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Raghavendra Rau

Raghavendra Rau

Seminar in Corporate Finance

REQUIRED/RECOMMENDED TEXTS

Joao Amaro de Matos, 2001, Theoretical foundations of corporate finance, Princeton University Press (This text has been placed on reserve in the library).

Eugene F. Fama and Merton H. Miller, 1972, The theory of finance, Dryden Press (This text is out of print but the relevant pages will be given to you).

COURSE DESCRIPTION

This is the first of a two-course sequence in corporate finance. In this course we will focus on the foundations of the modern theory of corporate finance. The first part of the course will come primarily from the Fama and Miller text and will deal with the theory of finance under perfect market conditions. After establishing this basic framework, we will incorporate various market imperfections, such as taxes, agency costs and asymmetric information, into the analysis. The Amaro de Matos book provides a short summary of the literature and is useful to get an overview of the subject before reading the papers themselves. We will look at three basic topics in this course: First, how do firms raise capital? Do they prefer to choose debt or equity? Second, do managerial incentives affect firm policy? Third, how do firms pay out their earnings to their shareholders? What determines dividend policy and the choice between dividends and share repurchases?

In the second part of the course, we will focus on testing the theory. We will cover a broad range of papers which cover the basic methodologies used in empirical corporate finance. The goal of the course is to provide a solid foundation so that the frontiers of research in corporate finance can be examined in MGMT 619. Note that this syllabus is preliminary and may change as the course progresses.

The course will be taught through a mixture of lectures and presentations. Each student will be expected to present at least 3-4 papers during the course of the semester. You are expected to have a thorough understanding of the central idea of each paper, the data and research methodology, and the conclusions drawn. Ideally, you should be able to critically evaluate each paper and also suggest possible extensions of the paper.

In addition, students should become accustomed to keeping up with the current finance literature by subscribing to the Journal of Financial Economics and the Journal of Finance. Student subscriptions are available at a discounted price.

You should be able to download all the papers published in the Journal of Finance from the JStor and the Journal website. Articles from the American Economic Review, the Journal of Political Economy and the Journal of Business are also available from the JStor site. All articles published in the Review of Financial Studies are available from the OUP website. Journal of Financial Economics articles are available from Elsevier at ScienceDirect.com after 1995. Working papers are available on SSRN. Articles which are not available from any of these sources will be given to you.

GRADES
Final Examination    20%
Class participation   20%
Presentations           20%
Term paper             20%
First-day quiz          20%

There will be a quiz on the first day of class to test your preparation for the course. The quiz will be based on Principles of Corporate Finance by Brealey and Myers (7th edition) or Corporate Finance by Ross, Westerfield and Jaffe (6th edition).

The term paper requirement is intended to get you started on research in corporate finance. For first-year students, the term paper can be a thorough literature review on a specific topic. Second-year students will be expected to propose an extension to the literature. Ideally, the term paper would be the beginnings of a thesis proposal and/or a research publication.

COURSE OUTLINE
THE BASICS

Fama & Miller, Chapter 1 and Appendix (pp. 1-57).
Fama & Miller, Chapter 2 and Appendix (pp. 58-107).
Fama & Miller, Chapter 3.
Fama & Miller, Chapter 4.

PART I: THE THEORY
A. DEBT OR EQUITY? OPTIMAL CAPITAL STRUCTURE

SUMMARIES:
Amaro de Matos, Chapter 2-3.

THE CLASSICS: SYMMETRIC INFORMATION
Modigliani, Franco, and Merton H. Miller, 1958, The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review 48, 261-297.

Miller, Merton H., 1977, Debt and taxes, Journal of Finance 32, 261-275.

DeAngelo, Harry, and Ronald W. Masulis, 1980, Optimal Capital Structure Under Corporate and Personal Taxation, Journal of Financial Economics 8, 3-29.

THE CLASSICS: ASYMMETRIC INFORMATION
Jensen, Michael C., and William H. Meckling, 1976, Theory of the firm: Managerial behavior, agency costs and ownership structure, Journal of Financial Economics 3, 305-360.

Leland, Hayne E., and David H. Pyle, 1977, Informational asymmetries, financial structure, and financial intermediation, Journal of Finance 32, 371-387.

Ross, Stephen A., 1977, The determination of financial structure: The Incentive-signalling approach, Bell Journal of Economics 8, 23-40.

Myers, Stewart C., 1977, Determinants of corporate borrowing, Journal of Financial Economics 5, 147-175.

Myers, Stewart C., and Nicholas S. Majluf, 1984, Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics 13, 187-221.

OTHER PAPERS:
Fluck, Zsuzsanna, 1998, Optimal financial contracting: Debt versus outside equity, Review of Financial Studies 11, 383-418.

