Chapter 14

Raising Equity
and Debt
Globally
 Learning Objectives

• Design a strategy to source capital equity

globally
• Examine the potential differences in the
optimal financial structure of the
multinational firm compared to that of the
domestic firm
• Describe the various financial instruments
that can be used to source equity in the
global equity markets

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 Learning Objectives

• Understand the different forms of foreign

listings—depositary receipts—in U.S.
markets
• Analyze the unique role private placement
enjoys in raising global capital
• Evaluate the different goals and
considerations relevant to a firm pursuing
foreign equity listing and issuance
• Explore the different structures that can be
used to source debt globally

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 Sourcing Equity Globally

• To implement the goal of gaining access to

global capital markets a firm must begin by
designing a strategy that will ultimately
attract international investors.
• This would mean identifying and choosing
alternative paths to access global markets.
• This would also require some restructuring
of the firm, improving the quality and level
of its disclosure, and making its accounting
and reporting standards more transparent
to potential foreign investors.
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 Designing a Strategy to Source
Equity Globally
• Designing a capital sourcing strategy requires that
management agree upon a long-run financial
objective and then choose among the various
alternative paths to get there.
• Often, this decision-making process is aided by an
early appointment of an investment bank as an
official advisor to the firm.
• Investment bankers are in touch with potential
foreign investors and know what they currently
require, and can also help navigate the numerous
institutional and regulatory barriers in place.

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 Designing a Strategy to Source
Equity Globally
• Most firms raise their initial capital in their
own domestic market.
• However, most firms that have only raised
capital in their domestic market are not well
known enough to attract foreign investors.
• Incremental steps to bridge this gap include
conducting an international bond offering
and/or cross-listing equity shares on more
highly liquid foreign stock exchanges.
• Exhibit 14.1 shows global paths to the
availability of capital
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 Exhibit 14.1 Alternative Paths to Globalize the
Cost and Availability of Capital

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 Optimal Financial Structure

• The domestic theory of optimal financial structure must be

modified considerably to encompass the multinational firm.
• Most finance theorists are now in agreement about whether
an optimal financial structure exists for a firm, and if so, how
it can be determined.
• When taxes and bankruptcy costs are considered, a firm has
an optimal financial structure determined by that particular
mix of debt and equity that minimizes the firm’s cost of capital
for a given level of business risk.
• As the business risk of new projects differs from the risk of
existing projects, the optimal mix of debt and equity would
change to recognize tradeoffs between business and financial
risks.

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 Optimal Financial Structure

• Exhibit 14.2 illustrates how the cost of

capital varies with the amount of debt
employed.
• As the debt ratio increases, the overall cost
of capital (kWACC) decreases because of the
heavier weight of low-cost (due to tax-
deductibility) debt ([kd(1 - t)] compared to
high-cost equity (ke).

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 Exhibit 14.2 The Cost of Capital
and Financial Structure

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 Optimal Financial Structure
and the Multinational Enterprise

• The domestic theory of optimal financial

structures needs to be modified by four
more variables in order to accommodate the
case of the MNE:
– Availability of capital
– Diversification of cash flows
– Foreign exchange risk
– Expectations of international portfolio investors

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 Optimal Financial Structure
and the Multinational Enterprise

• Availability of capital:
– A multinational firm’s marginal cost of capital is
constant for considerable ranges of its capital
budget
– This statement is not true for most small
domestic firms (as they do not have equal access
to capital markets), nor for MNEs located in
countries that have illiquid capital markets
(unless they have gained a global cost and
availability of capital)

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 Optimal Financial Structure
and the Multinational Enterprise

• Diversification of cash flows:

– The theoretical possibility exists that
multinational firms are in a better position than
domestic firms to support higher debt ratios
because their cash flows are diversified
internationally
– As returns are not perfectly correlated between
countries, an MNE might be able to achieve a
reduction in cash flow variability (much in the
same way as portfolio investors who diversify
their security holdings globally)

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 Optimal Financial Structure
and the Multinational Enterprise

• Foreign exchange risk and the cost of debt:

– When a firm issues foreign currency
denominated debt, its effective cost equals the
after-tax cost of repaying the principal and
interest in terms of the firm’s own currency
– This amount includes the nominal cost of
principal and interest in foreign currency terms,
adjusted for any foreign exchange gains or
losses

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 Optimal Financial Structure
and the Multinational Enterprise

• Expectations of International Portfolio

Investors:
– The key to gaining a global cost and availability
of capital is attracting and retaining international
portfolio investors
– If a firm wants to raise capital in global markets,
it must adopt global norms that are close to the
U.S. and U.K. norms as these markets represent
the most liquid and unsegmented markets

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 Raising Equity Globally

• Exhibit 14.3 describes three key critical elements to

understanding the issues that any firm must
confront when seeking to raise equity capital.
– First, a public or private equity placement
– Then, where to list the offering
– Finally, the type of issuance
• A firm seeking to raise equity capital is ultimately in
search of an issuance (IPO or SPO), although it
need not be public.

