8 2 Funding: Introduction
incentive to be effective. Furthermore, a listed company can attract hostile bidders
if it is not lean. If the firm is on the market for control and the firm wants to re-
main independent and survive in the long term, the firm must signal several im-
portant points to potential buyers: that its capital is already being employed in an
efficient way; that the amount of assets that can be distributed to shareholders is
limited; that the buyer would not be able to finance a hostile bid by loading the
firm with new debt; and that a takeover would bring a low rate of return. A com-
pany that is on the market for control therefore prefers to keep the amount of
shareholders’ capital and the amount of funds that can be distributed to owners
low.
The real cost of shareholders’ capital can be higher or lower compared with ab-
stract financial theory. Capital markets are not far advanced in all countries. Even
in highly developed countries, the cost of shareholders’ capital depends on the
firm.
For example, shareholders’ capital may sometimes cost less because of certain
ancillary services provided by block-holders or shareholders acting as business
partners. The cost of shareholders’ capital can also be reduced by the private non-
pecuniary benefits of controlling shareholders.
Protection against hostile takeovers is a common ancillary service provided by controlling
shareholders. Even in countries with highly developed capital markets, a company is not
yet on the market for control if it is controlled, directly or indirectly, by an owner who has
no intention to sell and who holds a block of shares large enough to make it impossible for
anyone else to obtain control. The company is typically not on the market for control if it is
controlled by a long-term shareholder or shareholders, such as a family, a foundation, or a
state.
On the other hand, the cost of shareholders’ capital can be increased when influen-
tial shareholders have a very short investment perspective and only try to maxi-
mise their own short-term profits regardless of the interests of the firm. This is one
of the main differences between, say, large listed companies and family-owned
firms.
Even information management can play a role. Investors might be uncertain
about the motive behind the firm’s financing decision. For example, the issuing of
new shares could be interpreted by the market as a sign of overvaluation, and
firms do tend to issue shares during good times when share prices are high.^14 Al-
ternatively, it could be interpreted as a sign of a profitable investment opportunity.
In order to convince investors that the latter is true and make them forget what
they should know about the rational behaviour of issuers, the issuer can mask the
issuance as one made necessary by a profitable investment decision such as a
takeover and communicate the investment decision clearly to the equity market.^15
(^14) See, for example, Tirole J, op cit, p 244
(^15) See Schlingemann FP, Financing decisions and bidder gains, J Corp Fin 10 (2004) pp
683–701, citing Myers SC, Majluf NS, J Fin Econ 1984 pp 187–221 (overvaluation) and
Cooney JW Jr, Kalay A, J Fin Econ 33 (1993) pp 149–172 (profitable investment oppor-
tunity).