Incentives provided to firms by implicit and explicit government guarantees, debt vs. preferred stock vs. common stock, gov chooses preferred stock. First, preferred stocks don’ t need companies to pay downside of leverage, analysis of various gov’t interventions/policies
2. Basic review
Valuation metrics (e.g., NPV, IRR, payback period),
Modigliani-Miller irrelevance propositions 3. Stock-Based Compensation
Characteristics of employee stock options,
When employees are granted “stock options,” they are being granted call options on the company’s stock. The value of the option increases with the firm’s stock price. * American call options (can exercise early) * Typical life = 10 years * Granted “at-the-money” (exercise price = share price at the time of the grant) * Rarely dividend protected * Cannot be sold (non-transferable) * Have vesting restrictions
trends over time, option granted is increasing over past years. High tech companies prefer to offer options
Which firms use more stock-based compensation (options) and why? * Cross-sectionally, firms with high market-to-book ratios:(High MB ratio means large intangible assets and relatively big beta and volatility, option is not a fixed cost as salary be. Fewer options will be exercised when companies performed weakly. So it can lower the volatility of earning and beta.) * higher past stock returns: * less regulatory constraints, and lower cash flow tend to grant more compensation via stock options.
(Option is not ) * Pay for performance sensitivity. * Used to motivate higher management to perform a better job and reward with options.
How do options affect behaviors of workers, of executives, affect payout policy and investment decisions?
To align incentives to ameliorate(promote & improve) principal-agent problems.(employee is also a winner if the stock price goes up.)
* firms with options programs tend to repurchase more stock and pay fewer dividends. * Options are rarely dividend protected (if pay dividend, it reduces stock price and thus value of option). * Firms often repurchase stock to undo the dilution from option grants.
Investors tend to assume if returns are positive at the beginning then will most likely will be positive in 5 or 10 years later. Some evidence executives may sell some of their stock if granted more options, so their exposure to firm stock price does not change.
Stock options vs. restricted stock
Restricted stock: can be sold only in future years and only when employees are still in the company.
The stock award program offers employees the opportunity to earn shares of our stock over time, rather than options that give employees the right to purchase stock at a set price.
4. Valuation (Interco, Netscape, Google cases)
Various methods to value business (look at comparable transactions, look at price multiples of a publicly traded competitor and apply that to you, discounted cash flow), WACC and free cash flows values the whole firm (values the firm’s assets), factors to valuation (marketability, firm’s fortunes tied to one key person, value of control)
Cost Approach * Adjusted Book Value
Involves restating the value of individual assets and liabilities to reflect their fair market values.
2) Market Approach * Comparables relies on key assumption: Comparable companies have future cash flow expectations and risks similar to the firm being valued * Generally tough to find appropriate companies to be comparable * Which ratio/comparable do you use? There isn’t a “right” answer, so comparables approach will give a range of values rather than one. SENSITIVITY ANALYSIS important here! * Many comparable companies have different capital structures.
3) Income Approach * Discounted Cash Flow * Capitalizes the cash flows the firm is expected