Advanced Corporate Finance Lecture 1: Capital Structure Basics
Data oriented course. World of big data.
Based on research articles, video lectures, case studies.
At least 5 for the exam to pass the course.
Exam: comment on academic articles (not in reading list) and solve simple exercises related to what
you have seen in class.
- Follow the video lectures
- Attend and participate in Q&A sessions
- Be active, ask questions
- Go back to the material after the lecture
Instruction lecture with teaching assistant to go through old exam.
First 4 lectures: mostly micro economics. It’s about specific firms.
Later on: more macro economics. Financial markets are important for economics growth.
Moral Hazard problem is solved with good corporate governance. Moral hazard: borrower does not
want to pay back.
Q&A lecture 1
Value of firm (with taxes included), calculate the value of the firm when it’s financed only with
equity. For this, you use the cashflow of the unlevered firm. This you discount. Then you calculate the
PV of the tax shield and add that to the value of the unlevered firm.
Trade-off theory: there are taxes and bankruptcy costs. Issuing debt allows you to benefit from tax
shield, but it increases the probability of going bankrupt. In a graph the turning point can be shown,
the optimal debt can be calculated.
Bankruptcy costs:
- Direct: legal costs for hiring a lawyer. Administrative costs.
- Indirect: loss of sales. Selfish strategies.
Tangible assets = vaste activa.
The more tangible assets, the more can be sold to pay off debtholders. So: less bankruptcy costs.
Theories: smaller companies have less bankruptcy costs because they have smaller results. Large
companies have less bankruptcy costs because they are more diversified and are located in more
places.
Variables that indicate bankruptcy costs: size and tangibility.
Relationship between size and leverage is positive, but not statistically significant.
Tangibility also has a positive relationship with leverage, also statistically significant.
Lecture 2: Debt Covenants
Why issue more equity if value is higher than true value when this is not in line with pecking order?
Pecking Order:
A company has equity worth $5 per share.
Another company has equity worth $10 per share.
Investors are not able to distinguish the two companies. They price the equity $7,5 per share.
Bad companies will enter the market, good companies will stay out.
C1-Intern use
, Answer
In the previous example the bad company enters the market because it knows that it will get a price
above its fundamental value (7,5>5)
So, if a manager knows that the market is overvaluing the shares of her/his firm, she/he will have an
incentive to issue shares.
Pecking order theory tells you more about what to do when you manage a good firm that is not
overvalued.
To minimize your cost of financing: don’t pay dividend and re-invest in the company. Then, issue
debt: borrow from the debt market. Last option (most costly) is to issue equity.
But, there are bad guys around issuing equity again and again because their shares are overvalued.
Pecking Order mostly applies to starting companies.
It is likely the unrated loans have the same behavior as the B and CCC rated loans throughout the
years (so an increase towards 2019-2020).
Back to the paper about violations of debt covenants.
After a violation, most companies start “de-leveraging” 2 quarters after. They are repaying debt.
The smaller the delta, the faster the company is adjusting.
Companies that have higher market-to-book ratio need more time to adjust. They are taking longer
to pay back their debt.
The question means two things:
High market to book ratio may identify high share prices because the company will deliver lots of
profits in the future.
High market to book ratio may identify mispricing and overvaluation
If (1) lender’s actions are justified. If (2) they are not and lead to more risk taking.
What is the relationship between the leverage ratio and the net debt issuance/assets?
Negative and statistically insignificant: companies with higher leverage ratio reduce their net debt
issuance faster than average company.
What is the economic interpretation?
Companies with high leverage have a higher risk of default. After a covenant violation a lender is
more likely to take a tougher approach towards the company and forcing a faster reduction of net
debt issuance and hence leverage ratio.
What is the relationship between credit rating and net debt issuance?
Positive and statistically insignificant. This means that companies with a credit rating ratio reduce
their net debt issuance at a slower pace than companies without.
What is the economic interpretation?
Companies with a credit rating tend to have a lower risk of default than companies without. We
know this in general. The paper of Roberts and Sufi shows that unrated companies have quite high
probability of violating a covenant.
Q&A question 4.
Negative relationship between cash and delta net debt issuance. Companies with more cash are
adjusting their net debt issuance faster. From perspective of lender, companies with more cash are
good guys. Why the negative delta?
Theory is more straight forward than reality (sadly).
Coefficient is not statistically insignificant. Very unprecise and very difficult to take apart from 0. In
term of properties of distribution of a variable, it is very similar to distribution of leverage ratio. The
two coefficients can be compared. The economic effect of cash is very small. It does not matter
statistically. Variable does not really matter that much.
