Letter number 105 of 105 July 2017

  • NEW

News : Do you want to improve your corporate finance skills?

FFI and Columbia Business School (CBS) announce their partnership to deliver an online certification in corporate finance: ICCF @ Columbia Business School.

This online program consists of 3 courses, delivered by CBS professors (financial analysis, corporate valuation, investment and funding decisions), and a final exam, ICCF, that can be taken in any Pearson VUE center around the world.

The final exam has been designed by us and ICCF is becoming a benchmark certification in corporate finance with more than 1000 managers who haved passed it with a very high level of satisfaction.


Here are 5 good reasons to consider ICCF @ Columbia Business School!

1. Earn an Ivy League Credential in Just 17 Weeks

In less than five months you can earn a credential from one of the world’s top ranked business schools. Columbia Business School distinguishes itself from its peers in many ways, including being a 13-time winner of the Nobel Prize in Economics.

2. Learn at Your Own Pace, Online

ICCF @ Columbia Business School was designed for busy executives. The weekly instructional videos, faculty offices hours and assessments can all be completed at your own convenience. You set the learning schedule that works for you.

3. Expand Your Professional Network

ICCF is more than just instructional videos and case studies. Launched in 2014, the ICCF community consists of more than 2,220 individuals from 40 countries.

4. Improve Your Corporate Finance Skills

By the end of the 17-week program participants should at a minimum be able to conduct a financial analysis, assess a company’s financial outlook, conduct a valuation analysis and ultimately be able to make thoughtful decisions on investments and funding options.

5. Have Fun While You Learn

Corporate finance can be serious business and we deploy a rigorous instructional design model. On the other hand the cohort-based model is designed to make ICCF a fun learning experience for all. Social learning is at the heart of ICCF and participants often engage in late night debates in the online forums and organize social events with like-minded students.


We hope you will consider joining us for inaugural cohort which starts October 2, 2017. For more information on ICCF@Columbia Business School and the inaugural cohort please visit: cbs.ff.institute

News : Investor reaction to a capital increase

On the day of the announcement of a capital increase, the share price of the listed company in question rarely remains stable. Here are four recent examples:

  • On 13 April, Erytech Pharma announced a €70m capital increase representing 26% of its capital. Its share price rose by 3.3%.
  • On 15 March, Tesla announced a $250m capital increase (and $750m convertible bond issue), representing 2.5% of its capital. Its share price rose by 2.5%.
  • On 7 March, EDF announced a €4bn capital increase, representing 30% of its capital. It share price fell by 11%.
  • On 5 March, Deutsche Bank announced an €8bn capital increase, representing 43% of its capital. Its share price fell by 10%.

What is it that explains why in some cases, the share price rises on the announcement of a capital increase, and in other cases it falls?

Let’s just say that there’s one general case, two special cases and some surrounding noise.

1/ The general case

The general case is that of a company that is in good health and about which there are no concerns with regard to its solvency or its liquidity. Here, the essential parameter for explaining the reaction of the share price is investor expectations of the company’s ability to earn more than, or at least as much as, its cost of capital on the investments that will be financed by the capital increase.

Given the history of value destruction since 2008, not a year in which EDF’s ROCE was at least equal to its cost of capital, investors were not expecting anything in this sector with long cycles other than for ROCE to continue to be below (3.3% per year by 2020 according to Exane BNP Paribas) the cost of capital (6%). Within two days of the announcement, the fall in the share price (excluding detachment of the subscription right) was €1 per share, which represents value destruction of €2.7bn for a capital increase of €4bn, i.e. two-thirds of the funds raised. The judgement is severe, but that’s the judgement. The same reasoning applies to Deutsche Bank.

For Tesla and Erytech Pharma, even though neither of these companies has made a single euro in earnings, and accordingly their ROCE is negative, investors considered that their prospects in the areas of electric cars and research into rare forms of cancer and orphan illnesses were sufficiently promising to allow for hope, by an undefined deadline, of the possibility of ROCE that is higher than the cost of capital. This is why their share prices rose on the announcement of the capital increase.

So we can understand that for a company that is unable to convince investors of its ability to generate earnings in line with the risk, it is very difficult to carry out a capital increase. Given that equity capital is limited, it is just as well not to waste it by allocating it to projects promoted by managers who do not convince.

This is why Italian banks had and are having a lot of trouble raising equity capital, given that they have been consistently destroying value since 2008, see for example Monte dei Paschi di Siena. But a bank that took the bull by the horns, UniCredit, by replacing its management team, selling assets and depreciating those that needed to be depreciated, by implementing a restructuring plan that was in line with the challenges (2016 loss of €11.8bn), was able to raise €13bn in February and seems to be back on the right track.

