Prof. Thomas J. Chemmanur
Office: Fulton 440
Phone: (617) 552 3980
Fall 2009
e-mail: chemmanu@bc.edu
web-page: www2.bc.edu/~chemmanu
MF881: Theory of Corporate Finance/Advanced Corporate Finance
I.
COURSE OBJECTIVE
The objective of this course is to
provide an advanced analysis of the major issues affecting the financial policy
of a modern corporation. We will first review some of the important theoretical
work in each area, before going on to discuss real-life cases dealing with the
major issues of financial policy facing the firm, such as its choice of
dividend policy, capital structure and related financing choices, the role of
venture capital financing, the going-public decision, the impact of agency
problems between firm management and security holders and between different
classes of security holders on corporate governance (and different ways of
solving such agency problems), as well as
mergers/takeovers and other restructuring decisions. In this context, we will
also discuss the valuation of firms and financial instruments like warrants,
convertibles and other equity derivatives (like PERCS and DECS) and the use of
real-options analysis in capital budgeting.
II. PRE-REQUISITES
Corporate
Finance (MF807) or equivalent knowledge of concepts. A working
knowledge of basic mathematics and statistics is assumed.
III. REQUIRED COURSE MATERIALS
The course will be
a blend of lectures, case discussions, and exercises. The articles and cases
mentioned in the course schedule below can be obtained from the following:
1. Chew, D. H., The
New Corporate Finance: Where Theory Meets Practice, Third Edition,
2. Packet of
cases and readings (hereafter, "Course Packet"), available from the
bookstore.
3.
4. Course Notes:
Since this is an advanced course for which no text book is available, we will
also rely to a considerable extent on my course notes (downloadable from my
web-site). There are two kinds of notes available to students. The "topic
notes," available on the course web-site (keyed to various topics in the
syllabus), is either background material, or material we will rely on for our
class discussion. Students are expected to download and review these notes
before they come to class. I will also distribute class notes to accompany the
lectures on some of the topics mentioned in the outline.
IV.
SUGGESTED REVIEW BOOKS
FOR THE ENTIRE COURSE (NOT REQUIRED)
Students should
consult one of the following (or any other corporate finance text book
they bought for the previous corporate finance class) for a review of concepts studied in previous
courses, and some extensions:
4. Brealey, R.A., S.C. Myers, and Allen, F. (BM), Principles of Corporate Finance,
Eighth ed.,
5. Ross, S.A., R.
W. Westerfield, and Jaffe (RWJ) Corporate Finance,
Seventh Edition, McGraw Hill Higher Education (or any other edition you may have).
6. Welch, Ivo, A First
Course in Corporate Finance. This book is an excellent introduction to
corporate finance. It has the additional advantage of being a free download
from the author’s web site. Chapter 10 on valuation using comparables is
excellent from the point of view of this class (since I won’t talk too
much about valuation using comparables, I urge students to download this from
the author’s web site). Many other chapters (including the one on IPOs)
will also be useful for this class.
V. SOME OTHER REVIEW MATERIALS FOR SPECIFIC TOPICS (NOT
REQUIRED)
7. Copeland, T.A., J.F. Weston, and Shasthri, K., Financial Theory and Corporate Policy,
Pearson Addison-Wesley Publishing 4th
Edition, 2003. This book is primarily useful for the excellent summaries of
academic studies on most of the topics we will discuss.
8. Copeland, T.,
T. Koller and J. Murrin, Valuation: Measuring and
Managing the Value of Companies, 2nd Edition, Wiley and Sons,
9. Grinblatt, M., and
S. Titman, Financial Markets and Corporate Strategy, Irwin/McGraw-Hill,
1998. Chapters 17, 18 and 19 of this book provide a useful discussion of issues
of financing strategy facing the firm arising from asymmetric information and
agency relationships.
10. William Megginson and Scott Smart, Introduction to Corporate
Finance, Thomson South-Western Publishing Company, 2005. While this is a good introductory corporate finance text book.
Chapter 11 on IPOs and Chapter 14 on Venture Capital are particularly useful
from the point of view of this class.
11. M. Amram, and N. Kulatilaka, Real
Options: Managing Strategic Investment in an Uncertain World. This book is
a useful source of further applications of real options.
Books 1, and 4 through 10 will be available from the Library
Reserve Desk.
I will assign
additional readings for Ph. D. students in finance taking this course. They are
required to come and meet me within the first two weeks of the course.
