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The second meeting was set up a week after all the requests for pricing had been submitted. Each response had its pluses and minuses. While most of the nonunion bids were slightly lower, they had certain negative components. For example, the plumbing contractor could not provide the number of skilled plumbers needed just when the project would most require their skill. The heating and cooling contractor cost pennies less than its union counterpart but had fewer licensed specialists on its payroll. The union contractors came in with bids that met all the special requirements and certifications needed, but they were slightly higher in labor cost. After reviewing the bids, John told Peter he’d like to go with the union contractors if the union would lower its cost by two cents per labor hour. That would make the union contractors’ bids economically competitive with nonunion labor. Peter thought the job would hire enough skilled labor to make the project worthwhile, so he’d ask the locals to tap funds from their Market Recovery Program—a fund union members pay into just for this sort of situation—to apply toward labor costs. But labor could offer things—such as certified skilled workers and the resources to commit to completing the job—the nonunion contractors couldn’t, and John knew this.

A family succession is different from all other exit options in so far as the emphasis is often not on maximising the owner’s exit price, but rather on ensuring that the business continues successfully under the ownership of the successor. Consequently, the tailoring (or grooming) is concentrated on the successor, rather than on the business. This alters the perspective of the business’s suitability for the exit option chosen and the notion of what purchasers are looking for. This will become clearer from what follows below.

Generally speaking, most types of businesses qualify for a family succession. However, if the successor is required to borrow money against the business’s assets to acquire the business, the business will need to be able to support the borrowings and the successor will need to have a professionally produced business plan demonstrating this ability.

As I have said, the emphasis in family successions is usually more on the suitability of the heir than the suitability of the business, so this question has to be changed to: ‘What are we looking for in the successor?’ This will influence the choice of successor and the way he or she should be groomed for the take over.

We will now look at the steps necessary for grooming (or tailoring) the heir for taking over the business.

Another major challenge of corporate entrepreneurs today is to explore, identify and recognize the opportunities available for developing new business enterprises. Large enterprises face such challenges more seriously than their counterparts, as the utilization of opportunities is crucial in the outcomes of entrepreneurship. Also, such organizations do have the problem of middle management crisis and confl ict between the young talent and the old experts. The middle management, particularly in large enterprises, is passing through a stage of transition. It does not see any space for contribution in decision-making or self development. Dissatisfaction of all kinds is clearly visible, leading to ineffective utilization of available talent for organizational effectiveness. Senior management can play an important role here in creating an environment supporting entrepreneurial initiatives and asserting their value for the organization.

As we have pointed out for short-term spreads expected recovery value may be too high for short-term liabilities due to the assumptions of the model. Commercial implementations of the original structural model are more sophisticated, in order to produce more accurate spreads, default probabilities and recovery rates even for short time horizons. While in pure diffusion models with a barrier overnight debt is quasi-riskless, the introduction of a jump process captures the fact that default could be triggered by a sudden, unexpected event. Thus, the jump process is appropriate to model the possibility of the firm defaulting instantaneously due to the arrival of negative information with respect to, for example, litigation or fraud.

The second kind of models that we want to highlight is “reduced-form models.” Unlike structural models, they are based on information from the credit market, such as asset swap spreads or credit default swap spreads. Thus they are capable of capturing valuable information regarding the probability of default that is contained in bond and credit default swap markets. This is particularly helpful when insufficient or no balance sheet data is available. In the reduced-form framework, default is modeled as a surprise event. Rather than modeling the value of a firm’s assets, here the probability of default is derived directly from market data. The interested reader may note that this approach is similar to the way interest rates are modeled in order to price fixed income derivatives.

The bear market for credit between 1997 and mid-2002 has put a new focus on valuing corporate credit. The debt-financed equity bull market of the second half of the 1990s was accompanied by historically high default rates and investigations of the management and reporting of corporate balance sheets.

Obviously the standard approach of using rating agency credit ratings to gauge credit risk is no longer sufficient. As a consequence, quantitative approaches have recently gained popularity, particularly structural models based on equity-market inputs. Quantitative models can be used as a tool to provide warning signals or to determine whether the spread on a corporate bond adequately compensates the investor for the risk. Due to the current low-yield/low-return environment the number of investors interested in credit products has grown worldwide. Credit models like KMV or CreditGrades have been developed to meet the growing investor demand.

These enhancements of the Merton model are able to incorporate companyspecific details and can include subjective credit analyst views. With respect to the rapidly expanding credit derivatives market, quantitative models provide critical inputs for valuation and hedging. Default correlation, a major driver for the valuation of credit portfolio products, can be modeled in both structural and reduced form models. Finally, quantitative credit models have become indispensable tools for the risk management of financial institutions.

Although various quantitative models are used by credit investors, two approaches for modeling default have gained widespread acceptance: structural models and reduced-form models. Both of these methods provide estimates of default probabilities or fair market spreads.

The securities issued by the U.S. Department of the Treasury are backed by the full faith and credit of the U.S. government. Consequently, market participants through¬out the world view,them as having no credit risk. As such, interest rates on Treasury securities are the key interest rates in the U.S. economy as well as in international capital markets. The large size of any single issue has contributed to making the Trea¬sury market the most active and hence the most liquid market in the world.

The minimum interest rate that investors want is referred to as the base interest rate or benchmark interest rate that investors will demand for investing in a non-Trea¬sury security. This rate is the yield to maturity (hereafter referred to as simply yield) offered on a comparable maturity Treasury security that was most recently issued (“on the run”). So, for example, if an investor wanted to purchase a 10-year bond on September 19, 1997, the minimum yield the investor would seek is 6.086%, the yield on the most recently issued 10-year Treasury