Advanced Corporate Finance
(1) Objectives and focus of the course
Under some conditions a firm‘s financial structure, i.e., its choice of leverage or of dividend policy, is irrelevant. The simplest set of such conditions is the Arrow-Debreu environment, where the value of a financial claim is equal to the value of the random return of this claim computed at the Arrow-Debreu prices. In other words, the size of the corporate pie is unaffected by the way it is carved. In this Modigliani-Miller (MM) world, we have little to say about firms’ financial choices and governance. Rather the MM Theorems act as a benchmark whose assumptions needed to be relaxed in order to investigate the determinants of financial structures. In particular, the assumption that the size of the pie is unaffected by how it is carved has to be discarded. Following path-breaking developments in information economics and game theory, the principal direction of analysis since the 1980s has been to introduce agency and informational problems at various levels of the corporate structure.
The course “Advanced Corporate Finance” offers an advanced level introduction into the theoretical background of these changes. The course follows the excellent exposition in Tirole (2006) and also reviews important contributions to a large empirical literature testing these theories. While we use scholarly articles, we also make use of other some more popular sources. More precisely, the course focuses on the following major branches of theoretical work:
(a) Focus on the incentives of the firm‘s insiders (passive outsiders!)
Insiders may have private information about the firm‘s technology or environment (adverse selection) or about the firm‘s realized income (hidden knowledge). Outsiders cannot observe the insiders‘ carefulness in selecting projects, the riskiness of investments, or the effort they exert to make the firm profitable (moral hazard). Informational asymmetries may prevent outsiders from hindering insider behavior that jeopardizes their investment.
Standard themes: financial contracting, the firm‘s temptation to over-borrow, the resulting need for covenants to restrict future borrowing, the sensitivity of investment to cash flow, „debt overhang“, determinants of borrowing capacity, market breakdown, cross-subsidization of bad borrowers by good ones, negative stock price reaction to equity offerings, the „pecking order hypothesis“, why do good borrowers use dissipative signals: e.g., costly certifiers, costly collateral?
(b) Focus on both insiders‘ and outsiders‘ incentives (less passive outsiders!)
Outsiders may occasionally affect the course of events chosen by insiders. E.g., the board of directors or a venture capitalist may dismiss the CEO or demand that insiders change their investment policy, raiders may, after a takeover, break up the firm and spin off some divisions, a bank may take advantage of a covenant violation to impose more rigor in management. Such possibilities destroy the simplicity of the classical agency relationship, and their analysis paves the way to the study of security design.
Standard themes: Social costs and benefits of passive monitoring, why are entrepreneurs and managers often compensated through stocks and stock options rather than on profits and losses? Do shareholders who are in for the long-term benefit from liquid and deep secondary markets for shares? What are the costs of monitoring? Reduction in future competition in lending? Block illiquidity? Monitor‘s private benefit of control? Allocation of formal control between insiders and outsiders, takeovers.
(c) Factors that influence the interaction between insiders and outsiders
The last decade has witnessed a growing attention on corporations’ social responsibilities, termed as “corporate social responsibility” (CSR) both in the academic literature and in the business world. This development involves the practice of responsible investing, whereby almost all categories of investors incorporate environmental, social, and governance (ESG) issues into their investment processes, and also other players in the financial markets taking similar steps. Thus, it is imperative to understand how ESG issues are integrated into the strategies and processes of corporate finance. The last section of the course focuses on these aspects.
Standard themes:Environment: Does a company’s impact on the natural ecosystem affect its riskiness and financing costs? How do investors respond to the externalities produced by companies? Social: This dimension covers a company’s relation with its workforce, customers and society. As such, it includes, e.g., its efforts to maintain loyal workers (e.g., employment quality, health and safety, training and development), satisfied customers (e.g., producing quality goods and services that keep costumers safe) and being a good citizen within the communities it operates. Governance: in the CSR context, governance is usually defined narrowly with a focus on diversity and inclusion, and hence the representation of the rights of minorities (based on gender, race, sexual orientation, etc.) on the board of directors and management, and in corporate processes. With respect to these three aspects, do firms have to undertake more than their legal obligations? What are the determinants and consequences of such voluntary actions?
| Date | Time |
|---|---|
| Thursday, 01.09.2022 | 11:30 - 15:15 |
| Tuesday, 06.09.2022 | 08:00 - 11:15 |
| Wednesday, 07.09.2022 | 11:30 - 13:00 |
| Thursday, 08.09.2022 | 09:45 - 15:15 |
| Monday, 12.09.2022 | 15:30 - 18:45 |
| Friday, 16.09.2022 | 08:00 - 11:15 |
| Tuesday, 20.09.2022 | 11:30 - 15:15 |
| Thursday, 22.09.2022 | 11:30 - 13:00 |
Discussions of major economic implications
Hands-on excercises
- Group Work: 40%
- Final Exam: 60%