Introduction to Corporate Finance

PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY

■ Issuing securities enable companies to

access greater potential pools of funding.

However, with this comes increased

reporting requirements, exposure to external

scrutiny and, in the case of issuing common

equity, a reduction in both ownership and

control. In addition, the process of raising

capital, for example via an IPO, can be

expensive both financially and with respect

to managerial focus.

■ Companies wanting to raise capital

externally must make a series of decisions,

beginning with whether to issue debt or

equity and whether to employ an investment

bank to assist with the securities sale. This

chapter focuses on ordinary equity offerings,

but the decisions and issuing procedures

are similar for preferred equity and debt

securities.

■ Companies wanting to raise new ordinary

equity can sell shares to public investors,

typically with the help of an investment

bank. The company must decide whether

to sell shares to public investors through

a general cash offering or to rely on sales

to existing shareholders using a rights

offering. Rights offerings are very popular in

Australia, though fairly rare in the US today.

They remain common in other developed

countries also.

■ Ordinary equity can be sold through private

placements to accredited investors, or it can

be sold to the public if the securities are

registered with the market regulator.

■ A company’s first public offering of ordinary

equity is known as its initial public offering,

or IPO. The average IPO in the US is

underpriced by about 15%, and this has held

true for several decades. Non-US IPOs are

also underpriced, as appears to be the case

in Australia and New Zealand. It is unclear

whether or not IPOs are poor long-term

investments.

■ Subsequent offerings of ordinary equity

are known as seasoned equity offerings, or

SEOs. The announcement of a seasoned

equity issue tends to decrease a company’s

share price, and there is evidence that firms

issuing seasoned equity underperform over

the long term.

■ Non-US firms in countries with well-

functioning stock markets can raise

equity capital using an IPO. Once issued,

their shares can trade in the US either

by directly listing on a US exchange,

or, more commonly, through American

depositary receipts (ADRs), which are

dollar-denominated claims issued by US

banks against the actual foreign shares that

they hold on deposit. There are numerous

Australian listed companies that have listed

ADRs on a US exchange. They benefit

from increased exposure to non-domestic

markets (especially the US) without having

to conform to all the US listing rules and

regulations. The largest share offerings

in world history have all been share issue

privatisations (SIPs), which have done as

much as any other single factor to promote

the development of international stock

markets.

KEY TERMS

accredited investors, 458

American depositary receipts

(ADRs), 451

Australian Prudential Regulation

Authority (APRA), 436

book building, 442

bookrunner, 442

bulge bracket, 440

cash flow from operations, 434

certification, 443

debt capital market (DCM), 434

due diligence, 443

equity capital market (ECM), 434

equity carve-out (ECO), 455

Eurobond, 438

external financing, 433

financial deficit, 434

financial intermediary (FI), 435

fixed-price offer, 442

flip, 448

foreign bond, 439

full disclosure, 443

general cash offerings, 458

Glass-Steagall Act, 435

initial public offering (IPO), 438

IPO initial return, 448

IPO underpricing, 448

internal financing, 433

international ordinary equity, 439

investment bank, 440

LO12.3

LO12.4

LO12.5

LO12.6