The Business Sector

Whereas household financial decisions are concerned with how to invest money, businesses typically need to raise money to finance their investments in real assets: plant, equipment, technological know-how, and so forth. Table 1.5 presents balance sheets of U.S. corporations as a whole. The heavy concentration on tangible assets is obvious. Broadly speaking, there are two ways for businesses to raise money—they can borrow it, either from banks or directly from households by issuing bonds, or they can "take in new partners" by issuing stocks, which are ownership shares in the firm.

Businesses issuing securities to the public have several objectives. First, they want to get the best price possible for their securities. Second, they want to market the issues to the public at the lowest possible cost. This has two implications. First, businesses might want to farm out the marketing of their securities to firms that specialize in such security issuance, because it is unlikely that any single firm is in the market often enough to justify a full-time security issuance division. Issue of securities requires immense effort. The security issue must be brought to the attention of the public. Buyers then must subscribe to the issue, and records of subscriptions and deposits must be kept. The allocation of the security to each buyer must be determined, and subscribers finally must exchange money for securities. These activities clearly call for specialists. The complexities of security issuance

CHAPTER 1 The Investment Environment

Table 1.5 Balance Sheet of Nonfinancial U.S. Business*

Assets

$ Billion

% Total

Liabilities and Net Worth

$ Billion

% Total

Tangible assets

Liabilities

Equipment and structures

$ 2,997

19.0%

Bonds and mortgages

$ 2,686

17.0%

Real Estate

4,491

28.5

Bank loans

873

5.5

Inventories

1,269

8.0

Other loans

653

4.1

Total tangibles

$ 8,757

55.5%

Trade debt

1,081

6.8

Other

2,626

16.6

Total liabilities

$ 7,919

50.2%

Financial assets

Deposits and cash

$ 365

2.3%

Marketable securities

413

2.6

Consumer credit

73

0.5

Trade credit

1,525

9.7

Other

4,650

29.5

Total financial assets

7,026

44.5

Net worth

7,864

49.8

TOTAL

$15,783

100.0%

$15,783

100.0%

"Column sums may differ from total because of rounding error.

Source: Flow of Funds Accounts of the United States, Board of Governors of the Federal Reserve System, June 2000.

"Column sums may differ from total because of rounding error.

Source: Flow of Funds Accounts of the United States, Board of Governors of the Federal Reserve System, June 2000.

have been the catalyst for creation of an investment banking industry to cater to business demands. We will return to this industry shortly.

The second implication of the desire for low-cost security issuance is that most businesses will prefer to issue fairly simple securities that require the least extensive incremental analysis and, correspondingly, are the least expensive to arrange. Such a demand for simplicity or uniformity by business-sector security issuers is likely to be at odds with the household sector's demand for a wide variety of risk-specific securities. This mismatch of objectives gives rise to an industry of middlemen who act as intermediaries between the two sectors, specializing in transforming simple securities into complex issues that suit particular market niches.

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