Noe, Thomas, 2003, Legal-system arbitrage and the theory of multinational finance, unpublished working paper, Tulane University.

Chemmanur, Thomas, Debarshi Nandy and An Yan, 2003, Why issue mandatory convertibles? Theory and empirical evidence, unpublished working paper, Boston College.

SYNTHESES:
Chen, Andrew H., and E. Han Kim, 1979, Theories of corporate debt policy: A synthesis, Journal of Finance 34, 371-384.

Myers, Stewart C., 1984, The capital structure puzzle, Journal of Finance 39, 575-592.

Miller, Merton H., 1988, The Modigliani-Miller propositions after thirty years, Journal of Economic Perspectives 2, 99-120.

Harris, Milton, and Artur Raviv, 1991, The theory of capital structure, Journal of Finance 46, 297-355.

B. EQUITY OWNERSHIP

THE CLASSICS:

Jensen, Michael C., 1986, Agency costs of free cash flow, corporate finance and takeovers, American Economic Review 76, 323-329.

Stulz, René M., 1990, Managerial discretion and optimal financing policies, Journal of Financial Economics 26, 3-27.

Myers, Stewart C., 2000, Outside equity, Journal of Finance 55, 1005 - 1037.

C. PAYOUT POLICY

SUMMARY:
Amaro de Matos, Chapter 4.

THE CLASSICS:
Miller, Merton H., and Franco Modigliani, 1961, Dividend policy, growth, and the valuation of shares, Journal of Business 34, 411-433.

Miller, Merton H., and Myron S. Scholes, 1978, Dividends and taxes, Journal of Financial Economics 6, 333-364.

Bhattacharya, Sudipto, 1979, Imperfect information, dividend policy, and “the bird in the hand” fallacy, Bell Journal of Economics 10, 259-270.

Miller, Merton H., and Kevin Rock, 1985, Dividend policy under asymmetric information, Journal of Finance 40, 1031-1051.

OTHER PAPERS:
Allen, Franklin, Antonio E. Bernardo, and Ivo Welch, 2000, A theory of dividends based on tax clienteles, Journal of Finance 55, 2499-2536.

Fan, Hua, and Suresh M. Sundaresan, 2000, Debt valuation, renegotiation, and optimal dividend policy, Review of Financial Studies 13, 1057-1099.

PART II: EMPIRICAL TESTS
A. DEBT VERSUS EQUITY

SYNTHESES:
Graham, John R., and Campbell R. Harvey, 2001, The theory and practice of corporate finance: Evidence from the field, Journal of Financial Economics 60, 187-243.

Graham, John R., 2003, Taxes and corporate finance: A review, Review of Financial Studies forthcoming.

TAXES:
Graham, John R., 1996, Debt and the marginal tax rate, Journal of Financial Economics 41, 41-73.

Fama, Eugene, and Kenneth R. French, 1998, Taxes, financing decisions and firm value, Journal of Finance 53, 819-843.

Graham, John R., 2000, How big are the tax benefits of debt?, Journal of Finance 55, 1901–1941.

Graham, John R., Douglas A. Shackelford, and Mark H. Lang, 2003, Employee stock options, corporate taxes and debt policy, Journal of Finance forthcoming.

AGENCY COSTS:
Berger, Philip G., Eli Ofek, and David L. Yermack, 1997, Managerial entrenchment and capital structure decisions, Journal of Finance 52, 1411-1438.

Hanka, Gordon, 1998, Debt and the terms of employment, Journal of Financial Economics 48, 245-282.

Parrino, Robert, and Michael S. Weisbach, 1999, Measuring investment distortions arising from stockholder-bondholder conflicts, Journal of Financial Economics 53, 3-42.

TRADEOFF THEORY:
Berens, James L., and Charles J. Cuny, 1995, The capital structure puzzle revisited, Review of Financial Studies 8, 1185-1208.

Shyam-Sunder, Lakshmi, and Stewart C. Myers, 1999, Testing static tradeoff against pecking order models of capital structure, Journal of Financial Economics 51, 219-244.

Chirinko, Robert S., and Anuja R. Singha, 2000, Testing static tradeoff against pecking order models of capital structure: A critical comment, Journal of Financial Economics 58, 417-425.

Hovakimian, Armen, Tim Opler, and Sheridan Titman, 2001, The debt-equity choice: An analysis of issuing firms, Journal of Financial and Quantitative Analysis 36, 1-24.

Fama, Eugene F., and Kenneth R. French, 2002, Testing tradeoff and pecking order predictions about dividends and debt, Review of Financial Studies 15, 1-33.

