Dynamic Corporate Finance Swiss Finance Institute - NCCR FinRisk

Dynamic Corporate Finance Swiss Finance Institute Erwan Morellec University of Lausanne 2007-2008

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Introduction

This course is designed to provide a framework for understanding the determinants of corporate …nancing, dividend, hedging, and investment policies. The course will provide an analysis of the economic determinants of each policy as well as the quantitative implementation of the considered policies.

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Course material

There is no required textbook. Readings will be based on articles. Reading assignments will follow the sequence below. Papers followed by an asterisk are strongly recommended.

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Grading

Your …nal grade will be based on an assignment (referee report) and a …nal exam. The …nal exam will be drawn from the material covered in class and the readings. You will require a calculator for the …nal exam. There will be no early or late …nal exam. There will be NO make-up …nal; students not present at the …nal exam will fail the class, unless they provide a medical certi…cate.

4

O¢ ce hours

By appointment. Send me an email to set it up.

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Capital structure with …xed investment policy Acharya, V., J. Kose, and R. Sundaram, 2004, “Cross-Country Variations in CapitalStructures: The Role of Bankruptcy Codes,” Working Paper, London Business School. Andrade, G., and S. Kaplan, 1998, “How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed”, Journal of Finance 53, 1443-1493. Black, F., and J. Cox, 1976, “Valuing Corporate Securities: Some E¤ects of Bond Indenture Provisions”, Journal of Finance 31, 351-367. (*) Franks, J. and W. Torous, 1989, “An Empirical Investigation of Firms in Reorganization”, Journal of Finance 44, 747-769. Gilson, S., 1997, “Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms”, Journal of Finance 52, 161-196. Gilson, S., K. John and L. Lang, 1990, “Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Default”, Journal of Financial Economics 27, 315-353. Graham, John R., 2000, “How Big Are the Tax Bene…ts of Debt?, Journal of Finance 55, 1901-1941. Graham, John R., 2003, “Taxes and corporate …nance: A review,” Review of Financial Studies 16, 1074-1128. Harris, M., and A. Raviv, 1991, “The Theory of Capital Structure,” Journal of Finance 46, 297-355. (*) Maksimovic, V. and G. Phillips, 1998, “E¢ ciency of Bankrupt Firms and Industry Conditions: Theory and Evidence”, Journal of Finance 53, 1495-1532. Miller, M., 1977, “Debt and Taxes,” Journal of Finance 32, 261-275. Modigliani, F., and M. Miller, 1958, “The Cost of Capital, Corporation Finance, and the Theory of Investment,” American Economic Review 48, 261-297. (*) Modigliani, F., and M. Miller, 1963, “Corporate Income Taxes and the Cost of Capital: A Correction,” American Economic Review 53, 433-443. Shleifer, A., and R. Vishny, 1992, “Liquidation Values and Debt Capacity: A Market Equilibrium Approach”, Journal of Finance 47, 1343-1366. (*) Weiss, L., 1990, “Bankruptcy Resolution: Direct Costs and Violation of Priority of Claims”, Journal of Financial Economics 27, 285-314. 2

Agency theory with capital structure applications Barclay, M., and C. Smith, 1995, “The maturity structure of corporate debt”, Journal of Finance 50, 609-631. Barclay, M., and C. Smith, 1995, “The priority structure of corporate liabilities”, Journal of Finance 50, 899-917. Barclay, M., E. Morellec, and C. Smith, 2006, “On the debt capacity of growth options”, Journal of Business 79, 37-59. Berger, P., E. Ofek, and D. Yermak, 1997, “Managerial Entrenchment and Capital Structure decisions”, Journal of Finance 52, 1411-1438. Berglöf, E., and E.-L. von Thadden, 1994, “Short-Term versus Long-Term Interests: Capital Structure with Multiple Creditors”, Quarterly Journal of Economics 109, 1055-1084. Blanchard, O., F. Lopez-de-Silanes, and A. Shleifer, 1994, “What Do Firms Do with Cash Windfalls?”, Journal of Financial Economics 36, 337-360. Bolton, P., and D. Schartfstein, 1990, “A theory of predation based on agency problems in …nancial contracting,” American Economic Review 80, 93-106. Bolton, P., and D. Schartfstein, 1996, “Optimal debt structure with multiple creditors,” Journal of Political Economy 104, 1-26. Bradley, M., and M. Roberts, 2005, “The structure and pricing of debt covenants,” working paper, Duke University. Brennan, M., and A. Kraus, 1987, “E¢ cient Financing under Asymetric Information,” Journal of Finance 42, 1225-1243. Chava, S., P. Kumar, and A. Warga, 2005, “Agency costs and the pricing of bond covenants,” working paper, University of Houston. Frank, M., and V. Goyal, 2003, “Testing the Pecking Order Theory of Capital Structure”, Journal of Financial Economics 67, 217-248. (*) Harford, J., 1999, “Corporate Cash Reserves and Acquisitions”, Journal of Finance 54, 1969-1997. Hart, O. and J. Moore, 1994, “A Theory of Debt Based on the Inalienability of Human Capital”, Quarterly Journal of Economics 109, 841-879. Hart, O. and J. Moore, 1995, “Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management”, American Economic Review 85, 567-585.

