发信人: fku0000 (fku), 信区: Economics
标 题: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Wed Apr 22 13:26:25 2009)

did anyone read that article in yesterday's WSJ?

Milken was basically making the points that overleveraging can have a
negative impact on firm valuation, contrary to what M&M said.

that makes a lot of sense from my personal point of view. Milken
attributed it to 1) the signaling effect and 2) supply of new equity.

what he didn't cover and I have yet to say anyone covering it is the
specialization of labor / expertise argument.

investors in different parts of the capital structures have different
"expertise" to their investment instruments: equity investors are good
at running companies, and lenders are good at economy of scale and
mitigating losses. a lender wouldn't know how to run a company as
effectively and an equity investor isn't equip'd to deploy massive
amount of capital in many companies over a short period of time.

so a firm has two "values": when the equity investor is in charge,
everything hums along just fine and the firm has its highest valuation
(a "going concern" valuation).

when the equity is foreclosed upon by the lenders, the lenders don't
know how to run the company and they may not get the full value out of
the firm and some times they may just liquidate the copmany
("liquidation value", which is less than the going concern value).

so if you construct a model where the going concern value follows a
random pattern (it is subject to shocks), and if it falls below the
value of the debt, the equity is foreclosed upon and the lenders realize
the liquidation value, you can easily see how the market value of equity
is impacted by the leverage of the firm.

aka, Milken's point that capital structure matters.


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发信人: smxzr (smxzr), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Wed Apr 22 14:55:44 2009)

Very interesting. Good topic for research. I am always confused why firms
alway do in a way that is not predicted by the theories...
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发信人: Sigma (不必勉强), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Wed Apr 22 17:10:10 2009), 转信

does not make much sense,

equity holders do NOT run the company, they hire CEO as an agent to run the
company,

if firm defaults, the bond holders would normally go to chapter 11 and hire
new managers, given managerial labor market is competitive, it's easy to hir
e a new agent to run the company.



【 在 fku0000 (fku) 的大作中提到: 】
: did anyone read that article in yesterday's WSJ?
: Milken was basically making the points that overleveraging can have a
: negative impact on firm valuation, contrary to what M&M said.
: that makes a lot of sense from my personal point of view. Milken
: attributed it to 1) the signaling effect and 2) supply of new equity.
: what he didn't cover and I have yet to say anyone covering it is the
: specialization of labor / expertise argument.
: investors in different parts of the capital structures have different
: "expertise" to their investment instruments: equity investors are good
: at running companies, and lenders are good at economy of scale and
: ...................

--
我办了一辈子的事，练兵也，海军也，都是纸糊的老虎，何尝能实在放手办理，不过勉
强涂饰，虚有其表，不揭破，犹可敷衍一时。如一间破屋，由裱糊匠东补西贴，居然成
一间净室，虽明知为纸片糊裱，然究竟决不定里面是何等材料。即有小小风雨，打成几
个窟笼，随时补葺，亦可支吾对付。乃必欲爽手扯破，又未预备何种修葺材料，何种改
造方式，自然真相破露，不可收拾，但裱糊匠又何术能负其责？



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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Wed Apr 22 19:15:49 2009)


【 在 Sigma (不必勉强) 的大作中提到: 】
: does not make much sense,
: equity holders do NOT run the company, they hire CEO as an agent to
run the
: company,
: if firm defaults, the bond holders would normally go to chapter 11 and
hire
: new managers, given managerial labor market is competitive, it's easy
to hir
: e a new agent to run the company.


equity investors have considerably more expertise in running the
company. this is particularly true for private companies or for private
equity firms. even investors of public equity have developed better
skills in evaluating operating talents.

lenders on the other hand aren't specialized in running a company. that
the proliferation / specialization of restructuring firms, or
intermediate management firms that serve the lenders.

foreclosure on a commercial loan is considerably stressful for lenders
and is something a lender would rather not do. Thus the liquidation of
distressed loans by lenders even though historically and statistically
those loans recover much more than what the lenders can fetch on the
market.

this comes from a guy who made his living in work-out.


