Showing papers on "Debt published in 1977"

Corporate mergers and the co-insurance of corporate debt

Abstract: WHILE NUMEROUS STUDIES have been devoted to examining the returns to the stockholders of merging firms, the same detailed analysis has not been extended to another group of emminently interested security owners-namely the bondholders of these same firms. Indeed, there exists a fundamental unresolved controversy concerning the impact of corporate merger on the value of the merging firms' bonds, and, by implication, the value of their common stock. The controversy revolves around the notion of a "co-insurance" effect for corporate debt and the wealth-transfers thereby engendered. The idea of a co-insurance effect for corporate debt was first advanced by Lewellen (11). He argued that the joining-together of two or more firms whose earnings streams were less-than-perfectly correlated would reduce the risk of default of the merged firms (i.e., the co-insurance effect) and thereby increase the "debt capacity" or "borrowing ability" of the combined enterprise. He concluded that the increased total borrowing capacity of the resulting firm, in combination with the well-known effect of tax-deductible interest payments, provided an economic incentive for shareholder-wealth-maximizing firms to engage in merger. However, Lewellen's thesis was incomplete because he failed to examine carefully the impact of the co-insurance effect on the value of the merging firm's already outstanding debt. Higgins and Schall (6) and Galai and Masulis (5) extended the analysis to show that the co-insurance effect would lead to an increase in the market value of the merging firms' debt and a concomitant decline in the market value of their equity. Thus, the net financial result of non-synergistic mergers would be a wealth-transfer from stockholders to debtholders. They concluded that unless firms can neutralize this wealth-transfer they should not engage in merger. However, if firms are either controlled by stockholders or if managers at least seek to maintain shareholders' wealth-let us define these more generally as shareholder-wealth-protecting firmswe would expect to observe that merging firms do take steps to neutralize this wealth-transfer. This paper is a theoretical and empirical examination of corporate merger and the co-insurance of corporate debt. The theoretical section uses a cash-flow analysis to re-examine the co-insurance effect. The comparative advantages of the theoretical framework used here is that the valuation consequences of the coinsurance effect are provided with no distributional assumptions and without

Determining an optimal capital standard for the banking industry

Abstract: DURING THE LAST CENTURY the expansion of this country's commercial banks has been financed with less and less capital relative to debt. While many bankers have delighted in the increased leverage that declining capital positions allowed them, some economists and most regulators regard this trend with considerable skepticism. These economists are concerned that lower capital may lead to more bank failures, jeopardizing the financial stability and the viability of the present monetary exchange system. They have proposed various plans to prevent economic loss to depositors in the event of bank failures, Mayer [1965], and to heighten awareness of potential failures, Cohen [1970]. Regulatory authorities are convinced that allowing bank capital positions to erode is neither safe nor proper, and they have resisted this trend. Supervisory authorities argue that additional restraints on capital adequacy are needed to protect the public's interest in the financial system. They contend that the losses sustained when a bank fails exceed the costs borne by investors in the bank's securities because of the public nature of its liabilities; see for example, Shay [1974] and Watson [1974].

A Perspective on the Debt of Developing Countries

Abstract: Since 1973, when the price of oil was raised very sharply, developing countries have incurred heavy debts. This paper looks at their ability to carry debt, first by examining the balance of payments and external borrowing of all developing countries that are not oil producers in general. It then focuses on a group of ten advanced developing countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, Phillipines, South Korea, Taiwan, and Thailand) that account for the bulk of the borrowing from private sources that has given rise to widely expressed concern. The analysis that follows leads to an optimistic conclusion about the capacity of the ten countries not only to carry their present debt but to expand it. It does not follow that decision makers in private financial markets will come to the same conclusion. Thus, attention is given also to supplementing private lending with resources supplied by the International Monetary Fund. Furthermore, questions are raised about what could go wrong--what international developments could make the outlook less rosy for the heavy debtors.

