UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN
College of Business DEPARTMENT OF FINANCE
Finance 594: CORPORATE FINANCE
Professor: Heitor Almeida Class Time: Wednesday, 11:00 – 1:50 Class Location: BIF 4001 E-mail: [email protected]
Phone: 217-333-2704 Office: BIF 4037 Office Hours: by appointment, open door policy Website: on compass2G Course Description A thorough doctoral level class on corporate finance, covering both theory and empirical work. In the first part of the course we will cover corporate financing decisions, with an emphasis on the interactions between financing and real investment decisions. We will try to discuss several approaches to corporate financing decisions, in particular agency- and information-based theories, and static trade-off arguments (taxes and financial distress). In the second part of the course we will study the theory of financial intermediation (banking) and some benchmark empirical papers. Finally, we will study equilibrium interactions among firms, and the macroeconomic implications of corporate financing frictions. If we don’t have time to cover a specific topic that you might become interested in, you can use the reading list as a platform to approach that topic. Intended Audience This course is largely intended to help prepare students for research in the area of Corporate Finance. Hopefully, this course will be stimulating enough that you will become interested in writing a thesis in Corporate Finance. Course Requirements
Students are required to do the assigned readings prior to class, and participate in the class discussion. Readings marked with * are required, while the other readings are recommended but not required. I will cold-call students to answers questions about the readings, and if it becomes obvious that you have not done the readings, it will affect your participation grade. Students are required to hand in the solutions to the problem sets that I will distribute during the year. In some cases the problem sets will involve empirical work. I recommend that you use Stata to do your homework, but any software is fine as long as you deliver the “correct” result. I will give you the data that you need for these empirical problems. All students will be required to write referee reports on two papers that I will distribute later. Students are encouraged to work in groups to do the problem sets, but the referee reports are individual work. Students need to present an individual final project, which is described below. Final Project The final project will consist of a written report and a presentation. Each student is expected to replicate the results of an empirical paper which was published in a top Finance journal. I will provide you with a list of empirical papers to select from. Papers are available on a first-come-first-served basis. I will also provide you with a list of tables from each paper that you should attempt to replicate, and general instructions on what to do in each paper. Each paper should require approximately the same amount of work. Besides the replication, each student must prepare a critical discussion of the paper. The student must explain the key motivation for the paper, and discuss why the paper was successful in reaching a top journal. Then, each student should briefly discuss the key hypotheses that the paper tests, and explain the data collection and methodology for the replication exercise. After presenting the replication, the student should present a critical discussion of the results in the paper. In particular, do the results support the hypotheses and interpretation suggested by the authors? What is the contribution of the paper to the literature? What are the potential problems with the paper, and which questions does the paper leave open? Finally, try to formulate a couple of follow up ideas that stem from your analysis of the paper. These ideas could be extensions of the paper’s analysis, or additional tests to prove or disprove the paper’s main thesis. Each student should prepare a presentation of his or her work, and present to the entire class at the last day of classes (to be determined later). I will try to allocate 30 minutes for each paper, including questions from the audience. Presentation skills are absolutely essential in our profession, and so you really need to start practicing as early as possible. The final grade will be based both on the written report and the presentation, 50% for each.
