Introduction to Corporate Finance

12-1 THE BASIC CHOICES IN LONG-TERM

FINANCING

Debt and equity constitute the two main sources of corporate long-term financing. Equity capital

represents an ownership interest that is junior to debt (in the seniority rankings), because debt capital

represents a legally enforceable claim, with cash flows that can be either fixed or varied, according to

LO 12.1

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

This chapter introduces the primary instruments

that companies around the world use for long-term

financing: ordinary equity, preferred equity and

long-term debt. Although the types of securities

are similar, significant differences exist across

countries in terms of how corporations use them

and in the degree to which firms obtain financing

in capital markets rather than through financial

intermediaries. For example, countries such as

Australia, Canada, the United States and the United

Kingdom are characterised by large, highly liquid

equity and bond markets. Other industrialised

countries, particularly those in continental Europe,

have much smaller capital markets and rely primarily

on commercial banks for financing. Despite these

differences in financial systems, corporations around

the world display certain common tendencies;

most importantly, they universally rely on internally

generated cash flow (principally retained profits) as

the dominant source of new financing. Funding a

company’s operations this way – by retaining rather

than paying out corporate profits – is called internal

financing. The alternative, external financing, refers

to raising money from sources external to the firm,

such as banks or capital markets.

internal financing

Relying on internally

generated cash flow

(principally retained profits) as

the dominant source of new

financing

external financing

Raising money from sources

external to the firm, such as

banks or capital markets

discuss the basic choices that corporations

face in raising long-term financing

describe the costs and benefits of raising

long-term funds by issuing securities

rather than by borrowing from a financial

intermediary

understand how investment banks help

corporations issue securities, and describe

the services investment banks provide

before, during and after a security issue

explain the basic issuance and pricing

patterns observed in the initial public

offering (IPO) market

describe the basic issuance and pricing

patterns observed in the market for

seasoned equity offerings (SEOs), and

explain why so few large companies issue

seasoned ordinary equity

explain some important aspects of

international ordinary equity offerings,

including the role of American Depositary

Receipts (ADRs).

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LO12.3

LO12.4

LO12.5

LO12.6

12: Raising Long-Term Financing