Chapter 14

International Debt and

Equity Financing
 Designing a Strategy to
Source Capital Globally
• Designing a capital sourcing strategy requires that
management agree upon a long-run financial objective and
then choose among the various alternative paths to get there.
• Often, this decision-making process is aided by an early
appointment of an investment bank as an official advisor to
the firm.
• Investment bankers are in touch with potential foreign
investors and know what they currently require, and can also
help navigate the numerous institutional and regulatory
barriers in place.
 Designing a Strategy to
Source Capital Globally
• Most firms raise their initial capital in their own
domestic market.
• However, most firms that have only raised capital in
their domestic market are not well known enough to
attract foreign investors.
• Incremental steps to bridge this gap include
conducting an international bond offering and/or
cross-listing equity shares on more highly liquid
foreign stock exchanges.
• Exhibit 14.1 shows global paths to the availability of
capital
Exhibit 14.1 Alternative Paths to Globalize
the Cost and Availability of Capital
 Optimal Financial Structure

• The domestic theory of optimal financial structure must be modified

considerably to encompass the multinational firm.
• Most finance theorists are now in agreement about whether an optimal
financial structure exists for a firm, and if so, how it can be determined.
• When taxes and bankruptcy costs are considered, a firm has an optimal
financial structure determined by that particular mix of debt and equity
that minimizes the firm’s cost of capital for a given level of business risk.
• As the business risk of new projects differs from the risk of existing
projects, the optimal mix of debt and equity would change to recognize
tradeoffs between business and financial risks.
 Optimal Financial Structure

• Exhibit 14.2 illustrates how the cost of capital varies

with the amount of debt employed.
• As the debt ratio increases, the overall cost of capital
(kWACC) decreases because of the heavier weight of
low-cost (due to tax-deductibility) debt ([kd(1 - t)]
compared to high-cost equity (ke).
Exhibit 14.2 The Cost of
Capital and Financial
Structure
 Optimal Financial Structure
and the Multinational
Enterprise
• The domestic theory of optimal financial structures
needs to be modified by four more variables in order
to accommodate the case of the MNE:
– Availability of capital
– Diversification of cash flows
– Foreign exchange risk
– Expectations of international portfolio investors
 Optimal Financial Structure
and the Multinational
Enterprise
• Availability of capital:
– A multinational firm’s marginal cost of capital is
constant for considerable ranges of its capital
budget
– This statement is not true for most small domestic
firms (as they do not have equal access to capital
markets), nor for MNEs located in countries that
have illiquid capital markets (unless they have
gained a global cost and availability of capital)
 Optimal Financial Structure
and the Multinational
Enterprise
• Diversification of cash flows:MNC can diverse their cash flows

– The theoretical possibility exists that multinational

firms are in a better position than domestic firms
to support higher debt ratios because their cash
flows are diversified internationally
– As returns are not perfectly correlated between
countries, an MNE might be able to achieve a
reduction in cash flow variability (much in the
same way as portfolio investors who diversify their
security holdings globally)
 Optimal Financial Structure
and the Multinational
Enterprise
• Foreign exchange risk and the cost of debt:
– When a firm issues foreign currency denominated
debt, its effective cost equals the after-tax cost of
repaying the principal and interest in terms of the
firm’s own currency the firm issues debt in foreign currency, the exchange rate can change at any points
in time -> affect the repaying the principal and interest in the firm's own currency.
So the firm can pay more or less depending on the exchange rates.

– This amount includes the nominal cost of principal

and interest in foreign currency terms, adjusted
for any foreign exchange gains or losses
 Optimal Financial Structure
and the Multinational
Enterprise
• Expectations of International Portfolio Investors:
– The key to gaining a global cost and availability of
capital is attracting and retaining international
portfolio investors
– If a firm wants to raise capital in global markets, it
must adopt global norms that are close to the U.S.
and U.K. norms as these markets represent the
most liquid and unsegmented markets
 Raising Equity Globally

• There are three key critical elements to understanding the

issues that any firm must confront when seeking to raise
equity capital.
– First, a public or private equity placement
– Then, where to list the offering
– Finally, the type of issuance
• A firm seeking to raise equity capital is ultimately in search of
an issuance (IPO or SPO), although it need not be public.
MNCs usually are not publicly company traded
 Raising Equity Globally

• Exhibit 14.4 provides an overview of the four major

equity alternatives available to multinational firms
today:
– IPO
– Euroequity issue
– Directed public/private issue
– Private placement
 Exhibit 14.4 Equity
Alternatives in the Global
Market

the investor can sell their investment

like certificate through an institution or group.
 Raising Equity Globally—IPO

• Initial Public Offering (IPO) – the first public issue of a

firm’s equity shares. issuing IPO reduce cost benefit and expose more

the first thing needed to prepare.

