Prof.
Thomas Chemmanur
Office:
Fulton 440
Phone:
(617) 552 3980
e-mail:
chemmanu@bc.edu
Web-page:
http://www2.bc.edu/~chemmanu
Spring
2004
BOSTON COLLEGE
Wallace E. Carroll School of
Management
This
course has the objective of introducing doctoral students to theoretical
research in corporate finance. The emphasis will be on incomplete information
models, though a few models driven by other considerations will also be
studied. The first part of the course (around two thirds) will examine the
fundamentals of corporate finance theory (e.g., the theory of the firm's choice
of its capital structure and dividend policy under alternative assumptions), as
well as various tool areas in corporate finance (e..g, the notion of moral
hazard and agency problems, adverse selection and signalling, various aspects
of non-cooperative games with and without incomplete information, and the
equilibrium concepts in such games). The second part of the course will focus
on two or three important related topics which are the focus of recent research
in corporate finance (this part of the course changes every year; it is
suggested that students look at syllabi from earlier years for references on
other current topics of research in corporate finance) .
Pre-requisites: Since
many of the models in corporate finance make use of tools from information
economics/game theory, some knowledge of these tools is required. But those who
do not have these tools but are willing to catch up with some reading on their
own should not have too many problems, since many ideas in corporate finance
are quite intuitive, and I will try to emphasize intuition over mere technical
detail wherever possible. For game theory, there have been numerous excellent
and easily accessible text books written in the last four or five years. I will
mention only three of these below:
1. Eric Rasmusen, Games and Information: An introduction to game theory, Basil
Blackell. (A basic book)
2. Gibbons, R., Game Theory for Applied Economists, Princeton University Press,
Princeton, New Jersey (intermediate level).
3. Fudenberg, D., and J. Tirole, Game Theory, M.I.T Press, Cambridge
Massachusetts. (Fairly advanced)
Books for supplementary reading: Unfortunately, there are not many Ph.D. level text books in corporate
finance. A Ph. D. text book which provides at least some basic coverage of the
main topics is (referred to as Matos in this outline):
1. J. A. de Matos, Theoretical Foundations of Corporate Finance,
Princeton University Press, 2002.
There are many good MBA text books.
Two advanced M.B.A text books which summarizes the ideas behind some of the
earlier theory papers, and also much of the empirical literature in corporate
finance:
2. Copeland, T.A., and J.F. Weston, Financial Theory and Corporate Policy,
third edition, Addison-Wesley Publishing Company (this book will be referred to
as CW in the outline). Although this book will not help you with any of the
current research, it will give you a quick introduction and a summary of the
earlier theoretical and empirical research in corporate finance, thus allowing
you to place the current literature in perspective.
3. 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 (the discussion is, however,
only at the M.B.A level, and thus serves only as a starting point, at an
intuitive level, for Ph.D students).
Of course, the standard text book on
corporate finance at the MBA level is:
4. R. A. Brealey and S. C. Myers,
Principles of Corporate Finance, 7th Edition (New York, McGraw Hill,
2002).
Other course materials:
Most of the lectures will be based on academic papers. I plan to make these
available to you as we go along. The papers directly relevant for class
discussion on each topic are mentioned under that topic in the outline below;
however, the discussion will not be confined to these papers, and additional
papers may be added as we go along. I will also be giving out copies of my
class notes for every lecture.
Course Organization:
The first part of the course will consist entirely of my lectures; the second
part will be a combination of my lectures and student presentations. Each
student will be required to write a short paper, either synthesizing the
literature in a certain area, or, for the more ambitious, a paper which
constitutes original research, which will be due approximately one month after
the end of the course. Students will be asked to work out hand-in problem sets.
Each student will also be asked to make a class presentation of one or more
papers (in the second part of the course), which should also be chosen jointly
with me. Students will also be asked to critique some of the papers that other
students are presenting. There will also be a final exam. The final grade will
thus depend on performance in the problem sets, final exam, the research paper,
and student presentation and other class participation exercises.
The course grade is determined as
follows:
a. Class presentation: 15%
b. Class participation and problem
set: 15%
c. Critiques of papers: 10%
c. Research Paper/synthesis: 20 %
d. Final Exam: 40%
Office Hours: Office
hours for this course will be after class Wednesday 5-30 to 6:30 P.M. However,
Ph.D students are welcome to drop by at other times as well, or to set up an
appointment for some other convenient time (send me e-mail if you wish to make
an appointment). The best way to contact me is through e-mail (rather than by
phone).
