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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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FINANCIAL POLICY CONSIDERATIONS

Financial policy appears to be a second-order issue, in terms of what types of policies are most consistent with winning strategies. Optimal financial policies (financial liquidity, financial leverage, and shareholder distributions) tend to differ between higher and lower growth businesses. Industry factors also drive different common practices between sectors, leading to opportunity in WACC and capitalization rates.

Although financial liquidity might affect the incidence of deals for a company, liquidity is not a meaningful factor in success. There is no statistically significant difference in the liquidity profiles of winners or losers, long-term or short-term, with a wide dispersion in the data.

With respect to financial leverage, lower leverage is associated with longer-term success, where the difference is more meaningful. Lower levels of financial leverage provide an advantageous bargaining position and an increased financial strength to execute an acquisitive growth strategy. The lower levels enhance the ability to use cash and debt, factors associated with success. Interestingly, highly leveraged targets tend to fare poorly because they tend to be less profitable and more likely to involve stock. Shareholder losses in diversification are partly a function of firm leverage.29 Industry factors drive different practices, where suboptimal capital structures increase WACC and reduce value. Though independent capitalization of different businesses ...

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