Welcome to Scribd. Sign in or start your free trial to enjoy unlimited e-books, audiobooks & documents.Find out more
Standard view
Full view
of .
Look up keyword
Like this
0 of .
Results for:
No results containing your search query
P. 1


Ratings: (0)|Views: 0|Likes:
Published by fedfraser

More info:

Published by: fedfraser on May 05, 2014
Copyright:Traditional Copyright: All rights reserved


Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less





Recent Developments in Corporate Finance
This article was prepared in the Capital Mar  kets Section of the Division of Research an
The concurrence of rapid inflation and declining
real economic activity placed unusual financing
pressures on nonfinancial business corporations
in 1974. Even though real business activity
weakened progressively throughout the year,
current-dollar requirements by industry for
working capital and investment outlays contin ued to rise because of the persistent advance of 
prices and costs. Consequently, corporations
tapped financial markets for a record volume of 
funds last year. In contrast, during the first half 
of 1975 total demands on credit markets abated
as corporations made sizable cutbacks in inven tories and fixed investment outlays. Never theless, the volume of bond financing has
reached historically high levels in recent months
as corporations have shifted from short- to
long-term debt.The record total of $77 billion raised by
nonfinancial corporations in external markets in
1974 was 15 per cent more than in the boom
year of 1973. Rather than sell new equity shares
at depressed 1974 market prices, firms turned
to debt markets for funds to meet their increased
financing requirements. Thus, while net stock
issues of nonfinancial corporations declined to
$4.1 billion, the lowest volume since 1969, net
issues of corporate debt soared to a record $73
billion. Short-term debt accounted for a signifi cant share of this increased corporate borrow ing, with bank loans to business expanding at
the same advanced pace in 1974 as in 1973.
Corporate issuance of open-market paper also
rose substantially in 1974; this was in contrast
to 1973, when corporations had substituted bank
loans for funds raised through sales of commer cial paper because of the much lower relative
cost of bank credit.Over the past decade, trends in corporate
finance have led to a considerable reduction in
the relative importance of equity in corporate
balance sheets. The sharp increase in debt fi nancing in 1974 accelerated this decline, and
corporate debt-to-equity ratios rose to unprece dented levels. In addition, the already unfavor able maturity structure of the debt shown on
many corporate balance sheets was worsened by
the continued heavy reliance on short-term fi nancing. Because of this deterioration, many
corporations found their credit ratings ques tioned and their ability to obtain external funds
impaired at a time when their internal funds
were declining. Market investors became in creasingly quality-conscious, requiring large
risk premiums for lower-rated corporate issues;
as a result, firms with less than prime credit
ratingsincluding many public utilities—were
virtually excluded from market participation for
many months of last year.Efforts to repair these widespread financial
imbalances began late in 1974 and dominated
corporate financial strategy through the first half 
of 1975. With the economy in the midst of the
deepest decline of the postwar period, busi nesses curtailed their capital outlays and reduced
their inventories sharply, thus lessening pres sures on total external financing. The funding
of short-term liabilities in order to restructure
balance sheets and to rebuild liquidity has been
reflected in the large volume of corporate bond
offerings and the pronounced decline in short term borrowings during the first 6 months.
Meanwhile, the recovery in stock prices has led
to an increase in the volume of new equity
issues, with public utilities accounting for a
large share of this growth.These efforts have improved the financial base
of many corporations, though considerable re structuring remains to be done. In particular,
a significant accumulation of financial assets
August 1975
464 Federal Reserve Bulletin August 1975
probably will not occur until corporate profits
rebound from their decline earlier this year.
Moreover, for many of the weaker firms, im proving their financial position is an arduous
process, which could conceivably be hindered
if the economic recovery should sharply in crease total demands on capital markets.CAPITAL EXPENDITURES
AND INTERNAL FUNDSThe gap between corporate internal funds and
capital expenditures widened substantially in
1974 for the fourth consecutive year. As a
result, firms had to turn to external sources of 
funds to finance more than $44 billion in total
capital outlays (including inventory investment)
during the year, $7 billion more than in 1973