VI. CASE DISCUSSION AND WRITE-UPS
We will discuss seven cases during
this course, to illustrate the real-world applications of the various concepts
discussed in class and in the various assigned readings. Of these, students are
expected to prepare a write-up for four of the cases (Apex, ImmunoLogic,
Consolidated Edison, and Chrysler's Warrants) and hand them in at the start of
class on the assigned dates (but only the best three case-grades count); the
other three cases are for class discussion only. Questions for case discussion
and write-ups will be distributed in advance. Cases must be carefully
type-written and proof-read (you may, however, write in any formulae or
figures, etc., that are difficult to type in). You may prepare write-ups either
individually or in groups of two or three (maximum) students (group write-ups
are encouraged). Since class participation is essential for case discussion, I
will feel free to call upon any student for any of the cases.
VII. PROBLEM SETS You will also be
provided with additional practice problems on various topics. The problem sets,
with solutions, are available from the course web-site. While these problem
sets are not to be handed in; however, I cannot overemphasize the importance of
working these out in detail by yourselves, before
looking at the solutions. The exam problems are very often modelled
on the problems in these problem sets.
VIII. COURSE REQUIREMENTS
Written work for the course will
consist of four case write-ups, a mid-term exam (take home, to be handed in on
a date to be announced) and in-class final exam. Grading weights are as follows:
4 written cases: but only the best 3
case-grades count (10% each) 35%
Mid-term 20%
Class participation 10%
Final
35%
(Note: 5% of the case credit is purely for submitting all four cases with adequate work; you will lose 5% credit if you submit only 3 cases, for example).
IX. OFFICE HOURS I have set-up the following office
hours:
Wednesday: 5:45 - 6:45 P.M
Additional Office Hours: By
appointment (please e-mail to make appointments)
Feel free to drop
by at other times as well, and also e-mail or call me with questions (I prefer
e-mail to phone calls; if you do call, please leave a phone number where you
can be contacted on my phone mail if I am not in the office when you call). You
can also make an appointment to see me if you can't make it to the regular
office hours. The best way to contact me (especially if you have only a quick question,
or you want to make an appointment to see me later) is by e-mail:
chemmanu@bc.edu (I check my e-mail even when I am traveling, in the U.S. or
abroad, so you are guaranteed to be able to contact me this way). Any student
suggestions for improving the course are welcome.
X. FINAL EXAM CALENDAR: Please follow
the final exam date given in this syllabus, and not that in any other
university calendar (which does not apply to an advanced class like this one).
XI. HANDOUTS: This is a very handout-intensive
class, where I often give out a number of handouts on any given day. So if, for
some reason, you plan to be absent from class on a given day, please arrange
for a friend to pick up extra copies for you of any handouts given that day.
Because of the large number of different handouts that I give out, I do not
keep spare copies of any handouts with me; so you will not be able to pick up
these handouts you missed directly from me.
XI. OUTLINE OF TOPICS
Session 1 (Sep 9)
Introduction and overview of the course. Review of Dividend Policy under
perfect capital markets: The Modigliani-Miller Proposition on Dividends. Dividends and Taxes. The Information content of dividends:
Signaling with dividends. Share repurchases as an alternative to dividends. The dynamic aspects of dividend policy. Establishing
a dividend policy for a corporation.
Review Chapters 16 (BM) OR Chapter 18 (RWJ).
PROBLEM SET IV Problems 1 to 4.
Session 2 (Sep 16) Review of
Capital Structure under perfect capital markets: The Modigliani-Miller
proposition on Capital structure. Capital structure under asymmetric
information: selling equity and other securities under asymmetric information.
The information effects of stock issues and repurchases.
Review Chapters 14, 17 & 18 (BM) OR Chapters 14, 15 &
16 (RWJ).
READING Smith, C:
"Raising capital: Theory and Evidence" (Chew)
PROBLEM SET-IV Problem 5.
Session 3 (Sep 23) Valuation--review of
conceptual issues. Valuation methodologies.
Performance
of alternative valuation techniques.
CASE DISCUSSION: Atlantic Corporation
Review Chapter 17.3 (RWJ).
READING Kim, M., and
J.R. Ritter: "Valuing IPOs" (Course Pack).
PROBLEM SET-I (All problems)
Session 4 (Sep 30) Financial
contracting. The role of the venture capitalist and the
private placement market in the early stages of financing a company. The
incentive effects of alternative venture capital contracts: Structuring a
venture capital financing deal. Two rationales for why venture capital deals
often involve warrants and convertible securities.
