FBE 431: Financial Policies and Corporate Control
Fall semester 2012
Professor Harry DeAngelo
Kenneth King Stonier Chair in Business Administration
Office: ACC 308-D
Office Phone: 213-740-6541 (no voice mail messages, please)
E-mail: hdeangelo@marshall.usc.edu (best way to contact me)
Class meetings:
Tues & Thurs 10:00 – 11:50
HOH 305
Office hours:
Tues & Thurs 8:45 – 9:45
or by appointment (please use email to set up an appointment).
Course objectives: This course develops a framework that is useful for understanding a broad range of
real-world corporate financial decisions. Applications to be covered include:
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features of real-world capital structures and payout policies
Wall Street’s view of share dilution
economic dilution
IPOs, seasoned stock offerings, private equity placements, rights offerings
common stock repurchases
Dutch auction versus fixed price tender offers
equity carve-outs, spinoffs, splitoffs, and tracking stock
corporate growth and over-expansion
managerial concern with bolstering EPS growth and avoiding EPS dilution
financial flexibility and corporate capital structures
capital structure: target leverage ratios, zones, and planning heuristics
transitory debt financing
credit lines
junk bond financing
event-contingent debt obligations
stock pyramids
capital structures with dual classes of common stock
value of corporate control
proxy contests
poison pills
takeover attack and defense strategies
LBOs and leveraged recapitalizations
stock market manipulation and the corporate cost of capital
the modern crisis in corporate governance
corporate financing implications of the recent financial crisis
The conceptual framework and applications developed in this course will be useful to students who seek to
understand both the institutional details of, and substantive motivations for, important corporate financing
decisions. In terms of career tracks, the skill set developed in this course will provide a strong foundation
for analyzing corporate financial policies for (i) those people who will work for corporations, with or
without a specialization in finance, (ii) those who will serve as outside consultants to corporations on
appropriate financial policies, (iii) those who will work as external financial analysts, or more generally for
(iv) anyone interested in understanding 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), eight 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, October 9. The final will be given on Tuesday, December 18 from 8 a.m. until 10
a.m. Attendance at both of these exams is a requirement of the course.
Grading: Course grades will be determined by approximately curving the total points earned on three class
requirements:
Point range
1. Problem sets
0 to 40
2. Midterm examination
0 to 100
3. Final examination
0 to 130
Total
0 to 270
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:
Problem set
1
2
3
4
5
6
7
8
Due date
Tuesday September 4
Tuesday September 11
Thursday September 20
Tuesday, September 25
Thursday, October 2
Thursday, November 8
Thursday, November 29
Thursday, December 6
Points
4
4
4
4
4
4
4
12
Note that Problem set 8 is due at the last class meeting of the semester. You should be ready to start
thinking about this problem set after the midterm. The problem set refers to an article listed later in the
syllabus under leveraged recapitalizations. We will discuss that article in class, but you can read that article
shortly after the midterm and be ready at that time to start into Problem set 8.
Regular email messages with course-related materials: I will use Blackboard to send you emails
throughout the semester about ongoing developments in the world of corporate finance (and for other
course-related items). I will rely to a large degree on the Wall Street Journal as a source for this material.
Student subscriptions to the WSJ may be obtained at: http://subscribe.wsj.com/semester. An alternative
link is: https://buy.wsj.com/shopandbuy/order/subscribe.jsp?trackCode=aaajb2on For the zip code, type
in 900. For school, highlight U STHRN CAL LS ANG. For professor, highlight DEANGELO, HARRY.
[MyMarshall has a link to the WSJ, but the interface is not user friendly.]
2 Target Dates of Topic Coverage
Topic #s are given in the reading list that immediately follows this summary page. The dates given for
in-class discussions are targets that may change as the class evolves. The main determinant of any
changes in topic coverage dates will be developments in the world of corporate finance that occur during
this class. We will discuss real-world developments in every class session (except exams and reviews).