and $21 billion more than in 1972.Capital outlays and internal funds
Billons of dollars
Internal funds are undistributed profits (including foreign branch
profits) plus capital consumption allowances.Flow of funds quarterly data for nonfinancial corporations at season ally adjusted annual rates. Data for 1975-11 are preliminary.
The increasing gap between internal funds
and capital outlays reflected in large part the
impact of inflation on business investment ac tivity. Although corporate plant and equipment
expenditures in real terms weakened in the first
half of 1974 and actually declined in the final
months, these outlays in current dollars were
more than 8 per cent higher for the year as a
whole than in 1973. The largest increases oc curred among manufacturers of nondurable
goods—particularly petroleum, chemicals, and
paper—but there were also strong advances for
durable goods manufacturers. In the nonmanu facturing sector, public utility outlays expanded
at a rate close to 10 per cent, even though the
utilities were scaling back their planned ex penditures throughout the year in response to
sharply rising operating costs, reductions in
consumer demand, and unfavorable terms of 
financing.Inventory investment in 1974 was below the
record pace of 1973, but it still remained high
by historical standards. A large part of the
inventory building in the first half of the year
was the result of producers’ desires to stockpile
materials that had been, or might be, in short
supply—especially steel and coal. But as the
year progressed, inflation and rising unemploy ment adversely affected consumer expenditures,
and sales fell off rapidly. The decline in demand
resulted in a sizable increase in inventories of 
finished goods, despite vigorous efforts by re tailers to reduce excessive stocks. Unintentional
inventory accumulation was most apparent in
the fourth quarter in the durable goods indus tries, especially in new cars.Whereas outlays for fixed investment and
inventories were rising during most of 1974,
corporate cash flow—retained earnings plus
capital consumption allowances—declined on
balance for the year. The reduction in cash flow
occurred despite a large increase in before-tax
profits, all of which was attributable to an enor mous expansion in inventory profits—that is,
profits generated by an increase in the value of 
inventories as a result of inflation. Although
inventory profits are taxed the same as all other
earnings, they are offset by increased costs of 
inventories needed for replacement and hence
August 1975
 Recent Developments in Corporate Finance
Composition of capital outlays
Billions of dollarsBillions of dollars 10
Other fixed investment includes expenditures for multiunit and 1-
to 4-family residential construction.
do not provide corporations with internal funds
for any other purpose.With the sharp rise in prices—especially o
fuel—in 1974, inventory profits became ex tremely large and tended to obscure the picture
of firms’ liquidity. If inventory gains are ex cluded from reported profits, the resulting fig ureprofits from current production—shows a
sizable decline in corporate after-tax profits from
late 1973 to the fourth quarter of 1974, the first
sustained decline in such profits since 1969.
Retained earnings (adjusted to exclude inven tory profits) fell even more sharply as corpora tions increased their dividend payouts.Gains from inventory profits dropped sharply
in early 1975, in part because firms liquidated
stocks and also because many of them changed
their accounting methods from first-in, first-out
(FIFO) to last-in, first-out (LIFO) to minimize
the effects of inflation on reported inventory
values. The decline in inventory profits contrib uted to a sharp reversal in total before-tax profits
of nonfinancial corporations in the first two
quarters of this year. Nevertheless, after-tax
profits actually improved, as corporate tax lia bilities fell significantly because of the sharp
drop in inventory profits and the relief obtained
through the Tax Reduction Act of 1975.The gap between internal funds and capital
expenditures narrowed markedly in the first
Flow of funds quarterly data for nonfinancial corporations at season ally adjusted annual rates. Data for 1975-11 are preliminary.
quarter of 1975—in part because of the improve ment in cash flow, but primarily because of 
sharp reductions in capital outlays. Responding
to the accelerating decline in economic activity,
industrial firms—like the utilities earlier—began
to scale down or stretch out their expenditures.
As a result, the annual rate of outlays for plantCorporate profits
Flow of funds quarterly data for nonfinancial corporations at season ally adjusted annual rates. Data for 1975-11 are preliminary.
Billions of dollarsProfits before taxInventory profits-Before taxExcluding inventory profitsAfter taxExcluding inventory profits
August 1975

You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->