C1-Intern use
Data oriented course. World of big data.
Based on research articles, video lectures, case studies.
At least 5 for the exam to pass the course.
Exam: comment on academic articles (not in reading list) and solve simple exercises related to what
you have seen in class.
- Follow the video lectures
- Attend and participate in Q&A sessions
- Be active, ask questions
- Go back to the material after the lecture
Instruction lecture with teaching assistant to go through old exam.
First 4 lectures: mostly micro economics. It’s about specific firms.
Later on: more macro economics. Financial markets are important for economics growth.
Moral Hazard problem is solved with good corporate governance. Moral hazard: borrower does not
want to pay back.
Q&A lecture 1
Value of firm (with taxes included), calculate the value of the firm when it’s financed only with
equity. For this, you use the cashflow of the unlevered firm. This you discount. Then you calculate the
PV of the tax shield and add that to the value of the unlevered firm.
Trade-off theory: there are taxes and bankruptcy costs. Issuing debt allows you to benefit from tax
shield, but it increases the probability of going bankrupt. In a graph the turning point can be shown,
the optimal debt can be calculated.
Bankruptcy costs:
- Direct: legal costs for hiring a lawyer. Administrative costs.
- Indirect: loss of sales. Selfish strategies.
Tangible assets = vaste activa.
The more tangible assets, the more can be sold to pay off debtholders. So: less bankruptcy costs.
Theories: smaller companies have less bankruptcy costs because they have smaller results. Large
companies have less bankruptcy costs because they are more diversified and are located in more
places.
Variables that indicate bankruptcy costs: size and tangibility.
Relationship between size and leverage is positive, but not statistically significant.
Tangibility also has a positive relationship with leverage, also statistically significant.
Lecture 2: Debt Covenants
Why issue more equity if value is higher than true value when this is not in line with pecking order?
Pecking Order:
A company has equity worth $5 per share.
Another company has equity worth $10 per share.
Investors are not able to distinguish the two companies. They price the equity $7,5 per share.
Bad companies will enter the market, good companies will stay out.
C1-Intern use
, Answer
In the previous example the bad company enters the market because it knows that it will get a price
above its fundamental value (7,5>5)
So, if a manager knows that the market is overvaluing the shares of her/his firm, she/he will have an
incentive to issue shares.
Pecking order theory tells you more about what to do when you manage a good firm that is not
overvalued.
To minimize your cost of financing: don’t pay dividend and re-invest in the company. Then, issue
debt: borrow from the debt market. Last option (most costly) is to issue equity.
But, there are bad guys around issuing equity again and again because their shares are overvalued.
Pecking Order mostly applies to starting companies.
It is likely the unrated loans have the same behavior as the B and CCC rated loans throughout the
years (so an increase towards 2019-2020).
Back to the paper about violations of debt covenants.
After a violation, most companies start “de-leveraging” 2 quarters after. They are repaying debt.
The smaller the delta, the faster the company is adjusting.
Companies that have higher market-to-book ratio need more time to adjust. They are taking longer
to pay back their debt.
The question means two things:
High market to book ratio may identify high share prices because the company will deliver lots of
profits in the future.
High market to book ratio may identify mispricing and overvaluation
If (1) lender’s actions are justified. If (2) they are not and lead to more risk taking.
What is the relationship between the leverage ratio and the net debt issuance/assets?
Negative and statistically insignificant: companies with higher leverage ratio reduce their net debt
issuance faster than average company.
What is the economic interpretation?
Companies with high leverage have a higher risk of default. After a covenant violation a lender is
more likely to take a tougher approach towards the company and forcing a faster reduction of net
debt issuance and hence leverage ratio.
What is the relationship between credit rating and net debt issuance?
Positive and statistically insignificant. This means that companies with a credit rating ratio reduce
their net debt issuance at a slower pace than companies without.
What is the economic interpretation?
Companies with a credit rating tend to have a lower risk of default than companies without. We
know this in general. The paper of Roberts and Sufi shows that unrated companies have quite high
probability of violating a covenant.
Q&A question 4.
Negative relationship between cash and delta net debt issuance. Companies with more cash are
adjusting their net debt issuance faster. From perspective of lender, companies with more cash are
good guys. Why the negative delta?
Theory is more straight forward than reality (sadly).
Coefficient is not statistically insignificant. Very unprecise and very difficult to take apart from 0. In
term of properties of distribution of a variable, it is very similar to distribution of leverage ratio. The
two coefficients can be compared. The economic effect of cash is very small. It does not matter
statistically. Variable does not really matter that much.
C1-Intern use
