Frequently Asked Questions: Financial policy

Question 1: Is the financial policy of a high tech company different from that of other companies?

Question 2: For company’s classified as "cyclical stocks", how do you work out the payout and dividend yield that would be best suited to maximising the share price, especially at the bottom of the cycle?

Question 3: Why should a highly geared company issue convertible bonds rather mandatory convertible bonds?

Question 4: What are the possible reasons behind a share buyback? What are the different methods that could be used?

Question 5: What problems arise when measuring financial equilibrium?

Question 6: When a company is listed on a stock exchange such as Frankfurt and it also wants to be listed on the London stock exchange, for example, does a new company have to be set up in the new country?

Question 7: What are the Pros and Cons of off-market share buy-back?

Back to Questions and answers

Question 1:

Is the financial policy of a high tech company different from that of other companies?

Answer:

No, the financial policy of a high tech company is not fundamentally different from that of other companies.


Back to the top


Question 2:

For company’s classified as "cyclical stocks", how do you work out the payout and dividend yield that would be best suited to maximising the share price, especially at the bottom of the cycle?

Answer:

For cyclical stocks, the payout rate doesn’t mean much. What is important is the amount of the dividend per share, which companies do their best not to cut. This is what causes very erratic payout rates – very low when the economic situation is good, very high at the bottom of a cycle. At best, they’ll aim at an average payout rate over the whole cycle, which doesn’t mean much as the cycle could be very long.


Back to the top


Question 3:

Why should a highly geared company issue convertible bonds rather mandatory convertible bonds?

Answer:

The following factors should be taken into account when choosing between convertible bonds and mandatory convertible bonds.
- the issuer of a convertible bond is not sure at the time of issue that the bond will be converted on maturity and that it will not have to be repaid in cash. By definition, this risk is not a factor with mandatory convertible bonds as they will always be repaid in shares.
- On financial markets, especially right now, mandatory convertible bonds are very difficult to place as they are not very competitive compared with shares. There is very little difference between a mandatory convertible bond and a share. On the other hand, there is a lot of investor appetite for convertible bonds, which have less in common with shares than do mandatory convertible bonds, since the risks and returns fall between those of a share and an ordinary bond.
- In financial analysis, mandatory convertible bonds are treated as equity as they have to be repaid in shares, while convertible bonds are treated as debt, at least for as long as the share price does not exceed the conversion price.


Back to the top


Question 4:

What are the possible reasons behind a share buyback? What are the different methods that could be used?

Answer:

There are several possible reasons behind a share buyback:
- Desire to provide a shareholder with an exit
- Desire to consolidate shareholding, as the share of shareholders who do not participate is automatically increased
- Desire to improve ratios Return on equity, growth of EPS
- Desire to change a financial structure by replacing equity with debt
- Desire to pay funds to shareholders at a more advantageous tax rate than for a dividend payout
- Desire to regulate a share price that is going through a low period
- Desire to acquire shares that will later be allocated to staff as part of stock options plans
- Desire to return money to shareholders, when the company does not know what else to do with it.
- Technically, the operation could take the form of buybacks on the market over time, or a public buyback offer for larger amounts. Moreover, to a certain degree, LBOs end up reducing capital. For more information, see chapter 38 of the Vernimmen.

Back to the top


Question 5:

What problems arise when measuring financial equilibrium?

Answer:

That's a tough question as there is no equilibrium in the true sense of the word in corporate finance.

As Modigliani and Miller have shown, there is no optimum financial structure (split of financing of capital employed between debt and equity). All financial structures have their place and whether they are acceptable or not depends only on the level of risk that the shareholders are prepared to run. A highly geared company will thus be more profitable, all other things being equal, than a company without debts, but it will also carry more risk. Neither situation is better than the other – they are simply equivalent with different risk/reward ratios.

In the short term, we could describe financial equilibrium as the ability of a company to meet its debts at all times. It's thus essentially a liquidity problem. This will depend on:
- the amount of short term liabilities relative to the amount of short term assets – if you have short term liabilities of 10, and short term assets of 7, and you cannot either reschedule your debts or raise new funds, you may as well file for bankruptcy. This information on a company is generally easy to assess and is what we call working capital.
- how quickly your assets become liquid and how soon you have to pay off your debts. This information is not made public and external analysts are hard pressed to estimate it. Internally, it's the ABC of any finance director's key indicators.
For more information, see chapter 36 of the Vernimmen.

Back to the top


Question 6:

When a company is listed on a stock exchange such as Frankfurt and it also wants to be listed on the London stock exchange, for example, does a new company have to be set up in the new country?

Answer:

Either the company gets its shareholders to accept the principle of a capital increase without preferential subscription rights, and the company will issue new shares which will be offered to UK investors if it is seeking a London listing.

Or no new shares are issued, the company’s advisory bank will simply carry out an arbitrage by buying a block of shares listed in Frankfurt and the selling them on the first trading day of the London listing at the same price as in Frankfurt.

So a new company is never actually set up.
For more information, see chapter 41 of the Vernimmen.

Back to the top


Question 7:

What are the Pros and Cons of off-market share buy-back?

Answer:

you do a share buy back off market when you want to buy a large quantity of shares owned by a large shareholder so as to prevent him from off loading them on the market and depressing the stock price. You might even be in a position to buy those shares with a discount compared to the current stock price, which is good for all shareholders as they get reluted at a below-the-market price

sometimes you buy them at a premium compared to the current stock price ( if allowed by local regulators)in order to get rid of a nasty shareholder who may be doing some blackmail to the management of the company : buy me out or I launch an hostile bid. the interest of minority shareholders is not clear in such a move as they are reluted at an above-the-market price. The one of the management is very real!

For more see chapter 38 of the Vernimmen.

Back to the top