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发信人: UnameMe (痛饮结局，继续等待), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Thu Apr 23 20:52:22 2009)

What do you mean by "work-out"?

As far as I know, in every popular Corporate Finance textbook, there is a
chapter about the costs of financial distress just following the chapter of
the MM propositions. One of the costs of financial distress is about the
conflict between shareholders and bondholders, which will hurt the total
value of a firm.

With the above said, your observation of different expertise could be an
interesting assumption of a new theory.


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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 08:19:20 2009)


【 在 UnameMe (痛饮结局，继续等待) 的大作中提到: 】
: What do you mean by "work-out"?

you guys study corporate finance and don't know what a "work-out" is?
remarkable.

when a borrower cannot service its debt, the loan goes into default and
the lenders try to find a way out of that. That process is called "work-
out": they work it out with the borrower / equity.


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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 08:24:15 2009)


【 在 UnameMe (痛饮结局，继续等待) 的大作中提到: 】
: With the above said, your observation of different expertise could be
an
: interesting assumption of a new theory.


the specialization is widely known and I am sure someone has
incorporated into some theories in corporate finance.

the real "point of differentiation" I am proposing here is that
enterprise value changes depending on who is in control, as a result of
the specialization discussed above.

a highly leveraged firm is more likely to be in default, giving the
lenders control of the firm, resulting in lower valuation of the firm.

so before the loan goes into default, the (expected) value of a highly
leveraged firm would be lower than that of an otherwise identical firm.

This means that deleveraging a firm can result in improved shareholder
value, as we are observing right now, and contrary to most textbook
examples (where one easy way to maximize shareholder returns is to
maximize leverage).

that goes to Milken's point about why capital structure matters.


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发信人: UnameMe (痛饮结局，继续等待), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 10:19:58 2009), 转信


Thanks. I am just keep learning.

【 在 fku0000 (fku) 的大作中提到: 】
: you guys study corporate finance and don't know what a "work-out" is?
: remarkable.
: when a borrower cannot service its debt, the loan goes into default and
: the lenders try to find a way out of that. That process is called "work-
: out": they work it out with the borrower / equity.



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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 11:29:18 2009)

to expand on what I said earlier.

a firm's ability to service its debt, thus avoid bankruptcy / foreclosure,
depends on 1) its cash flow stability; and 2) its leverage. the less
predictable its cash flow, the more likely it wouldn't be able to service
its debt, everything else being equal.

the more leveraged the firm is, the more likely it wouldn't be able to
service its debt.

this means that

1) the optimal capital structure for highly volatile industries requires
lower leverage;

2) the deleveraging benefits to equity would be higher for highly volatile
firms. ie. when economic stress comes, the more volatile firms can rep more
benefits from deleveraging.



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发信人: sagittare (壬生狼：恶·即·斩), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 14:52:31 2009), 转信

MM定理后来好像有修正，举债不是没有成本的，有破产成本在，包括显性和隐性的。
【 在 fku0000 (fku) 的大作中提到: 】
: did anyone read that article in yesterday's WSJ?
: Milken was basically making the points that overleveraging can have a
: negative impact on firm valuation, contrary to what M&M said.
: that makes a lot of sense from my personal point of view. Milken
: attributed it to 1) the signaling effect and 2) supply of new equity.
: what he didn't cover and I have yet to say anyone covering it is the
: specialization of labor / expertise argument.
: investors in different parts of the capital structures have different
: "expertise" to their investment instruments: equity investors are good
: at running companies, and lenders are good at economy of scale and
: ...................


--

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发信人: niko (Niko), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 21:02:44 2009)

It is well known in finance.

Two well cited papers are Merton (1974) and Leland (1994, 1998). Just goog
them. Merton's model is the European option, while Leland (1994) is the
American verison.


