Overview
Corporate Issuers covers the financial and governance decisions made by companies: how they raise capital, optimize their capital structure, manage working capital, and distribute profits to shareholders. It also addresses corporate governance — the system by which companies are directed and controlled in the interests of stakeholders.
Capital Structure and the Cost of Capital
A firm’s capital structure is the mix of debt and equity it uses to finance its assets. The weighted average cost of capital (WACC) represents the average return required by all capital providers:
WACC = (E/V) × Rₑ + (D/V) × Rd × (1 − t)
where E is equity value, D is debt value, V = E + D, Rₑ is the cost of equity, Rd is the pre-tax cost of debt, and t is the corporate tax rate. Debt is cheaper than equity (interest is tax-deductible) but increases financial risk.
Modigliani-Miller Theorem: In a world without taxes and transaction costs, capital structure is irrelevant. With taxes, debt has value because of the interest tax shield. With financial distress costs, an optimal capital structure exists that balances the tax shield against distress risk.
Leverage
Operating leverage arises from fixed operating costs. A firm with high fixed costs has a high degree of operating leverage (DOL): small revenue changes produce large swings in operating income. DOL = % change in EBIT / % change in revenue.
Financial leverage arises from fixed financing costs (interest). The degree of financial leverage (DFL) = % change in EPS / % change in EBIT. Combined, the degree of total leverage (DTL) = DOL × DFL.
Dividends and Share Buybacks
Dividend policy determines how much profit is returned to shareholders versus retained for reinvestment. Key policies include:
- Residual dividend model: Pay dividends only after all positive-NPV projects are funded
- Stable dividend policy: Maintain a predictable, gradually increasing dividend
- Constant payout ratio: Pay a fixed percentage of earnings each period
Share buybacks are an alternative to dividends; they signal management confidence, can be more tax-efficient for shareholders, and increase EPS by reducing share count.
Corporate Governance
Good governance aligns the interests of management with those of shareholders and other stakeholders. Key mechanisms include: independent board of directors, audit committees, executive compensation tied to performance, shareholder voting rights, and proxy access.
Agency problems arise when managers act in their own interest at the expense of shareholders (principal-agent conflict). Contractual arrangements, monitoring, and incentive design reduce agency costs.