2/ The first special case

This is the case of the company that is very, even too, indebted, which carries out a capital increase to reduce its debt. This is often the only alternative to filing for bankruptcy. Take for example Solocal which, after a lengthy procedure, carried out a €398m capital increase.  

A drop in share price following the announcement of a capital increase is often automatic, because there is a transfer of value from shareholders to lenders. What happens is that a capital increase gives value to debt: part of the debt will be repaid at par, and the other part is then used to finance a larger portion of capital employed. It can only but be worth more. As debt is worth more following the capital increase, we cannot see how entreprise value could be greater just because of the announcement of a capital increase intended to change the capital structure and not to make investments; necessarily, the value of equity should be adjusted downwards.

Those of our readers who are keen on options theory applied to capital structure[1] are aware, following the work of Robert Merton, that a share can be assimilated to a call option on operating assets for a strike price in the amount of the debt to be repaid.

Like an option, the value of a share can be broken down into intrinsic value and time value[2]. For this type of over-indebted company, the intrinsic value of the share is very low or zero because it corresponds to the difference between entreprise value and the amount of debts to be repaid. In fact, the entreprise value is often close to the amount of the debts to be repaid. The time value of the share, for its part, is maximal because it is equal to the difference between entreprise value and the strike price of the corresponding option. In these conditions, a capital increase has two contrary effects:

  • it increases the intrinsic value of equity capital by its amount;
  • it reduces the time value of equity because the strike price of the option (the amount of the debt to be repaid) becomes lower than the entreprise value.

So logically, there is a loss of value resulting from the capital increase because of the transfer of value to the company’s lenders. Nevertheless, shareholders do not shy away from the recapitalisation necessary, because it is better to lose a little than to lose everything (file for bankruptcy).

3/ The second special case

This is the case of the company which, unlike the previous one, doesn’t have a solvency problem but a liquidity problem. For example, a company which has a large short-term debt that is due and that doesn’t have the internal resources to pay it. This does not mean that it is insolvent[3]. Accordingly, in a world where liquidity is normal, the company just needs to refinance this short-term debt issuing new debt. But it does happen that liquidity dries up (late 2008, early 2009 or late 2015 for mining groups in a context of a sudden drop in mineral prices). We then see what Yann Aït-Mokthar calls an Asset Liability Refinancing Gap (ALRG), i.e. a new liability for the company that corresponds conceptually to the present value of additional financial expense on the refinanced debt compared to the debt in place. The more serious the liquidity crisis, the higher the cost of the future replacement debt and the greater the value of the ALRG. Because there is no reason why the entreprise value should grow at the same time, ALRG can only develop to the detriment of the value of equity, just like a cancer that destroys healthy cells.

When the liquidity problem is solved, often following the announcement of a capital increase, the ALRG is absorbed and disappears as the value of equity takes its place. Therefore, we observe a rise in the share price when a capital increase is announced which is concrete evidence of the disappearance of the liquidity problem. We saw this in February 2009 when Lafarge announced a capital increase of €1.5bn and in September 2015 when Glencore announced one of $2.5bn.

This reaction to a capital increase differs from the previous one because this analysis calls into question one of the postulates of Merton’s model (1973), that liquidity is always present on the market. We could have said this was true before 2008, but this is no longer the case.

4/ The surrounding noise[4]

A capital increase is naturally an exceptional event that attracts investors’ attention to the company. On this occasion, some investors carry out an arbitrage between the share and the preferential subscription rights (PSRs), selling the share short and buying the PSR if its price is lower than its theoretical value. Or selling the share short if this is possible on the securities lending market, to buy it back later on the market or via PSRs. Some investors prefer to defer any purchases of the share knowing that the previous movements will decrease its value, which is another factor behind a temporary drop.


[3] To avoid confusing liquidity and solvency, see chapters 12 and 14 of the Vernimmen.

[4] Out thanks to Valérie Vitter Mouradian who helped us to clarify our ideas on this topic.


Statistics : Corporate income tax rates around the world

The average corporation tax rate in the world in 2016 is 23.95%, showing stability at around 24% since 2013:

Source: KPMG

Corporate income tax rates are down in countries where they were high such Italy, Japan non to mention the UK, for another reason (how to be continue being attractive after having left the largest and wealthiest free trade area). France has announced it would follow and aims at 25% in 2022.


These rates are useful to compute corporate income taxes to be paid on pre-tax profits, to compute free cash flows or cost of capital or produce business plans. But they cannot be compared from one country to the other one to appreciate the tax burden borne by companies. Indeed in some countries some local tax are not levied on the pre tax result but on added value, turnover or the renting value of buildings. And they are in addition to those computed on the pre tax result and shown in this table.