Grading Policy The final grade will be constructed as follows: Class participation Problem sets Referee reports Final project and presentation Reading List We will cover several articles and working papers. Most are available from journal web pages, NBER, SSRN, and JSTOR. See reading list below. We will also use the following textbook for several class topics. Tirole, J., The Theory of Corporate Finance, Princeton University Press, 2006. I refer to this book below as “Tirole’s TCF”. I think it is a good idea to purchase this textbook, since it is a useful reference to most (though not all) important corporate finance topics. It focuses mostly on theory, so we will complement the textbook with discussion of several empirical papers. In addition, Tirole’s book leaves out several important topics, which we will try to discuss as well. The book’s website (http://press.princeton.edu/titles/8123.html) contains some useful information including an errata, teaching transparencies and problem solutions. BIF Emergency Procedures Because BIF is not a designated tornado shelter, in the event of a tornado warning please seek shelter in the Wohlers Hall basement or the Armory (the nearest designated University tornado shelters). If a tornado is imminent, the BIF basement stairwells can be used on an emergency basis. In the event of a fire in BIF, exit BIF and proceed to 141 Wohlers Hall. In the event of threat from a shooter on campus, lock down the classroom and move to a place of safety within the classroom. If you encounter a suspicious package, do not touch the package, alert campus security, and refrain from cell phone usage until the situation is resolved. More detailed information and action instructions are available in the BIF Building Emergency Action Plan. 20% 30% 20% 30%
List of Topics 1. Financial Policy, Capital Structure, and Corporate Investment
1.1 Some stylized facts, and the M&M theorem * Tirole’s TCF chapter 2. 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. (1988), “The M-M Propositions After 30 Years,” Journal of Economic Perspectives 2 (no. 4): 99-120. Booth, L., V. Aivazian, A. Demirguc-Kunt, and V. Maksimovic, 2001, Capital structures in developing countries, Journal of Finance 56, 87-130. * Rajan, R. and L. Zingales, 1995, What do we know about capital structure? Some evidence from international data, Journal of Finance 50, 1421-1460. * Frank, M. and V. Goyal, 2004, Capital Structure Decisions: Which Factors are Reliably Important? Working paper. * Lemmon, M., M. Roberts and Jaime F. Zender, “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structure” Journal of Finance, 2008, 63: 1-37 1.2 Trade-off theory Graham, John R. (2000), “How Big Are the Tax Benefits of Debt?,” Journal of Finance 55: 1901-1941. * (Section 1) Graham, John (2003), “Taxes and Corporate Finance, A Review,” Review of Financial Studies. Altman, Edward, 1984, A Further Empirical Investigation of the Bankruptcy Cost Question, Journal of Finance 39, 1067-1089. * Andrade, Gregor and Steven Kaplan, 1998, How Costly is Financial (not Economic) Distress? Evidence from Highly Leveraged Transactions that Become Distressed, Journal of Finance 53, 1443-1493. Opler, Tim and Sheridan Titman, 1994, Financial Distress and Corporate Performance, Journal of Finance 49, 1015-1040. * Almeida, Heitor and Thomas Philippon, 2007, “The Risk-Adjusted Cost of Financial Distress“, Journal of Finance, December Elkamhi, R., Ericsson, J., and Parsons, C., 2012 The Cost and Timing of Financial Distress, Journal of Financial Economics, 105: 62-81. * Chen, H., "Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure" Journal of Finance, 2010, 65(6): 2171-2212 1.3 Financing capacity and investment-cash flow sensitivities * Tirole’s TCF chapters 3.1, 3.2, 3.4.1, 3.4.2, 4.3.1.
* Erickson, T., and T. Whited, 2000, ``Measurement Error and the Relationship between Investment and Q, Journal of Political Economy 108, 1027-1057. * Fazzari S., R. G. Hubbard, and B. Petersen, 1988, ``Financing Constraints and Corporate Investment, Brooking Papers on Economic Activity 1, 141-195. Hubbard, R. G., 1998, ``Capital Market Imperfections and Investment,'' Journal of Economic Literature 36, 193-227. * Kaplan, S., and L. Zingales, 1997, ``Do Financing Constraints Explain why Investment is Correlated with Cash Flow?'' Quarterly Journal of Economics 112, 169-215. * Rauh, J., 2006, ``Investment and Financing Constraints: Evidence from the Funding of Corporate Pension Plans,'' Journal of Finance 61, 33-71. * Tor-Erik Bakke, Toni Whited. "Threshold Events and Identification: A Study of Cash Shortfalls," Journal of Finance 25 (2012): 1286-1329. Almeida, Heitor, and Murillo Campello, 2007, ``Financing Constraints, Asset Tangibility, and Corporate Investment,'' Review of Financial Studies 20, 1429-1460. Stein, J., 2003, “Agency Information and Corporate Investment,'' in G. Constantinides, M. Harris, and R. Stulz (eds.), Handbook of the Economics of Finance, Elsevier/North-Holland, Amsterdam (part A). 1.4 Debt versus outside equity: incentives and investment distortions * Tirole’s TCF 3.3, 3.4.3 Jensen, Michael C. and William H. Meckling (1976), “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics 3: 305360. Myers, S., 1977. Determinants of corporate borrowing. Journal of Financial Economics 5, 147-175. * Lang, L., E. Ofek, and R. Stulz, 1996, Leverage, Investment and Firm Growth, Journal of Financial Economics 40, 3-29. Rauh, Joshua, 2009, ``Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans,'' Review of Financial Studies. * Eisdorfer, A., 2008, ``Empirical Evidence of Risk-Shifting in Financially Distressed Firms,'' forthcoming, Journal of Finance.