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Hennessy, C., D. Livdan, and B. Miranda, 2006, “A Dynamic Theory of Corporate Finance Based Upon Repeated Signalling,” Working Paper, UC Berkeley. Jensen, M. and W. Meckling, 1976, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure”, Journal of Financial Economics 3, 305-360. (*) Kahl, M., 2002, “Economic Distress, Financial Distress and Dynamic Liquidation”, Journal of Finance 57, 135-168. Lang, L., and R. Stulz, 1994, “Tobin’s q, Corporate Diversi…cation, and Firm Performance”, Journal of Political Economy 102, 1248-1280. Leland, H., and D. Pyle, 1977, “Informational Asymmetries, Financial Structure and Financial Intermediation,” Journal of Finance 32, 371-387. Myers, S., 1977, “Determinants of Corporate Borrowing,” Journal of Financial Economics, 5, 147-175. (*) Myers, S., and N. Majluf, 1984, “Corporate Financing and Investment Decisions when Firms Have Information that Investors Do not Have”, Journal of Financial Economics 13, 187-221. (*) Smith, C. and J. Warner, 1979, “On …nancial contracting: An analysis of bond covenants”, Journal of Financial Economics 7, June, 117-161. (*) Stein, J., 1992, “Convertible Bonds as Backdoor Equity Financing”, Journal of Financial Economics 32, 3-23. (*) Stulz, R., 1988, “Managerial Control of Voting Rights: Financing Policies and the Market for Corporate Control,” Journal of Financial Economics 20, 25-54.

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Corporate governance Bebchuk, L., A. Cohen, and A. Ferrell, 2004, “What Matters in Corporate Governance?,” Working Paper, Harvard University. Gompers, P., I. Ishii, and A. Metrick, 2003, “Corporate Governance and Equity Prices,” Quarterly Journal of Economics 118, 107-155. Jensen, M., 1986, “Agency Costs of Free Cash Flow, Corporate Finance and Takeovers,” American Economic Review 76, 323-329. John, K., and T. John, 1993, “Top-Management Compensation and Capital Structure”, Journal of Finance 48, 949-974. Kuhnen, C., and J. Zwiebel, 2007, “Executive Pay, Hidden Compensation, and Managerial Entrenchment,” Working Paper, Northwestern University. Lambrecht, B., and S. Myers, 2006, “Debt and managerial rents in a real-options model of the …rm,” forthcoming Journal of Financial Economics. La Porta, R., F. Lopez-de Silanes, A. Shleifer and R. Vishny, 1998, “Law and Finance”, Journal of Political Economy 106, 1113-1155. La Porta, R., F. López-de-Silanes, and A. Shleifer, 1999, “Corporate Ownership Around the World”, Journal of Finance 54: 471-517. La Porta, R., F. Lopez-de Silanes, A. Shleifer, and R. Vishny, 2002, “Investor Protection and Corporate Valuation”, Journal of Finance 57, 1147-1170. Stulz, R., 1990, “Managerial Discretion and Optimal Financial Policies,” Journal of Financial Economics 26, 3-27.(*) Zwiebel, J., 1996, “Dynamic Capital Structure under Managerial Entrenchment”, American Economic Review 86, 1197-1215. (*)