Bankruptcy Costs and the Firm's Optimal Debt Capacity: A Positive Theory of Capital Structure

Abstract: independent of its capital structure is a conceptual subject which continues to receive considerable attention and discussion in recent financial theory literature.1 The basic underlying premise of the M-M proposition is simply that in perfect securities markets, the capital structure decisions by firms belonging to the same risk class do not alter the opportunity set available to investors. Hence any discrepancies in total market values of identical firms in the same risk class arising from differences in financing mix will be removed through arbitrage operations by investors. But as recent financial writers point out, individual investors do not enjoy the limited liability priviledge accorded to firms, and more significantly, there are explicit costs to bankruptcy which may offset the advantage to the firm arising from the tax deductibility of interest payments. Hence the purpose of this paper is to examine in a formal manner, within the context of a mean-variance framework, if recognition of these securities market imperfections are sufficient to establish the traditional finance position that capital structure decisions have a significant impact on total firm value, and thereby provide the theoretical basis for a financial synergy rationale for conglomerate

Loansharking in American Cities: Historical Analysis of a Marginal Enterprise

Abstract: In the recent past, two distinct types of loansharking have flourished in American cities. The first, which developed in the 1870's or 1880's and probably reached its high point from 1900 to World War I, functioned with an appearance of legality. There is no evidence that these loansharks used violence for collection of debts. Rather, their effectiveness often involved persuading the borrower that the loan represented a legal obligation. Much like a modern, legal lending institution, most such lenders operated out of an office; a prospective borrower was investigated to determine whether he had a steady job; and the borrower signed complicated forms before receiving the loan. Commonly, the loan was treated as a "purchase" of the borrower's future salary. In the event that a borrower failed to meet his payments, collection was attempted by threatening to inform the employer of the debt, by harassment of various sorts, or by filing a law suit. Such loansharks, so far as can be determined, had no connection with gambling syndicates or other "organized crime" activities. They were often referred to as salary lenders. The second type of loansharking made little or no pretense of legality. Instead, the understanding between lender and borrower was that, while the borrower would be expected to repay because he had promised to do so, the sanction of violence might ultimately be used. Although such loansharks sometimes used a legal lending institution or some other legitimate business as a front, they more often met their customers in saloons, on streetcorners, in the factory, and at other informal but regular public places. These loansharks often had prior or concurrent careers in bootlegging, gambling, labor racketeering, or other "organized

East Europe's debt to the West: interdependence is a two-way street

Abstract: A policy analysis of East--West economic interdependence examines the implications that capital export into Eastern Europe has for the new economic order. Although the East European debt is smaller than that of non-OPEC less-developed countries (LDCs), it is significant in the Euromarket. As an oil exporter, Eastern Europe's debts are not the result of oil deficits and must be considered to have different economic, political, and strategic bases. The possibility of requests to treat these debts with the same arrangements negotiated for the LDCs needs to be taken under consideration as economic policy is formulated. Less debt servicing data are available from these centralized countries, making decisions based on default predications more difficult. Debt reduction by the East European countries can only be accomplished by a movement of manufactured goods to the West and a resistance in the West to trade discriminations. The interdependence that has developed should bring Eastern European countries into the discussions of their economic credibility and their involvement in the international monetary system. (DCK)

Risk management in international corporations

Abstract: private pension plans have accumulated assets and reserves, and are a major source of funds for the capital markets of the country." This reviewer's greatest disappointment in reading this book came from the last chapter on future growth prospects. For a book that is inundated with statistics, numerical forecasts were expected. Bishop expects little change in either the mix of insurance products sold or investments made. His predictions or rather extrapolations are generally in line with past experience. Rather than discussing the role that the life insurance industry will play in the future formation of capital, the author is content with discussing recent patterns or trends of products sold and investments made by life insurance companies. Given the assumption of moderate inflation, Bishop expects the trend to continue from endowment and whole life policies to term policies. Funds from group life insurance should continue to grow with the current dollar level of wages and salaries. Funds provided from pension plans should be fairly stable and immune to varying rates of inflation. With respect to industry investments, Bishop expects that life companies should maintain or slightly increase their percentage share in corporate debt investments. Privately placed debt should maintain its relative degree of importance. With respect to mortgage investments the author feels that the industry is capable of maintaining its position. Bishop meticulously describes the movements in life insurance products and investments from 1950 to 1974. Plausible explanations or factors are presented to account for these movements. The book, however, lacks an elaborate theoretical foundation for explaining why certain products or investments have increased or decreased in popularity. Also, little or no attempt is made to rank/order the factors that have caused particular products or investments to move. Nevertheless, for those who are interested in an introductory discussion of capital formation through life insurance, this book should be a valuable reference source.

