Capital structure: the Modigliani and Miller theorem, impact of taxes

New Economic School
(Financial contracting and corporate governance)
Module 4, 2005–2006
Sergey Stepanov ([email protected])
1. Andrei Malenko ([email protected])
2. Andrei Vashevnik ([email protected])
Corporate Finance II is complementary to Corporate Finance I. Corp. Fin. I and Contract Theory are
prerequisites for Corp. Fin. II.
Corp. Fin. II will focus on the issues of financial contracting and corporate control. It will discuss the
ways in which financial contracts (financial structure) and control mechanisms (i.e. corporate
governance) should be designed so as to mitigate the conflicts between insiders and outsiders in a
firm and maximize the overall efficiency of a firm’s decisions. We will also look at how the market
for corporate control (takeovers) helps (or fails) to ensure that firms are governed by the most able
managers (or controlling owners) and that their incentives are best aligned with shareholders’
interests. Furthermore, we will discuss why ownership structures of firms, corporate governance
mechanisms and overall financial development substantially differ across countries, focusing on the
role of law and political economy explanations. We will finally discuss the problems of corporate
governance in transition and developing economies with a focus on the case of Russia.
Course materials
There is no single textbook for the course. Some topics are covered well in [1] and [2]. We will
mainly use these two books and the most important papers for each topic directly. [3] can be used as
a supplementary reading. Some sections dealing with financial contracting of [4] are also useful
background reading. Other necessary materials will be handed out in class or made available at
1. Tirole, Jean, 2006, The Theory of Corporate Finance, Princeton University Press.
2. Hart, Oliver, 1995, Firms, Contracts, and Financial Structure, Oxford University Press.
3. Amaro De Matos, Joao, 2001, Theoretical Foundations of Corporate Finance, Princeton
University Press.
4. Bolton, Partick, and Mathias Dewatripont, 2005, Contract Theory, MIT Press.
Course outline with references to specific papers
Note: The list of references is long; I will not cover all of them in detail but will rather focus on some
of them and summarize the rest. Topics marked with * will be covered if there is enough time.
1. Introduction ([1], ch. 1)
1.1. Overview of the course
1.2. Agency problem and the notion of pledgeable income.
Tirole, Jean, 2001, "Corporate Governance", Econometrica, 69, 1: 1-35
2. Financial contracts and allocation of control ([1], ch. 3.8, 10; [2], ch. 5, 6)
Hart, Oliver, 2001, "Financial Contracting", Journal of Economic Literature, 39: 1079-1100.
2.1. Allocation of control between insiders and outsiders.
Aghion, Philippe, and Patrick Bolton, 1992, "An Incomplete Contracts Approach to Financial
Contracting," Review of Economic Studies, 77:388-401.
Hart, Oliver D., and John Moore, 1994, "A Theory of Debt Based on the Inalienability of Human
Capital," Quarterly Journal of Economics, 109:841-879.
Hart, Oliver D. and John Moore, 1998, "Default and Renegotiation: A Dynamic Model of Debt",
Quarterly Journal of Economics, 113: 1-42.
Bolton, Patrick, and David S. Scharfstein, 1990, "A Theory of Predation Based on Agency
Problems in Financial Contracting," American Economic Review, 80:94-106.
Kaplan, Steven and Per Strömberg, 2003, “Financial contracting theory meets the real world:
Evidence from venture capital contracts”, Review of Economic Studies 70(2), 281-316.
2.2. Allocation of control between different investors and diversity of outside claims
Hart, Oliver D., and John Moore, 1995, "Debt and Seniority: An Analysis of the Role of Hard
Claims in Constraining Management," American Economic Review, 85: 567-585.
Berglöf, Erik and von Thadden, Ernst-Ludwig, 1994, "Short-Term versus Long-Term Interests:
Capital Structure with Multiple Investors," Quarterly Journal of Economics, 109: 1055-1084.
Bolton, Patrick, and David S. Scharfstein, 1996, "Optimal Debt Structure and the Number of
Creditors," Journal of Political Economy, 104:1-25.
