochead, Ritter, and Zhao 1996 paper which is abstracted on the Journal of Financial Research Web Site.
The promised table from Cliff Smith's book that helps us to understand signaling and expected price reactions surrounding capital structure changes is now available. I also included a table from a paper by Ronald Masulis. Both tables are excellent summaries of what we know in this area. Smith and Masulis tables.
The best site for information on Initial Public Offerings, IPOs, that I have found is from Hoovers. It has many good articles, definitions, and statistics. It additionally has a great set of notes on IPOs from William Schwerts' class at the University of Rochester. He is an excellent teacher and his notes are informative and concise. Unfortunately the site does not have Fortune's November 23, 1998 article on IPOs or Ritter's 1991 paper, or his 1998 working paper. An interesting article on how Peter Lynch evaluated IPOs is found on the Worth Magazine's web site. The November 23 Fortune article on IPOs is excellent but I can not find it on the web. (if anyone can please let me know). I would highly recommend you read the article. Also the Feb 1st WSJ article on page c1.
As was requested, a brief description of Bankruptcy is now available. For an example of how banks and other lenders monitor a firm to make sure the cash flow is secure click here. This is also a good example of how a lender may use ratios to predict financial difficulties. An even better explanation can be found from www.creditworthy.com which is a detailed explanation of the Altman Z-Score. (hint to 488 students, you will need this for the Safe Packaging Case) There are also some good links at the bottom of the Creditworthy page. For practical use I suggest you look at the MasterCard section on Z-Scores.
An alternative means of raising funds for smaller companies is through a direct public offering. The amount a firm can issue with this type of offering is limited to $1 million for any 12 month period. These type of issues are also called SCORs after the registration statement that must be filed. (SCOR stands for Small Corportae Offering Registration). This type of issue is relatively new (started in 1982 when SEC adopted regulation D). There are several restrictions such as who can buy the stock and even what types of firms can use this process. Many of these regulations vary by state. (in fact in some states Direct public offerings are not allowed at all.) Although there are many web-sites explaining the process, the two best that I have found are biz-dot.com and www.scor-report.com.
Rights issues are an alternative form of issuance.(3/18/99) This is where the compnay sells new stock to investors who hold rights. This type of issue typically has lower floatation costs.
Additionally here is an excellent site on several costs of capital issues.
Convertibles are again a hot topic. They are often a means of a firm issuing securities when there is a great opportunity for the firm to take advantage of typical bond holders. (That is a severe BH-SH conflict...generally due to large information assymetries or a firm with many growth opportunities). Lummer and Riepe have an article that explains this risk as well as gives historical returns on convertibles (hint: as expected the returns fall between straight debt and equity)..
Here are some additional sources for the interested reader:
The Demise of the Rights Issue, The Rewiew of Financial Studies, Fall 1998
Adverse selection and the rights offer paradox*, Journal of Financial Economics, Vol. 32, 1992
The effect of equity issues on ownership structure and stock liquidity: A comparison of rights and public offerings, Journal of Financial Economics, Vol. 43, 1997
Why underwrite rights offerings? Some new evidence, Journal of Financial Economics, Vol. 46, 1997