– First a prospectus is published

– The IPO typically represents 15% to 25% of
ownership
– Later issues by the firm are considered “seasoned
offerings”
– With public issuance of shares comes greater
public disclosure
 Raising Equity Globally—
Euroequity Issue

• A euroequity or euroequity issue is an initial public

offering on multiple exchanges in multiple countries
at the same time.
• The “Euro” market (a generic term for international
securities issues originating and being sold anywhere
in the world) was created by the same financial
institutions that had previously created an
infrastructure for the Euronote and Eurobond
markets.
 Raising Equity Globally—
Directed Public Share Issues

• A directed public share issue is defined as one that is

targeted at investors in a single country and
underwritten in whole or in part by investment
institutions from that country.
• The issue might or might not be denominated in the
currency of the target market.
• The shares might or might not be cross-listed on a
stock exchange in the target market.
 Depositary Receipts

• Depositary receipts (shares) are negotiable certificates issued

by a bank to represent the underlying shares of stock, which
are held in trust at a foreign custodian bank.
• American depository receipts (ADRs) are traded in the United
States and denominated in U.S. dollars.
• ADRs are sold, registered, and transferred in the U.S. in the
same manner as any share of stock with each ADR
representing some multiple of the underlying foreign share
(allowing for ADR pricing to resemble conventional U.S. share
pricing).
 Exhibit 14.5 TelMex’s
American Depositary Receipt
(Sample)
Exhibit 14.6 The Structural
Execution of ADRs
 ADR Mechanics

• ADRs can be exchanged for the underlying foreign shares, or

vice versa, so arbitrage keeps foreign and U.S. prices of any
given share the same after adjusting for transfer costs.
• ADRs also convey certain technical advantages to U.S.
shareholders.
• While ADRs are quoted only in U.S. dollars and traded only in
the U.S., Global Depositary Receipts (GDRs) can be traded on
equity exchanges around the globe in a variety of currencies.
 DR Markets Today: Who,
What, and Where

• Who: mix of major multinationals, but participation

has shifted back toward industrial countries.
• What: split between IPO and follow-on offerings
• Where: mostly New York and London
• Exhibit 14.8 shows the distribution of money raised
in the depositary receipts market since 2000
Exhibit 14.8 Equity Capital
Raised Through Depositary
Receipts
 Global Registered Shares
(GRS)

• A global registered share is a share of equity that is

traded across borders and markets without
conversion, where one share on the home exchange
equals one share on the foreign exchange.
• Different from a global depositary receipt in that the
DR is bundled or split so that the price represents a
typically traded value for that market, a GRS has the
same value everywhere and is not bundled (or split)
for purposes of trading.
 Private Placement

• One type of directed issue with a long history as a source of both equity
and debt is the private placement market.
• A private placement is the sale of a security to a small set of qualified
institutional buyers.
• Since the securities are not registered for sale to the public, investors have
typically followed a “buy and hold” policy.
• Private placement markets now exist in most countries.
• Private equity funds have become well-known as vehicles for takeover of
firms. They leverage their investments with large amounts of borrowing
and have significant tax advantages.
 Private Placement

