Deals with debt as a toxic option and the virtues of equity shares rediscovered by venture capital. It also shows how hollow the benefits of financial leverage and what an outdated concept it is.

1. Financial Leverage: the
Balance Sheet Polluter
-B.V.Raghunandan
Department of Commerce,
Poornaprajna College,
Udupi
September 8, 2015

2. Leverage
• Leverage: Having debt in the
capital structure of a
company
• In 1950s and 60s, it was
considered to be a magical
act through comparison of
leveraged company and a
non-leveraged company
• Effect was considered for
profitable companies and
non-profitable companies
were ignored

3. Rationale for Acceptance
• High corporate taxes caused reduced tax incidence as interest
on debt was a business expense
• Promoters’ Control was not diluted as debt did not carry
voting rights
• Equity form of finance like venture capital emerged later
• The concept of risk management also emerged later

4. Reality Check
• During a long gestation period of heavy industries and
infrastructure projects, it becomes toxic
• For the industry having a huge capital cost and huge running
expenses like civil aviation, it is devastating
• When unexpected risks exist, the tables will turn very quickly
• Prolonged trade cycles like mining and metal industries

5. Warning
• Sharia held debt to be a sin
• Shakespeare maintained, "never a lender nor a borrower be”
and also depicted the cruelest aspect through the character
of Shylock in Merchant of Venice
• Financial Management considered both equity and debt to be
the components of capital structure
• Never considered the repayment programme, cautions,
warning signals etc as an important exercise

6. A Carefree World
• Corporates did not learn the
lesson leading to the
development of art and science
of bankruptcy
• Individuals and families were
encouraged to over-borrow like
housing finance, consumer
finance, finance for hospital
bills, student loans
• Questionable methods
employed for recovery including
foreclosure
• Credit card booms
• Empty houses and homeless
population

7. Banks: the uninnovative bureaucrats
• Since 2003, after the reverse merger of ICICI into
ICICI Bank, commercial banks started development
finance also
• However, it was in the form of Long Term Loans
rather than in the form of subscribing to equity
shares
• Eventually, the loans get converted into equity as a
part of Strategic Corporate Debt Restructuring
• Loan targets are given to bank managers forcing
them to find borrowers

8. Revival of Equity Culture
• A more mature and developed primary market and stock market
• Reduced corporate tax rates
• Emergence of venture capital and private equity fund
• Contribution of HNI and Angel Investors
• A Systematic Risk Management and Popularity of debt-free capital structure
• Basel Norms for Banks

9. Rationale for Equity Shares
• No need to pay dividend in the absence of profit
• Even in the presence of profit, a growth oriented
company does not declare dividend
• No need to pay dividend during gestation period
• Large body of investors to share the losses
• Equity shares are the cheapest source of finance
• Shareholder Loyalty for other projects and group
companies
• Huge funds can be raised through IPOs and FPOs
• Share Premium as another cheap source of finance
• Listed companies having access to cheaper foreign
funds

10. The Fallen Empire-DLF Limited
• 1946-Chaudhry Ragvendra
Singh promoted
• Developer of residential
and other complexes in
Delhi until 1957
• 1957-Delhi Development
Authority banned private
developers
• It went out to Gurgaon in
Haryana to develop a city

11. IPO Details of DLF Ltd.
• 2007-IPO made
• 17.5 crore shares of Rs.2 through book-building
• Cut-off Price Rs.525
• Face Value of Shares: Rs.35 crore
• Share Premium: Rs.9,152.5 crore
• Share Price went upto Rs.1000 in 2008

12. Falling Down from Grace
• Forays into Capital Intensive
expansion
• Hospitality Industry
• Wind and other power
business
• Extensive Borrowings
• Debt: Rs.19000 crores
• Questionable Trade Practices

13. Correlation between Interest and Profit of DLF Ltd.(Figures in Rs.Crore)
Year Sales Interest Profit
2007-08 14433 310 7,847
2008-09 10,035 555 4,497
2009-10 7,423 1,110 1,709
2010-11 9,560 1,706 1,638
2011-12 9,629 2,246 1,169
2012-13 7,773 2,314 663
2013-14 8,298 2,463 582

14. Alternative
• FPO at the cut-off price of IPO could have
brought in a huge amount of cost-free funds
• It would have saved the interest
• More meaningful diversification
• Taking care of quality of building in Gurgaon
and maintaining the customer relation

15. THANK YOU