Rescuing the LDCs. [Proposal of developed countries to maintain current account deficits]

Abstract: Analysis of the debt accumulated by less-developed countries (LDCs) leads to a recommendation that the U.S. and other developed countries maintain current account deficits to make it easier for the LDCs to purchase goods and services. International trade policy is too complicated to finance LDC borrowing needs and maintain trade barriers at the same time. An effort to retain LDC access to markets is valid in order to maintain their ability to purchase our manufactured goods and to ease the repayment of debts to our banks. A review of LDC debt development separates commercial (those having access to commercial banks) and aid-dependent (those relying only on foreign aid) countries and uses the examples of Argentina, Peru, and Zaire. Excessive debts can cause lenders to press for slower economic growth, resulting in recession and political unrest. A better solution is seen in the current account deficit since it would stimulate the LDC's economy by easing trade barriers and would let them repay their debts by claiming foreign bank deposits or purchasing U.S. notes and bills. (DCK)

Optimality in Municipal Debt

Abstract: The recent financial pressure an cities has renewed interest in the management of municipal debt. The concepts of optimum municipal debt and optimum municipal capital stock are examined here. Several popular misconceptions about local debt management are discussed, and counter-assertions are made. A model is proposed for minimization of local debt costs, and it is suggested that municipal investment, rather than municipal indebtedness, ought to be limited.

Debt problems of developing countries

Abstract: Much concern has been expressed in recent years over the mounting debt burden of developing countries. The increasing amounts of loans and their hardening terms have in many cases led to external debt servicing problems of alarming magnitudes. The following contribution addresses itself to evaluating these problems.

Are the LDCs in over their heads. [Review of debt-servicing and borrowing problems]

Abstract: Heavy borrowing on the part of non-oil less-developed countries (LDCs) raises questions about the lending and risk-taking practices of international banks and about future high demands for foreign loans. International banks with a balanced loan portfolio are generally cushioned against the risk of loss from unpaid loans and have premium interest rates for high-risk loans to provide insurance against loss. Measures to protect capital also include rescheduling debts to delay repayment. The rapid rise of LDC indebtedness is credited to a combination of high oil prices, recessions in the developed countries, and over-ambitious domestic policies. Results of economic modeling indicate a future decline in LDC debts relative to their gross national product and reveal that domestic economic policies have no significant impact on current account balances. A policy of gradual stabilization, based on depreciating exchange rates to eliminate deficits, would cause only a temporary slowdown but no effect on real growth or employment level. (DCK)

An analysis of optimal farm capital structure

Abstract: Use of debt in financing agricultural firms is an weak theoretical framework. Many earlier writings issue of perennial interest. Much of this interest have been conceptualized in a marginal returns and reflects farmers' disastrous experience with debt marginal costs framework. Conceptual and empirical during the Great Depression. The foreclosed mort- difficulties in including risk in this standard framegages and bankruptcies of that era reaffirmed an work limit its usefulness in analyzing situations where historical feeling that achieving a level of zero debt or risk is important. In corporate finance theory, the financial leverage was a high priority goal. E.G. concept of cost of capital is utilized to analyze Johnson, who was Chief of the Economic and Credit optimum level of financial leverage [1, 11]. While Research Division of the Farm Credit Administration, Hopkin, Barry and Baker present a theoretical disarticulated the position in the 1940 Yearbook of cussion of this concept in their textbook [5, pp. Agriculture that this goal is even more important than 251-256], it has not been integrated into empirical increasing profits: "It may be well to emphasize again analysis in agricultural finance. The purpose of this that while credit properly used may help farmers to paper is to explore applicability of the concept of increase their income and raise their standard of cost of capital in analyzing farmers' decisions to living, the fact must not be overlooked that more utilize financial leverage. Specific objectives include: credit will not cure all the ills of agriculture. The (1) a brief discussion of the concept of cost of greatest need is to assist the farmers in getting out of capital, (2) derivation of an empirical model from the debt, not deeper into it," [6, p. 754]. As memories cost of capital concept to analyze the decision to of the Great Depression faded, agricultural econo- employ financial leverage and (3) presentation of a mists tended to emphasize the effect of debt on farm discriminant analysis which tests the model for a size and therefore net income. Heady emphasized sample of Georgia farmers. increased income from obtaining more resources through use of debt [3, pp. 535-561], and Hopkin, Barry and Baker stressed that leverage could increase

