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49 Cards in this Set
- Front
- Back
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Question
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Answer
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Bond Covenants use Restrictions on:-
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Investment Policy Dividend Policy Financing Policy Required Bonding Activities
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Bonus plans
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Help the effort problem risk exposure - can provide incentives to stir the pot Makes the payout problem worse Horizon problem not helped because you can manipulate the timing of earnings.
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Bonus Plans effect on Horizon Problem
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Effiect on Horiaon problem because the timing of earning can be manipulated
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Chapter 11 Chapter 7
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11 is court ordered reorganization of finances 7 is liquidation
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Closely held firm
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salary - higher Bonus - higher options - higher
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Cobra
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Consolidated Omnibus Budget Reconciliation Act -A COBRA health plan says if you leave your job you have the right to continue the health insurance coverage you and your family received, for 18 months.
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conflicts between owners and managers
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effort problem horizon problem risk exposure problem payout problem
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Conflicts of interests in Bond contracts
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Dividend payouts Claim Dilution Asset Substitution Underinvestment
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contracting cost
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agency cost
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Credence Goods company compensation
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salary - higher Bonus - higher options - higher
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Debenture Bond
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An unsecured bond whose holder has a claim on the general creditor on all assets of the issuer. Not secured by a specific asset
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Debenture stock
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A type of stock that makes fixed payments at scheduled intervals of time. Has the status of equity not debt in liquidation
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Divisional performance vs Firm Performance
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Where little cooperation is required between autonomous business groups bonus will be biased towards divisional profit. Where cooperation is required on transfer pricing or market pricing to customers firm wide plan will be used.
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due diligence
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a meeting with investment bankers and lawyers prior to issuing security
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effect on compensation assets in place business versus Growth opportunity business
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The more growth opportunity the more compensation and executive will receive and the more it will be conditional on performance. Effect of managers decisions more critical to this type of firm that a high asset maintenance mode type of company.
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ERISA Employee retirement income security Act1974 Federal law
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Requires plans to provide information to participants Provides Fiduciary responsibility for those who manage and control Has been expanded to cover health benefits
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Free cash flow problem
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Issue in high assets in place company where there are limited numbers of positive NPV projects in which to invest. (utilities)
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Growth option companies
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salary - higher Bonus - lower options - higher
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Higher dividends make
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The value of equity go up the value of debt go down This is why banks put loan covenants on firms that restrict the level of dividend payments
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If a stock price goes up the change in the value of the call is
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Positive
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If you increase the value of the equity
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The value of the debt increases too (more assets as security for the debt)
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Incentive effects of options
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Incentive effect of options is greater wrt creating volatility than with RSU's
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Incentive effects of options
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Incentive effect of options is greater warranty creating volatility than with RSU's
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Increasing time to maturity
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Increases the value of equity Lowers the value of bonds
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Increasing volatility
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Increases the value of equity Lowers the value of debt because the risk of default increases)
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Investment opportunities
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assets in place Low cost of debt, high benefit of debt, predicted leverage high. Growth opportunity company, high cost of debt, low benefit of debt, predicted leverage low.
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Large Firm compensation plan
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salary - higher Bonus - higher options - higher
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Modigiliani and Miller 2
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If the choice of capital structure affects the value of the firm then it does so by Changing taxes Changing contracting costs Changing investment incentives
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Modigliani and Miller
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If there are no Taxes No contracting costs The firm's investment policy is fixed The value of the firm is independent of its financing policy.
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Non Qualified Stock options
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Not taxed on receipt but taxed on exercise
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Product warranty companies compensation
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salary - higher Bonus - higher options - higher
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Qualified Stock Options
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Not taxable when granted or exercised but taxed when sold
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Regulated firm comp plan
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salary - lower Bonus - lower options - lower
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Repurchase Stock
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Increases leverage
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Restrictions on investments
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seldom includes acquisition of physical assets but restricts financial investments disposition of assets (sold as a unit) Security provisions (e.g. collateral) asset maintenance (ship example) restrictions on Mergers
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Secured debt Ordinary debt Subordinated debt Equity
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secured first claim against assets Ordinary next in line bonds Subordinated next claim after ordinary Equity residual claim
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Sell Equity
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Lowers leverage
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Sinking fund
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A fund to which money is added on a regular basis that is used to ensure investor confidence that promised payments will be made. It is used to redeem debt securities or preferred stock issues.
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Sinking Fund Requirement
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A condition included in some corporate bond indentures that requires the issuer to retire a specified portion of debt each year. Any principal due at maturity is called the balloon maturity.
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Stock appreciation rights
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work like non qualified options - bankers and brokers don't get a fee.
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Stock option effect on payout problem
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Makes it worse because the option holder only has a claim on the capital gain of the stock, not the dividend. It biases managers towards share repurchase
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Stock plans vs Bonus
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Top managers who set accounting policy are typically compensated with stock based plans. Lower level manager receive bonus based on accounting numbers that allow desegregation of results. However perverse incentives can be created.
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Subordinated debenture bond
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An unsecured bond that ranks after secured debt, after debenture bonds and often after some general creditors in its claim on the earnings and assets of the firm.
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Subordination clause
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A provision in a bond indenture that restricts the issuer's future borrowing by subordinating future lender's claims on the firm to those of the existing bondholders
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Take a positive NPV project that LOWERS the variance of the future firm value
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Value of equity goes up (because of return on positive NPV - not because volatility is reduced) Value of debt goes down.
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Time to maturity on a bond
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The sooner the bond matures the more value it has
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Value creation/ destruction for bondholder through merger
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Synergies that add value bond goes up. If leverage goes down risk goes down so bonds go up Dividend goes up , coverage on debt goes down value of bond goes down time to maturity goes up bond goes down
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Volatility
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A measure of risk based on the standard deviation of the asset return.
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