FINANCING AN EXPANSION the head of " Trading on the Equity" we discussed the general principles governing the capitalization of a corporation formed to engage in a new enterprise. We have not considered what provision the cor poration might make to finance a possible fu ture extension of the business, nor, when this possibility was not foreseen and provided for, how it might meet the emergency.
After the corporation has established an earning power, it may wish to extend its busi ness, build an addition to its plant, erect a new plant, lay its tracks farther, or do what ever other thing the nature of the enterprise may make necessary for expansion. Such an extension of operation requires financing of some kind. What can the corporation do ? It might issue and sell common stock. To do this it must either have some authorized stock still unissued or must get its charter amended to authorize more stock. It may be in place here to call to mind that the statutes governing incorporations regard capital stock as a fundamental matter, and require the charter creating the corporation to limit to a definite amount the number of shares it may issue. Though these statutes may make many other regulations about a corporation's capi tal stock, it is not necessary to our purpose here to go into them. Organizers of the cor poration may have considered the possibility of expansion and have provided for a much larger authorized capital stock than they ex pect immediately to issue. Through a mis nomer this often goes by the name of " treas ury " stock. But, of course, it is not an asset as that name implies. A more careful termin ology calls it " authorized and unissued." If the corporation has not exhausted its au thority to issue, it may finance by selling such stock. In case it has already put out all the stock it had authority to issue, the corporation may apply for an amendment to its charter increasing the amount authorized.
Financing an extension of business on com mon stock would increase the equity the com mon shareholders are trading on. The de cision to expand may have come as a result of assured and increasing earnings, in view of which the managers of the enterprise might feel justified in trading on a thinner equity. Besides, the demonstrated earning power would enable them to finance on more favor able terms than in the beginning. They may
avoid adding to their equity by financing either on preferred stock or on bonds. We have already discussed principles that will in fluence their decision between the two. Be sides the consideration of (1) whether or not they can safely increase their fixed charges by issuing bonds, on the one hand, and on the other *(2) whether they want to cut down their percentage of the total voting power by issu ing stock, add (3) the question of the relative price they can secure in the investment mar ket for bonds and preferred stock, and we have the influences that will determine their decision.
Since the question of relative market prices of classes of securities has arisen in our discus sion, we may properly give it a brief consider ation at this point. Fashions change in invest-. ing as well as in other matters, so that the relative prices obtainable for different classes of securities vary somewhat from time to time. During a period of dull or declining business people may be attaching more importance to the security afforded by a mortgage lien. Through a time of active and expanding busi ness they may be readier to see the advantages rising out of participation in profits.
When current interest rates are running high, bond interest rates tend to follow them. At such a time the managers of a corporation will feel reluctant to commit their enterprise to the issue of bonds which will carry a high interest for their entire life, twenty, thirty, or fifty years. They are then likely to temporize by financing on short-term notes, which will impose a high rate of interest, to be sure, but will fall due in several years. The corporation managers hope they will be able by that time to finance on long-term securities at more fa vorable rates. During the period just before the panic of 1907, when interest rates were running high, the corporations issued many millions of notes running three and five years. Once a special financial practice of this kind starts, it acquires a momentum not easy to check. People get a liking for short-term securities, say, and in their desire for this class of paper will not readily subscribe for long-term bonds. So they tend to prolong the situation when the condition creating it has ceased.