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 Exhibit 14.3 Equity Avenues,
Activities, and Attributes

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 Raising Equity Globally

• Exhibit 14.4 provides an overview of the

four major equity alternatives available to
multinational firms today:
– IPO
– Euroequity issue
– Directed public/private issue
– Private placement

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 Exhibit 14.4 Equity Alternatives in
the Global Market

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 Raising Equity Globally—IPO

• Initial Public Offering (IPO) – the first public

issue of a firm’s equity shares.
– First a prospectus is published
– The IPO typically represents 15% to 25% of
ownership
– Later issues by the firm are considered
“seasoned offerings”
– With public issuance of shares comes greater
public disclosure

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 Raising Equity Globally—
Euroequity Issue

• A euroequity or euroequity issue is an initial

public offering on multiple exchanges in
multiple countries at the same time.
• The “Euro” market (a generic term for
international securities issues originating
and being sold anywhere in the world), was
created by the same financial institutions
that had previously created an
infrastructure for the Euronote and
Eurobond markets.

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 Raising Equity Globally—Directed
Public Share Issues

• A directed public share issue is defined as

one that is targeted at investors in a single
country and underwritten in whole or in part
by investment institutions from that
country.
• The issue might or might not be
denominated in the currency of the target
market.
• The shares might or might not be cross-
listed on a stock exchange in the target
market.
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 Depositary Receipts

• Depositary receipts (shares) are negotiable

certificates issued by a bank to represent the
underlying shares of stock, which are held in trust
at a foreign custodian bank.
• American depository receipts (ADRs) are traded in
the United States and denominated in US dollars.
• ADRs are sold, registered, and transferred in the US
in the same manner as any share of stock with
each ADR representing some multiple of the
underlying foreign share (allowing for ADR pricing
to resemble conventional US share pricing between
$20 and $50 per share).

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 Exhibit 14.5 TelMex’s American
Depositary Receipt (Sample)

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 Depositary Receipts

• Exhibit 14.6 presents the mechanics of the issuance

of an ADR.
1. The U.S. investor instructs his broker to make a purchase of shares in
the publicly traded Brazilian company.
2. The U.S. broker contacts a local broker in Brazil (either through the
broker’s international offices or directly), placing the order.
3. The Brazilian broker purchases the desired ordinary shares and delivers
them to a custodian bank in Brazil.
4. The U.S. broker converts the U.S. dollars received from the investor into
Brazilian reais to pay the Brazilian broker for the shares purchased.
5. On the same day that the shares are delivered to the Brazilian custodian
bank, the custodian notifies the U.S. depositary bank of their deposit.
6. Upon notification, the U.S. depositary bank issues and delivers
Depositary Receipts for the Brazilian company shares to the U.S. broker.
7. The U.S. broker then delivers the DRs to the U.S. investor.

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 Exhibit 14.6 The Structural
Execution of ADRs

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 ADR Mechanics

• ADRs can be exchanged for the underlying foreign

shares, or vice versa, so arbitrage keeps foreign
and U.S. prices of any given share the same after
adjusting for transfer costs.
• ADRs also convey certain technical advantages to
U.S. shareholders.
• While ADRs are quoted only in U.S. dollars and
traded only in the U.S., Global Registered Shares
(GRSs) can be traded on equity exchanges around
the globe in a variety of currencies.

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 ADR Program Structures

• Sponsored ADRs are created at the request

of the foreign firm wishing to be listed in the
U.S.
• Unsponsored ADRs are a result of investor
demand and initiated by a U.S. securities
firm—these must be approved by the firm
whose shares are being listed.

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 ADR Program Structures

• Level I Programs: easiest and least

restrictive listing requirements
• Level II Programs: for firms that want to list
existing shares on a U.S. exchange—must
meet SEC listing requirements
• Level III Programs: for firms that want to
sell new equity shares on a U.S. exchange
• Exhibit 14.7 illustrates in detail

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 Exhibit 14.7 American Depositary
Receipt (ADR) Programs by Level

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 DR Markets Today: Who, What,
and Where

• Who: mix of major multinationals, but

participation has shifted back toward
industrial countries.
• What: split between IPO and follow-on
offerings
• Where: mostly New York and London

• Exhibit 14.8 shows the distribution of money

raised in the depositary receipts market
since 2000
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 Exhibit 14.8 Equity Capital Raised
Through Depositary Receipts

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 Global Registered Shares (GRS)

• A global registered share is a share of

equity that is traded across borders and
markets without conversion, where one
share on the home exchange equals one
share on the foreign exchange.
• Different from a global depositary receipt in
that the DR is bundled or split so that the
price represents a typically traded value for
that market. A GSR has the same value
everywhere and is not bundled (or split) for
purposes of trading.
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 Private Placement

• Private equity funds are usually limited partnerships of

institutional and wealthy individual investors that raise their
capital in the most liquid capital markets.
• These investors then invest the private equity fund in mature,
family-owned firms located in emerging markets.
• The investment objective is to help these firms to restructure
and modernize in order to face increasing competition and the
growth of new technologies.
• Private equity funds differ from traditional venture capital
funds as private equity funds operate in many countries, fund
companies in many industry sectors and often have a longer
time horizon for exiting.