Some of those discussions will be short. Others will be long if developments dictate that we need more
time to understand the phenomenon at hand. The longer discussions may lead to changes in the actual
dates we cover a given reading list topic. I will keep you informed about any changes in coverage dates.
If you have any questions, please do not hesitate to ask. Problem set due dates will not be moved
earlier in time. Midterm and final examination dates will not be changed.
Session #
S1
S2
S3
S4
S5
S6
S7
S8
S9
S10
S11
S12
S13
S14
S15
S16
S17
S18
S19
S20
S21
S22
S23
S24
S25
S26
S27
S28
S29
Final exam
Day
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Tues
Thurs
Date
Aug 28
Aug 30
Sept 4
Sept 6
Sept 11
Sept13
Sept 18
Sept 20
Sept 25
Sept 27
Oct 2
Oct 4
Oct 9
Oct 11
Oct 16
Oct 18
Oct 23
Oct 25
Oct 30
Nov 1
Nov 6
Nov 8
Nov 13
Nov 15
Nov 20
Nov 22
Nov 27
Nov 29
Dec 4
Dec 6
Topic #s from reading list
1
2, begin 3
3
4
5
Finish 5, begin 6
Finish 6, begin 7
Finish 7
8, 9
10, 11
12
Review session
Midterm exam
13
Discuss exam, finish13
14
14
Finish 14, 15
16, 17
18
18
19
20, 21
22, 23
24
Thanksgiving
24
25, begin 26
Finish 26, 27
Review session
Final exam
3 Assignment due
Problem set #1
Problem set #2
Problem set #3
Problem set #4
Problem set #5
Midterm exam
Problem set #6
Problem set #7
Problem set #8
Final exam
Topics and Reading List
(See prior page for target calendar dates of coverage of these topics)
The outline below specifies readings for each topic that we will discuss in class over the semester. In
addition to these readings, many handouts will be distributed during class meetings. Those handouts are
an integral part of the required reading for the course.
1.
Logic and limitations of the efficient markets hypothesis
Review:
• In the text you used in your introductory finance class, review the discussion of the Efficient Markets
Hypothesis. Emphasize the logic of the general concepts, not the findings of particular studies.
2.
What is the appropriate managerial objective when choosing financial policy?
Review:
• In your introductory text, review the discussion of the proper objective for management.
3.
Payout policy: Foundations
Review:
In the textbook you used for introductory finance, review the discussion of MM’s conclusions about
dividend irrelevance in an idealized market setting.
Blackboard readings:
• DeAngelo, Harry, DeAngelo, Linda, and Douglas Skinner, “Corporate Payout Policy,” Foundations
and Trends in Finance, 2009. Designated CPP below.
Read chapters 1, 2, and 3.
4.
Payout policy: Taxes, free cash flow, and other real-world considerations
Blackboard readings:
• CPP (see topic 3 for reference)
Read the appendix on Microsoft.
• Vascellaro, Jessica, “Apple Pads Investors’ Wallets,” Wall Street Journal, March 20, 2012
• Buckman, Rebecca, “Microsoft, Awash in Cash, Declares Its First Dividend,” Wall Street Journal,
January 17, 2003.
• Wayne, Leslie, “Arms Makers Find Being Cash-Heavy Is Mixed Blessing,” NY Times, May 12, 2005.
• Monga, Vipal, “After Earning Cash in China, the Trick is Getting it Out,” Wall Street Journal,
February 15, 2012.
Packet readings:
• Fuller, Joseph and Michael Jensen, “How Bigger Dividends Build Trust,” Financial Times, October 6,
2003.
5.
Payout policy: What do real-world payout policies look like?
Blackboard readings:
• CPP (see topic 3 for reference)
Read chapters 4 through 8. As with all such readings, do NOT get bogged down in mastering the details of
each study. Rely on the discussion in class to get the main points.
