Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VI. Cost of Capital and

Long−Term Financial

Policy

(^586) 16. Raising Capital © The McGraw−Hill
Companies, 2002
An additional, and very important, consideration is that the flotation costs associated
with selling debt are much less than the comparable costs associated with selling equity.
SHELF REGISTRATION
To simplify the procedures for issuing securities, in March 1982 the SEC adopted Rule
415 on a temporary basis, and it was made permanent in November 1983. Rule 415 al-
lows shelf registration. Both debt and equity securities can be shelf registered.
Shelf registrationpermits a corporation to register an offering that it reasonably ex-
pects to sell within the next two years and then sell the issue whenever it wants during
that two-year period. For example, in June 2001, John Deere Capital, the finance arm of
farm equipment manufacturer John Deere, filed with the SEC to offer $3 billion pri-
marily in debt securities and preferred stock. The company also had $1.08 billion left
from a previous shelf registration for a total of $4.08 billion “on the shelf.” Not all com-
panies can use Rule 415. The primary qualifications are:

1. The company must be rated investment grade.


2. The firm cannot have defaulted on its debt in the past three years.


3. The aggregate market value of the firm’s outstanding stock must be more than $150
   million.


4. The firm must not have had a violation of the Securities Act of 1934 in the past
   three years.
   Shelf registration allows firms to use a dribble method of new equity issuance. In
   dribbling, a company registers the issue and hires an underwriter as its selling agent. The
   company sells shares in “dribs and drabs” from time to time directly via a stock ex-
   change (for example, the NYSE). Companies that have used dribble programs include
   Niagara Mohawk, Pacific Gas and Electric, and The Southern Company.
   The rule has been controversial. Arguments have been constructed against shelf reg-
   istration:


5. The costs of new issues might go up because underwriters might not be able to
   provide as much current information to potential investors as they would otherwise,
   so investors would pay less. The expense of selling the issue piece by piece might
   therefore be higher than that of selling it all at once.


6. Some investment bankers have argued that shelf registration will cause a “market
   overhang” that will depress market prices. In other words, the possibility that the
   company may increase the supply of stock at any time will have a negative impact
   on the current stock price.
   Shelf registration is much more common with bonds than stocks, but some equity
   shelf sales do occur. For example, in late 1998, Ford Motor filed a shelf registration to
   issue 10 million shares of common stock. It planned to use the shares to buy dealerships

CONCEPT QUESTIONS

16.10a What is the difference between private and public bond issues?

16.10bA private placement is likely to have a higher interest rate than a public issue.

Why?

558 PART SIX Cost of Capital and Long-Term Financial Policy

16.11

shelf registration
Registration permitted
by SEC Rule 415, which
allows a company to
register all issues it
expects to sell within two
years at one time, with
subsequent sales at any
time within those two
years.