Capital Structure Decisions

 

The modern day organisation, seems to be focused on one aspect; shareholder wealth and ensuring that they remain content. Unlike companies who, in the nineteenth century, wanted to contribute more as a business to society such as Ford (Henry and William Clay Ford), today’s major organisations have undoubtedly one main goal of creating wealth for shareholders. Of course this is the main goal of most companies, but at what lengths do they go to create shareholder value, and what risks are they willing to take to do so?

 

 In June 2014, Pfizer made public their failed takeover bid of UK based AstraZeneca, with price being the issue according to their CFO Frank D’Amelio. The takeover offer, valued at £55 per share, was rejected and led to Pfizer’s share price declining by 1 percent. The significant part of D’Amelio’s comments was that he said that the company would be willing to take on more debt for the right deal, and that he would, if necessary, lever up the balance sheet to get a deal done that would create shareholder value (Pettypiece, 2014). To do so they would have to reshuffle their capital structure to identify their optimal capital structure. The optimal capital structure only exists when a certain mixture of capital used by the firm leads to maximising the company value (Culp, 2002: p72).   

 

Effectively what the CFO was saying, was that they were willing to risk taking on more debt, and become more highly geared in order for them to create value for their shareholders. By increasing their debt capital, their equity capital would reduce. This would surely increase the risk, given they are willing to be more highly geared, or would it?

 

It is important to also consider the other motives towards the move, as they wanted to use their merger with AstraZeneca to move its tax base to the UK, a move commonly known as tax inversion (Kollewe, 2014).

 

Well if Pfizer were to increase their financial leverage, they risk exposing themselves to risks and financial distress costs, and increase debt means increased repayment costs (Petty et al, 2011). Pfizer currently have a debt to equity ratio (as of 2014) of around 0.50, as they have almost twice as much owner equity compared to their debt (Stock Analysis on Net, 2014). So they are not currently at major risk of increased debt, and could afford to take on more debt to boost their balance sheet.

 

Frank D’Amelio (CEO) had clear intentions of boosting shareholder wealth significantly through the attempted takeover, and signalled that they were in a strong financial position, despite decreasing profits, to take on more debt if it led to increased shareholder wealth. However following the failed takeover, their share price declined by 1 percent. This is not unusual, as even if the takeover was approved Pfizer, as the bigger of the two, would have inevitably seen a slight decrease in share price. However, if the deal was successful, then the future share price would surely increase as the company was expanding its portfolio with another major firm and would reap the benefits of M & A activity.

Of course, there are tax reasons to why they wanted to acquire AstraZeneca, but they have done so with the clear, stated, intention of increasing their shareholder wealth by stating that they would be willing to take on more debt to make a deal surface, with little risk to the company.     

 

 

 

 

 

Reference List

 

Culp, C, L. (2002). The ART of Risk Management: Alternative Risk Transfer, Capital Structure, and the Convergence of Insurance and Capital Markets. New York: John Wiley & Sons.

Kollewe, J. (2014). Pfizer unlikely to try AstraZeneca takeover again after tax clampdown. Retrieved from: http://www.theguardian.com/business/2014/nov/06/pfizer-unlikely-astrazeneca-takeover-tax-inversion-clampdown

 

Petty, J, W., Titman, S., Keown, A, J., Martin, P., Martin, J, D., Burrow, M., Nguyen, H. (2011).  Financial Management: Principles and Applications, 6^th Edition. New South Wales: Pearson Higher Education.

Pettypiece, S. (2014). Price the Reason Pfizer-AstraZeneca Deal Died, CFO Says. Retrieved from: http://www.bloomberg.com/news/articles/2014-06-11/pfizer-cfo-says-astrazeneca-deal-broke-down-over-price

 

Stock Analysis on Net (2014). Long-term Debt and Solvency Analysis. Retrieved from: https://www.stock-analysis-on.net/NYSE/Company/Pfizer-Inc/Ratios/Long-term-Debt-and-Solvency