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BRN 482 Corporate Financial Policy Clifford W. Smith Summer 2007 Handout 5 * Covers readings on course outline through Barclay/Smith (1996)
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Financial Architecture Leverage Leverage Bond covenants Bond covenants Public vs. private debt Public vs. private debt Maturity Maturity Priority Priority Conversion rights Conversion rights Call provisions Call provisions
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Private vs. Public Debt Larger issues usually public Larger issues usually public fixed registration fees under-diversification of private lenders The riskier the debt, the more likely that it will be private The riskier the debt, the more likely that it will be private easier to renegotiate usually contains more, and more specific, contract provisions
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Relation between Yield on Net Proceeds & Issue Size for Representative Private Placement and Public Issue Debt Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA
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Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA
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Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt Baa (Private) Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA S BAA Baa (Public)
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Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt Baa (Private) Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) S AAA S BAA Baa (Public)
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Investment Opportunity Set Assets in Place Growth Opportunities Cost of Longer Maturity Low High (Underinvestment) Predicted Maturity Long Short
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Investment Opportunity Set Assets in Place Growth Opportunities Cost of Low Priority Low High Fixed Claims (Creditor Conflicts)
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Assets in Place Growth Opportunities Cost of Low Priority Low High Fixed Claims (Creditor Conflicts) Concentration of Lower Greater Priority Classes Investment Opportunity Set
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Benchmarking Impact on Private Debt Impact on Maturity Impact on Priority Concentration Growth Options (Merck)GreaterShorterGreater Credence Goods (Eastern)GreaterShorterGreater Product Warranties (Yugo)GreaterShorterGreater Future Product Support (Yugo/Wang)GreaterShorterGreater Supplier Financing (Campeau)GreaterShorterGreater Firm SizeLessLongerLess Closely Held FirmGreaterShorterGreater RegulationLessLonger? Tax Credits ——Less Marginal Corporate Tax Rate —— — Marginal Personal Tax Rate — — — Abnormal EarningsGreater ShorterGreater
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Deregulation and Debt Maturity Leverage and Debt Maturity in the Telecommunications industry 1974-1994
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Investment Opportunity Set Financial Architecture Leverage High Low Maturity Long Short Priority(Table 5) Diffuse Concentrated Conversional RightsLow High Leasing(Table 4)High Low Compensation Level of Pay Low High Conditional Pay Low High Assets in Place Growth Opportunities
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