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Ernst Maug
University of Mannheim
http://cf.bwl.uni-mannheim.de
Tel: +49 (621) 181-1952
Corporate Finance & Risk Management
01 Overview
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 2
Questions
� How do corporations fund their operations?
� Is corporate finance in Europe different from the US or Japan?
� What is the role of financial institutions?
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 3
Financial Markets
Primary
Markets
Secondary
Markets
OTC
Markets
Money
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 4
Financial Institutions (1)
Company
IntermediariesBanks
Insurance Cos.
Brokerage Firms
ObligationsFunds
$ € ¥
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 5
Financial Institutions (2)
Intermediaries
InvestorsDepositors
Policyholders
Investors
ObligationsFunds
$ € ¥
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 6
Sources and uses of funds
� Sources of funds…
= operating cash flow
+ proceeds from equity issues
+ proceeds from debt issues
(+ proceeds from issues of other securities)
� …always equal the uses of funds
= capital expenditure (in PPE)
+ investment in working capital
+ dividend payments
+ interest payments
(+ payments to holders of other securities)
+ increase (- decrease) in cash position
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 7
Example: Sources and uses of funds
Volkswagen AG in € million
Operating cash flow 12,595
Proceeds from equity issues 3,067
Proceeds from bond issues 22,118
Proceeds from other securities 285
Sources of funds 38,065
Capital expenditure (PPE & working capital) 16,890
Dividend payments 1,849
Interest payments 14,614
Payments to other securities 35
Uses of funds 33,388
Difference 4,677
Effects of exchange rate changes on cash -462
Change in firms cash position 4,215
Source: Volkswagen AG Annual Report 2013
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview
Patterns of Corporate Financing (1)Sources of funds for US nonfinancial corporations
-100%
-50%
0%
50%
100%
Internal funds Net equity issues Net borrowing
Source: Brealey/Myers/Allen (2011), Fig. 14.1
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 9
Patterns of Corporate Financing (2)Sources of funds for German nonfinancial corporations
-60.0
-40.0
-20.0
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
160.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
in %
Sources of Funds for German Nonfinancial Corporations
Internal Funds Net Equity Issues Debt Instruments
Source: Deutsche Bundesbank (2013)
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 10
Book value balance sheet
Aggregate Balance Sheet for German Corporations* in 2011€ Billions € Billions
Intangible Assets 32.2 Shareholders' equity 595.7
Tangible Assets 460.8
Inventory 373.8 Current Liabilities 825.5
Fixed Assets 866.8
Long-term Debt 136.3
Cash 124.9 Other long-term Liabilities 122.6
Reicevables 709.0 Total long-term Liabilities 258.9
current 663.8
non-current 45.3 Accrued Liabilities 420.7
Investments among: Pensions Provisions for Pensions 138.1
current assets 28.8
Current Assets 862.7 Accruals and Deferrals 11.2
Other long-term assets 374.0
Accruals and Deferrals 8.6
Total Assets 2,112 2,112
* Manufacturing sector (including minig industry, construction industry, trade and transport)
Source: Deutsche Bundesbank (2013).
Total liabilities and stockholders' equity
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 11
Long-term debt
�Long-term debt: commonly debt with maturity > 1 year
LT debt
LT debt + equity =
136.3
136.3 + 595.7= 0.186
LT liabilities
LT liabilities + equity =
258.9
258.9 + 595.7= 0.303
LT liabilities
Total assets =
258.9
2,112=0.123
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 12
Debt Ratio in EuropeBook values vs. market values
Average Market and Book Debt Ratio*
of European Nonfinancial Companies
0
0.1
0.2
0.3
0.4
0.5
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Book Debt Ratio Market Debt Ratio
*Market (book) debt ratio is total debt over total debt plus market (book) value of equity.
