INSTITUTE OF BUSINESS ADMINISTRATION

CORPORATE FINANCE
BY AAQIB NAZIMUDDIN

ERP:04270
12/29/2014
CHAPTER 19
A dividend is a payment made by a corporation to its shareholders, usually as a distribution
of profits. When a corporation earns a profit or surplus, it can either re-invest it in the business
(called retained earnings), or it can distribute it to shareholders. A corporation may retain a portion
of its earnings and pay the remainder as a dividend. Distribution to shareholders can be in cash
(usually a deposit into a bank account) or, if the corporation has a dividend reinvestment plan, the
amount can be paid by the issue of further shares or share repurchase. The most common type of
dividend is in the form of cash. When public companies pay dividends, they usually pay
regular cash dividends four times a year. Sometimes firms will pay a regular cash dividend
and an extra cash dividend . Paying a cash dividend reduces corporate cash and retained
earningsexcept in the case of a liquidating dividend (where paid-in capital may be
reduced).

Dividends

A dividend is allocated as a fixed amount per share, with shareholders receiving a dividend in
proportion to their shareholding. For the joint stock company, paying dividends is not an expense;
rather, it is the division of after tax profits among shareholders. Retained earnings (profits that
have not been distributed as dividends) are shown in the shareholders' equity section on the
company's balance sheet - the same as its issued share capital. Public companies usually pay
dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special
dividend to distinguish it from the fixed schedule dividends. Cooperatives, on the other hand,
allocate dividends according to members' activity, so their dividends are often considered to be a
pre-tax expense.

Any dividend that is declared must be approved by a company's board of directors before it is paid.
For public companies, there are four important dates to remember regarding dividends. These are
discussed in detail with examples at the Securities and Exchange Commission site [4]

Declaration date is the day the Board of Directors announces its intention to pay a dividend. On
this day, a liability is created and the company records that liability on its books; it now owes the
money to the stockholders. On the declaration date, the Board will also announce a date of record
and a payment date.

In-dividend date is the last day, which is one trading day before the ex-dividend date, where the
stock is said to be cum dividend ('with [including] dividend'). In other words, existing holders of the
stock and anyone who buys it on this day will receive the dividend, whereas any holders selling the
stock lose their right to the dividend. After this date the stock becomes ex dividend.

Ex-dividend date (typically 2 trading days before the record date for U.S. securities) is the day on
which all shares bought and sold no longer come attached with the right to be paid the most
recently declared dividend. This is an important date for any company that has many stockholders,
including those that trade on exchanges, as it makes reconciliation of who is to be paid the
dividend easier. Existing holders of the stock will receive the dividend even if they now sell the
stock, whereas anyone who now buys the stock will not receive the dividend. It is relatively
common for a stock's price to decrease on the ex-dividend date by an amount roughly equal to the
dividend paid. This reflects the decrease in the company's assets resulting from the declaration of
the dividend. The company does not take any explicit action to adjust its stock price; in an efficient
market, buyers and sellers will automatically price this in.

Book closure Date Whenever a company announces a dividend pay-out, it also announces a date
on which the company will ideally temporarily close its books for fresh transfers of stock.

Record date Shareholders registered in the stockholders of record on or before the date of
record will receive the dividend. Shareholders who are not registered as of this date will not
receive the dividend. Registration in most countries is essentially automatic for shares purchased
before the ex-dividend date.

Payment date is the day when the dividend cheques will actually be mailed to the shareholders of
a company or credited to brokerage accounts.

Share repurchase (or stock buyback) is the re-acquisition by a company of its own stock.[1] In some
countries, including the US and the UK, a corporation can repurchase its own stock by
distributing cash to existing shareholders in exchange for a fraction of the company's
outstanding equity; that is, cash is exchanged for a reduction in the number ofshares
outstanding. The company either retires the repurchased shares or keeps them as treasury stock,
available for re-issuance.

A type of internal cost that arises from, or must be paid to, an agent acting on behalf of a principal.
Agency costs arise because of core problems such as conflicts of interest between shareholders and
management. Shareholders wish for management to run the company in a way that increases
shareholder value. But management may wish to grow the company in ways that maximize their
personal power and wealth that may not be in the best interests of shareholders.

Some common examples of the principal-agent relationship include: management (agent) and
shareholders (principal), or politicians (agent) and voters (principal).

