Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
Building on the abuse of warrants subject from the last chapter, the authors delve into its impact on stockholders and the abuse of holding company structure.At the basic level, such action results in additional (management) expenses. For example, the low-priced warrants, in effect, give management ownership of a portion of the future profits. Moreover, the use of warrants can result in hiding such expenses.
Mr. Graham and Mr. Dodd note the role of investment banking firms involved in the floatation of warrants with stock issuance. Investment banking firms, tasked with such issuance, should act as an agent for the shareholder. Such practices have resulted in stockholder dilution and excessive management compensation even before shareholders get paid.
It should be noted that the chances of bad behavior are higher during times of easy money.
The writers also discuss how promoters have used corporate pyramiding structures to gain a controlling position while putting up little equity (Speculative capital structure). Given the short memory of financial participants, there are numerous examples of such bad behavior over the years. Holding companies owning stock of the subsidiary can value them at a high price. Assuming issuance of multiple subscription rights as return on investment. Manipulation of the low float of the subsidiary to increase the book value parent holding company. The inflated value of stock warrants could be used to increase equity value. The writers point to indirect methods of creating speculative balance sheets such as issuing large senior securities.
While some legislations were created to restrict the above abuses, an investor and analysts should be on guard.
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