Prof. Thomas Chemmanur

Office: Fulton 440

Phone: (617) 552 3980

E-mail:

Web-page: www2.bc.edu/~chemmanu

Spring 2006

BOSTON COLLEGE

Wallace E. Carroll School of Management

MF891: Doctoral Seminar in Corporate Finance

Course Objective

This course has the objective of introducing doctoral students to theoretical research in corporate finance. The emphasis will be on incomplete information models, though a few models driven by other considerations will also be studied. The first part of the course (around two thirds) will examine the fundamentals of corporate finance theory (e.g., the theory of the firm's choice of its capital structure and dividend policy under alternative assumptions), as well as various tool areas in corporate finance (e.g, the notion of moral hazard and agency problems, adverse selection and signalling, various aspects of non-cooperative games with and without incomplete information, and the equilibrium concepts in such games). The second part of the course will focus on two or three important related topics which are the focus of recent research in corporate finance (this part of the course changes every year; it is suggested that students look at syllabi from earlier years for references on other current topics of research in corporate finance) .

Pre-requisites: Since many of the models in corporate finance make use of tools from information economics/game theory, some knowledge of these tools is required. But those who do not have these tools but are willing to catch up with some reading on their own should not have too many problems, since many ideas in corporate finance are quite intuitive, and I will try to emphasize intuition over mere technical detail wherever possible. For game theory, there have been numerous excellent and easily accessible text books written in the last four or five years. I will mention only three of these below:

1. Eric Rasmusen, Games and Information: An introduction to game theory, Basil Blackell. (A basic book)

2. Gibbons, R., Game Theory for Applied Economists, Princeton University Press, Princeton, New Jersey (intermediate level).

3. Fudenberg, D., and J. Tirole, Game Theory, M.I.T Press, Cambridge Massachusetts. (Fairly advanced)

Books for supplementary reading: Ph.D. level text books in corporate finance are starting to become available only now. A Ph. D. text book which provides at least some basic coverage of the main topics is by J. A. de Matos (referred to as Matos in this outline). There is another excellent book by Tirole, but since it will become available only in the middle of the term, all my references are going to be to the following book by J. A. Matos.

Ph.D. level books:

1. Tirole, Jean, The Theory of Corporate Finance , Princeton University Press, 2006.

This is a brand new book, by one of the top economists working in corporate finance, game theory, and applied Industrial Organization. This is a very good book.

2. J. A. de Matos, Theoretical Foundations of Corporate Finance, Princeton University Press, 2002. This book has a reasonable extent of coverage on many topics, but is likely to be superseded by the Tirole book in the future.

There are many good MBA text books. Two advanced M.B.A text books which summarizes the ideas behind some of the earlier theory papers, and also much of the empirical literature in corporate finance:

3. Copeland, T.A., and J.F. Weston, Financial Theory and Corporate Policy, third edition, Addison-Wesley Publishing Company (this book will be referred to as CW in the outline). Although this book will not help you with any of the current research, it will give you a quick introduction and a summary of the earlier theoretical and empirical research in corporate finance, thus allowing you to place the current literature in perspective.

4. 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 (the discussion is, however, only at the M.B.A level, and thus serves only as a starting point, at an intuitive level, for Ph.D students).

Of course, the standard text book on corporate finance at the MBA level is:

5. R. A. Brealey and S. C. Myers, Principles of Corporate Finance, 7th Edition (New York, McGraw Hill, 2002).

Other course materials: Most of the lectures will be based on academic papers. I plan to make these available to you as we go along. The papers directly relevant for class discussion on each topic are mentioned under that topic in the outline below; however, the discussion will not be confined to these papers, and additional papers may be added as we go along. I will also be giving out copies of my class notes for every lecture.

