Extended Markets and Innovative Extensions

Financial innovation is the engine driving the financial system toward improved performance in the real economy. The conventional view of financial instruments is based upon the categorical distinction between debt and equity, but financial innovations have evolved less as distinct categories than as a range of financial technologies involving characteristics of both, and in the high‐yield market, innovative debt securities have emerged, which have added value by various means. During the US recession and credit crunch of 1974, many companies (especially small and medium‐sized enterprises and emerging firms) learned that capital access was no longer guaranteed on the basis of profits or success. With dramatic changes in the world economy, companies required innovative securities to provide them with the financial freedom necessary to survive and grow, to enhance their flexibility in managing the capital structure of their firms in changing times, and to finance their objectives for accomplishing corporate growth strategies. These issues are addressed in different sections of this chapter as follows: The corporate finance revolution; Financial innovation and growth; Categorizing financial innovations – an elaboration of some of the more recent and innovative financial instruments that have evolved with and from the high‐yield market; The rise of the placement market: Rule 144A – which permits private placements to be freely traded among qualified institutional buyers (QIBs); Efficiency gains from Rule 144A; Implications of the ‘aircraft carrier’ proposal – a proposal to overhaul US securities laws and reduce private placements by encouraging companies to issue stocks and bonds through public offerings; Structured finance: collateralized debt obligations; Collateralized loan obligations; and Collateralized bond obligations.