BRN 482 BRN 482

Corporate Corporate Financial Financial PolicyPolicy

Clifford W. SmithClifford W. Smith

Summer 2007Summer 2007

Handout 5Handout 5

* Covers readings on course outline through Barclay/Smith (1996)

Financial ArchitectureFinancial Architecture

LeverageLeverage Bond covenantsBond covenants

Public vs. private debtPublic vs. private debt

MaturityMaturity

PriorityPriority

Conversion rightsConversion rights

Call provisionsCall provisions

Private vs. Public DebtPrivate vs. Public Debt

Larger issues usually publicLarger issues usually public fixed registration fees under-diversification of private

lenders

The riskier the debt, the The riskier the debt, the more likely that it will be more likely that it will be privateprivate easier to renegotiate usually contains more, and more

specific, contract provisions

Relation between Yield on Net Proceeds Relation between Yield on Net Proceeds & Issue Size for Representative Private & Issue Size for Representative Private

Placement and Public Issue DebtPlacement and Public Issue Debt

Yield on Net Proceeds

YNP (%)

Aaa (Private)

Aaa (Public)

Issue Size ($)SAAA

Relation between Yield on Net Proceeds and Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement Issue Size for Representative Private Placement

and and PublicPublic Issue Debt Issue Debt

Yield on Net Proceeds

YNP (%)

Aaa (Private)

Aaa (Public)

Issue Size ($)SAAA

Relation between Yield on Net Proceeds Relation between Yield on Net Proceeds and Issue Size for Representative Private and Issue Size for Representative Private

Placement and Public Issue DebtPlacement and Public Issue Debt

Baa (Private)

Yield on Net Proceeds

YNP (%)

Aaa (Private)

Aaa (Public)

Issue Size ($)SAAA SBAA

Baa (Public)

Relation between Yield on Net Proceeds Relation between Yield on Net Proceeds and Issue Size for Representative Private and Issue Size for Representative Private

Placement and Public Issue DebtPlacement and Public Issue Debt

Baa (Private)

Yield on Net Proceeds

YNP (%)

Aaa (Private)

Aaa (Public)

Issue Size ($)SAAA SBAA

Baa (Public)

Investment Opportunity SetInvestment Opportunity Set

Assets inPlace

GrowthOpportuniti

es

Cost of Longer Maturity Low High (Underinvestment)

Predicted Maturity Long Short

Investment Opportunity SetInvestment Opportunity Set

Assets in

Place

GrowthOpportuniti

es

Cost of Low Priority Low High Fixed Claims(Creditor Conflicts)

Assets in

Place

GrowthOpportuniti

es

Cost of Low Priority Low High Fixed Claims(Creditor Conflicts)

Concentration of Lower Greater Priority Classes

Investment Opportunity SetInvestment Opportunity Set

BenchmarkingImpact on

Private Debt

Impact on Maturity

Impact on Priority

Concentration

Growth Options (Merck) Greater Shorter Greater

Credence Goods (Eastern) Greater Shorter Greater

Product Warranties (Yugo) Greater Shorter GreaterFuture Product Support

(Yugo/Wang)Greater Shorter Greater

Supplier Financing (Campeau) Greater Shorter Greater

Firm Size Less Longer Less

Closely Held Firm Greater Shorter Greater

Regulation Less Longer ?

Tax Credits — — Less

Marginal Corporate Tax Rate — — —

Marginal Personal Tax Rate — — —

Abnormal Earnings Greater Shorter Greater

Deregulation and Debt MaturityDeregulation and Debt Maturity

Leverage and Debt Maturity in the Telecommunications industry 1974-1994

Investment Opportunity SetInvestment Opportunity Set

Financial Architecture Leverage High Low Maturity Long Short Priority (Table 5) Diffuse Concentrated Conversional Rights Low High Leasing (Table 4) High Low

Compensation Level of Pay Low High Conditional Pay Low High

Assets in

Place

GrowthOpportunitie

s