Equity Dilution Research Articles

Changes in risk characteristics of firms issuing hybrid securities: case of convertible bonds

AbstractThe present paper examines changes in risk characteristics of a firm when it issues convertible bonds by studying the change in beta before and after the issuance of convertible bonds. Using a sample of 149 firms, strong evidence was found of change in beta, along with significant heterogeneity across firms. On average, the beta of a firm issuing convertible bonds declines, although 40 per cent of firms showed an increase in beta. A cross‐sectional regression shows that after controlling for the reversion‐to‐mean phenomenon, the change in beta is significantly related to potential dilution of equity as well as to increase in debt, but is not significantly related to either the change in bond rating of a firm or to the stated use of funds from issuance.

Equity Dilution: An Alternative Perspective on Mortgage Default

Empirical research on mortgage default in the single‐family market has focused on the value of the borrower's put option using house price indices to estimate contemporaneous loan‐to‐value ratio or the probability of negative equity. But since the borrower possesses the option to increase leverage by taking on additional debt secured by junior liens subsequent to loan origination (a phenomenon termed here equity dilution), even a perfect house price adjustment cannot be expected to accurately measure changes in borrower equity over time. Since junior liens are generally unobservable to senior debt holders, proxies are required in empirical applications. This paper employs an independent estimate of junior lien probability developed from the 1998 Survey of Consumer Finances combined with loan level mortgage performance data to examine the role junior liens play in increasing default risk.

Why Do European Firms Issue Convertible Debt?

Abstract We survey European managers to gain some insights into motivations of convertible issuance. Our analysis shows that a majority of firms issue convertibles as ‘delayed equity’ and as ‘debt sweetener’. Managers also use convertibles to avoid short‐term equity dilution and to signal firm's future growth opportunities. We document a large cross‐sectional variation across firms in rationales for issuing convertibles and find mixed support for most theoretical models. Our evidence suggests that the popularity of convertibles is driven primarily by their versatility in adjusting their design to fit the financing needs of individual firms, and by their increased demand among institutional investors.

A Model for Valuing Multiple Employee Stock Options Issued by the Same Company

Current techniques employed in valuing multiple employee stock options issued by the same company treat each option as being independent of the others and do not reflect that the option values should be determined simultaneously. In this paper we develop a model to simultaneously value all employee options issued by the same firm and study the valuation impact associated with ignoring this simultaneity when more conventional approaches to employee option valuation are used. Using a set of valuation examples, we demonstrate that if each employee stock option is issued on a small to moderate fraction of a firm's outstanding shares, the standard Black-Scholes/binomial and multiple employee option-pricing models give values that are not materially different from each other. However, if employee options are issued on a larger portion of outstanding shares, using the Black-Scholes/binomial approach can result in mis-valuation on the order of 25 percent. Therefore, in cases for which there is the potential for significant equity dilution resulting from the exercise of employee options, there can be a material difference between option values computed via the multiple employee option-pricing model and those computed using more standard option valuation methods.

Bond calls, credible commitment, and equity dilution: a theoretical and clinical analysis of simultaneous tender and call (STAC) offers

This paper is an exploration of the ability of game theory to explain real-world corporate maneuvering. We explore this issue by investigating bond tender offers accompanied by a threat to call nontendered bonds, so called “Simultaneous Tender and Call” (STAC) offers. We argue that STACs engender a transparent game played by bondholders and shareholders. We model this game and use this model to predict the outcome of STACs. Finally, we investigate the issue of whether this theoretical model explains the outcomes of four actual STAC issues made by James River, May Department Stores, and Houston Lighting & Power Company. Our clinical analysis provides support for the explanatory power of our model. Calibrating the predictions of the model with data from these STACs, we demonstrate a correspondence between theory and actual corporate behavior. As predicted by our model, subgame perfection, or threat credibility, and preplay coordination are central to explaining the outcomes of the STACs.

