CFT

Readings Summary

Topic 4
Ameziane, Levis
(1998)
The determinants of the leasing decision of small and large companies
Basic Idea Why a firm leases is dependent on their size.

Leasing is correlated with companies that
- Have high tax losses
- High fixed capital investments
- High debt-to-equity ratios
- Larger than those that dont lease

But small firms also lease.
- Those with a high Tobins q and less profitable, will lease.

Why do large firms lease?
- Leasing, profitability, leverage and taxation are positively correlated
- Leasing is a substitute for debt financing
- Leasing is used as a financial instrument to minimize their after-tax cost of capital

Why do small firms lease?
- growth opportunities heavily correlated with prob(leasing)
- Taxation does not impact the prob(leasing)
- Leasing is a substitute for debt financing, for the small companies it may be harder
to get a debt as they have low profitability
- Leasing allows small firms to finance their growth opportunities and/or survival

Why lease? 1. Debt capacity
2. Asset type and salvage value
3. Conservation of working capital
4. Ease of obtaining credit with low credit ratings
5. Flexibility
6. Convenience
7. Decrease agency costs

CFT
Readings Summary
Topic 5
Lee, Loughran (1998) Performance following convertible bond issuance
Basic Idea Issuing convertible bonds negatively affects the performance of the firm in the long term

After issuing convertible bonds, the stock and operating performance of firms decreased
- Profit margins, ROA for issuers halved in four years
Convertible Bond (CB)
Issues
- Negative announcement effect of CB issues is 2% decline in stock price, Mikkelson
and Partch (1986)


Why does this occur?
- Most believe its due to asymmetric information between investors an managers
- Myers and Majluf (1986) presented the idea that a companys managers will issue
equity when the stock price is overvalued to try to maximize existing SH wealth
- Thus, investors discount the issue, declining the stock price
- As the CB has share like characteristics, the CB also has the same negative effect on
the stock price
- The size of the negative announcement effect of CB is between the stocks and
bonds

If managers are trying to take advantage of overvalued equity, why not just issue straight
equity instead of CB?
1. Many firms do actually issue straight equity too, just a bit earlier
2. For taxation reasons; issuing a CB to lower their taxes through the interest
deductibility of debt
Conclusion - Long-run CB issuing firms significantly underperform similar firms in the benchmark
- Issuers have a sharp decrease in operating performance after the CB offering
- PM and ROA drop dramatically after four years

CFT
Readings Summary
Topic 5

Mayers (2000) Convertible Bonds: Matching Financial and Real Options
Basic Idea CBs can be used to solve the sequential financing problem; how to fund not only todays
activities, but also tomorrows opportunities, GOs/real options

CB are the most cost-effective way for companies to finance growth opportunities in a
sequence of uncertain values and timing
- CB are cost effective for companies with major GOs as they allow management to
match capital inflows with expected investment outlays

CBs can be viewed as deferred equity, offerings that add value for companies with
promising future growth opportunities that arent fully reflected in current share prices

Future investment opportunities with uncertain value and timing = real options
- They are called options as though the projects may be not be valuable today, out
of the money, their value may rise and then become valuable
B dont give the best of both worlds to issuers and holders
- CB dont represent cheap debt for the issuers and dont sell at a premium for the
holders over the share price

Talking about the free and expensive lunch, the unfair comparisons
Free Lunch compares: Convertible to straight Debt when prices are going Down (F CDD
CEU) and Convertible to Equity when prices are going Up

Expensive lunch compares: Convertible to straight debt when prices are going up and
convertible to equity when prices are going down(E CDU CED)
Why do investors like
CBs?
1. Valuable Option
- Investors are willing to accept a lower coupon rate on convertibles than on straight
bonds only because they are able to use a valuable option on the companys stock
which is actually a dilution of existing SHs claims
2. Reduction of transaction, agency and asymmetric information costs
-


CFT
Readings Summary
Topic 6

Julio, Ikenberry (2004) Reappearing Dividends
Basic Idea -Questioning the fundamental causes of dividends increasing after the 2001
- Rebuttal to Fama and Frenchs Disappearing Dividends (2001) paper; on the slowing
growth of dividends and their replacement with stock buybacks
- Dividend puzzle: why companies payout earnings to SH, and their role in maintaining and
even increasing corporate values
-Julio and Ikenberry note there was a low in 2001, and then the % of dividend payers
turned up
- Julio and Ikenberry suggest that the drop in dividends was due to the number of IPOs
occurring, thus these newer and riskier firms are unlikely to pay dividends
- Isolating both the large and mid-cap stocks, can see that the downward trend occur til the
millennium and soon after picked up again

Five plausible reasons
1. Bush tax cut in May 2003 Nope
2. Companies trying to use divs to reassure investors about quality of earnings
3. Maturity hypothesis = Consequence of Internet-era start-ups maturing to
where they need to think of their repayout policies (in 90s tech growth soared)
4. Residual outcome of companys capital budgeting, avoiding overinvestment
5. Change in investors behavior and preferences, outside of the fundamentals
and bounds of rational behavior

