equityclaims

equityclaims - 1 Claims on Equity: Voting and Liquidity...

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Unformatted text preview: 1 Claims on Equity: Voting and Liquidity Differentials, Cash flow Preferences and Financing Rights Aswath Damodaran Stern School of Business August 14, 2008 2 Claims on Equity: Voting Differentials, Cash flow Preferences, Liquidity and Financing Rights In conventional valuation, we assume that all equity claims are identical and divide the value of equity by the number of claims (shares) to get the value per claim (share). In practice, though, claims on equity can vary on a number of dimensions. First, the claim can be a direct and perpetual one (standard equity) or it can be contingent on the value changing (equity option). Second, some equity investors have preferential claims on the cash flows dividends in some cases and cash flows in liquidation in other cases. Third, some equity claims have superior control rights over other claims: this can take the form of differential voting rights in some cases and a bigger role in board composition and management in others. In some instances, the power is triggered by a control event such as an acquisition or an initial public offering. Fourth, some equity investors are provided with special rights to protect their interests when the firm acts in later periods. These can include disproportionate rights in subsequent financing decisions the right to partake in the financing at a fixed price, for instance, or veto rights over new financing as well as redemption rights, where they can reclaim the capital that they have invested. Finally, equity claims can vary in terms of liquidity, with some claims being more marketable than others. All of these differences can affect value, resulting in some equity claims having higher value than others. 3 Much of the literature and theory in discounted cash flow valuation is directed at estimating the value of the enterprise, and from that value, deriving the value of equity. Thus, there has been a great deal of research on how best to estimate expected cash flows, discount rates and growth rates and the effects of these estimates on aggregate value. Once we derive equity value, though, we generally pay short shrift to assessing the value of individual equity claims (shares in the case of a publicly traded firm), because we implicitly assume that all equity investors have identical claims. In the real world, equity claims can be differentiated on at least five dimensions. First, some equity claims are contingent claims whereas others are direct ones: management options and warrants are examples of the former, with common stock being an example of the latter. Second, there are differences in cash flow claims across equity investors, with some investors entitled to higher dividends and cash flows in liquidation....
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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equityclaims - 1 Claims on Equity: Voting and Liquidity...

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