Maintaining profitability while resolving ethical issues are some of the main challenges that companies face. In the given scenario, Orlando Rubber & Tire (ORT) needs to raise funds for its expansion plans and sees issuing new security characterized by both debt and equity as a possible solution to the issue. However, some aspects need to be considered in the decision-making, such as a recent release of 30-year bonds and possible outcomes for the company’s market value. This paper aims to discuss the ethical issue of the ORT case study and analyze the ways to raise funds for the firm.
The Ethical Problem
There is an ethical issue since the conflict of interest is involved in the company’s decision-making process. For instance, if hybrid bonds are issues, the ORT’s stockholders and bondholders might earn remarkably fewer returns than in the case of conventional debt. Besides, the value of the recently released bonds would decrease and harm the investors who relied on the company’s low default risk. Thus, a decision should be taken with ethical aspects in mind.
Corporate Bond Credit Ratings
Corporate bond credit ratings refer to the numerical assessments of a corporation’s financial instruments and creditworthiness. According to Bevilaqua et al. (2020), corporate bonds credit ratings are essential, and “for advanced economies’ borrowers, the importance of corporate ratings increases” (p. 499). They are determined by the possibility of a default on the company’s debt. Credit ratings are assigned by special agencies and indicated by letters A, B, and C.
Using Boondocks to Raise Funds
The use of convertible bonds, or boondocks, is associated with both advantages and disadvantages. For instance, as Dong et al. (2018) state, companies apply this method as a cheaper financing form, compared to straight bonds and equity. Besides, convertible bonds are sold at a lower coupon rate. At the same time, they are riskier to investors since, in case of bankruptcy, secured debt holders are to be paid first. Earnings per share (EPS) can be diluted by such investments. Therefore, if ORT is considered to have high expected growth and substandard credit ratings, it can benefit from issuing boondocks.
Corporations’ Obligations to Their Stock Holders
To resolve ORT’s issue, it is crucial to consider the obligations companies have to their stockholders. As Hellwig (2019) reports, common shareholders have such rights as “voting power, ownership, the right to transfer ownership, dividends, the right to inspect corporate documents, and the right to sue for wrongful acts.” In the case of a company’s liquidation, creditors are the first to have debts paid, followed by preferred shareholders and common shareholders.
Corporations’ Obligations to Their Bond Holders
Similarly, corporations’ obligations to their bondholders need to be taken into account. They have the right to know the firm’s financial information and receive distributed assets in the event of bankruptcy (Dong et al., 2018). In contrast to shareholders, bondholders do not have voting rights but take priority in repayment when a corporate default occurs. Besides, interest is paid off to creditors regardless of the company’s financial situation and profitability.
Finding a Solution for the ORT Company
If I were to make recommendations for the company’s option of raising funds for its expansion, I would carefully analyze the data collected. Issuing convertible bonds can benefit both shareholders and bondholders if the company performs well with the expansion plans. However, the earnings will be lower if its performance is poor. At the same time, issuing boondocks is slightly higher than releasing new conventional bonds and remarkably lower than presenting new equity. Therefore, convertible bonds might be a valid option for the ORT company, given its growth rates and bond credit rating.
To conclude, the advantages and disadvantages of issuing boondocks as a way to raise funds need to be considered. In this regard, such a decision might imply risks for ORT’s shareholders and bondholders in the event of poor performance. However, there is a possibility to increase the company’s EPS, as opposed to conventional debt. Therefore, a weighed decision needs to be taken with consideration of the factors mentioned above.
References
Bevilaqua, J., Hale, G., & Tallman, E. (2020, May). Corporate yields: Effect of credit ratings and sovereign yields. AEA Papers and Proceedings, 110, 499-503.
Dong, M., Dutordoir, M., & Veld, C. (2018). Why do firms issue convertible bonds? Critical Finance Review, 7(1), 111-164. Web.
Hellwig, B. (2019). Know your shareholder rights. Investopedia. Web.