Research : Childhood and psychology of CEOs

With Simon Gueguen, teacher-researcher at the University of Paris-Dauphine

Last month we looked at an article showing the influence of agency problems on investment decisions made by CEOs. In this issue, we continue our analysis of CEO behaviour by analysing an article[1] on CEO psychology.

The influence of the psychological traits of CEOs on company policy has already been widely documented in academic literature. For example, financing choices depend on the CEO’s risk aversion, which is itself influenced by his/her past experiences (a military background for example)[2]. The originality of this month’s article is that it highlights the non-linear effect of events that happened in the CEO’s childhood: the occurrence of catastrophes with a high death toll results in greater risk aversion, while those with a lower death toll will, on the other hand, reduce risk aversion.

The method for this study involved crossing three main databases:

  • a data base containing the date and place of birth of S&P500 CEOs between 1992 and 2012 (a total of 1508 CEOs born in the USA);
  • a historical data base on natural disasters on US soil, with the number of victims per county in which the disaster occurred;
  • a financial data base of the companies concerned, with a particular focus on the development of financial leverage[3].

An empirical analysis shows that CEOs who during their childhoods (between the ages of 5 and 15) experienced a natural disaster with a low or moderate mortality rate have a lower risk aversion than those who did not experience such a disaster. This is seen in financial leverage that is higher by 3.4%[4]. On the other hand, those who experienced a disaster with a high mortality rate have a greater risk aversion, and financial leverage that is lower by 3.7% (so a difference of 7.1% between low and high mortality).

We note that Bernile et al include different control variables in their study to confirm the causality between natural disasters and CEO behaviour: for example, the CEO’s date of birth and the State in which he/she was born, to capture the possible cultural and generational effects on behaviour. They also carry out a number of additional tests, and show that changes in CEO linked to outside factors do lead to a variation in the company’s policies depending on the disasters experienced during childhood by the two CEOs in question.

These results are of interest for several reasons. On the one hand, they confirm an effect that is well-known in psychology (but rarely relied on in finance): the non-linearity of past experience on character. The fact that an individual has experienced a major disaster in his/her close environment tends to increase risk aversion. On the other hand, when disasters experienced have not had very serious consequences, risk aversion decreases. Accordingly, parameters linked to the personal histories of CEOs that are sometimes relied on in empirical studies, should take this non-linearity into account, in order to be able to better explain company policies.

[1] G.BERNILE, V.BHAGWAT et P.R.RAU (2017), What doesn’t kill you will only make you more risk-loving: Early-life disasters and CEO behavior, Journal of Finance, vol.72(1), pages 167 to 206

[2] See “Choice of financing, a question of character?” in the Vernimmen.com Newsletter n°73, March 2013

[3] Measured in the study as the ratio of debt to the book value of assets

[4] First decile of disasters in mortality per inhabitant


Q&A : What are the main reasons for the variability in the apparent income tax rate?

There may be several causes:



1 / The rate itself moves as in the years to come in France where it was planned by the government to gradually move from 33.3% to 28%.

2 / The company can consolidate activities in different countries with different tax rates (20% in the UK for example and 25% in Spain or the Netherlands) and if the proportion of foreign activities varies over time, the apparent average rate varies consequently.

3 / All operations of the company are not taxed at the same rate, for example the capital gains on equity securities may be taxed in some countries at a lower rate, same for patents incomes. This heterogeneity of products can alter the apparent average rate.

4 / If the company has used tax loss carry-forwards, the average rate is reduced, until the day when there is no longer any left, prompting the apparent tax rate to surge.


Regularly on the Vernimmen.com Facebook page[1] we publish comments on financial news that we deem to be of interest. Here are some of the comments published over the last month.

Nestlé announces a share buyback program of CHF20bn by 2020.

To create value for its shareholders, it has added.

Let us doubt it! A share buyback creates value only in one of the following three situations:

1 - the share is undervalued, and by buying it today cheaply to cancel it, a company makes a good deal in the long term for the shareholders who do not sell. At a multiple a bit more than 17 times its operating profit in 2017 and at a all-time high price, Nestlé's undervaluation is not spontaneously obvious.

2- the increase in the weight of the debt will put a sympathetic pressure on managers to be more effective in the management of the company because they will have to generate enough free cash flow to repay the debt. This is the LBO principle. With a net debt / EBITDA ratio of 1.5 in 2020, in a sector with low volatility in cash flow, the pressure will be non-existent. The debt-to-EBITDA ratio should at least double for the pressure to start being felt.