Zwiebel, Jeffrey, 1996, "Dynamic Capital Structure Under Managerial Entrenchment," American
Economic Review, 86: 1197-1215.
Dewatripont, Mathias, and Jean Tirole, 1994, "A Theory of Debt and Equity: Diversity of
Securities and Manager-Shareholder Congruence," Quarterly Journal of Economics, 109:10271054.
3. Costly state verification with single and multiple investors ([1], ch. 3.7; [2], ch. 5.appendix)
Gale, Douglas, and Martin Hellwig (1985), "Incentive Compatibility Debt Contracts:The One
Period Problem," Review of Economic Studies, 52:647-663.
Townsend, Robert (1979), "Optimal Contracts and Competitive Markets with Costly State
Verification," Journal of Economic Theory, 21:417-425.
Winton, Andrew (1995), "Costly State Verification and Multiple Investors: The Role of
Seniority," Review of Financial Studies, 8:91-123.
4. Theories of outside equity*
Fluck, Zsuzsanna (1998), “Optimal Financial Contracting: Debt vs Outside Equity,” Review of
Financial Studies, 11:383-418.
Myers, Stewart (2000), “Outside Equity”, Journal of Finance 55:1005-1037.
5. Corporate governance ([1], ch. 1; [2], ch. 8)
5.1. Agency problems and mechanisms of corporate governance (overview)
Becht, Marco, Patrick Bolton and Ailsa Röell, 2002, "Corporate Governance and Control", ECGI
- Finance Working Paper No. 02/2002
Shleifer, Andrei, and Robert Vishny, 1997, "A Survey of Corporate Governance", Journal of
Finance, 52: 737-783.
5.2. Transfers of corporate control (takeovers)
Scharfstein, David, 1988, The Disciplinary Role of Takeovers, Review of Economic Studies 55,
Shleifer, Andrei, and Lawrence H. Summers, 1988, Breach of Trust in Hostile Takeovers, in
Alan J. ed Auerbach, ed.: Corporate Takeovers: Causes And Consequences (University of
Chicago Press, National Bureau of Economic Research Project Report series, Chicago and
Grossman, Sanford J., and Oliver D. Hart (1980), "Takeover Bids, the Free Rider Problem and
the Theory of the Corporation," Bell Journal of Economics, 11:42-64.
Grossman, Sanford J., and Oliver D. Hart (1988), "One Share One Vote and the Market for
Corporate Control," Journal of Financial Economics, 20:175-202.
Bebchuk, Lucien A. (1994), "Efficient and Inefficient Sales of Corporate Control," Quarterly
Journal of Economics, 102: 957-993.
Burkart, Mike, Denis Gromb, and Fausto Panunzi (1998), "Why Higher Takeover Premia Protect
Minority Shareholders," Journal of Political Economy, 106:172-204.
Burkart, Mike, Denis Gromb, and Fausto Panunzi (2000), "Agency Conflicts in Public and
Negotiated Transfers of Corporate Control," Journal of Finance.
Zingales, Luigi (1995), "Insider Ownership and the Decision to Go Public", Review of Economic
Studies, 62: 425-448.
5.3. Ownership concentration and corporate control
Shleifer, Andrei and Robert W. Vishny, (1986), "Large Shareholders and Corporate Control",
Journal of Political Economy, 94: 461-488.
Burkart, Mike, Denis Gromb, and Fausto Panunzi (1997), "Large Shareholders, Monitoring and
the Value of the Firm," Quarterly Journal of Economics, 113:693-728 (see also [1], ch. 10.6)
Burkart, Mike, and Fausto Panunzi, 2005, "Agency Conflicts, Ownership Concentration and
Legal Shareholder Protection", forthcoming in Journal of Financial Intermediation.
Pagano, Marco, and Ailsa Roell, (1998), "The Choice of Stock Ownership Structure: Agency
Costs, Monitoring and the Decision to Go Public," Quarterly Journal of Economics, 113:187225.
