1、ChapterMcGraw-Hill/IrwinCopyright 2008 by The McGraw-Hill Companies,Inc.All rights reserved.Common and Preferred Stock Financing17第1页，共69页。Chapter 17-Outline Common Stock The Voting Right Rights Offering“Rights-on”and“Ex-rights”Poison Pill Preferred Stock Provisions Associated with Preferred Stock R
2、isk and Expected Return Summary and ConclusionsPPT 17-22第2页，共69页。Common Stock Stockholders-Ultimate owners of a firm Legally,stockholder directly controls the business A large creditor may have the power to exert pressure on the firm to meet certain financial performance standards3第3页，共69页。Preferred
3、 Stock Plays a secondary role in financing the corporate enterprise Represents a hybrid security by combining some of the features of debt and common stock Stockholders do not have an ownership interest in the firm Stockholders have a priority of claims to dividends superior to that of common stockh
4、olders4第4页，共69页。Common Stockholders Claim to Income Common stockholders have a residual claim to income These funds can be paid out as dividends or retained by the firm They do not have a legal or enforceable claim to dividends A firm may have several classes of common stock outstanding that carry d
5、ifferent rights to dividends and income5第5页，共69页。Institutional Ownership of U.S.Companies6第6页，共69页。The Voting Right Common stockholders have the right to:Vote in the election of board of directors Vote on all other major issues Assign a proxy or“power to cast their ballot”Companies can have differen
6、t classes of common stock with unequal voting rights Such as“founders shares”Bondholders and preferred stockholders may vote:If a corporate agreement has been violated7第7页，共69页。The Voting RightProxy:assigning shareholders right to vote to another individualMajority Voting:all directors must be elect
7、ed by at least 51%of the vote doesnt allow minority shareholders representation on the board of directorsCumulative Voting:a shareholders votes can all be used to elect 1 person allows minority shareholders representation on board PPT 17-48第8页，共69页。Cumulative Voting ProcessTo determine the number of
8、 shares needed to elect a given number of directors under this method of voting:If the number of minority shares outstanding under cumulative voting is known,the number of directors that can be elected can be determined:9第9页，共69页。The Right to Purchase New Shares Holders of common stock must be given
9、 the first option to buy new shares Ensures that management cannot subvert the position of present stockholders10第10页，共69页。The Use of Rights in Financing Used by many U.S.companies and is popular as fund raising method in Europe Questions to consider:How many rights should be necessary to purchase o
10、ne new share of stock?Rights required Stockholders may choose to sell their rights,rather than exercise them in the purchase of new shares11第11页，共69页。The Use of Rights in Financing(contd)What is the monetary value of these rights?Monetary value of a right two terms When a rights offering is announce
11、d a stock initially trades rights-on The value of the right when a stock is trading rights-on is:Alternate formula:Where:Mo=market value right-on;S=subscription price;N=number of rights required to purchase a new share of stock;Me=market value when trading ex-rights.Ex-rights when you buy a share th
12、ere is no right towards future purchase 12第12页，共69页。Effect of Rights on Stockholders PositionOption 1:Suppose Stockholder A owns 9 shares before the rights offering and has$30 in cash.His holdings would appear as:If he receives and exercises 9 rights to buy one new share at$30:13第13页，共69页。Effect of
13、Rights on Stockholders Position(contd)Option 2:Sell rights in the market and stay with his position of owning only nine shares and holding cash.The outcome would be:As indicated,whether you choose to exercise a rights or not,the stock will still go down a lower value.14第14页，共69页。Three options when p
14、resented with a rights offering Exercise the rights;no net gain or loss sell the rights;no net gain or loss allow the rights to lapse;a loss will be incurred due to the dilution of existing shares that is not offset by value of unsold or unexercised rights.15第15页，共69页。Poison Pills A rights offering
15、made to existing shareholders of a company Used to avoid a takeover Makes hostile takeovers very expensive and unattractive Allows existing shareholders the right to buy additional shares of the stock at a very low price16第16页，共69页。American Depository Receipts Certificates that have a legal claim on
16、 an ownership interest in a foreign companys common stock Also referred to as American Depository Shares(ADSs)Allows foreign shares to be traded in the United States much like common stock17第17页，共69页。Advantages of ADRs for the U.S.Investor Annual reports and financial statements are presented in Eng
17、lish according to GAAP Dividends are paid in dollars and are more easily collected Considered to be:More liquid Less expensive Easier to trade than buying foreign companies stock directly on that firms home exchange18第18页，共69页。Drawbacks of ADRs for the U.S.Investor ADRs are also traded in their own
