Shareholder’s funds (equity) and loan funds (debt) are the two broad sources of finances available to a firm. Shareholders’ funds come mainly in the form of equity capital and retained earnings and secondarily in the form of preference capital. Loan funds come in a variety of ways like debentures capital, term loans, deferred credit, fixed deposit, and working capital advance.
The important considerations in planning the capital structure of a firm are: earnings per share, risk, control, flexibility, and nature of assets.
A firm should use more equity when (1) the corporate tax rate applicable to the firm is negligible, (2) business risk exposure is high, (3) dilution of control is not an important issue, (4) the assets of the firm are mostly intangible, and (5) valuable growth options exist.
A firm should use more debt when: (1) the corporate tax rate applicable to the firm is high, (2) business risk exposure is low, (3) dilution of control is an important issue, (4) the assets of the firm are mostly tangible, and (5) the firm has few growth options.
The market for financial securities may be divided into two segments: the primary market and the secondary market. New issues are made in the primary market whereas outstanding issues are traded in the secondary market.
There are three ways in which a company may raise finances in the primary market: (1) public issue, (2) rights issues, and (3) private placement or preferential allotment.
A firm planning to raise finances may tap one or more of the following capital markets: Indian capital euro capital market, and foreign domestic capital market.
Since the market price and intrinsic value may diverge in real life situations, pricing and timing are important issues. Remember the following guidelines while resolving these issues: (1) Decouple financing and investment decisions, (2) Never be greedy (3) Ensure inter-generational fairness.
The key considerations influencing a firm’s dividend policy are: earnings prospects, funding, requirements dividend record, liquidity position, shareholder preference and control.
Bonus shares are issued to existing shareholders as a result of the capitalization of reserves. In a stock split, the par value per share is reduced and the number of shares is increased proportionately.
Given the dominant role of lead steers a company should bear in mind the following guidelines while communicating with the market: (1) De-emphasize creative accounting (2) Avoid financial hype, (3) Cut ‘lead steers’ into the planning process.
Corporate governance is concerned basically with the agency problem that arises from the separation of finance and management. To build a healthy, mutually beneficial long term relationship with its investors, it behooves on every company to improve the standard of its corporate governance.
There are a number of provisions in the regulatory framework (the companies Act, the Securities Exchange Board of India Act, and so on) to guard the interest of investors. However enlightened companies will have to go beyond them and measure that they are not run primarily for the benefit of dominant shareholders.
The ways of strengthening corporate governance are:
* Institutional investors must be treated as strategic partners, not adversaries.
* Office of the chairman should be seperatefrom that of the chief executive officer.
* The board of directors is well equipped with company information
* Link managerial compensation to performance.
* Improve corporate accounting and reporting practices.
Reform of corporate governance thus calls for a multi pronged approach. It is indeed a tall order. Understanding of the politics of corporate governance is rather limited, heightened competition that we are witnessing in all spheres of economic activity will lead to improvement in the quality of corporate governance. Enlightened self interest should prod a company to raise its standards of corporate governance. After all, the price of independence is active self discipline.