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4.1 Introduction

This section looks at how discounted cash flow (DCF) and the net present value (NPV) rule help investors to choose between possible alternative investments and decide whether the return offered on an investment is worth it, given the risk.

  • DCF allows us to compare two alternative investments with different expected cash flows, different maturities and different risks.

  • NPV allows us to decide whether or not to go ahead in either case.<
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3.3 Liquidity

Borrowers prefer to have the use of funds for as long as possible, while investors generally prefer to be able to get their money back as soon as possible. A major function of the financial markets, and of the stock market in particular, is to reconcile these conflicting requirements. The stock market enables shareholders and bondholders to realise their investment independently of the company by selling their holdings to other investors. This is called the secondary capital market, to distin
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7.5 Materials costs

There will be many categories of materials, supplies and consumables used in a project. Once again, the materials that are in constant use and easily and ‘freely’ available in an organisation might be overlooked in costing the project. For example, it is easy to assume that stationary will be available in much the same way as it is for day-to-day work. However, a project is a bounded activity, and if you are to understand the full cost of achieving the outcomes, you will need to know how
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Acknowledgements

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Grateful acknowledgement is made to the following sources for permission to reproduce material in this unit:


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1.8 Summary

In this unit we have looked at how companies raise equity finance.

We have examined how companies may move from private equity finance, supported by the venture capital companies, to public equity finance through an IPO. We then went on to study seasoned or secondary equity offerings (SEOs) with particular focus on rights issues.

We looked at why companies may choose to list on more than one exchange and at the circumstances that might lead to a company de-listing and reverting to
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1.7 Monitoring equity performance

For those equities in issue their current market value and some indicators of their performance are provided in the daily press. Table 3 shows the closing levels and the volume of shares traded in respect of a selection of companies on the London, New York, Frankfurt and Tokyo Stock Exchanges on 7 June 2005.

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1.6 Equity buybacks, de-listing and reversion to a ‘private’ company

Once its shares have been issued, a company has the option to buy back shares. Buybacks will occur if the company believes that it is overcapitalised and cannot generate a sufficiently high return on capital through its operations. Under these circumstances it is effectively saying to the investor ‘thanks but please now have some of your money back – you can probably make it work harder elsewhere’. A further reason for buybacks arises when a major capital restructuring is undertaken by
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1.5 Cross-listing

For many companies, particularly MNCs, there are attractions in having a share listing on more than one stock exchange. The last decade has witnessed an increase in such cross-listings globally.

Chouinard and D'Souza (2004) noted that the proportion of non-US listings on the New York Stock Exchange (NYSE) doubled from about 8.5 per cent in 1994 to 17 per cent at the start of 2003. This period also saw a rise from 7 per cent to 10 per cent in the non-US listings on NASDAQ. Author(s): The Open University

1.4 Seasoned equity offerings

The issuance of additional shares is called a seasoned or secondary equity offering (SEO). SEOs are common in the London market, but less common in the USA. In some countries, including the UK, one form of SEO is a rights issue. In such issues the existing shareholders are given the right to buy further shares, usually in an amount proportionate to their prevailing holdings. This is known as a pre-emption right.

While rights issues can support the need of a successful comp
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1.3 ‘Going public’

For many companies a point may be reached, particularly if the company has grown significantly in size and has aspirations for further expansion, to seek equity finance through an initial public offering of shares (IPO).

SAQ 4

In a recent
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1.2 Staying private – private equity and venture capital

For many companies – particularly in Europe and Asia – private equity together with retained earnings have been a sufficient source of capitalisation, allowing these companies to avoid listing on a stock exchange. (Retained earnings are the post-tax undistributed – i.e. not paid out in dividends – profits of a company.) The capacity to remain private has been assisted by the rapid growth of private equity in recent years. Private equity has been employed not just by newly established
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1.1 Equity instruments

Both public and private incorporated companies can issue shares in order to finance their operations. Those who invest in shares expect a return blended from dividend yield and capital growth – although the expectations of investors vary from country to country. In the USA, for example, many companies rarely, if ever, pay dividends, with the result that investors seek their returns through share price growth. You will have learnt from earlier finance studies that investors require higher re
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Learning outcomes

After studying this unit you should be able to:

  • understand private equity and the role of venture capital companies in providing this;

  • understand why and how public equity issues can be undertaken;

  • look at the reasons for cross-listing on stock exchanges;

  • examine why a company might de-list from an exchange and return to private ownership.


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Introduction

This unit looks at equity finance – the range of equity instruments and markets available to a company. First, we look at private equity and the role of venture capital companies that provide such finance. We look at the mechanics of an initial public offering (IPO) and at recent cases of companies ‘listing’ on a stock exchange for the first time. We go on to explore certain important strategic issues for a business when considering equity finance:

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Acknowledgements

The content acknowledged below is Proprietary (see terms and conditions) and is used under licence.

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Zohar_Manor-Abel

All other materials included in this unit are derived from content originated at the Open University.

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References

Baker, M. (2006). Private communication, Business in the Community, 29 March.
Brewster, D. (2004). ‘CalPERS wave-making brings flak’, Financial Times Fund Management, 9 August.
Business Week (2004). ‘Special report: corporate governance, investors fight back’, 17 May.
Butz, C. (2003). Decomposing SRI
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2.6 Conclusion

In this section we have looked at the different ways in which expectations about corporate governance have grown. We have briefly reviewed the role of corporate scandals as a generator of regulatory responses, and in particular the significant problems that surfaced in 2002–3. We have also noted that research shows that evidence of a positive correlation between good investment returns and good corporate governance policies is not conclusive.

We have looked at the growth of shareholde
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2.5 Rating agencies: corporate governance indices

A number of rating agencies, including credit rating agencies, have developed indices to measure corporate governance performance. Among the more well-known indices are FTSE-Institutional Shareholder Services (ISS) Corporate Governance Index, Standard & Poor's Corporate Governance Scores, Dow Jones Sustainability Index and Business in the Community Corporate Responsibility Index. Rating agencies can act as catalysts for corporate governance by either directly factoring corporate governance in
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2.4 Shareholder activism

Shareholder (investor) activism can also force better corporate governance. Historically, individual shareholders, whether institutions or private persons, have had little chance of influencing the board or management given the fragmentation of ownership.

Shareholders can ask questions at the annual general meeting, but they would need a majority of votes in order to pass a motion that was binding on management. Even institutional shareholders do not, in most countries, hold as much as
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2.3 Capital markets

In so far as better corporate governance has the objective of enhancing shareholder control, it should follow that companies with better corporate governance will attract investors and will reduce their cost of capital. A global investor opinion survey carried out by McKinsey & Company (2002) gives some evidence that good governance is linked to investment decisions. The survey found that:

  • investors state that they still put corporate governance on a
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