Strategic Corporate Finance: Applications in Valuation and Capital Structure

A NEW PERSPECTIVE ON EQUITY

Though many people might equate share price with the corporate cost of equity, equity’s true cost is determined by the interest rate environment and investor expectations. Both are at historic lows. As outlined earlier, the cost of equity has fallen. There has been a significant decline in the expectations of the equity capital markets, from analysis of historical excess returns and from the implied expectations of more recent equity market valuations. Several macroeconomic forces have conspired to reduce equity returns. We have empirically measured and documented the effects of structural change and offer the following economic rationale:

• Size. Larger markets provide more liquidity and less volatility and risk.
• Globalization. Global economic growth and trade has lowered total equity risk.
• Information and technology. Improved financial reporting, disclosure, and information technology has reduced uncertainty and required returns.
• Agency costs. Investors are more active in influencing companies to maximize shareholder value, which reduces the risk of common stock.

But issuing equity at low share prices leads to significant dilution of the existing ownership interests, a practical impediment to issuance no matter how compelling the rationale. How then, can equity be most efficiently raised in this environment?

Debt-for-Equity Exchange

Many highly leveraged companies find themselves boxed in by the combination of share price and reluctance or inability ...