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Hedging policy Bessembinder, H., 1991, “Forward Contracts and Firm Value: Investment Incentives and Contracting E¤ects”, Journal of Financial and Quantitative Analysis 26, 519-532. (*) Boyle, G., and G. Guthrie, 2003, “Hedging the Value of Waiting”, Working Paper, University of Otago. Bartram, S., G. Brown, and F. Fehle, 2004, “International Evidence on Financial Derivatives Usage,”Working Paper, University of North Carolina. Fehle, F., and S. Tsyplakov, 2005, “Dynamic Risk Management: Theory and Evidence,” Journal of Financial Economics 78, October, 3-47. Froot, K., D. Scharfstein, and J. Stein, 1993, “Risk Management: Coordinating Corporate Investment and Financing Policies,” Journal of Finance 48, 1629-1658. (*) Graham, J., and C. Smith, 1999, “Tax Incentives to Hedge,” Journal of Finance 53, 2241-2262. Leland H., 1998, “Agency Costs, Risk Management, and Capital Structure,” Journal of Finance 53, 1213-1243. Mello, A., and J. Parsons, 2000, “Hedging and Liquidity”, Review of Financial Studies 13, 127-153. (*) Mello, A., J. Parsons and A. Triantis, 1995, “An Integrated Model of Multinational Flexibility and Financial Hedging,” Journal of International Economics 39, 27-52. Morellec, E., and C. Smith, 2006, “Agency Con‡icts and Risk Management,” Review of Finance. Purnanandam, A., 2004, “Financial Distress and Corporate Risk Management: Theory and Evidence,” Working Paper, University of Michigan. Smith, C. and R. Stulz, 1985, “The Determinants of Firms’Hedging Policies”, Journal of Financial and Quantitative Analysis 20, 391-405. (*)

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Implementing optimal capital structure DeMarzo, P., and Y. Sannikov, “A Continuous Time Agency Model of Optimal Contracting and Dynamic Capital Structure,” Journal of Finance, forthcoming. Fan, H. and S. Sundaresan, 2000, “Debt Valuation, Renegotiation, and Optimal Dividend Policy,” Review of Financial Studies 13, 1057-1099. Hackbarth, D., C. Hennessy, and H. Leland, 2005, “Can the tradeo¤ theory explain debt structure,” Review of Financial Studies, forthcoming. Hackbarth, D., J. Miao, and E. Morellec, 2006, “Capital Structure, Credit Risk, and Macroeconomic Conditions,” Journal of Financial Economics 82, 519-550. Hennessy, C., and T. Whited, 2005, “Debt Dynamics,”Journal of Finance 60, 1129-1165. Hennessy, C., and T. Whited, 2007, “How Costly is External Financing? Evidence from a Structural Estimation,” Journal of Finance 62, 1705-1743. Hege, U., and P. Mella-Barral, 2003, “Repeated Dilution of Di¤usely Held Debt,”Journal of Business, forthcoming. Leland H., 1998, “Agency Costs, Risk Management, and Capital Structure,” Journal of Finance 53, 1213-1243. (*) Leland, H., 1994, “Corporate Debt Value, Bond Covenants, and Optimal Capital Structure,” Journal of Finance 49, 1213-1252. (*) Mella-Barral, P. and W. Perraudin, 1997, “Strategic Debt Service”, Journal of Finance 52, 531-556. Mello, A. and J. Parsons, 1992, “Measuring the Agency Cost of Debt,”Journal of Finance 47, 1887-1904. Miao, J., 2005, “Optimal Capital Structure and Industry Dynamics in Stationary Equilibrium,” Journal of Finance 60, 2621-2659. Morellec, E., 2001, “Asset Liquidity, Capital Structure and Secured Debt”, Journal of Financial Economics 61, 173-206. Morellec, E., 2004, “Can Managerial Discretion Explain Observed Leverage Ratios?” Review of Financial Studies 17, 257-290. (*) Morellec, E., B. Nikolov, and N. Schuerho¤, 2008, “Dynamic Capital Structure under Managerial Entrenchment: Evidence from a Structural Estimation,”working paper, University of Lausanne. Strebulaev, I., 2007, “Do Tests of Capital Structure Mean What They Say?” Journal of Finance 62, 1747-1787.(*) 7

