22: Legal Aspects of Corporate Finance
- Page ID
- 11165
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)After reading this chapter, you should understand the following:
- The general sources of corporate funds
- The basics of corporate bonds and other debt leveraging
- What the various types of stocks are
- Initial public offerings and consideration for stock
- What dividends are
- Some of the modern trends in corporate finance
A corporation requires money for many reasons. In this chapter, we look at the methods available to a corporation for raising funds, focusing on how firms generate large amounts of funds and finance large projects, such as building a new factory.
One major method of finance is the sale of stock. A corporation sells shares of stock, often in an initial public offering. In exchange for consideration—usually cash—the purchaser acquires stock in the corporation. This stock may give the owner a share in earnings, the right to transfer the stock, and, depending on the size of the corporation and the number of shares, power to exercise control. Other methods of corporate finance include bank financing and bonds. We also discuss some more modern financing methods, such as private equity and venture capital.
- 22.1: General Sources of Corporate Funds
- This page discusses primary sources for raising corporate funds: plowback (reinvesting earnings), debt securities (loans via bonds), equity securities (ownership through stock), and private equity/venture capital (investments from private investors). Plowback is preferred for maintaining control and avoiding external costs. Debt securities require repayment, while equity grants ownership rights.
- 22.2: Bonds
- This page discusses corporate bonds as a means for corporations to raise funds by selling IOUs rather than equity. Key advantages include maintaining ownership control, attracting investors, and tax-deductible interest. Conversely, disadvantages involve mandatory interest payments, bankruptcy risks from debt, and high-interest rates affecting appeal to investors. While offering financing flexibility, bonds also introduce financial risks.
- 22.3: Types of Stock
- This page covers corporate stock features, terminology, and types like preferred and common stock, as well as their classifications such as authorized and outstanding. It highlights preferred stock’s rights and common stockholders' voting rights. Additionally, it discusses stock buybacks, private equity partnerships, reasons for going private, and factors influencing capital-raising decisions between debt and equity.
- 22.4: Initial Public Offerings and Consideration for Stock
- This page outlines the IPO process and its implications for corporations, detailing how it allows companies to sell stock publicly under SEC regulations. It discusses advantages such as reduced debt and increased visibility, as well as disadvantages like ownership dilution and compliance burdens. The text defines consideration in stock transactions, mentioning the commonality of cash, and highlights concerns about "watered stock" and associated legal liabilities.
- 22.5: Dividends
- This page explains dividends, including cash, stock, and property types, along with legal limitations and the responsibilities of corporate directors in declaring them. It highlights profit sharing with stockholders, solvency-based legal restrictions, and the discretion directors have in dividend declaration, emphasizing liability for illegal payments. Additionally, it differentiates stock dividends from stock splits, addressing their effects on shares and market pricing.
- 22.6: The Winds of Change
- This page discusses the Revised Model Business Corporation Act (RMBCA), advocating for the modernization of corporate finance by removing outdated concepts like par value stock and emphasizing insolvency and balance sheet tests for shareholder distributions. While the RMBCA is advisory, states like Delaware permit par value stock.
- 22.7: Cases
- This page discusses a legal case where Ford Motor Company's management chose to reinvest profits instead of paying special dividends, prompting plaintiffs to challenge this decision. The court ruled that while directors have discretion in profit distribution, they can't arbitrarily withhold dividends.
- 22.8: Summary and Exercises
- This page outlines the various financing methods available to corporations, such as reinvesting profits, private equity, debt financing, and issuing stock. It explains the distinctions between common and preferred stocks, the regulations governing IPOs and stock sales, and the legal limitations on dividends. Each financing option presents unique advantages and disadvantages that corporations need to consider in their decision-making.