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Corporate Financial Policy: Leverage, Bond Covenants, and Debt Structure

This handout covers readings on corporate financial policy, including topics such as leverage, bond covenants, public vs. private debt, and debt maturity. It also explores the impact of investment opportunities and creditor conflicts on debt structure.

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Corporate Financial Policy: Leverage, Bond Covenants, and Debt Structure

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  1. BRN 482 Corporate Financial Policy Clifford W. Smith Summer 2007 Handout 5 * Covers readings on course outline through Barclay/Smith (1996)

  2. Financial Architecture • Leverage • Bond covenants • Public vs. private debt • Maturity • Priority • Conversion rights • Call provisions

  3. Private vs. Public Debt • Larger issues usually public • fixed registration fees • under-diversification of private lenders • The riskier the debt, the more likely that it will be private • easier to renegotiate • usually contains more, and more specific, contract provisions

  4. Relation between Yield on Net Proceeds & Issue Size for Representative Private Placement and Public Issue Debt Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) SAAA

  5. Yield on Net Proceeds YNP (%) Aaa (Private) Aaa (Public) Issue Size ($) SAAA Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt

  6. Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt Yield on Net Proceeds YNP (%) Baa (Private) Baa (Public) Aaa (Private) Aaa (Public) Issue Size ($) SBAA SAAA

  7. Relation between Yield on Net Proceeds and Issue Size for Representative Private Placement and Public Issue Debt Yield on Net Proceeds YNP (%) Baa (Private) Baa (Public) Aaa (Private) Aaa (Public) Issue Size ($) SBAA SAAA

  8. Investment Opportunity Set Assets in Place Growth Opportunities Cost of Longer Maturity Low High (Underinvestment) Predicted Maturity Long Short

  9. Investment Opportunity Set Growth Opportunities Assets in Place Cost of Low Priority Low High Fixed Claims (Creditor Conflicts)

  10. Investment Opportunity Set Growth Opportunities Assets in Place Cost of Low Priority LowHigh Fixed Claims (Creditor Conflicts) Concentration of LowerGreater Priority Classes

  11. Benchmarking Impact on Private Debt Impact on Maturity Impact on Priority Concentration Growth Options (Merck) Greater Shorter Greater Credence Goods (Eastern) Greater Shorter Greater Product Warranties (Yugo) Greater Shorter Greater Future Product Support (Yugo/Wang) Greater Shorter Greater Supplier Financing (Campeau) Greater Shorter Greater Firm Size Less Longer Less Closely Held Firm Greater Shorter Greater Regulation Less Longer ? Tax Credits — — Less Marginal Corporate Tax Rate — — — Marginal Personal Tax Rate — — — Abnormal Earnings Greater Shorter Greater

  12. Deregulation and Debt Maturity Leverage and Debt Maturity in the Telecommunications industry 1974-1994

  13. Investment Opportunity Set Growth Opportunities Assets in Place Financial Architecture Leverage High Low Maturity Long Short Priority (Table 5) Diffuse Concentrated Conversional Rights Low High Leasing (Table 4) High Low Compensation Level of Pay Low High Conditional Pay Low High

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