Identification of the Factors Affecting Brand Equity Building in the New Product Development Stage: Conjoint Analysis and ANOVA Perspective

The purpose of this research is to explore the impact of product concept, brand name, and the ”country of origin” on brand equity building from the perspective of new product development. Three studies were conducted using decompositional (conjoint analysis) and compositional models (ANOVA) respectively. Research findings revealed that all of the three factors have a significant impact upon brand equity building in the new product development stage. However, the conjoint analysis measurement results between scoring (premium price) and sequence preference demonstrate some differences on the importance of brand name vs. country of origin attributes. The effectiveness of a suggestive brand name may have an impact upon recall or association, but may not have influence on brand equity building. Conversely, the brand equity dilution effect does result from a non-suggestive brand name.

Brand Equity Dilution: Retailer Display and Context Brand Effects

Consistency among the various elements of a marketing program is believed essential in building and maintaining brand image and equity. And yet, a brand's ultimate presentation to customers is controlled more often by the retailer than by the manufacturer. In this research, the authors demonstrate that the retailer's display decisions can negate the equity of an established brand. The authors suggest that this occurs because consumers have expectations about retail displays and the relationship among displayed brands. Display conditions that disconfirm these expectations can lead consumers to reevaluate the brand. Specifically, the results demonstrate that high-equity brand valuations are influenced by an unfamiliar context brand when (1) a mixed display structure leads consumers to believe that the context brand is diagnostic for judging the high-equity brand, (2) the precedence given to one brand over another in the display makes expectations about brand differences or similarities accessible, and (3) the unfamiliar context brand disconfirms these expectations.

Brand Equity Dilution: Retailer Display and Context Brand Effects

Brand Equity Dilution: Retailer Display and Context Brand Effects

The Structure of Corporate Control and Ownership in a Regulatory Environment Unbiased toward One‐Share‐One‐Vote*

This paper seeks to identify the determinants of corporate ownership and control that emerge in regulatory environments which do not inhibit the issue of shares with differential voting rights and/or the establishment of pyramid holding companies (which serve exactly the same purpose). [Methodologically, the paper follows the seminal study of the US corporate structure by Demsetz & Lehn (1985).] Such settings tend to produce very concentrated control structures, which contrast sharply with those of the USA, the UK and Australia, where the distribution of shareholder votes in the large public corporations is relatively diffuse. Relatively lenient listing regulations have produced in South Africa a corporate landscape dominated by pyramid holding companies and multilayered diversified corporate groupings. These structures have effectively concentrated the control of most of the large public companies in the hands of a few entrepreneurial families (as well as the two large life insurance mutuals). This setting has enabled us to advance and test hypotheses about control and ownership which would be more difficult to test in a US, UK or Australian setting. Almost all the companies in our sample were found to be under the absolute control of a single identifiable shareholder coalition (usually one or two families) but the underlying percentage shareholding of the controlling group in each company was found to vary dramatically and systematically. We sought to explain that variation and to identify the role of the market as a constraint on the ability of controlling shareholders who wish to dilute their equity stake without surrendering control for the purpose of expanding their companies (without incurring additional debt) and/or diversifying their personal wealth. Demsetz & Lehn had already identified the factors that determine the demand by shareholders for equity dilution but not those constraining their ability to do so. This paper, therefore, attempts to shed light on the way in which principal/agent problems affecting shareholders and managers are resolved when one‐share‐one‐vote is neither enforced nor encouraged by the regulatory environment.

Why Do Firms Issue Convertible Debt?

Randall S. Billingsley is Associate Professor of Finance in the Pamplin College of Business at Virginia Polytechnic Institute and State University, Blacksburg, Virginia. David M Smith is Associate Professor of Finance at the University at Albany, SUNY, Albany, New York. This paper updates several widely cited studies on the motivation for convertible debt issuance. Our recent survey finds that firms use convertibles primarily as an alternative to straight debt, employing a conversion feature to buy down the coupon rate and thus preserve cash flow. The results confirm a decreasing reliance on convertibles as delayed equity financing. Cumulative abnormal returns are related to managers' estimates of the degree of equity underpricing, and to the degree of potential equity dilution associated with the convertible issue. Early evidence is also provided on managers' views of the recent regulatory innovation, Rule 144A.