U.S. Role in East-West Trade: An Appraisal

Abstract: This article reviews major factors involved in U.S. participation in East-West trade, including centralization and the structure of decision making in Eastern Europe, tariff and nontariff barriers, and the significance of financing and the level of debt in the Socialist countries. It also examines ways of ascertaining market potentials, new forms of trade, such as industrial cooperation and countertrade arrangements. It concludes with an assessment of outstanding issues in the future development of East-West trade.

Developing countries’ external debt and the private banks

Abstract: The paper discusses the permanence of the post-1973 developing country borrowing problem and assesses the adequacy of the steps taken by the international private banking system to protect itself against the risk of default on developing country debt. The particular problem is the rapid build-up of private banking system assets that are the short and medium-term foreign currency obligations of governments and private enterprise in the developing countries. The author provides evidence that suggests the developing country borrowing problem may be temporary, and that banks have acted to ensure themselves against the risk of default when that risk is high.

The Association between Firm Risk and Wealth Transfers Due to Inflation

Abstract: The net monetary position of a firm, defined as the nominal value of its monetary assets minus the nominal value of its monetary liabilities, partly determines the wealth transferred to (or from) the firm's owners when unanticipated price level change occurs. Price level change (a random variable) is defined as unanticipated when assessments of (the moments of) its probability distribution are systematically incorrect or biased. During unanticipated inflation, which conventionally means an underestimate of the expected value of the distribution of price level change, the real dollar returns of net monetary debtor firms are enhanced—the unforeseen honoring of debt contracts in dollars of lower purchasing power is a wealth transfer to the firm's owners from the firm's creditors. Conversely, real returns of net monetary creditor firms suffer during unanticipated inflation and gain during unanticipated deflation.

What was the Pertamina Crisis

Abstract: It has been suggested that if Revolution was the rallying-cry of Sukarno's Guided Democracy, its equivalent under the New Order of Suharto has been Development. Development has been invoked as a national goal, a call to order, a promise of better times to come. Oil, since 1972 the overwhelming source of Indonesia's nonaid foreign exchange and tax revenue, has been crucial to the realization of that promise. The state oil company, Pertamina, was to be, in the words of its former President Director, Lieutenant-General Dr. Ibnu Sutowo, a "national development com pany", the engine that would power the whole economy into sustained growth. Pertamina was then, both economically and politically, a key institution of the New Order. The series of disclosures beginning in November 1974 that Pertamina had accumulated massive debts which it was unable to cover would inevitably have far-reaching consequences for the Suharto Government. Even now, the exact scale of Pertamina's indebtedness is not fully known. In March 1975, it was admitted that Pertamina owed USS1-5 billion in short and medium-term debt. In June 1975, the Minister of Economic, Financial and Indus trial Affairs, Dr. Wijoyo Nitisastro, told the Dewan Perwakilan Rakyat (DPR, the People's Representative Assembly) that Pertamina's total debt was USS3-4 billion. By February 1976, officials were confirming reports that Pertamina owed both domestic and foreign creditors something in the region of USS10 billion or approximately two-thirds of the Indonesian GNP. Asked about the accuracy of that figure, Sutowo's successor, Major-General Piet Harjono, said: "I am still counting. It may be more, it may be less." At the same time, there were strong rumours that a Ministry of Defence team charged with investigating the size of the debt had come up with a figure of US$13 billion. In March, the Minister of Mines, Dr. Mohammad Sadli, said that, after repayment of short-term loans, renegotiation of contracts, the cancellation of some projects and the scaling down of others, the debt had been reduced to US$62 billion. However, the Minister's announcement may have been premature. In September, it was admitted that Pertamina owed US$3 -3 billion for tanker purchases and charters alone ? almost US$1 billion more than it was said to be owing when the total debt was US$10 billion. Whatever the actual amount, it is certain that at its height the Pertamina debt totalled more than the combined amounts of foreign government aid raised by the Sukarno and Suharto r?gimes ? approximately US$8 billion. Moreover, the Pertamina debt does not include a whole range of subsidiary costs such as interest charges (allegedly averaging the very high rate of 15%) or the cost incurred by the government in rebuilding depleted foreign exchange re serves or the cost of a shift to greater reliance on loan-financed rather than self financed development or the income that might have accrued from projects now

