To grow a company must invest retained earnings in

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To grow a company must invest retained earnings in things that will generate more return Retained earnings boost a company’s value and boost the amount that will be invested into it. With managers keeping retained capital the companies are valued as less 6. Why do regulators feel a need to intervene? What do you expect to be the results of closer government involvement? Companies were converting for the managers benefit- once converted managers were giving themselves a large benefit package that drew criticisms from congress, depositors, and regulators. o They want to make sure conversions were taken under for fiduciary reasons, not for the managers benefit I think less firms would convert because of the increased regulation which will slow down efficiency
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Chapter 15: Equity market is the market for shares in the ownership of corporations- investors hand over money for a promise of a part of the distributed profits o No default because promised payment is not specific Equity finance requires corporate governance (legal protection and reliance on some party with power to monitor arm’s length investors) Public equity (function of liquidity and price discovery) is arm’s length private equity is relationship dispersed shareholding is of necessity an arm’s length arrangement- each hold small share so don’t really have a say and don’t want it they’d rather exit insiders have a say in enterprise- can abuse arm’s length lenders o ways to protect- 1) legal protection, and 2) reliance on some party with sufficient power to monitor the enterprise on behalf of arm’s length in absence of monitoring and control, large corporations were run for the benefit of their managers rather than for the benefit of their shareholders. This is what we call FREE CASH FLOW PROBLEM o when managers are not monitored, they can invest internal funds on projects that are not worthwhile from the perspective of a shareholder o FREE CASH FLOW- excess of internal funds over the amount needed to finance worthwhile investments Should be paid out to owners (shareholders) through dividends or repurchase of stock Managers gain nothing from this so they will use free cash flow to their interest Could hold on to cash (protection if company runs into trouble) Can fund new projects without having to persuade the capital market of their value (can expand even when expansion is unprofitable) Reinvestment of internal funds faces the “free cash flow” problem Price discovery of equity market that reveals the existence of the problem when share prices rise by less than the amount invested Leveraged buyout LBO- addressed issue w large corporations and how it was difficult to come up with someone who had significant power to make monitoring worthwhile o Makes equity of corporation smaller by replacing with debt – borrow to buy the outstanding shares of the company, then the company issued debt to pay retire part of the shares they held Instead of firing managers, they gave them a stake in the company A good secondary market has good liquidity and good price discovery
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