READING Sahlman, W. A., "Aspects of financial contracting in
venture capital" (Course Pack)
PROBLEM SET-II (All problems)
Session 5 (Oct 7) CASE DISCUSSION AND WRITE-UP: Apex Investment Partners.
Session 6 (October 14): Initial Public Offerings. Why go
public? The costs vs. benefits of going public. Theories of IPO pricing. The role of the underwriter in an
IPO: The importance of underwriter reputation.
The relationship between management quality and IPOs.
Review Chapter 15 (BM) or Chapter 19 (RWJ).
READING Ibbotson, R., J.
Sindelar, and J. R. Ritter, "Initial public
offerings" (Chew)
READING Loughran, Ritter, and Rydqvist:
"Initial Public Offerings: International Insights." (Class Handout)
PROBLEM SET-I Problem 4.
Session 7 (October 21) CASE DISCUSSION AND WRITE-UP: Immunologic Pharmaceutical Corporation: Case (A), Case (B-1),
Case (B-2), Case (B-3), and Case (B-4).
Recent
developments in IPOs. Direct IPOs using new technologies (e.g., the
Internet). Long-term (post-IPO) performance of newly public
firms.
READING Ritter, J. R.,
"The Long-Term performance of IPOs" (Course Pack).
Session 8 (October 28) The agency
problem in corporations. The agency cost of equity. Controlling
the agency problems associated with equity, and improving corporate governance
through share-holder monitoring and investor activism.
CASE DISCUSSION:
The agency costs
of debt financing. The effect of debt on corporate investment policy:
under-investment and risk-shifting. The role of debt covenants in controlling
the agency cost of debt. The role of convertible securities in controlling the
agency problems associated with debt.
Review Chapter 16.2,
16.3 and 16.5 (RWJ)
READING Jensen, M. C.,
"Agency costs of free cash flow, corporate finance, and takeovers,"
Introduction, Sec-I, and Sec-II (Hand out in class).
READING Nesbitt, S.,
"Long-term rewards from shareholder activism: A study of the CALPERS
effect" (Course Pack).
PROBLEM SET-IV Problem 6.
Session 9 (November 4) First half: CASE DISCUSSION AND
WRITE-UP: Dividend Policy at FPL Group
Inc; To be discussed along with:
READING:
The dividend cut heard around the world: The case of FPL Group Inc (Chew).
The
different roles of bank debt and publicly traded debt. Summary on various aspects of a firm’s financial policies. Current state of the art on financial policy:
What we know and what we do not know about a firm’s financial policies.
READING James, C. and P. Weir, "Are bank loans different? Some evidence
from the stock market" (Chew)
Second half: Review of option pricing with the Black-Scholes formula, for a dividend paying stock. Application of the option
pricing methodology to valuing corporate securities.
Review Chapter 20 (BM) and 22 (BM) or Chapter 21 (RWJ) and 22
(RWJ).
READING Courtadon, G., and J. Merrick, "The option pricing
model and the valuation of corporate securities" (Course Pack)
Session 10 (November 11) Valuing Warrants. Valuing convertible debt and other equity derivatives.
Review Chapter 20 (BM) and 22 (BM) or Chapter 21 (RWJ) and 22
(RWJ).
Problem Set-V (All problems)
Session 11 (November 18) CASE
DISCUSSION AND WRITE-UP: Chrysler's
Warrants.
An introduction
to financial engineering and recent financial innovations: Valuation of PERCS,
DECS, and other mandatory convertibles.
Review Chapter 22 (BM) or Chapter 22 (RWJ).
READING Arzac, E. R., "PERCS,
DECS, and other Mandatory Convertibles."(Class Handout)
================ November 25: THANKSGIVING BREAK
==============
Session 12 (December 2) Introduction to
dynamic capital budgeting: Real options. The option to delay
undertaking a project. The option to expand a business
in scale and to enter new markets. Valuing a new
venture using the real options methodology. Using the
real-option methodology to develop financial strategy.
READING Copeland, T. E., and P. T. Keenan, "How much is
flexibility worth?" (Course Pack).
Session 13 (December 9) First Half: Mergers and acquisitions.
The source of value in mergers and acquisitions: the empirical evidence. Evaluating the terms of a merger. Choosing
the form of financing in acquisitions.
Review Chapter 33 (BM) or Chapter 30 (RWJ).
PROBLEM SET-III (All problems)
Second Half (As
Time Permits): Value Creation in Leveraged Buyouts.
Session 14
(December 16): FINAL EXAM