Introduction to Corporate Finance

PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY

separation of investment and commercial banking: it prohibited commercial banks from underwriting

corporate security issues, from providing security brokerage services to their customers and even from

owning voting equity securities on their own account. Banking’s corporate financing role was effectively

restricted to making commercial loans and providing closely related services, such as leasing. As with

the McFadden Act, there were repeated attempts to repeal Glass-Steagall, and these finally succeeded

in November 1999.

Non-bank FIs, such as insurance companies, pension funds and specialised finance companies

such as General Electric Credit Corporation and General Motors Acceptance Corporation, also play

important roles in US corporate finance, both as creditors and as equity investors.

The Corporate Finance Role of Non-US Financial Intermediaries

In markets outside the United States, commercial banks typically play much larger roles in corporate

finance. In most countries, a handful of very large banks service most large firms, and the size and

competence of these banks give them tremendous influence over corporate financial and operating

policies. This power is further strengthened by the ability of most non-US banks to underwrite corporate

security issues and to make direct equity investments in commercial firms. Most countries other than the

United States also allow commercial banks to provide a full range of financial services.

This industry has a rich history, and in Europe it can trace its origins back to the Middle Ages or

even earlier, when funding was needed to finance long trade journeys. The need for this type of funding

grew, as the cross-border trading and shipping industries expanded in the seventeenth and eighteenth

centuries. These institutions became known as merchant banks, a term that is still used in the UK today,

to refer to the British investment banks. Many of these started out as family-owned businesses, which

were quite entrepreneurial in terms of the types of transactions they undertook. Many grew into large

organisations, with multinational operations, but in the late twentieth century and early twenty-first

century, the industry underwent substantial consolidation following various global financial crises. As a

result there are fewer merchant banks in operation today. An example of one of these merchant banks

that is still in operation around the world is provided by Rothschild. This organisation can trace its

origins back to the nineteenth century. Although it has undergone various structural and name changes

in France and the United Kingdom, it is still predominantly controlled by the founding family – the

Rothschild family. In Australia, it provides some advisory services but is not a full service investment

bank, and focuses on mergers and acquisitions in the resources and utilities sectors.

A growing global trend in long-term financing in the last decade has been the increasing role played

by private equity funds and hedge funds in the corporate finance scene. These FIs have become large

financial backers for many deals, providing equity and mezzanine debt capital.

Financial Intermediaries in Australian Corporate Finance

The Australian market for long-term financing has developed as a hybrid, with some characteristics drawn

from the US, UK and European markets. The domestic market tends to be more heavily dominated by

the traditional banking sector, which provides the bulk of financing and accounts for the majority of the

financial assets. In Australia, banks, building societies, credit unions, superannuation funds and insurers

own around 80% of financial sector assets.^1 Their activities are regulated by the Australian Prudential

Regulation Authority (APRA). As Figure 12.1 shows, this market structure is very different from the US

market, where similar organisations only account for around half of the assets.

1 Financial Stability Review, Reserve Bank of Australia, September 2012, RBA Shadow Banking System, Graph B1, p. 36.

mezzanine debt
A hybrid form of debt funding
that is structured with some
sort of equity component –
for example, a convertible
structure, like a warrant. This
allows mezzanine investors
to be placed ahead of equity
investors in terms of seniority,
should the company receiving
funding fall into financial
difficulty. However, it also
gives the mezzanine investors
the option to convert their
investments into an equity
stake and benefit from the
upside of equity ownership,
should the company become
extremely successful

Australian Prudential
Regulation Authority
(APRA)
The Australian regulatory body
responsible for overseeing
the activities of banks, credit
unions, building societies,
general insurance, life
insurance and reinsurance
companies, friendly societies
and most members of the
superannuation industry