Corporate Financial Strategy This page intentionally left blank Corporate Financial Strategy 3rd edition Ruth Bender and Keith Ward AMSTERDAM • BOSTON • HEIDELBERG • LONDON NEW YORK • OXFORD • PARIS • SAN DIEGO SAN FRANCISCO • SINGAPORE • SYDNEY • TOKYO Butterworth Heinemann is an imprint of Elsevier Elsevier Butterworth-Heinemann Linacre House, Jordan Hill, Oxford OX2 8DP 30 Corporate Drive, Burlington, MA 01803 First published 1993 Reprinted 1993, 1994, 1995, 1997, 1998, 1999, 2000, 2001 Second edition 2002 Reprinted 2003 (twice), 2005 (twice) Copyright © 2009, Ruth Bender and Keith Ward. All rights reserved The rights of Ruth Bender and Keith Ward to be identifi ed as the authors of this work has been asserted in accordance with the Copyright, Designs and Patents Act 1988 No part of this publication may be reproduced in any material form (including photocopying or storing in any medium be electronic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright holder except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London, England W1T 4LP. Applications for the copyright holder’s written permission to reproduce any part of this publication should be addressed to the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone: (ϩ44) 1865 843830, fax: (ϩ44) 1865 85333, e-mail: [email protected]. You may also complete your request on-line via the Elsevier homepage (http://www.elsevier.com), by selecting ‘Customer Support’ and then ‘Obtaining Permissions’ British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 978-0-7506-8665-5 Typeset by Charon Tec Ltd., A Macmillan Company. (www.macmillansolutions.com) For information on all Elsevier Butterworth-Heinemann publications visit our website at www.bh.com Printed and bound in Hungary 09 10 11 12 10 9 8 7 6 5 4 3 2 1 Contents Preface to third edition vii PART 1: PUTTING FINANCIAL STRATEGY IN CONTEXT 1. Corporate fi nancial strategy: Setting the context 3 2. What does the share price tell us? 29 3. Executive summary: Linking corporate and fi nancial strategies 44 4. Linking corporate and fi nancial strategies 50 5. Corporate governance and fi nancial strategy 88 6. Executive compensation 104 PART 2: FINANCIAL STRATEGY AND THE CORPORATE LIFECYCLE 7. Start-up businesses and venture capital 125 8. Growth companies: Marketing focused 143 9. Mature companies: To divi or not? 164 10. Declining businesses: A case for euthanasia? 180 PART 3: FINANCIAL INSTRUMENTS 11. Financial instruments: The building blocks 193 12. Types of fi nancial instrument 208 13. Dividends and buybacks 226 vi Contents PART 4: TRANSACTIONS AND OPERATING ISSUES 14. Floating a company 243 15. Acquisitions, mergers and selling a business 258 16. Restructuring a company 276 17. Private equity 286 18. International corporate fi nance 309 19. Strategic working capital management 324 APPENDICES 1. Review of theories of fi nance 337 2. Valuing options and convertibles 353 3. Forecasting 366 Glossary of selected fi nancial terms 375 Discount table: present value of £1 380 Discount table: present value of £1 received annually for N years 382 Black–Scholes value of call option expressed as a percentage of the share price 384 Index 387 Preface to third edition This book describes how corporate fi nance works in prac- tice. It shows how an appropriate fi nancial strategy can be designed to complement the corporate strategy and add value to an organization. We consider the relevant theories of corporate fi nance, but our main thrust is to show how they can be applied in the real world. The material for the book is based upon many years’ expe- rience as practitioners and consultants in, and teachers of, corporate fi nance. It has been refi ned and tested by use on advanced MBA courses at Cranfi eld School of Management and in programmes held for senior managers and fi nanciers around the world. To bring it to life we include a number of real company Case Studies, together with a wide range of illustrative examples. We link together various parts of fi nancial theory and try to explain numerically how fi nan- cial markets really work. We have made no attempt to reproduce the many existing textbooks on fi nancial theory, although the requisite theories are summarized and explained. The objective is to go much further in placing the theory into a usable context which should enable practising managers to understand more fully the potential value added by the best fi nancial strategy available to them. The structure of the book has been designed to make it of value even if not read from cover to cover. It is divided into four parts. In Part One we give an overview of fi nancial strategy and its role within the