What'S In This Issue—A Message From The Editor

• Published date: 01 March 1998
• Date: 01 March 1998
• DOI: http://doi.org/10.1111/j.1745-6622.1998.tb00072.x

JOURNAL OF APPLIED CORPORATE FINANCE

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What’s In This Issue—A Message From The Editor

In 1984, Professor Stewart Myers

devoted his President’s address to

the American Finance Association to

a subject he called “The Capital Struc-

ture Puzzle.” The puzzle, in brief,

was this: Because the interest on

corporate debt is tax deductible but

dividends are not, debt is a cheaper

source of capital than equity. But

U.S. public companies did not ap-

pear to be making anything like full

use of their debt capacity, and so

seemed to be volunteering to pay

millions of dollars in avoidable cor-

porate taxes.

Since then, of course, a good part

of corporate America has discovered

the benefits of leverage. Many of the

dramatic corporate restructurings of

the 1980s, including the wave of LBOs,

involved significant use of debt fi-

nancing. And, after a brief suspension

of activity in the early ’90s, leveraged

transactions are back stronger than

ever. Moreover, the remarkable popu-

larity of stock buybacks in recent

years—even with prices at current

levels—suggests a clear recognition

that companies can have “too much

equity.” But the question remains:

What is the import of all this leverag-

ing for America’s largest public com-

panies, most of which continue to

prize their investment-grade bond

ratings?

This question, along with other

matters of corporate capital struc-

ture, was explored in a recent two-

day conference organized and hosted

by Professor Hans Stoll at Vanderbilt

University’s Owen Graduate School

of Management. And the first four

offerings in this issue of the JACF

are based on presentations at that

conference.

In the roundtable discussion that

opens the issue, Professor Myers re-

visits the capital structure puzzle with

a small group of financial academics

and practitioners. Consistent with the

“pecking order” theory of corporate

financing behavior that he presented

in 1984, Myers describes financing

decisions as “second-order” concerns

for most large, publicly traded U.S.

corporations. The new argument here

is that the most important issues for

such enterprises are matters not of

capital structure, but of financial struc-

ture—those having to do with “the

allocation of ownership and control,

which includes the division of the risk

and returns of the enterprise between

the insiders in the firm and the outsid-

ers.” The essence of the public corpo-

ration is said to be the coinvestment

of insiders’ “human capital” with out-

siders’ financial capital—and, as Myers

suggests, much corporate financing

behavior can be understood as value-

conserving strategies designed to pro-

tect a company’s human capital.

But if capital structure is a second-

order concern for many large public

companies, other panelists empha-

size the value-adding role for lever-

age in firms that are clearly failing to

maximize value. Besides shielding

operating cash flow from taxes, the

substitution of debt for equity in com-

panies with few profitable invest-

ment opportunities can also improve

performance by strengthening man-

agement incentives for efficiency. And

this latter role for debt financing is

illustrated with three cases of recent

leveraged recapitalizations involving

large share repurchases—and, in two

of the three cases, major changes in

dividend policy.

In the article that follows the

roundtable, SEC economists Erik Sirri

and Jennifer Bethel describe recent

changes in SEC procedures and re-

quirements designed to provide “ex-

press lanes” for corporate issuers.

Important changes include issuers’

ability to incorporate information into

registration statements “by reference,”

to use shelf registration to speed

offerings, and to place securities off-

shore with less regulatory uncertainty.

Although most of the benefits of such

changes accrue to large public issu-

ers, the SEC also has plans to extend

some of them to smaller public and

private issuers. In particular, a recent

“concept release” indicates the SEC is

seriously considering a plan that would

allow issuers to register just once as

companies rather than registering each

individual security. As the authors

suggest, this measure, along with the

recent relaxation of resale restrictions

on private securities, would go a long

way toward “unifying” the capital-

raising process for issuers (both large

and small) in the public and private

markets.

In “MIPS, QUIPS and TOPrS: Old

Wine in New Bottles,” Arun Khanna

and John McConnell describe a popu-

lar new kind of preferred stock—one

that offers issuers the tax advantages

of debt without the potential for bank-

ruptcy. But if these securities appear

new, there is another security—in-

come bonds—that has offered these

same advantages for at least the past

100 years. And, after discussing the

new securities, the authors explore

the question: Why are tax-deductible

preferreds so popular today when

income bonds have been shunned by

corporate issuers for the past 60 years?