Course Organization: The first part of the course will consist entirely of my lectures; the second part will be a combination of my lectures and student presentations. Each student will be required to write a short paper, either synthesizing the literature in a certain area, or, for the more ambitious, a paper which constitutes original research, which will be due approximately one month after the end of the course. Students will be asked to work out hand-in problem sets. Each student will also be asked to make a class presentation of one or more papers (in the second part of the course), which should also be chosen jointly with me. Students will also be asked to critique some of the papers that other students are presenting. There will also be a final exam. The final grade will thus depend on performance in the problem sets, final exam, the research paper, and student presentation and other class participation exercises.

The course grade is determined as follows:

a. Class presentation: 15%

b. Class participation and problem set: 15%

c. Critiques of papers: 10%

c. Research Paper/synthesis: 20 %

d. Final Exam: 40%

Office Hours: Office hours for this course will be after class Wednesday 5-30 to 6:30 P.M. However, Ph.D students are welcome to drop by at other times as well, or to set up an appointment for some other convenient time (send me e-mail if you wish to make an appointment). The best way to contact me is through e-mail (rather than by phone).

Outline of Topics

Part I: Fundamentals and Tools

The main papers that will be used in the discussion of each topic are listed below.

Topic One: Corporate Finance under Perfect Capital Markets: The Modigliani-Miller Propositions on Capital Structure.

Papers:

Modigliani, F. and M. Miller "The Cost of Capital, Corporation Finance and the Theory of Investment" American Economic Review, June 1958, 261-297.

Other reading: Matos sec 2.1; CW, chapters 13 and 14 respectively, provide a review (though a bit dated) of the large theoretical and empirical literature on capital structure.

Topic Two: Taxes and Capital Structure

Papers:

Modigliani, F. and M. Miller "Corporate Income Taxes and the Cost of Capital" American Economic Review, June 1963, 433-443.

Miller, M., "Debt and Taxes," Journal of Finance, June 1977, 32, 261-276.

Other reading: Matos sec 3.2

Topic Six: Dividend Policy Under Perfect Capital Markets and under Asymmetric Information

The Modigliani-Miller Proposition on Dividends. Dividend Policy Under Asymmetric Information and Taxes.

Papers:

Bhattacharya, S., "Imperfect Information, Dividend Policy, and the 'Bird in the Hand' Fallacy," Bell Journal of Economics, Spring 1979, 259-270.

John, K. and J. Williams, "Dividends, Dilution, and Taxes: A Signalling Equilibrium," Journal of Finance, September 1985, 40, 1053-1070.

Miller, M. and K. Rock, "Dividend Policy Under Asymmetric Information," Journal of Finance, September 1985, 40, 1031-1051.

Other reading: Matos Chapter 4; CW chapters 15 and 16 respectively, provides some background reading, as well as a quick summary (though somewhat dated), of the large theoretical and empirical literature on dividend policy.

Topic Seven: Initial Public Offerings (IPOs): An Introduction

Papers:

Rock, K., 1986, Why new issues are underpriced, Journal of Financial Economics 15, 187-212.

Chemmanur, T., 1993, The pricing of initial public offerings: A dynamic model with information production, Journal of Finance 48, 285-304.

Chemmanur, T., and P. Fulghieri, Investment bank reputation, information production, and financial intermediation, Journal of Finance, 1994.

Allen, F. and G. Faulhaber, 1989, Signaling by underpricing in the IPO market, Journal of Financial Economics 23, 303-23.

Topic Eight: Security Design/The Structure of Corporate Liabilities

Papers:

Gale, David and Martin Hellwig (1985), "Incentive Compatible Debt Contracts: The One Period Problem," Review of Economic Studies, 52, 646-663.

Townsend, R. (1979) "Optimal contracts and Competitive Markets with Costly State Verification," Journal of Economic Theory, 21, 265-293.

Aghion, P., and P. Bolton, 1992, “An ‘Incomplete Contracts’ Approach to Financial Contracting,” Review of Economic Studies 59, 473-494.

