Prof. Thomas J. Chemmanur
Office: Fulton 440
Phone: (617) 552 3980
Spring 2006
e-mail: chemmanu@bc.edu
web-page: www2.bc.edu/~chemmanu

BOSTON COLLEGE

Wallace E. Carroll School of Management

 

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, McGraw-Hill, New York (hereafter, "Chew"). A number of the readings can be found in this book; these readings will be indicated as such in the schedule below.

2. Packet of cases and readings (hereafter, "Course Packet"), available from the bookstore.

3. Readings (articles), mentioned in the accompanying outline but not contained in either the Chew book, or in the course packet, will be handed out in class.

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., McGraw Hill, New York (or any other edition you may have).

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, New York, 1994. Chapters 5 to 10 of this book contain a readable survey of applied valuation; also somewhat useful for the real-options material.

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)            30%

Mid-term                                                                                                 20%      

Class participation                                                                                   10%

Final                                                                                                        40%

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 travelling, 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 (Jan  18)  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). 

READING Asquith, P., and D. Mullins: Signalling with Dividends, Stock Repurchases, and Equity Issues, section I (Course Pack).

READING: MM Propositions after thirty years (Chew).

PROBLEM SET IV Problems 1 to 4.

Session 2  (Jan 25) 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 Asquith, P., and D. Mullins: Signalling with Dividends, Stock Repurchases, and Equity Issues, sections II- VII (Course Pack).

READING "The case for (and against) stock buybacks" (Class handout)

READING Smith, C: "Raising capital: Theory and Evidence" (Chew)

PROBLEM SET-IV Problem 5.

Session 3 (Feb 1)  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).

READING: Welch, Ivo, “A First Course in Corporate Finance,” Chapter 10: “Valuation  using Comparables” (Free download after registration from Author’s website).

PROBLEM SET-I (All problems)

Session 4 (Feb 8) 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 (Feb 15) CASE DISCUSSION AND WRITE-UP: Apex Investment Partners.

Session 6 (Feb 22): 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 (ADVANCED) Chemmanur, T., "The pricing of initial public offerings: A dynamic model with information production," pages 285-287 and 299-301 (Course Pack).

READING Loughran, Ritter, and Rydqvist: "Initial Public Offerings: International Insights." (Class Handout)

READING: Chemmanur, Thomas, and Imants Paeglis: “Management Quality, Certification, and Initial Public Offerings” (Download Here).

PROBLEM SET-I Problem 4.

Session 7 (March 1) 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).

================ March 8: SPRING BREAK ==============

Session 8 (March 15) 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: California PERS (A)

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 (March 22) 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 (March 29)  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 (Apr 5)  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)

========= April 12: EASTER BREAK =====================

Session 12 (Apr 19) 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 (Apr 26) 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): Corporate Restructuring: Spin-offs, tracking stock, and equity carve-outs.

READING: Cusatis, Miles, and Woolridge, “Some new evidence that spin-offs create value” (Chew).

READING Chemmanur and Paeglis: “Why Issue Tracking Stock? Insights from a  Comparison with Spin-offs and Carve Outs.” (Download  from website).

READING (ADVANCED): Chemmanur and Yan, “A Theory of Corporate Spin-offs” (Download from web site).

Session 14  (May 3): FINAL EXAM


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