18、country subjecting investors to currency risk Infrequent reporting of financial results Information lag due to the translation of reports into English19第19页，共69页。Preferred Stock Financing An intermediate or hybrid form of security Lacks the desirable characteristics of debt and common stock Merely e
19、ntitled to receive a stipulated dividend.Receive payment of dividends before common stockholders Rights for annual dividends is not mandatory for corporations Firm may forgo the preferred dividends when deemed necessary20第20页，共69页。Justification for Preferred Stock May be issued to achieve a balance
20、in capital structure A means of expanding the capital base without:Diluting the common stock ownership position Incurring contractual debt obligations A drawback is that interest payments are not tax-deductible21第21页，共69页。Investor Interest Primary purchasers of preferred stock are corporate investor
21、s,insurance companies,and pension funds Under the tax law,the corporate investor must need to add only 30%of preferred or common dividends of another corporation,to its taxable income By contrast,all the interest of bonds are taxable to the recipient except for municipal bond interest22第22页，共69页。Sum
22、mary of Tax Considerations Tax considerations for preferred stock work in two opposite directions:They make the after-tax cost of debt cheaper than preferred stock to the issuing corporation.Interest is deductible to the payer Tax considerations generally make the receipt of preferred dividends more
23、 valuable Since 70%of the dividend is exempt from taxation23第23页，共69页。Cumulative Dividends Cumulative preferred stock have a cumulative claim to dividends This feature makes a corporation aware of its obligations to preferred stockholders A financial recapitalization may occur if a financially troub
24、led firm has missed a number of dividend payments24第24页，共69页。Conversion Feature Preferred stock may be convertible to a specified number of shares of common stock Allows the company to force conversion from convertible preferred stock into convertible debt,Allows company to take advantage of falling
25、 interest rates,OR Allows company to change the preferred dividends into tax-deductible interest payments25第25页，共69页。Call Feature Allows corporations for the retirement of security before maturity At some small premium over par,at the discretion of the corporation A preferred issue carrying a call p
26、rovision will be accorded a slightly higher yield than a similar issue without this feature26第26页，共69页。Participation Provision A small percentage of preferred stock issues are participating preferreds They may participate over and above the quoted yield If the common stock dividend equals the prefer
27、red stock dividend:The two classes of securities may share equally in additional payouts27第27页，共69页。Floating Rate Dividends are adjustable in nature-floating rate preferred stock Investors can minimize the risk of price changes.Investors can take advantage of tax benefits associated with preferred s
28、tock corporate ownership The price stability makes it equivalent to a safe short-term investment28第28页，共69页。Dutch Auction Preferred Stock Short-term in nature The security matures every seven weeks and is re-auctioned at a subsequent bidding Allows investors to keep up with the changing interest rat
29、es in the short-term market Allows corporate investors to invest at short-term rates and get tax-benefits as well29第29页，共69页。Comparing Features of Common,Preferred Stock and Debt Highest return and risk is associated with common stock Preferred stock generally pays a lower return Due to the 70%tax e
30、xemption status for corporate purchasers Increasingly high return requirement on debt,is based on:The presence or absence of security provision The priority of claims on unsecured debts30第30页，共69页。CommonStock Belongs to common shareholders through voting rights and residual claim to income None Lowe
31、st claim of any security holder HighestPreferredStockLimited rights whendividends are missedMust receive payment before common shareholderBondholders and creditors must be satisfied firstModerateBondsLimited rights under default in interest paymentsContractual obligationHighest claimLowest1.Ownershi
32、p and control of the firm2.Obligation to provide return3.Claim to assets in bankruptcy4.Cost of distributionPPT17-13Features of alternative security issues31第31页，共69页。CommonStockHighest risk,highest return(at least in theory)Not deductibleDividend to another corporation is usually tax exemptSpecial
33、tax treatment with dividend tax creditPreferredStockModerate risk,moderate returnNot deductibleSame as common stockBondsLowest risk,moderate returnTax deductible Cost=Interest payment (1 Tax rate)Interest usually fully taxable5.Risk-return trade-off6.Tax status of payment by corporation7.Tax status
