22 3 Reduction of External Funding Needs
3.2 Retained Earnings..................................................................................
Internal financing constitutes the dominant source of finance.^1 In a limited-liability
company, the main rule is that this form of financing is at the discretion of the
board.
Whether the firm makes a profit depends on its business choices. The law can-
not say how much profit a company should make, or how it should make a profit.
At the strategic level, deciding on the allocation of value between the company
and its stakeholders and between stakeholders inter se belongs to the board’s core
functions.
In addition, the board can block the distribution of assets to shareholders in
many ways. For example, distributions to shareholders are constrained by the pro-
visions of the Second Company Law Directive (see section 10.2.2), and decisions
on the making of distributions in the form of dividends or share repurchases re-
quire the consent of the board. – There can be exceptions to the main rule of board
discretion depending on the governing law and the company form. For example,
the general meeting or a qualified minority can demand the distribution of mini-
mum profits; such a rule may be regarded as necessary in order to protect non-
controlling minority shareholders against controlling shareholders, or to protect
shareholders in general. The general meeting may also have a limited right to give
binding instructions to the board.
Companies operating as Real Estate Investment Trusts (REITS) must distribute the bulk of
their income to investors in regular dividends in return for tax breaks at the company level.
3.3 Management of Capital Invested in Assets............................................
3.3.1 Introduction
Generally, the firm can reduce funding needs by choosing a less capital-intensive
business model. The firm can reduce its other external funding needs by using tra-
ditional financial transactions such as leasing (section 3.3.3) or sale and lease-back
transactions (section 3.3.4). The firm can also release capital for a certain period
of time through sale and repurchase arrangements (repos), or reduce its other ex-
ternal funding needs by borrowing the securities it needs for a certain period of
time. Private-equity firms have perfected a method called refinancing in order to
reduce external funding needs and to return capital after a successful takeover
(section 10.5).
Just sell. Of course, the firm can simply release capital by selling existing as-
sets. The firm can sell physical assets, existing claims, and rights to future income
(^1) Tirole J, The Theory of Corporate Finance. Princeton U P, Princeton and Oxford (2006)
p 96.