overall corporate strategy of the business. Set in the context of shareholder value, we examine what the viii Preface to third edition share price tells us about the market’s expectations of the business and how this can affect both corporate and fi nancial strategies. We build up a model examin- ing how these expectations and the fi nancial drivers change over the lifecycle of the company, and demonstrate what this means for a company’s fi nancial choices. We also examine how and why governance requirements of the busi- ness change as it develops through different stages of ownership. Part Two considers in much more detail the various components of the fi nan- cial strategies which are appropriate to each stage of the company’s develop- ment. We consider how the company’s strategy will adapt to its changing circumstances, look at the changing sources of business risk, and explain how dividend policies and funding sources match the organization’s needs. In Part Three we move away from the lifecycle model to examine different types of fi nancial instrument. The choice of fi nancial instruments is fundamen- tal to designing a fi nancial strategy, and we deconstruct the key features of a variety of securities, setting them out in terms of the basic risk-return relation- ship that underlies pretty much everything in fi nance. Within this section we also examine companies’ dividend and buyback choices. We have entitled Part Four ‘Transactions and Operating Issues’. Here we consider the major transactions that a company might encounter – fl otation, acquisitions, restructuring. Separately, we examine the role of the private equity industry in business today, and show how and why these investors can create value for their participants. We also look at issues fundamental to the running of a business – international considerations and working capital management. We have relegated underlying detail to the Appendices. Here you will fi nd a brief overview of all of the theories of corporate fi nance needed to under- stand our approach in this book. We also use Appendices to give further detail on share options, and to set out advice on the preparation of forecasts, an area which is fundamental to devising a fi nancial plan, and which we have found in practice to be sadly inadequate in many businesses. Very deliberately the illustrative examples and real case studies used through- out the book have been analyzed using relatively simple mathematics; the simplifying assumptions do not destroy the underlying reasoning behind the analysis. The objective is to convey the conceptual logic behind fi nancial strat- egy rather than to confuse with spuriously accurate mathematics and exces- sively complex formulae. Changes in this edition The previous edition of this book was published six years ago. Since then much has changed. Economies have gone through cycles of boom and bust; compa- nies and their fi nance have become yet more global. When returning to update the text it was a comfort to us to see that the principles and commentary remain valid today, and we have not made any signifi cant changes to the structure of this text. However, in those six years we have worked with more companies, and have learned more ourselves. Accordingly the book has been updated to refl ect this. Preface to third edition ix The major changes we have made in this edition include: Executive summary Chapter 4 contains the main models underlying the of the key models book and is necessarily long. To simplify matters for the reader in a hurry we have prepared a new Chapter 3, which briefl y summarizes its content. New chapter on Corporate governance is becoming more and more governance and important to organizations. Chapter 5, new to this fi nance edition, sets out how governance impacts upon a company’s fi nancial strategy over its ownership life- cycle. The chapter on executive compensation has been moved from Part Four of the book to sit next to this, as Chapter 6. More on private Private equity plays a more signifi cant part in the equity global economy than it did a few years ago. Chapter 17 has been revised and expanded to refl ect this. New appendix Much of fi nancial strategy depends on a company’s on forecasting forecasts of its funding requirements. Appendix 3, new to this edition, discusses forecast preparation, and includes a brief section on behavioural fi nance. We have also updated many of the Case Studies and Working Insights, and made textual alterations to most chapters. Companion website At the request of our readers, the book now has a companion website, www.elsevierdirect.com/9780750686655 and www.textbooks.elsevier.com/ 9780750686655.