4 DeAngelo, Harry, Linda DeAngelo, and Douglas Skinner, “Are Dividends Disappearing? Dividend
Concentration and the Consolidation of Earnings,” Journal of Financial Economics, June 2004, pp.
425-456.
Do not get bogged down in mastering the numbers. Emphasize Figure 1 and Tables 1, 2, 3, and 10. Most
importantly, focus on the main points presented in section 7.
• Fama, Eugene F. and Kenneth R. French, “Disappearing Dividends: Changing Firm Characteristics or
Reduced Propensity to Pay?,” Journal of Financial Economics, April 2001, pp. 3-43.
Read pages 1 through 8 (top) and the concluding section of the study.
•
6.
Capital structure: Foundations
Review:
• In your introductory book, review the discussion of (i) the MM capital structure irrelevancy
proposition, (ii) MM on corporate taxes, (iii) bankruptcy costs and capital structure.
Blackboard readings:
• Miller, Merton H., “Debt and Taxes,” Journal of Finance, May 1977, pp. 261-276.
Emphasize the “horse and rabbit stew” discussion and 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 discuss the main implications of Miller's analysis in class.
• Smith, Randall and Sharon Terlep, “GM Could Be Free of Taxes for Years,” Wall Street Journal,
November 3, 2010.
• Terlep, Sharon, “GM’s Drive: Getting Out of Debt,” Wall Street Journal, December 15, 2010.
• Duhigg, Charles and David Kocieniewski, “How Apple Sidesteps Billions in Global Taxes,” New
York Times, April 28, 2012.
At the time this article was written, Apple had no debt and enormous cash balances. Something to think
about: What can be gleaned about the critical features of Apple’s financial policies from its debt and cash
positions and the facts reported in this article?
7.
Capital structure and the costs of financial distress
Blackboard readings:
• Mattioli, Dana and Mike Spector, “Kodak’s Rescue Plans Hit Hurdles,” Wall Street Journal, December
19, 2011.
• Martin, Andrew and Michael De La Merced, “Bankrupt, Kodak Vows to Rebound,” Wall Street
Journal, January 19, 2012.
• Weiss, Lawrence and Karen 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.
Read sections 1, 2, and 6.
Packet readings:
• “Bankruptcies, Workouts, and Turnarounds,” Transcript of Roundtable Discussion, Journal of Applied
Corporate Finance, Summer 1991.
8.
Agency costs: Corporate ownership structure and managerial incentives
Blackboard readings:
• Jensen, Michael and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and
Ownership Structure,” Journal of Financial Economics, October 1976, pp. 305-360.
The Jensen and Meckling article presents the agency theory approach to analyzing corporate finance issues
and identifies important concepts that will be used repeatedly throughout the course. You should read the
5 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. Read the article
for the intuition and skim the technical parts only to the extent necessary to preserve continuity in your
reading. Focus in particular on the intuition of the discussion in sections 1-2.2, 2.6, 3, 4, and 6.1-6.4.
9.
Agency costs of free cash flow
Blackboard readings:
• Jensen, Michael C., “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers,” American
Economic Review, May 1986, pp. 323-329.
Focus on the introduction and sections I and VI.
10.
Asymmetric information: Raising capital given disagreements over value
Blackboard readings:
• Smith, Clifford W., “Investment Banking and the Capital Acquisition Process,” Journal of Financial
Economics, January/February 1986, pp. 3-29.
Read only sections 1 and 2 for now. Focus on the evidence summarized in Table 1. Familiarize yourself
with the nature of the broad range of information provided in Tables 2-4, but do not memorize these
findings. It will be useful from time to time to refer back to this literature summary. Skim the section 2
data interpretations.
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.
• Myers, Stewart and Nicholas Majluf, “Corporate Financing and Investment Decisions When Firms
Have Information That Investors Do Not Have,” Journal of Financial Economics, June 1984, pp. 187221.
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.
11.
