Financial Accounting (Fach) / Shareholder's Equity (Lektion)
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- Capital Contributions - Common Stock & Preferred Stock Common Stock All firms issue Common stock Claim on firm’s assets after stated obligations (liabilities and preferred shares) are met Voting and Dividend rights Preferred Stock Infrequent for public firms ~6% of S&P 500 Fixed rate of dividend No voting rights May have cumulative dividends, i.e. dividends accumulate when not paid and are paid-out before common stock dividends can be paid May be convertible into common stock (optional)
- Capital Contributions: Terminology - Authorized shares: # shares that can be issued Stated in the Company’s Articles of Incorporation - Issued shares: # of authorized shares that a company has issued and not subsequently cancelled - Outstanding shares: Issued shares - treasury stock - Par value: Minimum legal capital per share that must be retained in the business
- Par Value UK historical artifact: companies cannot issue shares below par US Companies can issue shared below par, but in event of liquidation, shareholders arerequired to make good the difference between par and what has already been paid Possible to issue shares that do not have par value
- Secondary Market: Is share price relevant for managers and financial reporting? Financial reporting point of view: only changes in issued share capital are relevant (change only if: new shares are issued, company repurchases own shares) Ownership of share capital not relevant to the financial reports. Accounts only reflect money originally paid to purchase shares, not market valze Real effects may occur: Shares used for employee compensation (shares issued↑) Market to Book Ratio: Market value below book value indicates asset impairments i.e. Goodwill, Inventory write Down, Asset Write Down Low stock price, all else equal could make firm a takeover/activist target Management compensation (frequently based shareholder return)
- Equity Issuances for Public Companies 1. Open market issue: (e.g. SEO secondary equity offering) 2. Rights issue: Issue of new shares to existing shareholders = “rights” to purchase new shares are usually fixed at a price below current market price 3. Employee stock compensation: (a) Restricted stock: Vesting More common for non-executive employees When vesting, Companies let employees purchase a predetermined number of shares at a set price. The timing may be set according to company-wide or individual performance targets being met, or both time and performance criteria. After being vested, the employee may exercise his stock-purchasing option any time before the expiration date. (b) Stock options: More common for executives Grant options to employees 4. Bonus issue (not really a capital raise): Issue of new shares to existing shareholders for zero consideration5. Stock dividend (not really a capital raise):Issue new shares to existing shareholders, but their proportional interest in the business remains the same. Small stock dividend (< 20-25% of shares outstanding): transfer FV of shares from RE to common stock and additional paid-in capital. Large stock dividend & “stock split effected in form of a dividend”: transfer only par value of shares from RE to common stock. 6. Stock split (not really a capital raise): Recordkeeping entry to proportionately adjust the number of shares outstanding and their par value No effect on the equity account balances
- How do firms distribute earnings? (1) Dividends Dividend Yield = Dividends per share / current stock price (2) Repurchases of common stock Only shareholders selling shares receive cash Not selling: increase fraction of ownership in the company repurchases reduce Cash and SE by equal amounts. Retire the shares (Reduce shares issued and outstanding) Hold as Treasury stock (Reduce only outstanding share total)
- Advantages of Share Repurchases Option to Shareholders to sell or not; if they don't, they retain greater fractional ownership in firm (option value). Tax: By converting dividend distribution to share repurchase, the distribution is usually less-taxed than dividends (option value) Signal: Company believes their shares are undervalued Flexibility: More flexible for than issuing dividends which investors like to see at growing amounts --> Negative signal if dividends are reduced. Offset EPS Dilution from issuing shares i.e. to employees. EPS Increase Even if not issuing shares, the reduction in outstanding shares can increase EPS, even if underlying earnings growth is weak
- Share Repurchases – Treasury Stock buy back common stock but does not retire the shares. PP recorded as reduction of SE in contra-equity account IFRS requirement: not be shown as investments in Balance Sheet (Reversal of issuance of common stock) Distributions Treasury Stock: “gain” or “loss” in Share Premium If no balance in Share Premium & treasury shares are sold for less than their cost price difference charged either to: Other paid-in capital or Retained Earnings. Share retirement If PP < BV --> Paid-in Capital from Retirement of Shares.” If PP > BV --> is decrease in “Retained Earnings” ( treated as a dividend), which reduces Retained Earnings.
- Significant features of preferred shares in a VC setting 1. Dividend provisions: Cumulative Pay-in-Kind dividends of X%, priority over previous series2. Liquidation preference: Paid back first, including accrued dividends, before prior series3. Anti-dilution: Maintain ownership fraction if more equity is issued, at expense of prior series4. Voting and governance rights: Can vote and have right to appoint number of directors5. Conversion: Shares are converted to common at option of holder and at events like IPO
- EPS Reflect amount of PAST earnings attributable to common share outstanding when income was earned (IFRS & GAAP) Basic EPS: NI (- dividends on preferred stock) /Weighted average # common shares outstanding However, many financial instruments with contingent equity components: convertible deb warrants employee stock options Diluted EPS: NI (basic EPS) (- NI from dilutive securities) /Avg. # shares o/s from Basic EPS + average # shares of dilutive securities Securities are only dilutive if they reduce EPS available to common shareholders.
- Overview and Disclosures: Share-Based Compensation Restricted stock or stock options (in addition to cash, bonus). Advantage: align employee interests; no current period cash outlay. Expense: fair value of shares (market price) or options (market or model price) Cash flow statement effect: compared to equivalent cash compensation, increases CFO, reduces CFF if buybacks are used to offset.