Bolton, P. and D. Scharfstein, "Optimal debt structure and the number of creditors," Journal of Political Economy 104:1 (January 1996), 1-25.

Hart, O. and J. Moore (1989), "Default and Renegotiation: A Dynamic Model of Debt," mimeo, 1989.

Harris, Milton and Artur Raviv (1989), "The Design of Securities," Journal of Financial Economics, 24, 255-287.

Allen, F. and D. Gale (1988) "Optimal Security Design," Review of Financial Studies, 1, 229-263.

Part II: Seminar on Some Current Research Topics in Corporate Finance

In this part of the course, we will review in some detail several recent papers in two or three areas of current research in corporate finance. Students will be expected to present the papers in this part of the course (to be determined later: I am currently choosing these topics). Each paper presented should also be critiqued by two students (thus, each student will have to turn in multiple critiques). Students have to hand in their written critiques of each paper on the day of its presentation. Critique-writers, as well as presenters of various papers, should come to class prepared to answer questions arising in class discussion regarding these papers.

Presentation Format: Each presentation must adhere strictly to the following format (1) Statement of the problem studied; (2) Brief survey of the literature; (3) Concise, intuitive, explanation of the argument producing the major results (for theory papers) or empirical methodology; (4) Summary of main results; (5) Critical examination of the paper; (6) Sketch of major extensions to the paper with specific suggestions about possible solution techniques (for theory) or empirical methodology/data for these extensions (students who can effectively accomplish the last point will get extra credit). Most important, each presentation must be both informative and entertaining.

Critique Format: Critiques must be between three to six pages in length (depending on the paper). The format of the critiques should be roughly along the following lines: (1) Statement of the problem studied; (2) Brief survey of the literature; (3) Concise, intuitive explanation of the argument producing the major results (for theory papers) or empirical methodology; (4) Summary of results; (5) Critical examination of the paper.

Topic Nine: Group Lending

Laffont, J. and Rey, P., 2001. Collusion and Group Lending with Moral Hazard. Working Paper.

Ghatak M., 2000. Screening by the Company You Keep: Joint Liability Lending and the Peer Selection Effect. The Economic Journal 110, 601-631.

Aghion, B. and Gollier, C., 2000. Peer Group Formation in an Adverse Selection Model. The Economic Journal 110, 632-643.

Laffont J., 2003. Collusion and Group Lending with Adverse Selection. Journal of Development Economics 70, 329-348.

Laffont J., and N’Guessan T. 2000. Group Lending with Adverse Selection. European Economic Review 44 773-784.

Ghatak, M. and Guinnane, T., 1999. The Economics of Lending with Joint Liability: Theory and Practice. Journal of Development Economics. 60, 195-228.

Topic Ten: Dividends and Share Repurchases

Papers:

Brennan M. and Thakor A., 1990. Shareholder Preferences and Dividend Policy. Journal of Finance. XLV. 993-1018.

Jagannathan, M., Stephens, C, and Weisbach. M., 2000. Financial Flexibility and the Choice Between Dividends and Stock Repurchases. Journal of Financial Economics 57, 355-384.

Grullon, G., and Michaely, R., 2002. Dividends, Share Repurchases, and the Substitution Hypothesis. Journal of finance LVII 1649-1684.

Oded, J., 2005. Why do Firms Announce Open-Market Repurchase Programs? Review of Financial Studies 271-330.

Ikenberry, D., Lakonishok, J., and Vermaelen, T. 2000. Stock Repurchases in Canada: Performance and Strategic Trading. Journal of Finance LV 2373-2397.

Nohel, T., and Tarhan V. 1998. Share Repurchases and Firm Performance: New Evidence on the Agency Costs of Free Cash Flow. Journal of Financial Economics. 187-222.

Brav, A., Graham, J., Harvey, C., and Michaely, R. 2005. Payout Policy in the 21st Century. Journal of Financial Economics 77 483-527.