Reference no: EM131569009

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. 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 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 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, 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, keep in mind that during the period of 2012-2015, 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, that never happened in 2014, rose very moderately in 2015 and ultimately reversed course in 2016 before what many believe is an unsustainable rise post election.