* Hennessy, C., 2004, “Tobin’s Q, Debt Overhang, and Investment,” Journal of Finance 59, 1717-1742. 1.5 Corporate diversification and internal capital markets * Tirole’s TCF Chapters 4.2 and 10.5 Stein, J., 2003, ``Agency Information and Corporate Investment,'' in G. Constantinides, M. Harris, and R. Stulz (eds.), Handbook of the Economics of Finance, Elsevier/North-Holland, Amsterdam (part B). * Stein, Jeremy C., 1997, “Internal Capital Markets and the Competition for Corporate Resources,” Journal of Finance, 52: 111-133. * Lamont, O. 1997, Cash Flow and Investment: Evidence from Internal Capital Markets, Journal of Finance, [reprinted in Empirical Corporate Finance, 2001, edited by Michael J. Brennan] Rajan, Raghuram, Henri Servaes and Luigi Zingales (2000), “The Cost of Diversity: The Diversification Discount and Inefficient Investment,” Journal of Finance, 55: 35-80. Duchin, R., 2010, Cash Holdings and Corporate Diversification, Journal of Finance 65, 955992. Almeida, H., Kim, C.S., Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis, 2013. * Giroud, X., Mueller, 2013, Capital and Labor Reallocation Inside Firms. 1.6 Long term finance and corporate liquidity management * Tirole TCF Chapter 5, 15 * Almeida, H., M. Campello, and M. Weisbach, 2004, ``The Cash Flow Sensitivity of Cash,'' Journal of Finance 59, 1777-1804. * Froot, K., D. Scharfstein, and J. Stein, 1993, ``Risk Management: Coordinating Corporate Investment and Financing Policies,” Journal of Finance 48, 1629-1658. * Sufi, Amir, 2009, ``Bank Lines of Credit in Corporate Finance: An Empirical Analysis,'' Review of Financial Studies. Jensen, Michael C., 1986, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers,” American Economic Review 76: 323-329.
* Acharya, V., H. Almeida, and M. Campello, 2007, “Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies,'' Journal of Financial Intermediation. Opler, T., L. Pinkowitz, R. Stulz, and R. Williamson, 1999, ``The Determinants and Implications of Corporate Cash Holdings,'' Journal of Financial Economics 52, 3-46. Holmstrom, B., and J. Tirole, 1998, “Private and Public Supply of Liquidity,'' Journal of Political Economy 106, 1-40. * Acharya, V., H. Almeida and Murillo Campello, 2013. Aggregate Risk and the Choice Between Cash and Lines of Credit, forthcoming Journal of Finance Acharya, H. Almeida, Filippo Ippolito and Ander Perez-Orive,Credit Lines as Monitored Liquidity Insurance: Theory and Evidence, 2012. Forthcoming, Journal of Financial Economics. 1.7 The free cash flow problem, and payout policy * Tirole TCF Chapter 5 Brav, Alon, John R Graham, Campbell R Harvey, and Roni Michaely, 2005, Payout Policy in the 21st Century, Journal of Financial Economics 77, 483–527. * Grullon, G, and R Michaely, 2004, The Information Content of Share Repurchase Programs, The Journal of Finance 59, 651–680. Ikenberry, David Lawrence, Josef Lakonishok, and Theo Vermaelen, 1995, Market Underreaction to Open Market Share Repurchases, Journal of Financial Economics 39, 181– 208. Almeida, Fos, Kronlund, 2013,The Real Effects of Share Repurchases. Michaely, Roni and Michael R. Roberts, 2012, Corporate Dividend Policies: Lessons from Private Firms, Review of Financial Studies 25, 711-746. 1.8 Asymmetric information and corporate financing * Tirole’s TCF chapter 6 Myers, Stewart C. (1984), “The Capital Structure Puzzle,” Journal of Finance 39: 575-592. Asquith, P. and D. Mullins (1986), Seasoned Equity Offerings, Journal of Financial Economics 15: 61-89. Fama, Eugene and Kenneth 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. Shyam-Sunder, Lakshimi, and Stewart Myers, 1999, “Testing Static Tradeoff against Pecking Order Models of Capital Structure,'' Journal of Financial Economics 51, 219-244. Leary, Mark T. and Michael R. Roberts, 2010, The Pecking Order, Debt Capacity, and Information Asymmetry, Journal of Financial Economics 95, 332-355. Myers, Stewart C. and N. Majluf (1984), “Corporate Financing and Investment Decision when Firms Have Information that Investors Do Not Have,” Journal of Financial Economics 13: 187-222. Almeida, H. and Campello, M., 2010, “Financing Frictions and the Substitution Between Internal and External Funds”, with Murillo Campello. Forthcoming, Journal of Financial and Quantitative Analysis.