Frank, Murray, and Vidhan Goyal, 2003, Testing the pecking order theory of capital structure, Journal of Financial Economics 67, 217-248.

EXTERNAL FACTORS:
Dittmar, Amy K., 2002, Capital structure in corporate spin-offs, Journal of Business forthcoming.

MacKay, Peter, and Gordon Phillips, 2003, How does industry affect firm financial structure?, Unpublished working paper, University of Maryland.

Baker, Malcolm P., and Jeffrey Wurgler, 2002, Market timing and capital structure, Journal of Finance 57, 1-32.

Stulz, René M., and Rohan Williamson, 2002, Culture, openness, and finance, Journal of Financial Economics forthcoming.

COSTS OF DEBT:
Lang, Larry, Eli Ofek, and René M Stulz, 1996, Leverage, investment, and firm growth, Journal of Financial Economics 40, 3-29.

Gilson, Stuart C., 1997, Transaction costs and capital structure choice: Evidence from financially distressed firms, Journal of Finance 52, 161-196.

Andrade, Gregor, and Steven N. Kaplan, 1998, How costly is financial (not economic ) distress? Evidence from highly leveraged transactions that became distressed, Journal of Finance 53, 1443-1493.

INTERNATIONAL EVIDENCE:
Rajan, Raghuram, and Luigi Zingales, 1995, What do we know about capital structure? Some evidence from international data, Journal of Finance 50, 1421-1460.

La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W Vishny, 1997, Legal determinants of external finance, Journal of Finance 52, 1131-1150.

Harvey, Campbell R., Karl V. Lins, and Andrew H. Roper, 2003, The effect of capital structure when expected agency costs are extreme, Journal of Financial Economics forthcoming.

Fan, Joseph P. H., Sheridan Titman, and Garry Twite, 2003, An international comparison of capital structure and debt maturity choices, Unpublished working paper, Hong Kong University of Science and Technology.

OTHER FORMS OF FINANCING:
Rajan, Raghuram G., 1992, Insiders and outsiders: The choice between informed and arm’s-length debt, Journal of Finance 47, 1367-1400.

Hillion, Pierre, and Theo Vermaelen, 2003, Death Spiral Convertibles, Journal of Financial Economics forthcoming.

B. EQUITY OWNERSHIP

OWNERSHIP AND FIRM VALUE: THE CLASSICS:
Demsetz, Harold, and Kenneth Lehn, 1985, The structure of corporate ownership: Causes and consequences, Journal of Political Economy 93, 1155-1177.

Morck, Randall, Andrei Shleifer, and Robert W. Vishny, 1988, Management ownership and market valuation: An empirical analysis, Journal of Financial Economics 20, 293-315.

McConnell, John J., and Henri Servaes, 1990, Additional evidence on equity ownership and corporate value, Journal of Financial Economics 27, 595-612.

OTHER PAPERS:
McConnell, John J., and Henri Servaes, 1995, Equity ownership and the two faces of debt, Journal of Financial Economics 39, 131-157.

Denis, David J., and Atulya Sarin, 1999, Ownership and board structures in publicly traded corporations, Journal of Financial Economics 52, 187-223.

Himmelberg, Charles P., R. Glenn Hubbard, and Darius Palia, 1999, Understanding the determinants of managerial ownership and the link between ownership and performance, Journal of Financial Economics 53, 353-384.

Ang, James S., Rebel A. Cole, and James Wuh Lin, 2000, Agency costs and ownership structure, Journal of Finance 55, 81 - 106.

C. PAYOUT POLICY: DIVIDENDS AND SHARE REPURCHASES

THE CLASSICS:
Lintner, John, 1956, Distribution of incomes of corporations among dividends, retained earnings, and taxes, American Economic Review 46, 97-113.

Miller, Merton H., and Myron S. Scholes, 1982, Dividends and taxes: Some empirical evidence, Journal of Political Economy 90, 1118-1141.

Fama, Eugene F., and Kenneth R. French, 2001, Disappearing dividends: Changing firm characteristics or lower propensity to pay?, Journal of Financial Economics 60, 3-43.

THE CHOICE BETWEEN REPURCHASES AND DIVIDENDS:
DeAngelo, Harry, Linda DeAngelo, and Douglas J. Skinner, 2003, Are dividends disappearing? Dividend concentration and the consolidation of earnings, Journal of Financial Economics forthcoming.

Grullon, Gustavo, and Roni Michaely, 2002, Dividends, share repurchases and the substitution hypothesis, Journal of Finance 57, 1649-1684.

Jagannathan, Murali, Clifford P. Stephens, and Michael S. Weisbach, 2000, Financial flexibility and the choice between dividends and stock repurchases, Journal of Financial Economics 57, 355-384.

