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«FBE 431 Professor Harry DeAngelo Financial Policies Office: ACC 308E and Corporate Control Phone: 213-740-6541 Spring 2008 hdeangelo ...»

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FBE 431 Professor Harry DeAngelo

Financial Policies Office: ACC 308E

and Corporate Control Phone: 213-740-6541

Spring 2008 hdeangelo@marshall.usc.edu Course objectives: This course develops a framework that is useful for understanding a broad range of corporate financial decisions. Substantial emphasis will be placed on (i) the determinants of corporate debt and dividend policies, (ii) the allocation and value of corporate voting rights and the relation to issues of corporate governance, and (iii) alternative methods of security issuance and retirement. The discussion will

include application of the theory to issues such as:

• initial public offerings

• seasoned stock offerings

• common stock repurchases

• Dutch auction versus fixed price tender offers

• equity carve-outs

• spinoffs

• tracking stock

• debt covenants

• credit lines

• junk bond financing

• rating-contingent puttable debt

• stock pyramids

• dual class structures

• the value of corporate control

• proxy fights

• inter-firm tender offers

• hostile versus friendly acquisitions

• takeover attack and defense strategies

• LBOs and the role of private equity firms

• leveraged recapitalizations

• derivatives and financial policy

• stock market manipulation and the corporate cost of capital

• the crisis in corporate governance

• Wall Street analysts and the marketing of corporate equity The framework and applications will be useful to those who will work for corporations, those who will serve as outside consultants to corporations on appropriate financial policies, and those who will work as external financial analysts (whose primary focus is on understanding and evaluating the financial decisions made by corporate management).

Course structure: The course format will be lecture with classroom discussion. Students are responsible for material discussed during class meetings, assigned readings (see below), seven problem sets, a midterm examination, and a final examination.

Midterm and final examinations: The midterm will be given during the regularly scheduled class meeting on Tuesday, March 4. The final will be given on Thursday, May 8 from 4:30 p.m. until 6:30 p.m. Attendance at both of these exams is a requirement of the course.

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Problem sets: There will be seven graded problem sets which are to be done in groups of three to five

students. The problem sets are due at the beginning of class on the following dates:

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Note that Problem set 7 is due at the last class meeting of the semester. You should be ready to begin work on problem set 7 after we cover the material on IPOs, and you are encouraged to start working early on this problem set. [You will also need to draw on material from the first half of the course.] University policy on disabilities: Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP) each semester. A letter of verification for approved accommodations can be obtained from DSP. Please be sure the letter is delivered to me as early in the semester as possible. DSP is located in STU 301 and is open 8:30 a.m. p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.

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Some classroom time will be spent discussing issues that are treated in the suggested supplementary readings. These classroom discussions will be entirely self-contained so that it will not be necessary for you to work through the NR readings. The NR references are provided here as source documents for those people interested in a more detailed treatment of a given subject. Copies of the NR readings will be available on “library reserve.”

The outline also gives the location of each reading:

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A packet of course materials will be available for purchase at the USC Bookstore. The packet includes

required readings that are not included in the Smith book of readings:

Smith, Clifford W., Jr., The Modern Theory of Corporate Finance, second edition, 1990, McGraw Hill, New York.

A substantial amount of additional material will be distributed in class throughout the semester.

As opportunities arise, class time will be allocated to discussion of current events in the world of corporate finance that relate to the general issues covered in the course. Our discussion and analysis of current corporate finance events should be considered an integral part of the course (and may therefore be covered on examinations). Accordingly, you are strongly encouraged to subscribe to The Wall Street Journal and to read it consistently and carefully.

Student subscriptions to the Wall Street Journal may be obtained at: http://subscribe.wsj.com/semester. For the zip code, type in 900. For school, highlight U STHRN CAL LS ANG. For professor, highlight DEANGELO, HARRY.

Topic Coverage and Reading Assignments

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R Read your introductory textbook’s discussion of why stockholders would prefer managers to maximize market value (follow the NPV-maximization rule).

2. Foundations of Corporate Payout Policy Analysis R Read your introductory textbook's discussion of the MM dividend irrelevancy proposition.

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R/CD DeAngelo, Harry and Linda DeAngelo, “Payout Policy Pedagogy: What Matters and Why,” European Financial Management, January 2007, pp. 11-27. Downloadable via Blackboard or at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=890616 The executive summary gives the key points you should emphasize. Focus on section 2 and Table 1’s discussion of the sense in which the choice of payout policy matters even in the absence of taxes, transactions costs, or other frictions. Section 4.1 on the simple life-cycle theory of payout policy also deserves careful attention at this point in the course. In later lectures, we will discuss refinements that appear elsewhere in the article. For now, focus your attention on the material in sections 2 and 4.1.

NR/L DeAngelo, Harry and Linda DeAngelo, “The Irrelevance of the MM Dividend Irrelevance Theorem,” Journal of Financial Economics, February 2006, pp. 293-315.

3. Dividend Policy: Tax, Signaling, and Other Considerations

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R/Sm Brickley, James A., “Shareholder Wealth, Information Signaling, and the Specially Designated Dividend,” in Smith’s book of readings.

Focus on sections 1 and 7 and Tables 1-4. Skim the other material to fill in your understanding of regular versus specially designated dividends. Here and throughout the course you should emphasize the intuition of the numbers, not the details of statistical test methodology.

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R/P DeAngelo, Harry, Linda DeAngelo, and Douglas J. Skinner, “Are Dividends Disappearing?

Dividend Concentration and the Consolidation of Earnings,” Journal of Financial Economics, June 2004, pp. 425-456.

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R Read your introductory textbook's discussion of (i) the MM capital structure irrelevancy proposition, (ii) MM on corporate taxes, (iv) bankruptcy costs and capital structure, and (iv) Miller's “Debt and Taxes” analysis.

