The basic sources of long-term financing are long-term debt, preferred stock, and common stock. This chapter described the essential features of each.
We emphasized that common shareholders have
Residual risk and return in a corporation.
Voting rights.
Limited liability if the corporation elects to default on its debt and must transfer some or all of its assets to the creditors.
Long-term debt involves contractual obligations set out in indentures. There are many kinds of debt, but the essential feature is that debt involves a stated amount that must be repaid. Interest payments on debt are considered a business expense and are tax deductible.
Preferred stock has some of the features of debt and some of the features of common equity. Holders of preferred stock have preference in liquidation and in dividend payments compared to holders of common equity.
Firms need financing for capital expenditures, working capital, and other long-term uses. Most of the financing is provided from internally generated cash flow. In the United States only about 25 percent of financing comes from new debt and new equity. Only firms in Japan have historically relied more on external financing than on internal financing.
In the 1980s and recently, U.S. firms retired massive amounts of equity. These share buybacks have been financed with new debt.
