Assignment Due 10/05/2020 APA Format!!!!

APA format minimum 250 words – 400 words maximum

The textbook for the course is Financial Management: Theory and Practice by Eugene F. Brigham & Michael C. Ehrhardt, 16th edition, published by South-Western Cengage Learning. ISBN 978-1337902601

Chapter 15 of the book discusses capital structure decisions, the different capital categories, costs, and the signals sent when the Company chooses certain type of capital (debt, equity, hybrids). Unfortunately, considering the extraordinary developments during the last 10-year period with a large scale global credit crisis, the low interest rate response and debt friendly policies enforced by central banks across the world following the financial crisis, and the current crisis that has seen most companies rush towards debt to build up war chests for impending financial doom, I can’t help to think that some of the statements in the chapter are in the process of becoming forever irrelevant.

Let’s take a look at the discussion of the Signaling Theory. The text describes how informational asymmetry leads to the conclusion that when an already publicly-traded Company issues new round of stock to raise equity, the event is viewed as a negative signal that leads to a decline in the Company’s stock price. However, let me explain to you briefly what the word “credit crunch” means. Credit crunch is basically restrictions put in the market place by financial institutions in the debt markets to make it harder, or very expensive to borrow money (there is always money to borrow, the question is how much you are paying for it and will that cost eventually destroy the business). The action is simply out of fear that the borrower will go out of business, being another bank, a Company or an individual. As more banks restricted their lending practices during and in the aftermath of 2009 financial collapse, debt capital became rare, liquidity dried up and the financial machine simply stopped working.

Now, under this new reality with paralyzed debt market activity, wouldn’t you expect more companies look into equity as the only reasonable way to raise capital, without sending any “negative signals” to the investors? This is exactly what happened in 2009-2010, as many companies used equity, hybrid securities (with the most notorious case being Warren Buffett giving large amount of capital to Bank of American and Goldman Sachs in return for preferred stocks and warrants at very lucrative returns, cashing in on their desperation for a savior) or very expensive debt with harsh conditions as a way to finance their needs. Additionally, many households in the U.S. started the process of deleveraging, reducing debt from their balance sheets, and rather using equity when making purchases.

Consequently, the discussion topic for this week is as following. Taking in consideration the 2009 events that changed access to most debt market activity, the low interest rate environment that followed encouraging companies to borrow, and the rush to raise billions of corporate debt, what should be the preferred way of U.S. companies to raise capital? How do you see the capital structures and associated pricing change in the future compared to what’s described in chapter 15? Remember, do not automatically assume that all capital should be equity going forward. If you look at big failures such as Fannie, Freddie and AIG, debt issuers were the only group that will get some of their money back while the groups that provided equity capital to these companies saw their capital get wiped out. Debt Vs. equity, what will be the future of companies’ balance sheets? Also, remember that during the period of 2012-2020, many companies have taken advantage of historically low rates to borrow large amounts of money and while many predicted that the window of opportunity would narrow with rising rates, rates moved lower in 2019 and 2020 and American companies continue to take advantage of cheap debt and despite much stronger earnings and cash flow, many corporations are heavily in debt, much more debt than prior to 2009. 

In summary, give me an analysis of the debt and equity capital markets right now and what you think of it. Be factual, do your research (plenty of information out there, this is a "hot topic" in the financial news), don't forget about the 800 pound gorilla in your posts, the federal reserve, the central bank of America that refuses to close the spigot of low interest rate debt to keep the economy going and keeps pumping money into the debt markets.