Deregulation of issue pricing and its impact on corporate capital structure policies

Abstract

In the liberalised corporate scenario of today, the reforms in the financial sector are already beginning to have their effect on the financing strategy of companies. In the regulated era of the office of the Controller of Capital Issues, corporates.had to follow its guidelines while coming out with any issue of securities. The premium set by the CCI as per their formula usually resulted in an issue which was priced much below the prevailing market price. Thus, one witnessed companies resorting to• a high proportion of debt financing in their overall capital structure. In the form of term loans, debenture issues & bank loans for working capital. In the revised scenario following the abolition of the office of CCI on May 29th 1992, companies are now free to fix their own levels of premium on issues of shares. Thus, they can price their issues close to the market price. As far as short-term finance is. concerned, corporate finance managers have a wider & more often a cheaper, source than bank loans, such as Commercial Paper. This study focuses on the effect of deregulation on the long term financing strategy of companies, and the impact these have had on the target capital structure. Hypotheses, were formulated to the effect that the debt--equity. ratios have decreased & interest-coverage ratios have increased, in response to the deregulation of issue pricing. Public & rights issues in the CCI era & in the post CCI period were studied, and the effect of the project on the D/E ratio & the interest coverage was sought to be studied. Differences due to parameters such as industry categories & size of the company were also analysed. The data, obtained from.the prospectuses of the issues, was analysed using simple statistical tools such as proportion analysis frequency distributions, so as to capture the incidence of increase or• decrease, as wall as its magnitude. The analysis of the data reveals that corporates have indeed reacted to the revised scenario, by altering the capital structure in favour of more equity, and consequently the interest-coverage ratios of many companies have registered an increase. An attempt has then been made to draw implications of these phenomena in the realm of project-financing & capital structure, from the point of view of various players such as the companies themselves, financial institutions & the investing public.