Financial flexibility: Target capital structures and the option to borrow
Blackboard readings:
• DeAngelo, Harry, DeAngelo, Linda, and Toni. M. Whited, “Capital Structure Dynamics and Transitory
Debt,” Journal of Financial Economics, February 2011, pp. 235-261.
Read only the introduction and conclusion to get the intuitive idea of (i) the distinction between the
transitory and permanent roles of debt in capital structures and (ii) the value of the option to borrow. Do
not focus on the mathematical or statistical details.
• DeAngelo, Harry, DeAngelo, Linda, and Karen Wruck, “Asset Liquidity, Debt Covenants, and
Managerial Discretion in Financial Distress: The Collapse of L.A. Gear,” Journal of Financial
Economics, 2002, 3-34.
Read sections 1 and 7.
12.
Capital structure: What do real-world capital structures look like?
Blackboard readings:
• DeAngelo, Harry and Richard Roll, “How Stable Are Corporate Capital Structures?” Working paper,
USC and UCLA, 2012.
Emphasize the introduction and conclusion as well as section 7 and the appendix.
6 Denis, David and Stephen McKeon, “Debt Financing and Financial Flexibility: Evidence From ProActive Leverage Increases. Review of Financial Studies, 2012, pp. 1897-1929.
Emphasize the introduction, conclusion, and section 3.
• Press Releases for Kroger, Safeway, Caterpillar, and Yum! Brands, various dates.
• Ng, Serena, “Banks Get Tougher on Credit Line Provisions,” Wall Street Journal, May 4, 2009.
• Stol, John, “GM’s Move to Tap Credit Line May Intensify Worries,” Wall Street Journal, September
22, 2008.
•
Midterm exam
Ground rules:
Closed book. Closed notes. Calculators are fine. No sharing of calculators. Exam coverage will not
extend beyond topic #12.
13.
Marketing common stock: Rights offerings, underwritten sales, and private placements
Blackboard readings:
• Smith, Clifford W., “Investment Banking and the Capital Acquisition Process,” Journal of Financial
Economics, January/February 1986, 3-29.
Read only section 3.1 for now.
• Sears Rights Offering, Press Release dated February 23, 2012
14.
Initial public offerings (IPOs)
Blackboard readings:
• Ritter, Jay, “Equilibrium in the Initial Public Offering Market,” Annual Review of Financial
Economics, 2011, pp. 347-374.
This article gives an excellent overview of the systematic evidence on IPOs. Ignore sections 8.2 to 8.4.
• Rusli, Evelyn and Peter Eavis, “Facebook Raises $16 Billion in IPO,” New York Times, May 17,
2012.
• Chon, Gina and Drew Fitzgerald,”As Facebook’s Shares Sink, Focus on Morgan Stanley,” Wall Street
Journal, May 21, 2012.
• Langely, Monica, Das, Anupreeta, and Aaron Leccheti, “Morgan Stanley was ‘Driver’ on Facebook’s
Wild IPO Ride,” Wall Street Journal, June 18, 2012.
Packet readings:
• Utal, Bro, “Inside the Deal that Made Bill Gates $350,000,000,” Fortune, July 21, 1986, pp. 23+.
15.
Seasoned equity offerings and stock-market timing
Blackboard readings:
• DeAngelo, Harry, DeAngelo, Linda, and René Stulz, “Seasoned Equity Offerings, Market Timing, and
the Corporate Lifecycle,” Journal of Financial Economics, March 2010, pp. 275-295.
Emphasize the introduction, conclusion, and table 2.
7 16.
Spinoffs, splitoffs, equity carve-outs, and tracking stock
Blackboard readings:
• McDonald’s Split-off of Chipotle, Press Release dated October 12, 2006.
• Market Place Column, “Happy Days After the AOL-Time Warner Merger,” New York Times,
November 2, 2000.
• Sorkin, Andrew, “With AOL Spinoff, Time Warner Ends an Era,” New York Times, May 29, 2009.
17.