Enhancing the Obsolescing Bargain Theory: A Longitudinal Study of Foreign Ownership of U.S. and European Multinationals

This research attempts to enhance the obsolescing bargain theory, for manufacturing companies, by statistically testing the effects of nine explanatory variables on the static and dynamic manifestations of bargaining success, with longitudinal, firm-level data. In order to highlight those effects, it develops a conceptual framework that provides a broader context in which the primary variables operate. It demonstrates that the obsolescing bargain took effect in India over a fifteen-year period following restrictive legislation. Unlike previous research, this study measures the effect of benefits received by multinationals from the host government in exchange for equity dilution. American companies are found to retain a smaller share of their foreign ownership over time than British and other European multinationals. Some explanatory variables that have previously been found to influence level of foreign ownership (static bargaining success) are found to be less important, or have a different effect, in explaining proportion of foreign ownership retained (dynamic bargaining success).

Executive and Employee Share Options: Taxation, Dilution and Disclosure

Abstract Share option schemes have grown substantially in the UK in recent years. Disclosure requirements have not kept pace with innovation, and fuller disclosure of directors' option rewards has been among the recommendations of institutional shareholders on corporate governance. The current requirements are the result of unhappy historical accident; they are simultaneously complex and incomplete, achieving patchy compliance. When servicing option schemes, companies are able to choose between issuing new shares and purchasing existing shares. The choice has implications for dilution of equity, disclosure in financial statements and liability for corporation tax. This paper develops a comparative analysis of the post-tax cost of options which indicates that purchase is likely to be the cheaper method, and goes on to show that statutory disclosure requirements are less demanding when options are satisfied by the purchase of existing shares. Many companies nevertheless continue to use schemes involving sub...

Market reaction to long-term incentive plan adoption: Equity dilution as an explanatory variable

Long-term incentive plans are instituted to motivate top corporate executives and align principal-agent interests. Among others, forms of long-term incentive compensation include cash and stock awards, stock options, performance shares, stock appreciation rights, phantom stock, and participating units. The general contention behind instituting these awards is that they increase long-term shareholder wealth. Preliminary studies by Brickley, Bhagat & Lease (1985) , and Tehranian & Waeglein (1985) , support this contention. However, Jones, 1980a , Jones, 1980b documents evidence to show that shareholder groups do not view the impact of all incentive plans favourably. This paper focuses on the market reaction to the adoption of long-term incentive plans that reward executives through stock options. Analysing from an event-study perspective, our results provide some evidence that beyond a point incentive effects are offset by effects of equity dilution through stock options and shareholder wealth is reduced. Hence, it appears that a blanket endorsement of all long-term incentive plans as being in the interest of shareholders is not warranted. This study adds to existing literature on principal-agent relationships, and shows that equity dilution can be used as a variable to assess market reaction to long-term incentive plan adoption.

Venture capital investing for corporate development objectives

There is a significant new player emerging in the venture capital world whose participation is changing the way that the venture business is done. Domestic and foreign corporations have discovered that investing in venture capital adds a new dimension to their corporate development strategies and can also make an outstanding return on investment. Armed with serious amounts of cash, aware of the value of an association with their name and frequently possessing marketing power that a small company covets, corporations are competing with venture capitalists for the best deals. Obtaining a “corporate partner” is now an accepted part of a small company's financing strategy. For the corporate development executive, this activity provides a useful tool to widen the spectrum of participation in new technologies while retaining the entrepreneurial drive and reducing the cost and exposure of new ventures. However, it is not a panacea for growth and caution should be exercised to avoid creating unrealistic expectations. Both entrepreneurs and venture capitalists welcome this source of later-stage capital, providing it minimizes equity dilution and assists in product development, marketing and liquidity for their investment. However, it is a competitor for the venture capitalists in sourcing deals and a potential adversary for the entrepreneur when objectives clash. Additionally, entrepreneurs and venture capitalists often are suspicious of the corporation in the small company's boardroom. The objective of most corporations is the strategic benefits that can result from venture capital investing, such as acquisitions, technology licenses, product marketing rights, international opportunities and a window on technology. However, this objective is frequently mixed with a financial return objective and can lead to a confused strategy. Participation by corporations can take many different forms but usually begins with investments in several venture capital funds as a limited partner and evolves into direct investments in venture companies. Formation of a venture development subsidiary by the corporation is a demonstrated way to maximize the strategic rewards. If financial return is the only objective, then a stand-alone venture fund is the best vehicle. The most important factors for the strategic success of a corporate program are the creation of a high-quality deal stream and the use of outstanding people to interface between the corporation and the venture capital world. In addition, there has to be a long-term commitment, active involvement and a carefully devised internal communications strategy to promote and protect the program. Creation of a formal venture development subsidiary is probably the best way to maximize the strategic objectives. Lubrizol Enterprises operates as such a subsidiary of The Lubrizol Corporation and utilizes venture capital investing, acquisitions, partnerships, and contract research to develop strategic business units based on leading-edge technologies.

