Inhoud
1. Debt policies .................................................................................................................................... 3
1.1. financing a firm with debt and equity ..................................................................................... 3
2. Payout policy ................................................................................................................................. 22
2.1. Dividends versus share repurchases ..................................................................................... 22
2.2. Payout versus retention of cash ............................................................................................ 28
2.3. Dividend signalling................................................................................................................. 31
2.4. Stock dividends and stock splits ............................................................................................ 34
3. IPO’s............................................................................................................................................... 36
3.1. Why do firms go public? ........................................................................................................ 36
3.2. Why do companies delist? ........................................................................................................ 36
3.3. Underpricing .......................................................................................................................... 39
3.4. Overpricing ............................................................................................................................ 43
4. Company valuation........................................................................................................................ 48
4.1. Discounted free cash flow valuation with debt financing ..................................................... 48
4.1.1. Discounted free cash flow model....................................................................................... 48
4.2. Valuation multiples ............................................................................................................... 58
4.3. The valuation of delistings..................................................................................................... 62
Intermezzo: Telenet valuation .............................................................................................................. 63
Valuation of the 2012 Telenet delisting offer ................................................................................... 63
5. Mergers and acquisitions .............................................................................................................. 70
5.1. Do M&A create value? .......................................................................................................... 70
5.2. Reasons to acquire ................................................................................................................ 71
5.3. Other aspects ........................................................................................................................ 75
5.3.1. Shareholders vs debtholders.............................................................................................. 75
5.4. Breakup of firms .................................................................................................................... 84
6. Corporate governance................................................................................................................... 88
6.1. Corporate governance: what and why? ................................................................................ 88
6.2. Mechanisms to restrict expropriation by management........................................................ 94
7. Coporate governance: separation of ownership and control ..................................................... 100
7.1. How?.................................................................................................................................... 100
7.2. Agency costs ........................................................................................................................ 103
7.3. Private benefits from new acquisitions: evidence from the Italian stock market (M. Bigelli &
S. Mengoli)....................................................................................................................................... 104
8. Ownership characteristics ........................................................................................................... 108
,8.1. Family ownership ................................................................................................................ 108
8.2. Business groups ................................................................................................................... 110
8.3. Back to family firms… .......................................................................................................... 113
8.4. The value of government ownership .................................................................................. 116
8.5. Conclusions .......................................................................................................................... 121
,Corporate finance and governance
1. Debt policies
- Modigliani and Miller assumed that debt policy does not matter, but they didn’t include
taxes, financial distress, managerial incentives and information
1.1. financing a firm with debt and equity
- Modigliani and Miller argued that with “perfect” capital markets, the total value of a firm
should not depend on its capital structure.
o Investors and firms can trade the same set of securities at competitive market prices
equal to the present value of their future cash flows.
o There are no taxes, transaction costs, or issuance costs associated with security
trading.
o A firm’s financing decisions do not change the cash flows generated by its
investments, nor do they reveal new information about them.
- Debt is cheaper than equity for a firm
o It has less risk, it’s a fixed interest rate so you know what your return will be
- Levered equity has higher risk
- To compensate for this risk, more levered equity holders must receive a higher expected
return.
- Leverage increases the risk of equity even when there is no risk that the firm will default.
o Thus, while debt may be cheaper, its use raises the cost of capital for equity
o When you use both debt and equity, your cost of capital won’t change
- Leverage will not affect the total value of the firm.
o Instead, it merely changes the allocation of cash flows between debt and equity,
without altering the total cash flows of the firm.
1.1.1. Modigiliani-Miller Proposition I
- In a perfect capital market, the total value of a firm is equal to the market value of the total
cash flows generated by its assets and is not affected by its choice of capital structure.
Application: A leveraged recapitalization
- When a firm uses borrowed funds to pay a large special dividend or repurchase a significant
number of outstanding shares (the firm decides they want more debt and less equity)
- In a Modigliani & Miller world, this will not affect the value of the firm
- Harrison Industries is currently an all-equity firm operating in a perfect capital market, with
50 million shares outstanding that are trading for $4 per share.