34、of payment to recipientPPT17-14Features of alternative security issues32第32页，共69页。Risk and Expected Return for Various Security Classes33第33页，共69页。ChapterMcGraw-Hill/IrwinCopyright 2008 by The McGraw-Hill Companies,Inc.All rights reserved.Dividend Policy and Retained Earnings18第34页，共69页。Chapter Outl
35、ine Decisions on use of firms annual earnings Dividends and the dividend policy Factors influencing the dividend policy Stock dividends and stock splits Repurchase of the firms shares35第35页，共69页。The Marginal Principle of Retained Earnings Benefits to stockholders analyzed by comparing:Rate of return
36、 on retained earnings Earnings that may be generated by offering dividends Project financed by internally generated funds must provide a higher rate of return:Compared to what stockholders can achieve on other investments36第36页，共69页。Life Cycle Growth and Dividends37第37页，共69页。Dividends as a Passive V
37、ariable Dividends are paid out only if the corporation cannot make better use of the funds for the benefit of stockholders Active decision variable is the retained earnings Residual(after fulfilling internal corporate expenses)is paid to stockholders Cash dividends38第38页，共69页。An Incomplete Theory Re
38、sidual theory of earnings does not consider the stockholders opinion on dividends It is considered acceptable,if the stockholders only concern is achieving highest returns:Corporate retained earnings remaining in the business Paid out as current dividends If however,the stockholder prefers one over
39、the other option,then this theory is incomplete39第39页，共69页。Arguments for the Relevance of Dividends Dividends resolve uncertainty in the minds of investors It can be hypothesized that stockholders might:Apply a higher discount rate(Ke),and Assign a lower valuation of funds that are retained in the b
40、usiness Because of the information content of dividends viewed more favorably than retained earnings to the stockholders Stockholders needs and preferences go beyond the marginal principle of retained funds40第40页，共69页。Arguments for the Relevance of Dividends(contd)In practice,it appears that most co
41、rporations adhere to the following logic:Investment opportunities relative to a required return(marginal analysis)are determined Then,it is tempered by subjective notion of stockholders desires For mature firms:An analysis of both investment opportunities and stockholder preferences may indicate tha
42、t a higher rate of payout is required41第41页，共69页。Corporate Dividend PolicyHistorical Growth in EPS(2003-2007)Estimated Growth in EPS*(2008-2012)Dividend Payment as a Percentage of Aftertax Earnings(2007)Category 1-Rapid GrowthOracle22%16%0%Autodesk,Inc31150Allscripts Healthcare33230Yahoo!Inc.35220Ge
43、nentech,Inc.45200Category 2-Slow GrowthNisource-3%3%68%CH Energy Group-1576Duke Energy0578Consolidated Edison1269Southern Co.5472*Estimated growth from various issues of Value Line Investment Survey.42第42页，共69页。Dividend Stability Maintenance of stability is a primary factor in considering stockholde
44、r desire in dividend policy Dollar amount of cash dividends tends to be more stable Increases in value takes place when new permanent levels of income are achieved Management hopes to lower the discount rate(Ke),applied to future dividends,thus raising the value of the firm43第43页，共69页。Corporate Prof
45、its and Dividends for Non-Financial Firms 44第44页，共69页。Legal Rules Most states forbid payment of dividends that might impair the initial capital contributions to the firm They may thus be distributed only from past and current earnings Aim is to protect creditors If the firm chooses to pay dividends
46、equal to the retained earnings,the operation of the firm may be jeopardized45第45页，共69页。Raiding the CapitalAssume a company has the following statement of net worth,the maximum dividend payment would be$20 millionCommon stock(1 million Shares at$10 par value)*.$10,000,000Retained earnings.$20,000,000
47、Net worth$30,000,000*If there is a paid-in capital in excess of par account,some states will allow additional dividend payment while others will not.To simplify the problem now,paid-in capital in excess of par is not considered.46第46页，共69页。Cash Position of the Firm There are limitations to the use o
48、f current earnings as an indicator of liquidity A growth firm producing the greatest gains in earnings may be in the poorest cash position There is a buildup in receivables and inventory,with a rapid expansion in sales and earnings This may far exceed cash flow generated through earnings47第47页，共69页。
49、Access to Capital Markets A medium-to-large size company having relatively easy access to financial markets may be willing to pay dividends It can sell new common stock or bonds in the future if and when funds are necessary Some may issue debt or stock and use part of the proceeds to guarantee the m
50、aintenance of current dividends Justifying this action on the basis of maintaining stable dividends48第48页，共69页。Desire for Control Directors and officers of a small,closely held firms may hold back paying dividends To avoid diluting the cash position Larger firms face a different kind of threat:Stock