Outline of Topics
Part I: Fundamentals and Tools
The main papers that will be used in the
discussion of each topic are listed below.
Topic One: Corporate Finance under Perfect Capital
Markets: The Modigliani-Miller Propositions on Capital Structure.
Papers:
Modigliani, F. and M. Miller "The
Cost of Capital, Corporation Finance and the Theory of Investment" American
Economic Review, June 1958, 261-297.
Other reading: Matos sec 2.1; CW, chapters 13 and 14
respectively, provide a review
(though a bit dated) of the large theoretical and empirical literature on
capital structure.
Topic Two: Taxes and Capital Structure
Papers:
Modigliani, F. and M. Miller
"Corporate Income Taxes and the Cost of Capital" American Economic Review, June 1963, 433-443.
Miller, M., "Debt and
Taxes," Journal of Finance, June
1977, 32, 261-276.
Other reading: Matos sec 2.2
Topic Three: Agency Problems and Capital Structure.
Papers:
Jensen, M. and W. Meckling,
"Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership
Structure," Journal of Financial
Economics, October 1976, 3, 305-360.
Myers, S.C. "Determinants of
Corporate Borrowing" Journal of Financial Economics, November
1977, 147-176.
Jensen, M., "Agency Costs of Free
Cash Flow, Corporate Finance, and Takeovers," American Economic Review, May 1986, 76, 323-329.
Other reading: Matos sec 3.1
Topic Four: Adverse
Selection, Signaling, and Non-cooperative game theory.
Static and Dynamic Games of complete
information: pure and mixed strategies; Iterated Dominant Strategy Equilibrium;
Nash Equilibrium; Sub-game Perfect Nash Equilibrium. Static and Dynamic Games
of Incomplete information; Equilibrium refinements: Bayesian Nash Equilibrium,
Perfect Bayesian Equilibrium, Sequential Equilibrium, and the Cho-Kreps
Intuitive Criterion.
Papers:
Ackerlof, G. A., "The market for
lemons: Quality Uncertainty and the Market Mechanism," The Rand Journal of Economics.
Spence, M., "Job Market
Signaling," Quarterly Journal of
Economics 87, 355-374.
Cho, I. and D. Kreps, "Signaling
Games and Stable Equilibria," Quarterly
Journal of Economics, May 1987, 179-221.
The various text books I have
mentioned above on game theory will be directly useful for this part of the
course (as well as for the other parts as reference books for various tools
from game theory applied to corporate finance).
Topic Five: Adverse Selection and Capital Structure;
Issuing various Corporate Securities Under Asymmetric Information.
Papers:
Ross, S., "The Determination of
Financial Structure: The Incentive
Signalling Approach," Bell Journal
of Economics, Spring 1977, 23-40.
Leland, H. and D. Pyle,
"Information Asymmetries, Financial Structure, and Financial
Intermediation," Journal of Finance,
32, 1975 371-388.
Myers, S. and N. Majluf,
"Corporate Financing and Investment Decisions When Firms Have Information
that Investors Do Not Have," Journal
of Financial Economics, June 1984,187-221.
Other reading: Matos sec 3.2
Topic Six: Dividend Policy Under Perfect Capital
Markets and under Asymmetric
Information
The Modigliani-Miller Proposition on
Dividends. Dividend Policy Under Asymmetric Information and Taxes.
Papers:
Bhattacharya, S., "Imperfect
Information, Dividend Policy, and the 'Bird in the Hand' Fallacy," Bell Journal of Economics, Spring 1979,
259-270.
John, K. and J. Williams,
"Dividends, Dilution, and Taxes:
A Signalling Equilibrium," Journal
of Finance, September 1985, 40, 1053-1070.
Miller, M. and K. Rock, "Dividend
Policy Under Asymmetric Information," Journal
of Finance, September 1985, 40, 1031-1051.
Other reading: Matos Chapter 4; CW chapters 15 and 16
respectively, provides some background reading, as well as a quick summary
(though somewhat dated), of the large theoretical and empirical literature on
dividend policy.
Topic Seven: Initial Public Offerings (IPOs): An
Introduction
Papers:
Rock, K., 1986, Why new issues are
underpriced, Journal of Financial Economics 15, 187-212.
Chemmanur, T., 1993, The pricing of
initial public offerings: A dynamic model with information production, Journal of Finance 48, 285-304.
Chemmanur, T., and P. Fulghieri,
Investment bank reputation, information production, and financial
intermediation, Journal of Finance,
1994.
Allen, F. and G. Faulhaber, 1989,
Signaling by underpricing in the IPO market, Journal of Financial Economics 23, 303-23.