R/CD Outline Notes on Basic Capital Structure Theory R/P Miller, Merton H., “Debt and Taxes,” Journal of Finance, May 1977, pp.261-276.

Emphasize the material in section III that explains how personal taxes influence the gains from leverage. Do not spend a great deal of time on section IV's discussion of market equilibrium. We will extract the main points of Miller's analysis in class.

NR/Sm DeAngelo, Harry and Ronald W. Masulis, “Optimal Capital Structure Under Corporate and Personal Taxation,” in Smith’s book of readings.

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5. Bankruptcy Costs and Capital Structure R/Sm Warner, Jerold B., “Bankruptcy Costs: Some Evidence,” in Smith’s book of readings.

NR/L Gilson, Stuart C., “Management Turnover and Financial Distress,” Journal of Financial Economics, December 1989, pp. 241-262.

R/P Weiss, Lawrence A. and Karen H. Wruck, “Information Problems, Conflicts of Interest, and Asset Stripping: Chapter 11’s Failure in the Case of Eastern Airlines,” Journal of Financial Economics, April 1998, pp. 55-97. [Excerpts in packet.] R/P “Bankruptcies, Workouts, and Turnarounds,” Transcript of Roundtable Discussion, Journal of Applied Corporate Finance, Summer 1991.

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6. Agency Theory and Corporate Financial Policy R/Sm Jensen, Michael C. and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” in Smith’s book of readings.

The Jensen and Meckling article presents the agency theory approach to analyzing corporate finance issues and identifies some very important concepts that will be used repeatedly throughout the course. You should read the article because it is a classic, and because it provides the best available treatment of agency theory. Unfortunately, the article is quite long and too technical (for present purposes) in places. The best strategy is to study the article for the intuition and skim the technical parts only to the extent necessary to

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NR/Sm Smith, Clifford W., Jr. and Jerold B. Warner, “On Financial Contracting: An Analysis of Bond Covenants,” in Smith’s book of readings.

Section 1.1 provides a good summary of sources of potential conflict between stockholders and bondholders.

Sections 2 through 4 provide a useful summary of major bond covenants.

NR/Sm Myers, Stewart C., “Determinants of Corporate Borrowing,” Journal of Financial Economics, in Smith’s book of readings.

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Important reminder: In reading this paper (and all other empirical papers assigned in this course), focus on understanding the broad-brush empirical regularities. Do not memorize particular numbers or focus on details of statistical methods.

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Focus on the intuitive parts of the discussion in sections 1-2.4, 4.2-4.3, and 6. Read the technical material only to the extent necessary to understand the intuition of the argument.

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9. Financial Flexibility and Optimal Financial Policies R/P DeAngelo, Harry and Linda DeAngelo, “Capital Structure, Payout Policy, and Financial Flexibility,” USC Working Paper, Ocotber 2007.

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Private Placements of Common Stock NR/L Wruck, Karen H., “Equity Ownership Concentration and Firm Value: Evidence From Private Equity Financings,” Journal of Financial Economics, 1989, pp. 3-28.

11. Initial Public Offerings R/P Ibbotson, Roger G., Jody L. Sindelar, and Jay R. Ritter, “Initial Public Offerings,” Journal of Applied Corporate Finance, Summer 1988, pp. 37-45.

R/Sm Ritter, Jay R., “Investment Banking, Reputation, and the Underpricing of Initial Public Offerings,” in Smith’s book of readings.

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13. The Role of Wall Street Analysts in the Marketing of Corporate Equity R/P Rynecki, David, “The Price of Being Right,” Fortune, February 5, 2001, pp. 126+.

14. Stock Market Manipulation and the Corporate Cost of Capital

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Focus on the discussions of (i) the motives for substantial vote ownership by managers (section 2), (ii) the motives for dual class structures (section 5), and (iii) the summaries introduction and conclusion (sections 1 and 7). Read the empirical material only to get an intuitive understanding of the nature or managerial ownership in firms with multiple classes of common stock.

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16. Proxy Contests R/P DeAngelo, Harry and Linda DeAngelo, “Proxy Contests and the Governance of Publicly Held Corporations,” Journal of Financial Economics, June 1989, pp. 29-59.

17. Large Block Stockholders and Managerial Monitoring

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18. Corporate Growth, Contraction, and Value R/P Jensen, Michael C., “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,” Journal of Finance, July 1993, pp. 831-880. [Excerpts in packet.]

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20. Derivatives and Corporate Financial Policy R/P Loomis, Carol J., “Cracking the Derivatives Case,” Fortune, March 20, 1995, pp. 50+.

R/P Buffett, Warren, “Avoiding a Mega-Catastrophe: Derivatives Are Financial Weapons of Mass Destruction,” Fortune, March 3, 2003

21. Enron and Its Aftermath: Reputation, Trust, and Access to the Capital Markets R/P McLean, Bethany., “Why Enron Went Bust,” Fortune, December 24, 2001, pp. 58+.

22. Common Stock Repurchases R/Sm Dann, Larry Y., “Common Stock Repurchases: An Analysis of Returns to Bondholders and Stockholders,” in Smith’s book of readings.

In reading this article, emphasize (ii) the institutional details of stock repurchase methods, (ii) the suggested motivations for repurchase, and (iii) the broad-brush empirical findings summarized in Table 2 and Figure 1.

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23. Leveraged Buyouts and the Private Equity Revolution R/P DeAngelo, Harry and Linda DeAngelo, “Management Buyouts of Publicly Traded Corporations,” Financial Analysts Journal, May-June 1987, pp. 38-49.

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R/P “High Leverage and Stock Market Pressures on Corporate Management,” Transcript of Roundtable Discussion, Journal of Applied Corporate Finance, Summer 1990.

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