W.r.t. investment in R&D, which are the financing alternatives for big firms and SMEs?
What does the pecking order theory suggests?
To whom can the pecking order theory be applied?
What are pros and cons of financing through dept and equity?
Internal or external capital
Pecking order theory suggests
Internal capital first,
Then borrowed capital and equity
Can be applied to mature and bigger companies
Young and small firms might not have profits to reinvest – solution: giving out some of the control to venture capital or private equity companies
Financing through debt:
Con: Bankruptcy costs
But: Debt might appear more convenient if it is deductible
Financing through equity:
Con: Giving out part of the ownership power
Pro: Does not require neither any collateral nor the payment of interests (dies erfordert weder Sicherheiten noch die Zahlung von Zinsen)
Which problems might arise in dealing with external financing?
Incentive problem
Results of asymmetric information between the firm ́s owner/manager, and financial institutions / shareholders
In particular, if the entrepreneur/manager is insured against the risk of failure typical of an R&D project, he might overinvest in R&D and/or not put the adequate effort into the project
Short-termism
When capital markets put more emphasis on the short rather than the long run
Firm ́s owners (=investors) but also managers do everything possible to increase profits in the short run
Taking management decision that might compromise future cash flows
Lead to underinvestment in R&D, being intrinsically long term
With reference to managerially-led firms, in what do the principal-agent problems consist, how is it made possible and what are the results?
Principal-agent problem arises from managers and shareholders having different interests at stake
It is made possible by the presence of hidden information and hidden actions resulting in
adverse selection and
moral hazard
With reference to managerially-led firms, which actions can be taken to overcome the principle-agent problem?
Incentive schemes
Shareholder ́s risk also becomes the manager ́s one
A fixed salary + a salary dependent on the observable output
Monitoring
Making sure that managers put the appropriate level of effort in maximizing profits
However, monitoring is not always easy to implement —> comes at a cost
Signalling models
Follow the insights to identify good and bad managers
What do we mean by
equity
debt
private equity
venture capital
business angel
Equity: ownership of a company through shares of stock held by investors. Income stream is random and risky.
Debt: bonds that guarantee the investor a stream fixed-interest payments as well as the repayment of the principal (=the sum initially lent by the investor).
Private equity: equity in companies not traded on the stock exchange.
Venture capital: provision of equity for young, unquoted companies at an early stage showing high-growth potential and commercial uncertainty. The key feature is the “hands- on” involvement by the finance provider.
Business angel: private individual investing part of his personal assets in a start-up and also sharing his personal management experience with the entrepreneur.
Which accounting principles could be employed by a company to register investments in R&D in the balance sheet?
Principle of prudence
All expenditures in R&D undertaken in a specific year should be registered in the same time period in which they take place
Regardless of when the positive (and uncertain) cash flow will happen
Asset side —> “noncurrent assets”
Matching principle
Transaction (expenditure on R&D) should be registered as a liability in the same year in which the positive cash flow takes place.
Last changeda year ago