6. Theories of financial development
6.1. Law and finance theories
6.1.1. Law matters
La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert Vishny, 2000,
"Investor Protection and Corporate Governance", Journal of Financial Economics, 58: 3-27.
Denis, Diane K., and John McConnell, 2003, "International Corporate Governance", Journal
of Financial and Quantitative Analysis, 38: 1-36.
Beck, Thorsten, and Ross Levine, Legal Institutions and Financial Development, in
Handbook of New Institutional Economics, C. Menard and M. Shirley (eds)., Kluwer
Dordrecht (The Netherlands), 2004.
Shleifer, Andrei, and Daniel Wolfenzon, 2002, "Investor Protection and Equity Markets",
Journal of Financial Economics, 66: 3-27.
Burkart, Mike, Fausto Panunzi, and Andrei Shleifer, 2003, "Family Firms", Journal of
Finance, 58: 2173-2207.
Dyck, A., and L. Zingales, 2004, "Private Benefits of Control: An International Comparison",
Journal of Finance 59: 537-600.
6.1.2. Law matters?
Franks, Julian R., Colin Mayer, and Stefano Rossi, 2005, "Ownership: Evolution and
Regulation", ECGI - Finance Working Paper No. 09/2003.
Aganin, Alexander, and Paolo F. Volpin, 2003, "History of Corporate Ownership in Italy",
ECGI - Finance Working Paper No. 17/2003.
Rajan, Raghuram G., and Luigi Zingales, 2003, "The Great Reversals: The Politics of
Financial Development in the 20thCentury", Journal of Financial Economics, 69: 5-50.
6.2. Political economy theories
Rajan, Raghuram G., and Luigi Zingales, 2003, "The Great Reversals: The Politics of Financial
Development in the 20thCentury", Journal of Financial Economics, 69: 5-50.
Rajan and Zingales, Saving Capitalism from the Capitalists, Unleashing the Power of Financial
Markets to Create Wealth and Spread Opportunity, Crown Business, 2003.
Pagano, Marco, and Paolo Volpin, 2005, "The Political Economy of Corporate Governance",
American Economic Review, 95: 1005-1030.
Perotti, Enrico, and Ernst-Ludwig von Thadden, 2003, “The Political Economy of Bank- and
Market Dominance”, ECGI - Finance Working Paper No. 21/2003.
7. Corporate governance in transition and developing economies
7.1. Main problems and mechanisms of corporate governance
Berglöf, Erik, and Ernst-Ludwig von Thadden, 2000, "The Changing Corporate Governance
Paradigm", in Pleskovic and Stiglitz (eds.), World Development Conference, The World Bank.
Berglöf, Erik, and Stijn Claessens, 2004, "Enforcement and Corporate Governance", World Bank
Policy Research Working Paper 3409.
Guriev, Sergei, and Andrei Rachinsky, 2004, “Ownership Concentration in Russian Industry”,
CEFIR working paper #45.
7.2. Overcoming effects of bad institutions
Durnev, Artyom, and E. Han Kim, 2005, "To Steal or Not to Steal: Firm Attributes, Legal
Environment, and Valuation," Journal of Finance, forthcoming.
Klapper, Leora F., and Inessa Love, 2004, "Corporate Governance, Investor Protection, and
Performance in Emerging Markets", Journal of Corporate Finance, 10: 703-728.
Guriev, Sergei, Olga Lazareva, Andrei Rachinsky, and Serguei Tsoukhlo, 2005, "Concentrated
ownership, market for corporate control, and corporate governance", CEFIR working paper #32.
Black, Bernard, Inessa Love, and Andrei Rachinsky, 2005, Corporate Governance and Market
Value of Russian Firms: Time Series Evidences from Russia, CEFIR working paper #53.
Dyck, Alexander, Natalya Volchkova, and Luigi Zingales, 2005, “The Corporate Governance
Role of the Media: Evidence from Russia”, CEFIR working paper #54.
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