Guay, Wayne, and Jarrad Harford, 2000, The cash-flow permanence and information content of dividend increases versus repurchases, Journal of Financial Economics 57, 385-415.

Dittmar, Amy, 2000, Why do firms repurchase stock?, Journal of Business 73, 321-355.

Dittmar, Amy K., and Robert F. Dittmar, 2002, Stock repurchase waves: An explanation of the trends in aggregate corporate payout policy, Unpublished working paper, Indiana University.

Brav, Alon, John R. Graham, Campbell R. Harvey, and Roni Michaely, 2003, Payout policy in the 21st Century, Unpublished working paper, Duke University.

TAXES:
Lie, Erik, and Heidi J. Lie, 1999, The role of personal taxes in corporate decisions: An empirical analysis of share repurchases and dividends, Journal of Financial and Quantitative Analysis 34, 533-552.

Rau, P. Raghavendra, and Theo Vermaelen, 2002, Regulation, taxes, and share repurchases in the United Kingdom, Journal of Business 75, 245-282.

Gentry, William M., Deen Kemsley, and Christopher J. Mayer, 2003, Dividend taxes and share prices: Evidence from Real Estate Investment Trusts, Journal of Finance 58, 261-282.

Edwin J Elton, Martin J Gruber, and Christopher R Blake, 2003, Marginal stockholder tax effects and ex-dividend-day behavior - Thirty-two years later, unpublished working paper, New York University.

AGENCY COSTS AND SIGNALING:
Vermaelen, Theo, 1981, Common stock repurchases and market signaling: An empirical study, Journal of Financial Economics 9, 139-183.

Comment, Robert, and Gregg A. Jarrell, 1991, The relative signalling power of Dutch-auction and fixed-price self-tender offers and open-market share repurchases, Journal of Finance 46, 1243-1271.

Lie, Erik, and John J. McConnell, 1998, Earnings signals in fixed-price and Dutch auction self-tender offers, Journal of Financial Economics 49, 161-186.

Ikenberry, David, Josef Lakonishok, and Theo Vermaelen, 1995, Market underreaction to open market share repurchases, Journal of Financial Economics 39, 181-208.

Ikenberry, David, and Theo Vermaelen, 1996, The option to repurchase stock, Financial Management 25, 9-24.

DeAngelo, Harry, Linda DeAngelo, and Douglas J. Skinner, 1996, Reversal of fortune: Dividend signaling and the disappearance of sustained earnings growth, Journal of Financial Economics 40, 341-371.

Denis, David J., Diane K. Denis, and Atulya Sarin, 1994, The information content of dividend changes: Cash flow signaling, overinvestment, and dividend clienteles, Journal of Financial and Quantitative Analysis 29, 567-587.

Brook, Yaron, Robert Hendershott, and Billy Charlton, 1998, Do firms use dividends to signal large future cash flow increases?, Financial Management 27, 46-57.

Fenn, George W., and Nellie Liang, 2001, Corporate payout policy and managerial stock incentives, Journal of Financial Economics 60, 45-72.

DeAngelo, Harry, and Linda DeAngelo, 2000, Controlling stockholders and the disciplinary role of corporate payout policy: A study of the Times Mirror Company, Journal of Financial Economics 56, 153-207.

DeAngelo, Harry, Linda DeAngelo, and Douglas J. Skinner, 2000, Special dividends and the evolution of dividend signaling, Journal of Financial Economics 57, 309-354.

Dhillon, Upinder, Kartik Raman, and Gabriel Ramirez, 2003, Dividends still signal future profitability, Unpublished working paper, Binghamton University.

BEHAVIORAL ISSUES:
Shefrin, Hersh M., and Meir Statman, 1984, Explaining investor preferences for cash dividends, Journal of Financial Economics 13, 253-282.

Baker, Malcolm, and Jeffrey Wurgler, 2003, A Catering Theory of Dividends, Journal of Finance forthcoming.

Hirota, Shinichi, and Shyam Sunder, 2003, Stock Market as a 'Beauty Contest': Investor Beliefs and Price Bubbles sans Dividend Anchors, Unpublished working paper, Yale School of Management.

INTERNATIONAL PAYOUT POLICY:
Dewenter, Kathryn L., and Vincent A. Warther, 1998, Dividends, asymmetric information, and agency conflicts: Evidence from a comparison of the dividend policies of Japanese and U.S. firms, Journal of Finance 53, 879-904.

La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W Vishny, 2000, Agency problems and dividend policies around the world, Journal of Finance 55, 1-33.

Frank, Murray, and Ravi Jagannathan, 1998, Why do stock prices drop by less than the value of the dividend? Evidence from a country without taxes, Journal of Financial Economics 47, 161-188.