Topic: Is it possible for large corporations to exist without lending? (Read 1148 times)

You failed to realize the alternative method of raising funds.  You could issue $1000 worth of new stock (say 100 shares @ current market price of $10 per share) buy your widget doubler on day 0 and incur no debt.  If you wanted to pay it back (which the advantage of equity is you don't HAVE to) you could buy back the 100 shares with increased profits from the widget doubler.

But what if you can turn that $1 into more than a dollar? I think large corporations could easily exist without lending or borrowing, but I think it would severely hamper their ability to be productive. For example --I make widgets. Each day I produce 100 widgets, and sell them each for $1 profit. There's a new widgetMaker 5000 that would double my production rate, and it costs $1000 -- I could save up for 10 days and buy it then, or borrow money, buy it now, and pay it back in 6 or 7 days...which is the better decision?

The answer to that, unfortunately depends on how much demand there is for widgets, whether or not a flood drives up the prices of my raw materials on day 2, etc. etc.

I personally think the ability to borrow is a very, very good thing.

Indeed, Apple is in the situation where there's an opportunity cost to them in just stockpiling that money so it makes sense for them to use it in ways which generate further income (even if that's just putting it in rock solid investments).  They don't actually need to do anything with that money, but they might as well.

By contrast, you'll sometimes see companies borrowing in an attempt to solve cashflow problems - and that's something which often ends badly because the cashflow problems have a systemic cause which borrowing doesn't address.  Very often all it does is delay the inevitable for a while and result in more people being screwed when the house of cards collapses.

If you complete ignore risk and pretend no company can ever fail then yes however to an investor what matters is risk adjusted return.  A company which raises all it's money by equity will have a much higher cost of capital and thus be slower to expand and grow earnings faster however with none of revenue going to pay bond holders the company can remain solvent with much greater reductions in cashflow.

A company which borrows money can grow earnings much faster however now has a higher fixed operating cost (interest) and the shareholders take on that risk.  In essence a company which borrows is using leverage.

Economic theory tells us that in a perfect market both companies would be perfectly priced in that while the second company has the potential to grow faster it also has a higher potential to fail and adjusting for that risk premium isn't worth any more to shareholders.  Now no market is perfect so how much debt a company takes on has a lot to do with market perception of risk, the expectation of peers, and stability of cashflow.

For some companies no amount of debt makes sense.  Take Apple for example.  Apple throws off so much free cashflow that the cash is piling up.  There is no reason for them to borrow even a dollar long-term.

Not necessarily.  That sounds like a non-answer but there is an opportunity cost involved in every economic decision, including the decision to borrow money.  To a large extent whether you issue shares to raise capital, borrow money to raise capital, or retain earnings to fund future ventures is going to depend on what your desired outcome from spending that money is.  What specific problem you're hoping to solve with the money should influence where it comes from.

Borrowing's often attractive not just because it can be cheaper (from an opportunity cost viewpoint) and doesn't dilute share value but also because you can leverage.  But it can also be absolutely devastating financially if your forecasts are wrong (expansion is often one of the most dangerous times for a company financially) to the extent which the company itself can be taken in satisfaction of the debt (this nearly happened to various Virgin enterprises) even if the value of the company is greater than what is owed. 

Issuing debentures to the public can be a more attractive option than conventional borrowing, partly for this reason.  You still have to pay a yield but it doesn't dilute share prices and they have a maturity date.  In places where they're secured, it's by non-specified assets.  You need to be perceived as a financially sound company for your debentures to be attractive to investors, though.

So the question is, if borrowing money is the more economically sound option, would that render a large corporation who refused or couldn't borrow money noncompetitive with those who did?

This.  Borrowing money is often the more economically sound option.

In some countries it's not even expected that shares will pay high dividends.  People buy them hoping that the value of the company will increase and the value of their shares along with it.  If you don't have to pay high yields to attract investors but can focus on increasing the value of the company itself rather than its annual profits, different financial strategies make sense.

Which is fine, such institutions don't actually produce anything.  They will continue to exist to whatever extent the market requires them, which would likely be a fraction of the current need.

Makes sense regarding financial institutions - they wouldn't have much to lend out without borrowing heavily themselves.

Yes, but it is very hard - some corporations even like keeping debt on the books.

It's pretty much impossible for many financial institutions and investments firms to exist without heavy leverage though. (no, I'm not talking about fiat money)

It may reduce the profitability of BEING A SHAREHOLDER but the company could expand and generate revenue just the same.

Companies borrow money when it is cheaper than the cost of issuing new shares.

For example if issuing new shares will dillute profits (per share) by 5% but borrowing only reduces profits (per share) by 1% then it is better to borrow.

Now this is somewhat simplistic because there are other considerations (like insolvency, changing interest rates, accelerated repayment, etc) but generally speaking companies would be fine without the ability to borrow.

Yes.  My Voip provider is very proud about being entirely a debt free corporation.

Just curious what everyone's thoughts on this are...

Is it possible for large corporations to exist loan-free, and still be competitive in the marketplace today?

My immediate inclinations say yes, provided the necessary capital for operations is given through stocks/shareholders.  But, would the company remain competitive?  Or would the lack of ability to borrow money hinder the company's ability to expand in the same way that competitors would be able to?  Would it prevent the company from continuing operations in hard times whilist other companies could continue operating at a loss, or would the company have enough liquid assets to push past the hard times?

Discuss.