Question

Corporate Finance

Shelf Registration: Large firms filing one comprehensive registration statement:

1– Outlines the firm’s financing plans for up to two years.

2– Allowed to issue securities without further SEC approval when market conditions are appropriate.

3– Mostly use with debt issues, and utilize minimally with equity markets.

Please explain the third statement. Why?

Answer 1

Answer: Debt is also know as debenture which companies issues to raise long term source of funds. The companies raising debts promises to pay interest and principal in return on maturity. The lenders of debt who lent their funds to the borrowers are also know as debenture holders and bondholders. Debt is also know as bonds and fixed income security which is different from equity security with respect to ownership.

Following are the major advantages of debts over equity issues:

1. Less risky: The debt issue is less risky and costly as compared to equity issues. The reason being investor is assured of timely interest payments. The borrower could take the benefit of interest payment as the same are tax deductible. The dividend in equity issues are not certain. Due to less risky the investor demands low rate of interest.
2. There is no dilution of ownership: When the borrower issues debt the ownership does not dilute with the debt issues. When companies raise more funds through equity issues the ownership is diluted. Debt holders do not have voting rights as compared equity sharholders who have voting rights.
3. Fixed income in the form of interest payments: The bond holder get the fixed income in the form of interest and principal on maturity. They can not participate in the extra ordinary earnings of the companies. Equity shareholders benefit from the dividend when the companies make profit which is also sometime not certain because the companies invest the surplus profit for future business opportunities.
4. Low debt obligation in inflation: The debt issuers benefit most when there is high inflation. The reason being the companies have issued debt at lower cost and the same is fixed till maturity.