Agency Costs

Agency costs are inevitable within an organization whenever the principals are not completely in
charge; the costs can usually be best spent on providing proper material incentives (such as
performance bonuses and stock options) and moral incentives for agents to properly execute their
duties, thereby aligning the interests of principals (owners) and agents.

A theory that suggests company announcements of an increase in dividend payouts act as an

indicator of the firm possessing strong future prospects. The rationale behind dividend signaling
models stems from game theory. A manager who has good investment opportunities is more likely
to "signal" than one who doesn't because it is in his or her best interest to do so.

Stock Split and Stock Dividends

A corporate action in which a company divides its existing shares into multiple shares. Although the
number of shares outstanding increases by a specific multiple, the total dollar value of the shares
remains the same compared to pre-split amounts, because the split did not add any real value. The
most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or
three shares for every share held earlier.

Companies may decide to distribute stock to shareholders of record if the company's availability of
liquid cash is in short supply. These distributions are generally acknowledged in the form of
fractions paid per existing share. An example would be a company issuing a stock dividend of 0.05
shares for each single share held.

Proponents of stock dividends and stock splits frequently argue that a security has a proper
trading range. When the security is priced above this level, many investors do not have the
funds to buy the common trading unit of 100 shares, called a round lot . Although securities
can be purchased in odd-lot form (fewer than 100 shares), the commissions are greater.
Thus, firms will split the stock to keep the price in this trading range.

Reverse Split

A corporate action in which a company reduces the total number of its outstanding shares. A
reverse stock split involves the company dividing its current shares by a number such as 5 or 10,
which would be called a 1-for-5 or 1-for-10 split, respectively. A reverse stock split is the opposite
of a conventional (forward) stock split, which increases the number of shares outstanding. Similar
to a forward stock split, the reverse split does not add any real value to the company. But since the
motivation for a reverse split is very different from that for a forward split, the stocks price moves
after a reverse and forward split may be quite divergent. A reverse stock split is also known as a
stock consolidation or share rollback.
Chapter 20

A reference to a security that has been registered issued and is being sold on a market to the public
for the first time. New issues are sometimes referred to as primary shares or new offerings. The
term does not necessarily refer to newly issued stocks, although initial public offerings are the most
commonly known new issues. Securities that can be newly issued include both debt and equity.

Many investors buy new issues because they often experience tremendous demand and, as a
result, rapid price increases. Other investors don't believe that new issues warrant the hype that
they receive and choose to watch from the sidelines. An investor who purchases a new issue
should be aware of all the risks associated with investing in a product that has only been available
to the public for a short time; new issues often prove to be rather volatile and unpredictable.

Businesses large and small have one thing in common: They need long-term capital. This
chapter describes how they get it. We pay particular attention to what is probably the most
important stage in a companys financial life cyclethe IPO. Such offerings are the process
by which companies convert from being privately owned to publicly owned. For many
people, starting a company, growing it, and taking it public is the ultimate entrepreneurial
dream.
The Basic Procedure for a New I ssue

Managements first step in any issue of securities to the public is to obtain approval
from the board of directors.

Next, the firm must prepare and file a registration statement with the SEC. This
statement contains a great deal of financial information, including a financial history,
details of the existing business, proposed financing, and plans for the future. I t can easily
run to 50 or more pages. The document is required for all public issues of securities with
two principal exceptions:

Loans that mature within nine months.

I ssues that involve less than $5.0 million.

The second exception is known as the small-issues exemption. Issues of less than $5.0
million are governed by Regulation A, for which only a brief offering statementrather
than the full registration statementis needed. For Regulation A to be operative, no
more than $1.5 million may be sold by insiders.

The SEC studies the registration statement during a waiting period. During this time, the
firm may distribute copies of a preliminary prospectus. The preliminary prospectus is called
a red herring because bold red letters are printed on the cover. A prospectus contains much
of the information put into the registration statement, and it is given to potential
investors by the firm. The company cannot sell the securities during the waiting period.
However, oral offers can be made.

A registration statement will become effective on the 20th day after its filing unless the SEC
sends a letter of comment suggesting changes. After the changes are made, the 20-day
waiting period starts anew.

The registration statement does not initially contain the price of the new issue. On the
effective date of the registration statement, a price is determined and a full-fledged
selling effort gets under way. A final prospectus must accompany the delivery of securities
or confirmation of sale, whichever comes first.

Cash Offer
A cash offer is one of two types of public issues. We'll discuss the other type, a rights offer, later in
this section. A cash offer makes shares available to the general public in an initial public offering.
But first, let's go over the differences between private and public companies.

