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Yet a wide range of players, including investment bankers, say that the argument for junk bonds is now more valid than ever. Development of a vibrant corporate debt market is essential to reduce the cost of borrowing of the corporate sector, especially at a phase when the manufacturing sector in India is on an upswing.
Indian companies are in a good position to regain or expand market share, aided by funding activities. There are many infrastructure projects (telecom, manufacturing, highways, airports, etc.) in the pipeline and companies want to raise money at the least possible cost.

We can look at the example of Michael Milken, who transformed the USA bond market in 1970s by introducing high yield corporate bonds. The success of these junk bonds can be attributed to the economic condition of the country at that time. The telecom, automobile sector were coming up and many companies required low cost capital. Milken raised funds for more than one thousand such companies, including MCI, Ted Turner's CNN, McCaw Cellular, and many others. And he continued to assist firms which had fallen out of favor, raising money for Lorimar in 1979, Warner Communications (now Time Warner) in 1984, and Chrysler in 1984 when no one else would touch the auto company.

Aside from the difficulty for high-risk firms to get a good price for an equity issue at current market sentiment, raising equity has a far greater cost than issuing bonds. To attract investors, any company selling shares has to have a high cost of equity - the rate of return investors expect from a company. A standard way of computing cost of equity is by adding a risk-free rate, such as G-secs, to the product of equity risk premium and a company's beta - the extent to which its stock moves relative to the macro economy. Given any sign that expected returns would not be met - say, a profit warning - investors punish the company by dumping its shares, therefore, reducing its value. This could eventually make the company vulnerable to a takeover, or worse. Also, a higher equity component in a company's capital structure increases its cost of capital - a value that is inversely proportional to share price valuation.

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* Contributed by -
H. Sandeep Reddy & Puneet Jain,
Indian Institute of Management Kozhikode,
Kozhikode, Kerala.