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 Private Placement

• One type of directed issue with a long history as a source of

both equity and debt is the private placement market.
• A private placement is the sale of a security to a small set of
qualified institutional buyers under SEC Rule 144A.
• Since the securities are not registered for sale to the public,
investors have typically followed a “buy and hold” policy.
• Private placement markets now exist in most countries.
• Equity Funds have become well-known as vehicles for
takeover of firms. They leverage their investments with large
amounts of borrowing and have significant tax advantages.

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 Foreign Equity Listing and
Issuance
• Cross-listing attempts to accomplish one or more of
many objectives:
– Improve the liquidity of its shares and support a liquid
secondary market for new equity issues in foreign markets
– Increase its share price by overcoming mispricing in a
segmented and illiquid home capital market
– Increase the firm’s visibility and acceptance to its
customers, suppliers, creditors, and host governments
– Establish a liquid secondary market for shares used to
acquire other firms in the host market and to compensate
local management and employees of foreign subsidiaries

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 Foreign Equity Listing and
Issuance

• To maximize liquidity, it is desirable to

cross-list and/or sell equity in the most
liquid markets. Stock markets have been
subject to two major forces which are
changing their behavior and liquidity:
– Demutualization: ongoing process by which the
small controlling seat owners on a number of
exchanges have been giving up their exclusive
powers.
– Diversification: growing diversity of both
products and foreign companies/shares being
listed.
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 Foreign Equity Listing and
Issuance

• New York and London are the most liquid

stock exchanges.
• Most exchanges have moved heavily into
electronic trading in recent years, which has
allowed hedge funds and other high-
frequency traders to dominate the market.

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 Foreign Equity Listing and
Issuance
• Although cross-listing and equity issuance can
occur together, their impacts are separable and
significant in and of themselves.
• MNEs list in markets where they have substantial
physical operations mostly for political reasons.
• The establishment of a local liquid market for the
firm’s equity may aid in financing acquisitions and
in the creation of stock-based management
compensation programs for subsidiaries.

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 Foreign Equity Listing and
Issuance
• The most serious barriers to cross-listing and/or
selling equity abroad include the future
commitment to providing full and transparent
disclosure of operating results and balance sheets
as well as a continuous program of investor
relations.
• The U.S. school of thought is that the worldwide
trend toward requiring fuller, more transparent,
and more standardized financial disclosure of
operating results and balance sheet positions may
have the desirable effect of lowering the cost of
equity capital.

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 Raising Debt Globally

• The international debt market offers the borrower a

wide variety of different maturities, repayment
structures, and currencies of denomination.
• The markets and their many different instruments
vary by source of funding, pricing structure,
maturity, and subordination or linkage to other
debt and equity instruments.
• The three major sources of debt funding on the
international markets are depicted in Exhibit 14.9.

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 Exhibit 14.9 International Debt
Markets and Instruments

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 Bank Loans and Syndications

• International bank loans have traditionally been

sourced in the Eurocurrency markets; there is a
narrow interest rate spread between deposit and
loan rates of less than 1%.
• Eurocredits are bank loans to MNEs, sovereign
governments, international institutions, and banks
denominated in eurocurrencies and extended by
banks in countries other than the country in whose
currency the loan is denominated.
• The syndication of loans has enabled banks to
spread the risk of very large loans among a number
of banks.

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 Euronote Market

• Euronotes are short- to medium-term debt

instruments that are either underwritten
and non-underwritten
– Eurocommercial paper is a short-term debt
obligation of a corporation or bank (usually
denominated in US dollars)
– Euro medium-term notes bridge the gap between
eurocommercial paper and a longer-term and
less flexible international bond

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 International Bond Markets

• A Eurobond is underwritten by an international

syndicate of banks and other securities firms and is
sold exclusively in countries other than the country
in whose currency the issue is denominated
• A foreign bond is underwritten by a syndicate
composed of members from a single country, sold
principally within that country, and denominated in
the currency of that country
• The Eurobond markets differ from the Eurodollar
markets in that there is an absence of regulatory
interference, less stringent disclosure rules and
favorable tax treatments for these bonds

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 International Bond Markets

• Unique Characteristics of Eurobond Markets:

– Absence of regulatory interference
• National governments often impose tight controls on
foreign issuers of securities denominated in local
currencies, although governments generally have less
stringent limitations for securities denominated in
foreign currencies and sold within their markets
– Less stringent disclosure
• Disclosure requirements less stringent than those of the
SEC
– Favorable tax status
• Eurobonds offer tax anonymity and flexibility

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