A privately held company has fewer shareholders, and its owners don't have to disclose much
information about the company. Anybody can go out and incorporate a company; just put in some
money, file the right legal documents and follow the reporting rules of your jurisdiction. Most
small businesses are privately held. But large companies can be private, too.

It usually isn't possible to buy shares in a private company. You can approach the owners about
investing, but they're not obligated to sell you anything. Public companies, on the other hand,
have sold at least a portion of themselves to the public and trade on a stock exchange. This is why
doing an IPO is also referred to as "going public.

Public companies have thousands of shareholders and are subject to strict rules and regulations.
They must have a board of directors, and they must report financial information every quarter. In
the United States, public companies report to the Securities and Exchange Commission (SEC). In
other countries, public companies are overseen by governing bodies similar to the SEC. From an
investor's standpoint, the most exciting thing about a public company is that the stock is traded in
the open market like any other commodity. If you have the cash, you can invest. The CEO could
hate your guts, but there's nothing he or she could do to stop you from buying stock.

The Underwriting Process

Getting a piece of a hot IPO is very difficult, if not impossible. To understand why, we need to
know how an IPO is done, a process known as underwriting.

When a company wants to go public, the first thing it does is hire an investment bank. A company
could theoretically sell its shares on its own, but realistically, an investment bank is required - it's
just the way Wall Street works. To minimize the risks here, investment bankers combine
to form an underwriting group ( syndicate) to share the risk and to help sell the issue.
In such a group, one or more managers arrange or comanage the deal. The manager is
designated as the lead manager or principal manager. The lead manager typically has
responsibility for all aspects of the issue. The other investment bankers in the syndicate
serve primarily to sell the issue to their clients

The company and the investment bank will first meet to negotiate the deal. Items usually
discussed include the amount of money a company will raise, the type of securities to be issued
and all the details in the underwriting agreement. The deal can be structured in a variety of ways.
For example, in a firm commitment, the underwriter guarantees that a certain amount will be
raised by buying the entire offer and then reselling to the public. In a best effortsagreement,
however, the underwriter sells securities for the company but doesn't guarantee the amount to be
raised. Also, investment banks are hesitant to shoulder all the risk of an offering. Instead, they
form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of
the issue.
Dutch auction underwriting: With Dutch auction underwriting, the underwriter does not
set a fixed price for the shares to be sold. Instead, the underwriter conducts an auction
in which investors bid for shares. The offer price is determined based on the submitted
bids. A Dutch auction is also known by the more descriptive name uniform price auction.
This approach to selling securities to the public is relatively new in the IPO market and
has not been widely used there, but it is very common in the bond markets. For example,
it is the sole procedure used by the U.S. Treasury to sell enormous quantities of notes,
bonds, and bills to the public.

Lock-Up Agreements
A lock-up agreement may restrict the stock's trading somewhat after the company goes public. A
lock-up agreement is a legally binding contract between the underwriters and insiders of a
company prohibiting these individuals from selling any shares of stock for a specified period of
time. Lock-up periods typically last 180 days (six months) but can on occasion last for as little as
120 days or as long as one year.

Underwriters will have company executives, managers, employees and venture capitalists sign
lock-up agreements to ensure an element of stability in the stock's price in the first few months of
trading. When lock-ups expire, restricted people are permitted to sell their stock, which
sometimes (if these insiders are looking to sell their stock) results in a drastic drop in share price
due to the huge increase in supply of stock.

Right s

When new shares of common stock are offered to the general public in a seasoned new
equity issue, the proportionate ownership of existing shareholders is likely to be reduced.
However, if a preemptive right is contained in the firms articles of incorporation, the firm
must first offer any new issue of common stock to existing shareholders. This assures
each owner his proportionate owners share.

An issue of common stock to existing stockholders is called a rights offering. Here each
shareholder is issued an option to buy a specified number of new shares from the firm
at a specified price within a specified time, after which the rights expire. For example, a firm
whose stock is selling at $30 may let current stockholders buy a fixed number of shares at
$10 per share within two months. The terms of the option are evidenced by certificates
known as share warrants or rights. Such rights are often traded on securities exchanges or
over the counter.

Dilutive stock is any security that dilutes the ownership percentage of current shareholders - that
is, any security that does not have some sort of embedded anti-dilution provision. The reason why
dilutive stock has such negative connotations is quite simple: a company's shareholders are its
owners, and anything that decreases an investor's level of ownership also decreases the value of
the investor's holdings.