External Finance: A Necessary Component in Growth Projections for Southern Agriculture

Abstract: THE THEORETICAL MODEL income has been accompanied by large increases in The first portion of Penson's paper presents a outstanding debt. In view of rapidly rising asset theoretical or conceptual financial model of the farm values, many persons are currently asking whether the sector. It exposes his audience to one type of associated credit demands can be adequately accom- theoretical framework within which analysts at the modated within the present structure of lending research frontier of aggregate farm finance are institutions and arrangements. But at the same time, attempting to formulate their empirical explorations. wide fluctuations and a generally downward drift in But frankly, it is questionable whether the model farm income since 1973 are also leading analysts to plays, in this particular paper, the role apparently ask how borrowers and lenders alike can prepare for visualized by the author. periods in which normally useful financial leverage Penson states that he presents this model "to may be transformed into financial difficulty. While illustrate the channels through which the cost and Penson addresses both sets of concerns, this author's availability of debt and equity capital and increasing predilection to emphasize the latter leads one to financial risk can restrict the future rate of growth of believe that he performs the greater service in farm firms." This objective certainly goes to the heart documenting the significant relative increase in debt of his assigned topic. Let us, however, examine the incurred by Southern agriculture so far in the 1970s, discussion which accompanies the elements of the the dramatic lengthening of the payback periods that model. Necessarily each concept must be greatly relate outstanding debt to income, and the conse- abbreviated, but hopefully without undue distortion. quent rise in financial risk confronting both borEquations 1 through 4, he states, indicate that rowers and lenders. As he notes, increased risk capital stock is increased so long as the additions are reduces the optimum level of debt and suggests expected to more than pay for themselves. urgent research attention to farmer and lender Equation 5, he states, indicates that as demand adaptations involving a wide range of equity and for farm output increases, more capital stock is credit arrangements. His treatment of these subjects desired; as cost of capital increases, less capital stock

Debt-Management Policy and the Own Price Elasticity of Demand for U.S. Government Notes and Bonds

Abstract: It frEBT-management policies of the U.S. Government are actions which affect the composition of the publicly held Federal debt. Such actions include operations of both the U.S. Treasury and the Federal Reserve. As a macroeconomic policy tool, discretionary debt-management policy attempts to affect economic activity in a specific way by altering the maturity structure of the Government’s debt. The effectiveness of such a policy depends upon the extent to which changes in the composition of the debt affect the structure of interest rates, and the extent to which changes in the structure of interest rates affect economic activity.

Advance Refunding: A Practitioner's Perspective

Abstract: i On October 29, 1976, the Internal Revenue Service published new proposed arbitrage bond regulations. The preamble to the regulations stated that the main purpose of the new rules was to eliminate arbitrage as an inducement to refund. Arbitrage resulted from the yield differential between a municipal issuer's borrowing and lending rates. In an advance refunding, a municipal issuer borrows funds at a taxexempt rate and then reinvests the net proceeds in a portfolio of government securities which normally has a higher market yield. The portfolio is then structured to meet the debt service requirements of the issue being refunded. A primary determinant of the size of the new issue required to defease the outstanding debt is the differential in yield allowed on the government portfolio and the interest rate on the outstanding debt. Under the old regulations, 85% of the new issue proceeds were required to be invested at a yield not in ex-