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Advanced Corporate Finance

Course code
FIN602
Course type
MSc Course
Weekly Hours
2,5
ECTS
5.0
Term
HS 2021
Language
Englisch
Lecturers
Prof. Dr. Besim Burcin Yurtoglu
Please note that exchange students obtain a higher number of credits in the BSc-program at WHU than listed here. For further information please contact directly the International Relations Office.

(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
Wednesday, 01.09.2021 11:30 - 15:15
Monday, 06.09.2021 11:30 - 13:00
Tuesday, 07.09.2021 08:00 - 11:15
Thursday, 09.09.2021 09:45 - 15:15
Monday, 13.09.2021 15:30 - 18:45
Friday, 17.09.2021 08:00 - 11:15
Monday, 20.09.2021 11:30 - 15:15
Wednesday, 13.10.2021 11:30 - 13:00
Students will be able to analyze and solve problems that arise when corporations raise funds to finance their investments. In doing so, the students will be able to apply the major corporate finance theories and econometric techniques to decision-making under global influences. They will also be able to effectively communicate financial information by being able to present, discuss, and defend their analysis using appropriate terminology.
Detailed Overview of Topics and Readings:(+) indicates a required readingOther readings are recommendonly(a) BackgroundTheory:From “Jean Tirole, 2006,The Theory of Corporate Finance, Princeton University Press.”(+) Parts of Chapter 1 and 3, to the extent they are dealt with in the class- Chapter 1: Corporate Governance- Chapter 3: Outside Financing CapacityEmpirical Methods:The following two papers are comprehensive accounts of key methods of causal inference. We briefly introduce event study techniques, Differences in Differences (DiD), Regression Discontinuity Design (RDD), and use of panel data techniques (with fixed and random effects) that are regularly used in empirical corporate finance studies.(+) Roberts, M.R. and T. M. Whited, 2013, Chapter 7 - Endogeneity in empirical corporate finance, Editor(s): George M. Constantinides, Milton Harris, Rene M. Stulz,Handbook of the Economics of Finance, Elsevier, Volume 2, Part A, Pages 493-572,https://doi.org/10.1016/B978-0-44-453594-8.00007-0.(+) Craig MacKinlay, 1997, Event studies in economics and finance,Journal of Economic Literature35(1), 13-39.(b) Corporate Investment Policy and Sources of Finance(+) Jensen, M. C. and W. Meckling, 1976, Theory of the firm: managerial behavior, agency cost, and capital structure,Journal of Financial Economics3, 305-360.(+) Myers, S. and N. Majluf, 1984, Corporate financing and investment decisions when firms have information that investors do not have,Journal of Financial Economics13, 187- 221.Nikolov, B., Schmid, L. and Steri, R., 2021, The sources of financing constraints,Journal of Financial Economics139(2), 478-501.Hennessy, C.A. and T.M. Whited, 2007, How costly is external financing? Evidence from a structural estimation,The Journal of Finance62, 1705-1745. https://doi.org/10.1111/j.1540-6261.2007.01255.x.Fazzari, S.M., R.G. Hubbard and B.C. Petersen, 1988, Financing constraints and corporate investment,Brookings Papers on Economic Activity, 141–195.Blanchard, O.J., F. Lopez-de-Silanes and A. Shleifer, 1994, What do firms do with cash windfalls?,Journal of Financial Economics36, 337−360.Lamont, O. 1997, Cash flow and investment: Evidence from internal capital markets,TheJournal of Finance52(1), 83-109.Kaplan, S.N. and L. Zingales, 1997, Do investment-cash flow sensitivities provide useful measures of financing constraints?Quarterly Journal of Economics112, 159−216.(c) Dividend Policy(+) Brav, A. J.R. Graham, C.R. Harvey and R. Michaely, 2005, Payout policy in the 21st century,Journal of Financial Economics77(3), 483-527.Easterbrook, EH, 1984, Two agency-cost explanations of dividends,American Economic Review74 (4):650-659.Gugler, K.and B.B.Yurtoglu, 2003, Corporate governance anddividendpay-out policy in Germany,European Economic Review, 47(4), 731-758.Jensen, M C, 1986, Agency costs of free cash flow, corporate finance, and takeovers,American Economic Review76(2), 323-329.