Introduction to Corporate Finance

PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

describe the most important characteristics

of long-term debt financing, such as the

factors that influence its cost and the

covenants lenders include to protect their

investment

discuss the differences between the two

main types of loans arranged by corporate

borrowers and explain why syndicated

loans have become such an attractive

source of debt financing

describe the most important types of

corporate bonds issued by domestic

corporations and compare these to bonds

issued by international borrowers

explain how companies decide whether to

refund an existing bond issue by exercising

a call option

explain the difference between operating

leases and capital, or financial, leases

describe the steps involved in deciding

whether to acquire an asset through a

lease or by borrowing the money required

to purchase the asset (the lease-versus-

purchase decision).

LO 14.1

LO 14.2

LO 14.3

LO 14.4

LO 14.5

LO 14.6

14 -1 CHARACTERISTICS OF LONG-TERM

DEBT FINANCING

We observe that debt is the dominant form of long-term, external financing in most developed economies.

On the balance sheet, accountants classify debt as ‘long-term’ if it matures in more than one year.

Companies obtain long-term debt by negotiating to borrow from a financial institution (or a syndicate

consisting of several institutions) for a term loan, or by selling bonds. We begin by analysing the choice

between public and private debt offerings, and then we discuss long-term debt covenants and costs.

1 By definition, governments can raise funds only by issuing debt, because few investors would wish to purchase government equity even if

such a financial creature existed. Although government debt issuance is an extremely important and interesting topic, we henceforth focus

exclusively on corporate debt issuance.

Corporations and governments around the world

issue long-term debt in order to finance capital

investments or to fund current operations. As we

saw in Chapter 12, more external capital is raised

by companies worldwide each year in the form of

debt rather than equity, and most debt is long-

term.^1 This chapter examines the key features,

costs, advantages and disadvantages of two

sources of capital for business: long-term debt

and leasing.

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the bond markets in the region. Part of this

effect is due to Malaysia and Indonesia being

oil producers; but the limited exposure of Asian

markets to Greece’s debt problems then tempers

the contagion effects on the bond markets. Overall,

however, risk premia did rise for Asian bonds during

the first part of 2015.

This chapter explores the driving forces for

corporate bond issues, as well as choices in long-

term financing between bonds and leases.