Cumulative Voting: The Value of Minority Shareholder Voting Rights

W HEN investors purchase shares of common stock, they typically acquire the right to vote in the election of the firm's board of directors and on other major issues facing the corporation. In most corporations board members are elected through "straight voting." In straight voting each shareholder is entitled to cast votes equal to the number of shares held for each director position. If a group controls 51 percent of the vote, it can elect the entire board of directors by casting all of its votes for the candidate that it favors for each position. Some firms do not use straight voting but elect their board members through "cumulative voting" instead. In cumulative voting each share entitles the shareholder to as many votes as there are directors to be elected. A shareholder may cast all votes for a single candidate or distribute them among more than one nominee. With cumulative voting it may be possible for minority shareholders to elect some board members even if the majority of shareholders oppose their election. To elect these directors, the minority shareholders would cumu-

The Feasibility of Economic Leasing in the Oil Industry - An Equipment Analysis

Abstract This paper presents a complete analysis of the economics of leasing equipment by the petroleum producer. Using the basic premise that capital which is freed by leasing equipment rather than purchasing outright can be put to more productive use, graphs are presented to illustrate economic conditions which occur when the operator leases equipment. Both the major producer who might have large amounts of capital readily available and the smaller one with limited funds may be financially aided by equipment leasing. In the first case, the capital freed by leasing production equipment can be used more productively to discover or develop additional reserves, rather than as the advance payment for the future use of a capital asset. Secondly, since equipment leasing extends virtually 100 per cent financing to both, the small independent has the use of needed equipment without the over-extension of bank credit or the possible dilution of equity which can occur when outside financing is required. Long-term sale and lease-back of plant or producing facilities offers another method for the oil producer to acquire additional funds for development work. Under this plan it is possible for the producer to sell full or partially depreciated equipment to the leasing company and immediately lease it back. Any capital loss or gain which is realized can be effectively utilized by the producer. Introduction Still prevalent today is the concept that pride of ownership of fixed assets is justifiable even when cost considerations might suggest equipment leasing. This is a survival of the notion that buying all the future services of a given property at once is a more natural procedure than buying such services as needed. Today, the process of obtaining the use of capital assets by lease rather than purchase is gaining acceptance in many phases of United States business, but it is still relatively unknown in the petroleum industry. Lease financing or leasing of equipment has had a tremendous growth since the early 1950's not only in volume, but also in the types of equipment which can be leased. One company recently announced a "new milestone in American business finance", which turned out to be a program under which qualified applicants can lease money. This announcement pointed out the major advantage which the program offered over conventional equipment leasing-that the lessee was not restricted to a specific piece of equipment but could purchase any items he desired with the "leased" money. The equipment-leasing industry began to come into its own in 1952 and has had a substantial growth since that time. The dollar volume of equipment on lease, excluding transportation equipment and business machines, has grown from $40 million in 1954 to $500 million in 1960, as shown in Fig. 1. The industry estimates that it should exceed $1 billion by 1965. Approximately $330 million of the 1960 business was handled directly by equipment manufacturersThe remaining $200 million represents the contribution of the leasing companies who do no manufacturing themselves but who buy the equipment from manufacturers for lease to customers. JPT P. 355^