Prof. Thomas
Chemmanur
Office: Fulton 440
Phone: (617) 552 3980
e-mail: chemmanu@bc.edu
Web-page: www2.bc.edu/~chemmanu
Fall 2008
BOSTON COLLEGE
Wallace
E. Carroll
School
of Management
MF891: Doctoral
Seminar in Corporate Finance
Course Objective
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 which covers corporate finance comprehensively. Two Ph.
D. level text books which provides at
least some coverage of the main topics are by Jean Tirole or by J. A. De Matos:
1. Tirole, Jean, The Theory of Corporate Finance , Princeton University Press, 2005.
This is a new book by one of the top economists working
in corporate finance, game theory,
and applied Industrial Organization.
While it is reasonably good, I want to emphasize that I will not follow any
text book, but teach directly from academic papers. If you are going to buy one
Ph.D level in corporate finance, this would be a good choice.
2. J. A. de Matos,
Theoretical Foundations
of Corporate Finance, Princeton
University Press, 2002. This is an
earlier Ph.D. level text book.
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:
3. 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.
4. 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:
5. 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: Brief Review of Mechanism Design and the Revelation
Principle.
Papers:
Myerson, R., Mechanism Design, a Review, Unpublished
Working paper
Myerson, R., Nobel Memorial Lecture, reprinted in the American Economic Review, 2008.
Topic Six: 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 Seven: 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 Eight: 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 Nine: 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 several areas of current research in
corporate finance. Each paper presented in this part of the course 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.