Real options Abel, A. and J. Eberly, 1994, “A Uni…ed Model of Investment under Uncertainty”, American Economic Review 84, 1369-1384. (*) Boyle, G., and G. Guthrie, 2003, “Investment, Uncertainty, and Liquidity”, Forthcoming Journal of Finance. (*) Dixit, A., 1989, “Entry and Exit Decisions under Uncertainty”, Journal of Political Economy 97, 620-638. Dixit, A. and R. Pindyck, 1994, Investment Under Uncertainty, Princeton, NJ: Princeton University Press, Chapters 1-6. Dumas, B., 1991, “Super Contact and Related Optimality Conditions”, Journal of Economic Dynamics and Control 15, 675-685. (*) Grenadier, S., 2002, “Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms”, Review of Financial Studies 15, 691-721. (*) Grenadier, S., 1999, “Information Revelation Through Option Exercise”, Review of Financial Studies 12, 95-129. Grenadier, S., 1996, “The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets,” Journal of Finance 51, 1653-1679. Grenadier, S., and N. Wang, 2005, “Investment timing, agency, and information,”Journal of Financial Economics 75, 493-533. Hennessy, C., 2004, “Tobin’s Q, debt overhang, and investment,”Journal of Finance 59, 1717-1742. Lambrecht, B., Perraudin W., 2003. Real options and preemption under incomplete information. Journal of Economic Dynamics and Control 27, 619-643. Leahy, J., 1993, “Investment in Competitive Equilibrium: The Optimality of Myopic Behavior”, Quarterly Journal of Economics 108, 1005-1033. McDonald, R., and D. Siegel, 1986, “The Value of Waiting to Invest”, Quarterly Journal of Economics 101, 707-728. Novy-Marx, R., 2004, “An Equilibrium Model of Investment Under Uncertainty”, Working Paper, University of Chicago. (*) Pindyck, R., 1991, “Irreversibility, Uncertainty, and Investment”, Journal of Economic Literature 29, 1110-1152. (*) Pindyck, R., 1988, “Irreversible Investment, Capacity Choice, and the Value of the Firm”, American Economic Review 78, 969-985. (*) 8

Corporate …nance and asset pricing Aguerrevere, F., 2006, “Real options, product market competition, and asset returns,” Working Paper, University of Alberta. Berk, J., R. Green, and V. Naik, 1999, “Optimal investment, growth options, and security returns,” Journal of Finance 54, 1553–1607. (*) Berk, Jonathan B., Richard C. Green, and Vasant Naik, 2004, “The valuation and return dynamics of new ventures,” Review of Financial Studies 17, 1–35. Carlson, M., A. Fisher, and R. Giammarino, 2005, “Corporate Investment and Asset Price Dynamics: Implications for the Cross-Section of Returns,”Journal of Finance 59, 2577-2603. Carlson, M., A. Fisher, and R. Giammarino, 2005, “Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long-Run Performance,” Forthcoming Journal of Finance. (*) Cooper, Ilan, 2005, “Asset Pricing Implications of Non-Convex Adjustment Costs and Irreversibility of Investment,” Journal of Finance, Forthcoming. Garlappi, L., T. Shu, and H. Yan, 2007, “Default Risk, Shareholder Advantage, and Stock Returns,” Review of Financial Studies, Forthcoming. Garlappi, L., T. Shu, and H. Yan, 2007, “Financial Distress and the Cross-Section of Equity Returns,” Working Paper, University of Texas at Austin. (*) Gomes, J., and L. Schmid, “Levered Returns,” Working Paper, Wharton School. Hackbarth, D., and E. Morellec, 2007, “Stock returns in mergers and acquisitions,”Forthcoming Journal of Finance. (*) Li, E.X., 2006, “Corporate governance, the cross section of returns, and …nancing choices”, Working Paper, University of Rochester. Novy-Marx, R., 2004, “Investment-Cash Flow Sensitivity and the Value Premium”, Working Paper, University of Chicago. Sagi, J., and M. Seasholes, 2007, “Firm Speci…c Attributes and the Cross-Section of Momentum,” Journal of Financial Economics 84, 389-434. (*)

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