2. Financial intermediation
2.1 Bank lending * Tirole’s TCF Chapter 13.3.1, 13.3.2. Holmstrom, B., and J. Tirole, 1997, “Financial Intermediation, Loanable Funds and the Real Sector,'' Quarterly Journal of Economics 112, 663-91. Kashyap, Anil K and Jeremy C. Stein (2000), “What Do a Million Observations on Banks Say About the Transmission of Monetary Policy?,” American Economic Review, 90, 407-428. 2.2 Liquidity insurance * Tirole’s TCF Chapter 12 * Diamond, Douglas and Philip Dybvig (1983), “Bank Runs, Deposit Insurance and Liquidity,” Journal of Political Economy, 91, 401-419. Diamond, Douglas (1984), “Financial Intermediation and Delegated Monitoring,” Review of Economic Studies, 51, 393-414. Gorton, Gary and George Pennacchi (1990),“Financial Intermediaries and Liquidity Creation,” Journal of Finance 45, No. 1, March. Diamond, Douglas (1991), “Monitoring and Reputation: The Choice Between Bank Loans and Directly Placed Debt,” Journal of Political Economy 99, 689-721.
* Kashyap, A., R. Raghuram, and J. Stein, 2002, “Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking, Journal of Finance 57, 33-73. Gatev, E., and P. Strahan, 2006, Banks' Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market, Journal of Finance 61, 867-892. Pennacchi, G., 2006, Deposit Insurance, Bank Regulation, and Financial System Risks, Journal of Monetary Economics 53, 1-30. * Gatev, E., T. Schuermann, and P. Strahan, 2009, “Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions”, Review of Financial Studies, 22, p 995-1020. 2.3 Real effects of bank monitoring * Chava, Sudheer and Michael R. Roberts, 2008, How does Financing Impact Investment? The Role of Debt Covenants, Journal of Finance 63, 2085-2121. Roberts, Sufi, Renegotiation of Financial Contracts: Evidence from Private Credit Agreements, Journal of Financial Economics, August 2009, 93(2), 159-184 Roberts, Sufi, Control Rights and Capital Structure: An Empirical Investigation, Journal of Finance, August 2009, 64(4), 1657-1695 Nini, G., D. C. Smith, and A. Sufi, 2009, Creditor control rights and firm investment policy. Journal of Financial Economics, 92 (3), 400-420. * Nini, G., D. C. Smith, and A. Sufi, Creditor Control Rights, Corporate Governance, and Firm, Review of Financial Studies, 2012, 25: 1713-1761
3. Macroeconomic effects and interactions among firms
3.1 The financial accelerator and the lending channel * Tirole’s TCF Chapter 13.1, 13.2, 13.3.2, 13.3.3 * Lemmon, Michael and Michael R. Roberts, 2010, The Response of Corporate Financing and Investment to Changes in the Supply of Credit, Journal of Financial and Quantitative Analysis 45, 555-587 * Almeida, Campello, Laranjeira, and Weisbenner,Corporate Debt Maturity and the Real Effects of the 2007 Credit Crisis, 2012. Critical Finance Review, 1, p. 3-58. * Paravisini, Daniel (2008) Local bank financial constraints and firm access to external finance The journal of finance, 63 (5). 2161-2193.
* Khwaja and Mian, “Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market” American Economic Review, Vol. 98, Number 4, September 2008. Chava, Purnanandam , The Effect of Banking Crisis on Bank-Dependent Borrowers, Journal of Financial Economics 2011 Bernanke, B., M. Gertler, and S. Gilchrist, 1996, ``The Financial Accelerator and the Flight to Quality,'” Review of Economics and Statistics 78, 1-15. Bernanke, B. and M. Gertler, 1989, ``Agency costs, net worth, and business fluctuations,'' American Economic Review 79, 14-31. Gertler, M., and S. Gilchrist, 1994, ``Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms,'' Quarterly Journal of Economics 109, 309-340. 3.2 The bank liquidity channel Notes to be provided Irani, R., Bank Health and Corporate Liquidity Provision, Updated September 2012. 3.3 Equilibrium interactions among firms * Tirole’s TCF chapter 14.1, 14.2.1, 14.2.2, 14.2.5 Maksimovic, V. and G. Phillips. 2001. The market for corporate assets: who engages in mergers and asset sales and are there efficiency gains? Journal of Finance 56:2019–2065. Almeida, H., and D. Wolfenzon, 2005, The effect of external finance on the equilibrium allocation of capital, Journal of Financial Economics 75, 133-164. Shleifer, A., and R. Vishny, 1992, ``Liquidation Values and Debt Capacity: A Market Equilibrium Approach,” Journal of Finance 47, 1343-1365. Almeida, H., D. Wolfenzon, 2006, “Should Business Groups Be Dismantled? The Equilibrium Costs of Efficient Internal Capital Markets", Journal of Financial Economics 79, p. 99-144. Almeida, H., M. Campello and D. Hackbarth, 2012. Liquidity Mergers. Journal of Financial Economics.