Stock-market manipulation and the corporate cost of capital
Packet readings:
• Lewis, Michael, “His So-Called Life of Stock Fraud,” New York Times Magazine, February 25, 2001,
pp.26+.
18.
Corporate voting rights: Alternative arrangements, ownership, and value
Blackboard readings:
• Google IPO registration statement
• DeAngelo, Harry and Linda DeAngelo, “Managerial Ownership of Voting Rights: A Study of Public
Corporations with Dual Classes of Common Stock,” Journal of Financial Economics, March 1985, pp.
33-69.
Focus on (i) the motives for substantial vote ownership by managers (section 2), (ii) the motives for dual
class structures (section 5), and (iii) the summaries in the 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.
• Lublin, Joan and Spencer Ante, “ A Fight in Silicon Valley: Founders Push for Control,” Wall Street
Journal, July 10, 2012.
19.
Proxy contests
Blackboard readings:
• DeAngelo, Harry and Linda DeAngelo, “Proxy Contests and the Governance of Publicly Held
Corporations,” Journal of Financial Economics, June 1989, pp. 29-59.
• Reuters, “Icahn on Icahn,” interview of Carl Icahn, dated March 27, 2012.
20.
Large block stockholders and managerial monitoring
Blackboard readings:
• CPP (see topic 3 for reference)
Read section 11.3 on the “sleeping dogs” theory of payout policy
• DeAngelo, Harry and Linda DeAngelo, “Controlling Stockholders and the Disciplinary Role of
Corporate Payout Policy: A Study of the Times Mirror Company,” Journal of Financial Economics,
May 2000, 153-207.
Packet readings:
• Anders, George, “The “Barbarians” in the Boardroom,” Harvard Business Review, July-August 1992,
pp. 79-87.
• Munk, Nina, “How Levi’s Trashed a Great American Brand,” Fortune, April 12, 1999, pp. 83-90.
8 21.
Delusion in corporate finance: Growth, over-optimism, and contraction
Blackboard readings:
• Jensen, Michael, “The Modern Industrial Revolution, Exit, and the Failure of Internal Control
Systems,” Journal of Finance, July 1993, pp. 831-880.
This article is thought provoking, but too long to cover in totality in the time we have available. Read
sections I through V. Focus on section IV (“The Difficulty of Exit”) and especially on the discussion of the
asymmetry between the growth and decline stages for an organization. Treat sections I through III and VI
primarily as background for section IV.
• Dreazen, Vochi, “Wildly Optimistic Data Drove Telecoms to Build Fiber Glut,” Wall Street Journal,
September 26, 2002.
• Keats, Nancy, “Fore Sale: Prices Crash at Luxury Golf Communities,” Wall Street Journal, May 20,
2012.
Packet readings:
• Loomis, C., “The 15% Delusion,” Fortune, February 15, 2001.
• Buffett, Warren, “Avoiding a Mega-Catastrophe: Derivatives Are Financial Weapons of Mass
Destruction,” Fortune, March 3, 2003
22.
Junk bonds: Michael Milken and the ascent and collapse of Drexel Burnham Lambert
Packet readings:
• Rabinowitz, Dorothy, “Mr. Giulani and Mr. Milken,” Wall Street Journal, December 26, 2000, p. A 10.
23.
The modern crisis in corporate governance
Blackboard readings:
• Smith, Greg, “Why I Am Leaving Goldman Sachs,” New York Times, March 14, 2012.
The important message in this opinion piece is not about Goldman Sachs per se, but rather about the issue
of trust and ethical behavior on Wall Street and, more broadly, in Corporate America.
Packet readings:
• McLean, Bethany, “Why Enron Went Bust,” Fortune, December 24, 2001, pp. 58+.
24.
Common stock repurchases: Alternative methods, tendering behavior, and motives
Blackboard readings:
• CPP (see topic 3 for reference)
Read chapter 13.
25.