(+) Lang, L H P and R. H. Litzenberger, 1989, Dividend announcements: cash flow signaling vs free cash flow hypothesis,Journal of Financial Economics24(1), 181-192.Lintner, J., 1956, Distribution of incomes of corporations among dividends, retained earnings, and taxes,American Economic Review46(2), 97-113.Michaely, R. and A. Moin, 2021, Disappearing and reappearing dividends,Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2021.06.029.(d) Mergers and AcquisitionsGugler, K., D.C. Mueller, B.B. Yurtoglu, and C. Zulehner, 2003, The effects of mergers: an international comparison, International Journal of Industrial Organization21(5), 625-653.Moeller, S.B., F.P. Schlingemann, and R. M. Stulz, 2005, Wealth destruction on a massive scale? A study of acquiring-firm returns in the recent merger wave,Journal of Finance60(2), 757-782.Morck, R., A. Shleifer and R. Vishny, 1990, Do managerial objectives drive bad acquisitions?Journal of Finance45, 31−48.(+) Renneboog, L. and C. Vansteenkiste, 2019, Failure and success in mergers and acquisitions,Journal of Corporate Finance58, 650-699.Shleifer, Andrei and R. Vishny, 2003, Stock market driven acquisitions,Journal of Financial Economics70 (3), 295-489.Stephen W. Salant, Sheldon Switzer and Robert J. Reynolds, 1983, Losses from horizontal merger: The effects of an exogenous change in industry structure on Cournot-Nash Equilibrium,The Quarterly Journal of Economics98(2), 185-199.(e) Executive CompensationEdmans, A. and X. Gabaix, 2016, Executive compensation: A modern primer,Journal of Economic Literature54(4), 1232–1287,http://dx.doi.org/10.1257/jel.20161153 1232 1.(+) Gabaix X. and Landier A., 2008, Why has CEO pay increased so much?Quarterly Journal of Economics123(1), 49‐100.Hartzell J. C, Ofek E., Yermack, D., 2004, What’s in it for me? Private benefits obtained by CEOs whose companies are acquired,Review of Financial Studies17(1), 37‐61.Jensen M. and Murphy K., 1990, Performance pay and top management Incentives,Journal of Political Economy98(2), 225‐264.Rosen S., 1981, The Economics of Superstars,American Economic Review71(5), 845‐58.(f) Environmental, Social, and Governance (ESG) Factors, Corporate Social (Ir)Responsibility, and Corporate FinanceObjectives of the Firm, Governance, and CSR:(+) The Economist (August 22nd, 2019), What are companies for? Big business is beginning to accept broader social responsibilities.(+) Friedman, Milton, 1970, The social responsibility of business is to increase its profits,The New York Times Magazine, September 13, 1970.Environmental Aspects and Climate Change:Flammer, C., 2021, Corporate green bonds,Journal of Financial Economics, https://doi.org/10.1016/j.jfineco.2021.01.010.Krueger, P., Z. Sautner, and L.T. Starks, 2020, The importance of climate risks for institutional investors,The Review of Financial Studies33(3), 1067–1111.(+) Liang, H. and L. Renneboog, 2020, Corporate social responsibility and sustainable finance: A review of the literature, ECGI Finance Working Paper N° 701/2020.Nordhaus, W., 2019, Climate change: The ultimate challenge for economics,American Economic Review109(6): 1991–2014, https://doi.org/10.1257/aer.109.6.1991.Diversity:Adams, R.B., 2016, Women on boards: The superheroes of tomorrow?The Leadership Quarterly27(3), 371-386.Cumming, D., Leung, T. Y., and O. Rui, 2015. Gender diversity and securities fraud,Academy of Management Journal58, 1572–1593.Guest, P. M., 2019, Does board ethnic diversity impact board monitoring outcomes?British Journal of Management30(1), 53-74.Kim, D. and L.T. Starks, 2016. Gender diversity on corporate boards: Do women contribute unique skills?American Economic Review106 (5): 267-71.(+) Kirsch, A., 2018. The gender composition of corporate boards: A review and research agenda,The Leadership Quarterly29(2): 346-364.Corporate Social Irresponsibility, Media, and Leadership Fails:Kölbel, J.F., Busch, T. and Jancso, L.M. 2017, How media coverage of corporate social irresponsibility increases financial risk,Strategic Management Journal38, 2266-2284.https://doi.org/10.1002/smj.2647.(+) Tang, Y, Mack, DZ, Chen, G., 2018, The differential effects of CEO narcissism and hubris on corporate social responsibility,Strategic Management Journal39: 1370– 1387.https://doi.org/10.1002/smj.2761.
Interactive development of main results

Discussions of major economic implications

Hands-on excercises

Grading is based on the following components:

- Group Work: 40%

- Take home Final Exam: 60%

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