- Harrison plans to increase its leverage by borrowing $80 million and using the funds to
repurchase 20 million of its outstanding shares. (this way they create $80 million debt)
- This transaction can be viewed in two stages.
o First, Harrison sells debt to raise $80 million in cash.
o Second, Harrison uses the cash to repurchase shares.
- The number of shares is now 30 million, but the value per share is still $4
, 1.1.2. Modigiliani-Miller proposition II
- Leverage and the Equity Cost of Capital
o E: Market value of equity in a levered firm.
o D: Market value of debt in a levered firm.
o U: Market value of equity in an unlevered firm.
o A: Market value of the firm’s assets.
- MM Proposition I states that:
o E+D=U=A
▪ In a balance sheet the firm’s assets would be on the left and the equity and
debt would be on the right
- Leverage and the Equity Cost of Capital
o The return on unlevered equity (RU) is related to the returns of levered equity (RE)
and debt (RD):
𝐸 𝐷
𝑅𝐸 + 𝑅 = 𝑅𝑈
𝐸+𝐷 𝐸+𝐷 𝐷
- Leverage and the Equity Cost of Capital
o Solving for RE:
𝐷
𝑅𝐸 = 𝑅𝑈 + (𝑅𝑈 − 𝑅𝐷 )
𝐸
o 𝑅𝑈 = risk without leverage
𝐷
o (𝑅𝑈 − 𝑅𝐷 ) = Additional risk due to leverage
𝐸
o The levered equity return equals the unlevered return, plus a premium due to
leverage.
▪ The amount of the premium depends on the amount of leverage, measured
by the firm’s market value debt-equity ratio, D/E.
o Return for equity holders increases with the debt to equity ratio
- MM Proposition II:
The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a
premium that is proportional to the market value debt-equity ratio.
- Cost of Capital of Levered Equity
𝐷
𝑟𝐸 = 𝑟𝑈 + (𝑟𝑈 − 𝑟𝐷 )
𝐸
1. Debt policies .................................................................................................................................... 3
1.1. financing a firm with debt and equity ..................................................................................... 3
2. Payout policy ................................................................................................................................. 22
2.1. Dividends versus share repurchases ..................................................................................... 22
2.2. Payout versus retention of cash ............................................................................................ 28
2.3. Dividend signalling................................................................................................................. 31
2.4. Stock dividends and stock splits ............................................................................................ 34
3. IPO’s............................................................................................................................................... 36
3.1. Why do firms go public? ........................................................................................................ 36
3.2. Why do companies delist? ........................................................................................................ 36
3.3. Underpricing .......................................................................................................................... 39
3.4. Overpricing ............................................................................................................................ 43
4. Company valuation........................................................................................................................ 48
4.1. Discounted free cash flow valuation with debt financing ..................................................... 48
4.1.1. Discounted free cash flow model....................................................................................... 48
4.2. Valuation multiples ............................................................................................................... 58
4.3. The valuation of delistings..................................................................................................... 62
Intermezzo: Telenet valuation .............................................................................................................. 63
Valuation of the 2012 Telenet delisting offer ................................................................................... 63
5. Mergers and acquisitions .............................................................................................................. 70
5.1. Do M&A create value? .......................................................................................................... 70
5.2. Reasons to acquire ................................................................................................................ 71
5.3. Other aspects ........................................................................................................................ 75
5.3.1. Shareholders vs debtholders.............................................................................................. 75
5.4. Breakup of firms .................................................................................................................... 84
6. Corporate governance................................................................................................................... 88
6.1. Corporate governance: what and why? ................................................................................ 88
6.2. Mechanisms to restrict expropriation by management........................................................ 94
7. Coporate governance: separation of ownership and control ..................................................... 100
7.1. How?.................................................................................................................................... 100
7.2. Agency costs ........................................................................................................................ 103
7.3. Private benefits from new acquisitions: evidence from the Italian stock market (M. Bigelli &
S. Mengoli)....................................................................................................................................... 104
8. Ownership characteristics ........................................................................................................... 108
,8.1. Family ownership ................................................................................................................ 108
8.2. Business groups ................................................................................................................... 110
8.3. Back to family firms… .......................................................................................................... 113
8.4. The value of government ownership .................................................................................. 116
8.5. Conclusions .......................................................................................................................... 121
,Corporate finance and governance
1. Debt policies
- Modigliani and Miller assumed that debt policy does not matter, but they didn’t include
taxes, financial distress, managerial incentives and information
1.1. financing a firm with debt and equity
- Modigliani and Miller argued that with “perfect” capital markets, the total value of a firm
should not depend on its capital structure.