Topic Eight: Security Design/The Structure of Corporate
Liabilities
Papers:
Gale, David and Martin Hellwig (1985),
"Incentive Compatible Debt Contracts: The One Period Problem," Review of Economic Studies, 52, 646-663.
Townsend, R. (1979) "Optimal
contracts and Competitive Markets with Costly State Verification," Journal of Economic Theory, 21, 265-293.
Aghion, P., and P. Bolton, 1992, “An
‘Incomplete Contracts’ Approach to Financial Contracting,” Review of Economic Studies 59, 473-494.
Bolton, P. and D. Scharfstein,
"Optimal debt structure and the number of creditors," Journal of Political Economy 104:1 (January
1996), 1-25.
Hart, O. and J. Moore (1989),
"Default and Renegotiation: A Dynamic Model of Debt," mimeo, 1989.
Harris, Milton and Artur Raviv (1989),
"The Design of Securities," Journal
of Financial Economics, 24, 255-287.
Allen, F. and D. Gale (1988) "Optimal
Security Design," Review of
Financial Studies, 1, 229-263.
Part II: Seminar on Some Current Research Topics in Corporate Finance
In this part of the course, we will review in some detail several recent papers in two or three areas of current research in corporate finance. Students will be expected to present the papers in this part of the course (to be determined later: I am currently choosing these topics). Each paper presented should also be critiqued by two students (thus, each student will have to turn in multiple critiques). Students have to hand in their written critiques of each paper on the day of its presentation. Critique-writers, as well as presenters of various papers, should come to class prepared to answer questions arising in class discussion regarding these papers.
Presentation
Format: Each presentation
must adhere strictly to the following format (1) Statement of the problem
studied; (2) Brief survey of the literature; (3) Concise, intuitive,
explanation of the argument producing the major results (for theory papers) or
empirical methodology; (4) Summary of main results; (5)
Critical examination of the paper;
(6) Sketch of major extensions to the paper with specific suggestions
about possible solution techniques (for theory) or empirical methodology/data
for these extensions (students who can
effectively accomplish the last point will get extra credit). Most important, each presentation must
be both informative and entertaining.
Critique
Format: Critiques must be
between three to six pages in length (depending on the paper). The format of
the critiques should be roughly along the following lines: (1) Statement of the
problem studied; (2) Brief survey of the literature; (3) Concise, intuitive
explanation of the argument producing the major results (for theory papers) or
empirical methodology; (4) Summary of results; (5) Critical examination of the
paper.
Topic
Nine: Design of Firms and Other Organizations
Sah, R. K. and Stiglitz, J. E., 1986. “The
Architecture of Economic Systems: Hierarchies and Polyarchies”, American Economic Review 76, 716-727.
Harris, M. and Raviv, A., 1996. “The Capital
Budgeting Process, Incentives and Information”, Journal of Finance 51, 1139-1174.
Stein, J., 2002. “Information Production and
Capital Allocation: Decentralized vs Hierarchical Firms”, Journal of Finance 57, October.
Aghion, P. and Tirole, J., 1997. “Formal and Real
Authority in Organizations”, Journal of
Political Economy 105, 1-29.
Liberti, J. M., 2003. “Initiative, Incentives and
Soft Information. How Does Delegation Impact the Role of Bank Relationship
Managers?”, Working paper, London Business School. (This paper is to be presented in conjunction with the previous one).
Topic
Ten: Share Allocation, Trading, and Long-term Returns around IPOs
and SEOs
Papers:
Boehmer, Beatrice,
Ekkehart Boehmer, and Raymond P.H. Fishe, 2004, Do Institutions Receive
Favorable Allocations in IPOs with Better Long Run Returns?, Working paper,
Texas A&M University.
Field, Laura C., 1997,
Is Institutional Investment in Initial Public Offerings Related to Long-Run
Performance of these Firms?, Working Paper, Pennsylvania State University.
Ellis, Katrina, Rony
Michaely, and Maureen O’Hara, 2000, When the Underwriter Is the Market Maker:
An Examination of Trading in the IPO Aftermarket, Journal of Finance 55, 1039-1074.
Griffin,
J. M., Harris, J. H., and Topaloglu, S., 2004, IPO Underwriter Client Trading,
Working paper, University of Texas.
Gibson, Scott, Assem
Safieddine, and Ramana Sonti, 2004, Smart Investments by Smart Money: Evidence
from Seasoned Equity Offerings, Journal
of Financial Economics, forthcoming.
MF891: Doctoral Seminar in Corporate Finance