3- the funds thus returned to the shareholders had a return much lower than the cost of the capital within the company which was wasting the financial resources that had been entrusted to it. This is far from the case of Nestlé, which has no net cash (net debt / 2016 EBITDA of 0.8) and whose ROCE is 13%, much higher than its cost of capital of 6 %.

However, this seems to be a good decision, but not in terms of value creation.

Equity exists by construction in finite quantities and must be used to finance risky projects as a priority. Then when the risk decreases, the share of the debt can increase, releasing equity to go to finance other risky projects in other sectors such as at the moment 3 D printing, Internet of objects , Biotech, etc.

As the level of risk in the food industry is low, Nestlé does not take an undue risk by doubling its net debt / EBITDA ratio to 1.5. The good news is that CHF 20bn will by 2020 be able to finance sectors and companies that need equity.

Especially since CHF 20 bn corresponds roughly to Nestlé's remaining 23% stake in L'Oréal, which was an excellent financial diversification (initiated in 1974) for the shareholders of Nestlé, who probably contributed a lot to L'Oréal when the latter were still a small promising group, but with whom the industrial synergies seem, from the outside, non-existent.

Argentina issues $ 2.75 billion of bonds with a . . . 100 year maturity.

With a yield to maturity of 7.9% (in dollars). Demand was 3.5 times higher than supply. If it is understandable that Argentina is proud to show the success of its economic and financial recovery in as striking a manner as issuing for the longest possible period (before perpetuity), one can really ask whether the operation is financially interesting for it. Indeed, it blocks the cost of its loan to 7.9% for 100 years, and not for a small amount of money.

This rate corresponds to its rating, currently B, which is not brilliant. But it is hoped that the continuation of the efforts initiated and the return to an entrepreneurial spirit will make it possible to improve this rating in a few years, and in so doing, the yield to maturity of this loan. As an illustration, over this period, the Chinese government bond yields 4.25%.

Let's imagine that it moves down to 5% in 2 year times. The loan would then be worth 157% of par and if Argentina wanted to redeem it, financing itself by issuing a new loan with a yield of 5% over 98 years, it would nevertheless continue to bear for the 98 years that will come a cost of 7.9%. Only if Argentina were able to repurchase its loan at 100%, it could then benefit from a reduced rate of 5% for the last 98 years. Illusory, because who will want to sell at 100% a bond that would be worth 157%? Nobody naturally.

If this loan has been issued, there was of course an issuer and buyers. Clearly investors are betting on the rapid improvement of Argentina's credit. On the Argentina side, the financial interest is less clear, except if one bets on the country to fall back soon into its previous bad habits (8 bankruptcies since the independence of 1816) and that this rate of 7.9% will last only a while and not 100 years. But for a Minister of Finance, it is a daring reasoning!

Banco Popular sold for 1 € to escape bankruptcy. Sic transit gloria mundi.

Banco Popular, which capitalized up to € 19 billion in its fine years, was known for its operating efficiency, which was reflected in an costs/income ratio[2] among the lowest of all European banks: 32% in 2009; most banks are today between 60 and 70%.

After a nearly uninterrupted stock market decline since 2007, the Spanish bank has just been bought back by Santander, which will recapitalize it by € 7 billion to depreciate Spanish real estate loans that will never be repaid.

Several lessons and a good news:

  • It is not because a company has already lost 90% of its share price, that it can not yet fall by 90%.
  • "Success is a precarious state that requires staying on a permanent quest." (Maurice Levy).
  • Spanish taxpayers will have nothing to pay.


The OECD is concerned about the level of commissions paid by US companies to investment banks to join the stock market: 7% against 3% in Europe.

Unfortunately, this is not a new topic since it was already discussed in the 1990s. Researchers (Mark Abrahamson, Tim Jenkinson, and Howard Jones in Why do not US Issues Demand European Fees for IPOs?[3] showed that the convergence of IPO methods on both sides of the Atlantic should have led to a convergence of fee rates on the European level.

If this is not the case, it is simply that the level of competition between banks in the USA is much lower than the European situation. There are significantly fewer players across the Atlantic (US banks, Deutsche Bank, Credit Suisse and Barclays) than in Europe, the most competitive geographical area for investment banks with the US players already mentioned, European actors (which are more numerous than the American actors) and Nomura.

And it is not for nothing that the major European investment banks have tried to penetrate this lucrative market, with limited success unless they acquired a major American player (Lehman by Barclays for example).



[2] The cost / income ratio refers to the ratio between the operating costs of a bank and the net banking income (roughly speaking the turnover a bank).

[3] that we have summarized in the April 2011 issue of the Vernimmen.com letter