How much have dividends been replaced by stock repurchases?
- 1997, total cash dollar amount of stock repurchases> cash dividends
- Suggesting substitution effect between divs and repurchases? Nope. Not perfect
subs.
- Repurchases are more flexible and tax-efficient over divs for payouts flexibility in
repurchases
- Both can be used to signal confidence in firms prospects
- Repurchases manager believes shares are undervalued (or at least not
overvalued)
- Total payouts in mid 90s approx. 20% (divs+repurchases)
- In 92, see a shift away from divs to repurchases, and then a decline in repurchases
around 99.
-
Conclusion Best explanation = Maturity Hypothesis
- Between 92 and 96, 3000 new companies listed
- Decade later, companies find G.O.s shrinking compared to current cash levels and
market cap, i.e. Microsoft
Another explanation the underlying economy
- Dividends could be considered as leading or lagging indicator of earnings power,
thus hard to say whether the div policy is driven by the economy
Taxation change by Bush also helped

CFT
Readings Summary
Topic 6

La Porta et al. 2000 Agency Problems and Dividend Policies around the World
Basic Idea Outlines and test, agency models of dividends; OUTCOME and SUBSTITUTE
Outcome
- Dividends are paid as minority SH pressure corporate insiders to eject cash
Substitute
- Insiders interested in issuing equity in the future pay dividends to establish a
reputation of decent treatment of minority SH

Outcome predicts; stronger minority SH rights should be associated with higher div.
payouts
Substitute predicts opposite.
How do firms choose
their dividend
policies?
MM in a frictionless world, with investment policy constant, dividend payouts have no
effect on SH wealth
So dividend policy would not matter random, changing policies
Evidence suggests otherwise; companies have a deliberate and mostly constant dividend
strategy
Dividend policies
address agency
problems
Jensen, Myers and numbers of other authors pointed towards the idea that dividend
policies can be used to reduce agency problems between SH and managers
- It is suggested that if profits are retained in a firm after all positive NPV projects are
financed, the FCF will be wasted on overinvestment into negative NPV projects,
hurting SH value

Agency approach
- Moves away from the MM
1. Investment policy not independent of dividend policy
2. Allocation of profits on a pro rata basis cannot be taken for granted. This may
not actually occur due to preferential treatment of insiders, with asset
diversion, transfer prices etc.
Dividend policies and
law
Investors whom have good legal protection use their legal powers to extract dividends from
firms

Common law countries (USA, Aus etc.) have high investor protection higher dividend
payouts
Common law: high growth firms pay lower dividends than low growth firms

Civil law has lower investor protection lower div payouts

Agency Problems and
legal regimes
- Agency problems can be deterred by law
- Law gives outside investors certain powers and rights, this is legal protection =
viewed as a proxy for lower agency costs
- Legal protection differs between law systems and countries
- UK and US, common law countries = high quality protection
- French civil law countries weakest protection
Agency and Divs: Two
views
- Role of Divs in an Agency context
- Paying out divs ensures that managers dont use corporate earnings to benefit
themselves and may cause the company to come to the external financial market
for finance, giving outside investors chance to control the insiders

- Attempt to explain the basic mechanisms of how divs could be used to deal with
agency problems



CFT
Readings Summary
Divs as an Outcome of
Legal Protection
- Legal protection of SH, used by SH to force companies to disgorge cash, preventing
insiders from using it to benefit themselves
- i.e. voting for directors with higher div policies, or suing the company
- legal protection makes it harder, legally riskier and more expensive, for insiders to
divert assets
- example. Kirk Kerkorian and Chrysler in 95/96; as a large SH, used voting
mechanism to put his associates on board and then force the board to increase divs
- high protection allows investors to resist oppression rather than having any
specific dividend rights per se
- high protection, high growth companies lower divs than high protection and low
growth (mature firms)
Divs as a Sub for Legal
Protection of SH
- Views relies crucially on need of firms to go to the ext. financial markets for funds
- To raise funds with attractive terms, firm must establish a good rep. for moderation
in expropriating SH
- Thus payout divs, reducing what is left for expropriation
- A good rep is necessary in countries with weak legal protection of SH
- Implies that weak legal protection countries should have higher div payout ratios
than those with higher legal protection
Conclusions Outcome Model
- Dividends are an OUTCOME of effective legal protection of SH
Substitute Model
- Divs are used as a substitute for legal protection of SH, allowing companies to
present a good rep to the financial capital markets, allowing more favourable terms
for borrowing more capital
- Agency approach is highly relevant to understanding div policies
- No conclusive evidence of effect of taxes on div policies

Firms seem to payout divs because the opportunities to steal or mis-invest it are
limited by law and as SH have enough power to extract it


Free Lunch compares: Convertible to straight Debt when prices are going Down (F CDD CEU) and Convertible to
Equity when prices are going Up
Expensive lunch compares: Convertible to straight Debt when prices are going Up and Convertible to Equity when
prices are going Down (E CDU CED)