Takeover bargaining: Attack and defense strategies
Blackboard readings:
• Dann, Larry and Harry DeAngelo, “Corporate Financial Policy and Corporate Control: A Study of
Defensive Adjustments in Asset and Ownership Structure,” Journal of Financial Economics, April
1988, pp. 87-127.
Focus on sections 4 and 5. Read the appendix only to the extent that you are interested in learning more
about particular cases.
9 Moeller, Sara, Schlingemann, Frederick, and René Stulz, “Wealth Destruction on a Massive Scale? A
Study of Acquiring-Firm Returns in the Recent Merger Wave,” Journal of Finance, April 2005, pp.
757-782.
Read from the introduction through the second full paragraph on page 761 (plus Table I on page 762).
• Davidoff, Steven, “The Case Against Staggered Boards,” New York Times, March 20, 2012.
•
26.
Leveraged buyouts and leveraged recapitalizations
Blackboard readings:
• Denis, David, “Organizational Form and the Consequences of Highly Leveraged Transactions:
Kroger’s Recapitalization and Safeway’s LBO,” Journal of Financial Economics, 1994, pp. 193-224
Read section 2.2 and use the information provided there as background for problem set 8.
Packet readings:
• Kravis, Henry, Keynote Speech Delivered at the Private Equity Analyst Conference in New York City
on September 22, 2004, unpublished manuscript.
• Jensen, Michael, “Eclipse of the Public Corporation,” Harvard Business Review, September-October
1989, pp. 61-74.
27.
Private versus social consequences of corporate investment policy
Blackboard readings:
• DeAngelo, Harry and Linda DeAngelo, “Ancient Redwoods and the Politics of Finance: A Study of the
Hostile Takeover of the Pacific Lumber Company,” Journal of Financial Economics, January 1998, pp.
3-53.
Packet readings:
• McCoy, Charles, “For Takeover Baron, Redwood Forests Are Just One More Deal,” The Wall Street
Journal, August 6, 1993, pp. A1+.
• Walters, Mark, “California’s Chain-Saw Massacre,” Reader’s Digest, November 1989, p. 144+.
Final exam
Ground rules:
Closed book. Closed notes. Calculators are fine. No sharing of calculators. Exam coverage will
emphasize post-midterm material. Pre-midterm material is also relevant, since it is the foundation for the
material covered in the second half of the course.
USC and Marshall policies that govern this and all Marshall courses:
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. 5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.
10 Add/Drop Process: http://www.usc.edu/dept/publications/cat2011/academic/policies.html
In compliance with USC and Marshall’s policies classes are open enrollment (R-clearance) through the
first week of class. All classes are closed (switched to D-clearance) at the end of the first week. This
policy minimizes the complexity of the registration process for students by standardizing across classes. I
can drop you from my class if you don’t attend the first two sessions. Please note: If you decide to drop,
or if you choose not to attend the first two session and are dropped, you risk being not being able to add to
another section this semester, since they might reach capacity. You can only add a class after the first
week of classes if you receive approval from the instructor.
Statement on Academic Integrity:
USC seeks to maintain an optimal learning environment. General principles of academic honesty include
the concept of respect for the intellectual property of others, the expectation that individual work will be
submitted unless otherwise allowed by an instructor, and the obligations both to protect one’s own
academic work from misuse by others as well as to avoid using another’s work as one’s own. All students
are expected to understand and abide by these principles. SCampus, the Student Guidebook, contains the
Student Conduct Code in Section 11.00, while the recommended sanctions are located in Appendix A.
http://www.usc.edu/dept/publications/SCAMPUS/gov/
Students will be referred to the Office of Student Judicial Affairs and Community Standards for further
review, should there be any suspicion of academic dishonesty. The Review process can be found at:
http://www.usc.edu/student-affairs/SJACS/ Failure to adhere to the academic conduct standards set forth
by these guidelines and our programs will not be tolerated by the USC Marshall community and can lead
to dismissal.
11