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The term “business corporation” (excluding financial service institutions) means economic entities whose objective is to make a profit from such activities as the production and sale of goods or services . Business corporations invest funds in real assets (such as facilities and inventories) to carry out production and marketing activities on a continuing basis .
Funds raised by business corporations are divided into internal funds (those generated in the ordinary course of the production and sale of goods or services) and external funds (those raised from external sources ) , according to the method employed to raise them . Technically , internal reserves and depreciation charges are included in internal funds. As the company is not required to repay the principal of , or pay interest or dividends on , such funds , they are considered the most stable means of corporate financing . In actuality , however , business corporations cannot meet their funding requirements with internal funds alone , and many of them have to rely on external funds . External funds are divided into the proceeds resulting from loans and the issuance of equity and debt securities , according to the method employed to raise them .
Loans are obtained primarily from banking institutions . This method of raising funds with debt securities is termed “indirect financing” In addition to those issued at the time of their incorporation, business corporations issue additional equity shares(an increase of capital) to finance the expansion of their production capacity or for other purposes . As business corporations are not required to repay the principal thus raised, or pay interest thereon , the proceeds from the issuance of equity shares constitute the most stable form of funds among external funds . As is the case with equity shares , corporate debt securities are also an instrument for raising funds from the capital markets, and issuers have to redeem them on or by a predetermined date of redemption and pay a definite rate of interest on them . Corporate debt securities are largely divided into straight (SB), bonds with subscription rights, and structured bonds(see Chapter V). As the securities underlying equity shares or corporate debt are held directly by the providers of funds, this method of raising funds is called “direct financing”.
A survey of changes that have occurred in the amount of funds raised from external sources as a percentage of the outstanding balance of financial debts shows that bank borrowings have tended to decrease since 1990. In the 2000s, funds raised through the issue of securities have outpaced those obtained through bank borrowings, suggesting that the weight of corporate financing structure has shifted from indirect to direct financing. This may be explained by the fact (1) that following the liberalization and internationalization of the financial markets, businesses have actively sought to raise funds be selling new shares and bonds on the market and (2) that particularly since 1980, in addition to reductions of inter-company credits that businesses had made under the pressure of recession, banks have curtailed their lending and businesses have repaid their debt banks in an effort to improve their financial positions. And these facts have combined to produce a synergistic effect. Most recently, the proportion of financing by loans has risen because of the decline in the functioning of the capital market caused by the financial crisis. However, with the establishment of emerging markets and the liberalization and abolition of regulations on the issue of debt securities, small-to-medium-sized firms can now obtain financing through the capital market. Consequently, if the capital market rebounds, the proportion of financing through the issue of securities will likely recover.
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