o Investors and firms can trade the same set of securities at competitive market prices
equal to the present value of their future cash flows.
o There are no taxes, transaction costs, or issuance costs associated with security
trading.
o A firm’s financing decisions do not change the cash flows generated by its
investments, nor do they reveal new information about them.
- Debt is cheaper than equity for a firm
o It has less risk, it’s a fixed interest rate so you know what your return will be
- Levered equity has higher risk
- To compensate for this risk, more levered equity holders must receive a higher expected
return.
- Leverage increases the risk of equity even when there is no risk that the firm will default.
o Thus, while debt may be cheaper, its use raises the cost of capital for equity
o When you use both debt and equity, your cost of capital won’t change
- Leverage will not affect the total value of the firm.
o Instead, it merely changes the allocation of cash flows between debt and equity,
without altering the total cash flows of the firm.
1.1.1. Modigiliani-Miller Proposition I
- In a perfect capital market, the total value of a firm is equal to the market value of the total
cash flows generated by its assets and is not affected by its choice of capital structure.
Application: A leveraged recapitalization
- When a firm uses borrowed funds to pay a large special dividend or repurchase a significant
number of outstanding shares (the firm decides they want more debt and less equity)
- In a Modigliani & Miller world, this will not affect the value of the firm
- Harrison Industries is currently an all-equity firm operating in a perfect capital market, with
50 million shares outstanding that are trading for $4 per share.
- Harrison plans to increase its leverage by borrowing $80 million and using the funds to
repurchase 20 million of its outstanding shares. (this way they create $80 million debt)
- This transaction can be viewed in two stages.
o First, Harrison sells debt to raise $80 million in cash.
o Second, Harrison uses the cash to repurchase shares.
- The number of shares is now 30 million, but the value per share is still $4
, 1.1.2. Modigiliani-Miller proposition II
- Leverage and the Equity Cost of Capital
o E: Market value of equity in a levered firm.
o D: Market value of debt in a levered firm.
o U: Market value of equity in an unlevered firm.
o A: Market value of the firm’s assets.
- MM Proposition I states that:
o E+D=U=A
▪ In a balance sheet the firm’s assets would be on the left and the equity and
debt would be on the right
- Leverage and the Equity Cost of Capital
o The return on unlevered equity (RU) is related to the returns of levered equity (RE)
and debt (RD):
𝐸 𝐷
𝑅𝐸 + 𝑅 = 𝑅𝑈
𝐸+𝐷 𝐸+𝐷 𝐷
- Leverage and the Equity Cost of Capital
o Solving for RE:
𝐷
𝑅𝐸 = 𝑅𝑈 + (𝑅𝑈 − 𝑅𝐷 )
𝐸
o 𝑅𝑈 = risk without leverage
𝐷
o (𝑅𝑈 − 𝑅𝐷 ) = Additional risk due to leverage
𝐸
o The levered equity return equals the unlevered return, plus a premium due to
leverage.
▪ The amount of the premium depends on the amount of leverage, measured
by the firm’s market value debt-equity ratio, D/E.
o Return for equity holders increases with the debt to equity ratio
- MM Proposition II:
The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a
premium that is proportional to the market value debt-equity ratio.
- Cost of Capital of Levered Equity
𝐷
𝑟𝐸 = 𝑟𝑈 + (𝑟𝑈 − 𝑟𝐷 )
𝐸