【 在 fku0000 (fku) 的大作中提到: 】
: did anyone read that article in yesterday's WSJ?
: Milken was basically making the points that overleveraging can have a
: negative impact on firm valuation, contrary to what M&M said.
: that makes a lot of sense from my personal point of view. Milken
: attributed it to 1) the signaling effect and 2) supply of new equity.
: what he didn't cover and I have yet to say anyone covering it is the
: specialization of labor / expertise argument.
: investors in different parts of the capital structures have different
: "expertise" to their investment instruments: equity investors are good
: at running companies, and lenders are good at economy of scale and
: ...................



--

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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Fri Apr 24 21:34:34 2009)


【 在 niko (Niko) 的大作中提到: 】
: It is well known in finance.
: Two well cited papers are Merton (1974) and Leland (1994, 1998). Just
goog
: them. Merton's model is the European option, while Leland (1994) is
the
: American verison.


what's their intuition?
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发信人: niko (Niko), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Sat Apr 25 12:49:32 2009)

The model is essentially the option model. The firm'q euity is like a call
option and the debt is the strike price.

It is developed into the real options model nowadays, in which you can
examine the agency conflicts and firms' investment, default and financing
policy. A few Chinese are pretty good at them, such as Neng Wang and Jianjun
Miao.


【 在 fku0000 (fku) 的大作中提到: 】
: goog
: the
: what's their intuition?



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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Sat Apr 25 14:34:26 2009)


【 在 niko (Niko) 的大作中提到: 】
: The model is essentially the option model. The firm'q euity is like a
call
: option and the debt is the strike price.

how do you work leverage into an options model?
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发信人: niko (Niko), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Sat Apr 25 20:40:44 2009)

The option itself is a leverage by nature. Why don't you check out these
papers yourself if you are interested in them.


【 在 fku0000 (fku) 的大作中提到: 】
: call
: how do you work leverage into an options model?



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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Sat Apr 25 22:07:56 2009)


【 在 niko (Niko) 的大作中提到: 】
: The option itself is a leverage by nature.

so when you buy equity (which is an option on the value of the firm),
how do you lever it up or down?

: Why don't you check out these
: papers yourself if you are interested in them.


sometimes, people ask a question because they want you to get to an
answer.


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发信人: findmj (简单生活), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Mon Apr 27 04:30:20 2009)

Theory: When incorporating the distress risk due to high leverage ratio, the
trade-off theory applys: leverage ratio can achieve to an opitmal point
when the tax benefit of leverage is equal to the financial distress costs.

Practice in industry: After firm goes Chap 11, it usually has two choices:
emerges after restructuring or liquadates assets. Usually the bond holders
will group a committee that represents over 50% of bond holders and 70% of
value. The committed can elect a new CEO, but usually only big firms can
afford to do this. Most of the time, the CEO will stay in their position.

Empirically: Firms will high business volatility should keep a low leverage
ratio and a higher financial flexibility. This has already empirically
tested to be true. (e.g. DeAngelo)
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发信人: fku0000 (fku), 信区: Economics
标 题: Re: Milken: "Why Capital Structure Matters?"
发信站: BBS 未名空间站 (Mon Apr 27 07:48:03 2009)

the dynamics here works without tax benefits: if a firm's value is perfectly
predictable, the way to maximize equity return is to be 100% capitalized
with debt -> $0 equity -> infinity return on equity.

only you introduce uncertainty to the firm's value, and introduce a process
whereby equity is wiped out (through foreclosure / bankruptcy process for
example), it is then in the interest of equity NOT to leverage through the
roof -> they need to balance the benefit of high leverage / high return
against the bankruptcy risk (of being wiped out).

once you are in chapter 11, you restructure. once you are in chapter 7, you
liquidate. the creditor's committee at that point replaces the BoD and runs
the company -> from a control point of view, the creditors have become
shareholders, under court supervision though.



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