• Private equity funds are usually limited partnerships of institutional and

wealthy individual investors that raise their capital in the most liquid
capital markets.
• These investors then invest the private equity fund in mature, family-
owned firms located in emerging markets.
• The investment objective is to help these firms to restructure and
modernize in order to face increasing competition and the growth of new
technologies.
• Private equity funds differ from traditional venture capital funds as private
equity funds operate in many countries, fund companies in many industry
sectors and often have a longer time horizon for exiting.
 Foreign Equity Listing and
Issuance
• Cross-listing attempts to accomplish one or more of many
objectives:
– Improve the liquidity of its shares and support a liquid secondary
market for new equity issues in foreign markets
– Increase its share price by overcoming mispricing in a segmented and
illiquid home capital market
– Increase the firm’s visibility and acceptance to its customers, suppliers,
creditors, and host governments
– Establish a liquid secondary market for shares used to acquire other
firms in the host market and to compensate local management and
employees of foreign subsidiaries
It is easier for the MNC to use stock instead of cash because most of people outside using shares of the company to trade and the value
of its shares increase.
 Foreign Equity Listing and
Issuance

• To maximize liquidity, it is desirable to cross-list

and/or sell equity in the most liquid markets. Stock
markets have been subject to two major forces which
are changing their behavior and liquidity:
– Demutualization: ongoing process by which the
small controlling seat owners on a number of
exchanges have been giving up their exclusive
powers.
– Diversification: growing diversity of both products
and foreign companies/shares being listed.
 Foreign Equity Listing and
Issuance

• New York and London are the most liquid stock

exchanges.
• Most exchanges have moved heavily into electronic
trading in recent years, which has allowed hedge
funds and other high-frequency traders to dominate
the market.
 Foreign Equity Listing and
Issuance
• Although cross-listing and equity issuance can occur together,
their impacts are separable and significant in and of
themselves.
• MNEs list in markets where they have substantial physical
operations mostly for political reasons.
• The establishment of a local liquid market for the firm’s equity
may aid in financing acquisitions and in the creation of stock-
based management and employee compensation programs
for subsidiaries.
 Foreign Equity Listing and
Issuance
• The most serious barriers to cross-listing and/or selling equity
abroad include the future commitment to providing full and
transparent disclosure of operating results and balance sheets
as well as a continuous program of investor relations.
• The U.S. school of thought is that the worldwide trend toward
requiring fuller, more transparent, and more standardized
disclosure of operating results and financial positions may
have the desirable effect of lowering the cost of equity capital.
• The opposing school of thought sees the U.S.-level disclosure
as a burden.
 Raising Debt Globally

• The international debt market offers the borrower a wide

variety of different maturities, repayment structures, and
currencies of denomination.
• The markets and their many different instruments vary by
source of funding, pricing structure, maturity, and
subordination or linkage to other debt and equity
instruments.
• The three major sources of debt funding on the international
markets are depicted in Exhibit 14.9.
Exhibit 14.9 International
Debt Markets and
Instruments
 Bank Loans and Syndicated
Credits
• International bank loans have traditionally been sourced in
the Eurocurrency markets; there is a narrow interest rate
spread between deposit and loan rates of less than 1%.
• Eurocredits are bank loans to MNEs, sovereign governments,
international institutions, and banks denominated in
eurocurrencies and extended by banks in countries other than
the country in whose currency the loan is denominated.
• The syndication of loans has enabled banks to spread the risk
of very large loans among a number of banks.
 Euronote Market

• Euronotes are short-to-medium-term debt

instruments that are either underwritten and non-
underwritten
– Eurocommercial paper is a short-term debt
obligation of a corporation or bank (usually
denominated in U.S. dollars)
– Euro medium-term notes bridge the gap between
eurocommercial paper and longer-term and less
flexible international bond
 International Bond Markets

• A Eurobond is underwritten by an international syndicate of

banks and other securities firms and is sold exclusively in
countries other than the country in whose currency the issue
is denominated.
• A foreign bond is underwritten by a syndicate composed of
members from a single country, sold principally within that
country, and denominated in the currency of that country.
• The Eurobond markets differ from the Eurodollar markets in
that there is an absence of regulatory interference, less
stringent disclosure rules and favorable tax treatments for
these bonds.
 International Bond Markets

• Unique Characteristics of Eurobond Markets:

– Absence of regulatory interference
• National governments often impose tight controls on foreign
issuers of securities denominated in local currencies,
although governments generally have less stringent
limitations for securities denominated in foreign currencies
and sold within their markets.
– Less stringent disclosure
• Disclosure requirements less stringent than those of the SEC.
– Favorable tax status
• Eurobonds offer tax anonymity and flexibility.