Source: Worldscope Data
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview
Cross-Country Debt Ratios
0
10
20
30
40
50
60
70
80
Ital
y
Jap
an (
2005
)
Ger
man
y
Fra
nce
Sp
ain
Po
rtu
gal
Au
stri
a
U.S
.A (
2005
)
Fin
lan
d (
2005
)
Bel
giu
m
Net
her
lan
ds
Deb
t R
atio
(%
)
Source: Brealey/Myers/Allen (2011), Fig. 14.3
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 14
Stockholder’s EquityAn Example: SAP AG
Book Value of Common Stockholders' Equity of SAP AG, 2013
(in € million)
Common shares (nominal value 1€ per share) 1,229 €
Additional paid-in capital 551 €
Retained earnings 16,258 €
Treasury Shares 1,280 €-
Other adjustments 718 €-
Net common equity 16,040 €
Note:
Authorized shares (in millions) 1,479
Issued shares, of which: 1,229
Outstanding shares 1,194
Treasury shares 35
Source: SAP AG Annual Report 2013
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 15
Market value vs. book value of shares
� Book value of shares:
- 1,194 million shares outstanding
- Total shareholders‘ equity: €16,040 million
- Book value per share as of Dec 31, 2013:
€16,040
1,194= €13.43
� Market value of shares:
- 1,194 million shares outstanding
- Market value per share as of Dec 31, 2013: €62.31
- Market capitalization: €74,398 million
- Ratio of market value to book value: 74,398/16,040 = 4.64
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 16
Ownership structureSAP AG, Dec 31, 2013
Dietmar Hopp 65,233,575 5.3%
Hasso Plattner 119,287,761 9.7%
Klaus Tschira 92,137,817 7.5%
Treasury shares 34,398,118 2.8%
Free float 917,692,661 74.7%
1,228,504,232 100.0%
Source: SAP AG Annual Report 2013
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview
Ownership Structure of European Shares
17
Source: European Savings Institute, Final Report to the European Commission, p. 20
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview
Ownership Structure of German Shares
18
Source: European Savings Institute, Final Report to the European Commission, p. 43
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 19
Ownership and control – dual class shares
� Issue two classes of shares:
� 1st class: „A-shares“, common stock (Stammaktie)
- voting rights
- dividend rights
� 2nd class: „B-shares“, preferred stock (Vorzugsaktie)
- same/superior dividend rights
- no voting rights
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 20
Ownership and control - Pyramids
Company A
Company B
70% ownership by company A
� A‘s management dominates B
Company C
70% ownership by company B� B‘s management dominates C
� A‘s management dominates C..although it owns only 49%!
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 21
Dual-Class Shares
Number of Dual-Class Firms
0
10
20
30
40
50
60
70
Germ
any
Italy
Sweden
Switzer
land
Denmar
k UKFinl
and
Norway
Austri
aFra
nce
Luxe
mbo
urg
Turke
y
Source: Nenova (2003)
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 22
The value of a vote
Country
Sample
period
Firms in
sample
Voting
premium Source
USA 1940-1978 26 5.4% Lease, McConnell & Mikkelson (1983)
Canada 1981-1992 98 10.4% Smith & Amaoko-Adu (1995)
USA 1984-1990 94 10.5% Zingales (1995)
UK 1955-1982 152 13.3% Megginson (1990)
Sweden 1980-1990 65 15.2% Bergström & Rydqvist (1992)
Germany 1956-1998 101 17.2% Daske & Ehrhardt (2002), Dittmann (2005)
Switzerland 1990-1991 29 18.0% Kunz & Angel (1996)
Switzerland 1973-1983 45 22.4% Horner (1988)
Germany 1988-1997 84 26.3% Hoffman-Burchardi (1999), Dittmann (2005)
Israel 1981 25 45.5% Levy (1982)
Italy 1987-1990 96 81.5% Zingales (1994)Source: Dittmann (2005)
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 23
Corporate Bonds
� Secured Bonds (Asset-Backed)
- Secured by real property
- Ownership of the property reverts to the bondholders upon default.
� Debentures
- General creditors
- Have priority over stockholders, but are subordinated to secured
debt.
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 24
Features of corporate bonds
� Corporate bonds are complex and come with many bells and
whistles:
- Senior versus subordinated bonds: pecking order in case of bankruptcy
- Convertible bonds: exchange bond into shares
- Callable bonds: issuer can redeem bond early
- Putable bonds: investor can sell bond back to the issuer
- Sinking funds: Issuers sets aside funds to repay bond before maturity
- …and more
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 25
Bond Ratings
Moody's S&P Quality of Issue
Aaa AAA Highest quality. Very small risk of default.
Aa AA High quality. Small risk of default.
A A High-Medium quality. Strong attributes, but potentially vulnerable.
Baa BBB Medium quality. Currently adequate, but potentially unreliable.
Ba BB Some speculative element. Long-run prospects questionable.
B B Able to pay currently, but at risk of default in the future.
Caa CCC Poor quality. Clear danger of default .
Ca CC High specullative quality. May be in default.
C C Lowest rated. Poor prospects of repayment.
D - In default.
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 26
Ratings and spreads
Source: • Yield spread (1year bond): Reuters Corporate Spreads for Industrials (28/03/2014) • Probability of default: S&P 2013 Annual Global Corporate Default Study And Rating Transitions.
0
1
2
3
4
5
6
7
0
5
10
15
20
25
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC/C
Default rate - Average
Spread - 1yr
Pro
babi
lity
of d
efau
lt (%
)
Yie
ld s
prea
d (%
)
© 2016 Ernst Maug Corporate Finance & Risk Management: Overview 27
Funding requirements
Issue debt Finance internally Issue equity
Bonds Bank debt Voting Non-voting
Security Maturity Other features
SummaryThe financial manager‘s decision problem (highly simplified)