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MBA 610 Financial Management (Five Week Class)  
Course Overview 

This is the Advanced Finance Class at most universities.  It is targeted largely at Corporate Finance.

 Syllabus-- Syllabus

While it is on the Syllabus, I wanted to have another reminder, cheating will not be allowed and will result in a F grade for the class if I can prove it.

here is the link to the text's main web page for students .  It has quite a few useful pages of notes and online quizzes.  I am sure the quizzes will help also for tests!

Administrative stuff:

  • Class participation, attendance, Homework        25%

      Cases                                                              15%

      Midterm                                                           25%

      Final                                                                 35%

here is the link to the text's main web page for students .  It has quite a few useful pages of notes and online quizzes.  I am sure the quizzes will help also for tests!

Link to mini-corporate summaries   Many of the newer articles appear on the FinanceProfessor Blog. Some articles as well as class announcements will also appear on the Finance Class blog.  I highly recommend you "subscribe" to each of the blogs. 

Here is the podcast where I will be posting the lectures when possible (some might be too large).  The page is pretty bad, but go down to the bottom and it works.  This is the "alpha" version of their site and they need some improvements. ;)  but t is free and readliy accessible, so I can not complain too much. ;)

BEFORE PANIC SETS IN: Yes, there is a great deal of reading. However, I am sure you can handle it. I really only want you to be able to get the top one of two things from each article. From many of the links you do not even need to do that, but rather the links serve as means of documenting things for class (so you know I am not just making things up;)).  YOU DO NOT HAVE TO READ EVERY WORD!  If you get the main point (or in some cases a couple of points) from the papers, I am generally quite happy.  :)  I would much rather you learn the material than worry about a grade. Learn the material and the test should take care of itself.  But really know the material.  become an expert it will help you and make it more fun at the same time.  .  

Notes: 
These notes are constant works in process.  They will likely be updated repeatedly though out the year.  They serve as a much better indicator of what is due when then does the syllabus (which is made once and then does not change).  For that reason you should make a practice of printing the notes just before the class if at all possible.

Week 1

Welcome to class!

Please read the Summaries (the introductions and conclusions couldn't hurt either for the real ambitious) for the first 12 chapters of the text.

In past semesters I  had several requests for review material, so here some links from my introductory corporate finance page that should help. We will not spend much time on these, but you are expected to know it.  
Review material that you may find useful:

Also if you are looking for help in stats, may I recommend The Statistics Homepage.  It is good.

Actual new stuff begins here

We will spend quite a bit of time here

Pulling the goalie:
"Galai and Masulis (1976) show that debt in the capital structure may give shareholders the incentive accept risky negative NPV projects and pass on safe positive NPV projects. This happens when the benefits of the project must go to pay off debt holders. The shareholders will want to take on a risky project (even if it has a negative NPV) in order to have a chance at getting paid after the debt holders have been paid."

"Chevalier and Ellison (1996) apply similar logic and show that mutual fund managers who have underperformed their benchmarks increase the risk of their selections in order to “catch-up.” This is partially because of the high correlation between cash inflows into the fund (i.e. “new money”) and recent fund performance. In both settings, the situation is similar: unless something “big” happens, the principals get no, or a dramatically reduced, return. This creates incentives to take risks that in other settings would appear irrational."

Want a football example?  Click here.

Saturday--review of time value of money and valuation

Review of Portfolio Math and Valuation

 Discussion of Normal distribution  

RISK and Return--what is risk? Systematic vs non systematic

Risk aversion (video), notes for those who want more

A visual look at correlation coefficients

What's it all means: diversify!,international correlations (home country bias),commodities, real estate, market neutral hedge funds, easier one on hedge funds

Notes on CAPM

Why study CAPM if it doesn't work?  Long answer but theory is important
Sharpe

Ok, so CAPM may or may not work.  There is still a soft spot in my heart for CAPM.  Why? Because it is such an important and elegant model and I still think it should work.  But of course most research over the last decade suggests it does not work very well (example Fama And French!). Now why it does not work is the real fun. Is it the model? The market? The researcher? Or some combination of the above? Research from Ang and Chen finds that the time period studied matters as well. For instance, from 1963 on there appears to be a Value anomaly. However, this disappears when the 1926-2001 period is examined and “the market factor alone is able to explain the spread of average returns of these portfolios.” [note the portfolios were created based on book to market values.] Further they find evidence of a time-varying beta relationship where value stocks (i.e. high book to market or equivalently and more commonly in the popular press low market to book ratios) “were risky in the early part of sample, but not in the latter part. This could be really big.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=346600

Week 2
Market Efficiency

Dean Labaron provides a good introduction, Damodoran has a bit more academic look.
Overview: Class notes
Much more on Bahavorial finance to follow...stay tuned

Football, Baseball, Weather, and more on behavorial finance

Required readings:
(Chapter 13 from Book)

                        Theory of Stock Market Efficiency-Ray Ball (Summary available)

                        Fama 1991—Efficient Markets II

                        Behavioral finance Primer by Jay Ritter

What is Insider Trading?

A paper by Bainbridge that looks at Insider trading (great Bibliography and literature review

Will talk about the following in class, but do not worry too much about the specifics until then

          http://papers.ssrn.com/sol3/papers.cfm?abstract_id=440380

          http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=216210

See if insiders at your firm have been trading

Fast recap of Market Efficiency

Capital Budgeting: NPV, IRR, etc

Capital Structure: Capital structure decisions are basic part of doing business yet often misunderstood.  In terms of modern financial theory and EMH it should not matter what we issue as there is a zero NPV.  Managers, however, spend much time worrying about what to issue and when.  Why?   Partially because some of the assumptions we use in developing EMH do not hold, partially because of transaction costs, partially for agency cost reasons, and partially because the Investment banking community is convinced that what firms issue does matter.

Chapter 14 notes : essentially definitions/review of what financing alternatives are available
Notes on Capital Structure

Efficient markets and capital structure--Modigliani and Miller

Does it hold in practice?

In a Modigliani and Miller world when corporate taxes are introduced, the optimal debt level increases. Desai, Foley, and Hines have a cool paper that finds, among other things, that this positive relationship between tax rates and interest does hold. FWIW one of the “other  things” that influences debt financing is the interest rate: the higher the interest rate, the less debt firms use, which fits nicely with the  story above! (BTW, yes this is predominantly intended as an International Finance article, but it is cross-listed here because it is so relevant.)
http://papers.ssrn.com/abstract_id=405023


Capital Structure Debt is good, debt is bad ("Debt makes good times great, bad times horrible")

Financial Distress costs and investments-- Whited 1992

Pecking order--Myers and Majluf.  The "Quess what I am thinking" game!

Types of debt-
  • Treasury Bonds,US Agency Bonds, Strip bonds, Corporate Bonds, Callable bonds, Convertible bonds,Puttable bonds, Floating, Fixed, Extendables, Sr. Debt, Jr. Debt, Asset backed, Mortgage backed, Debentures,Income Bond,Eurobond, Zero Coupon, Original Issue Discount Bonds, General Obligation, Revenue, reverse floaters, etc.
Why are there so many types of securities? 

a look at Convertible Debt, Callable debt, Puttable debt

Non investment grade debt
Private vs. Public
International Differences

Types of equity

Common- what rights do you get? 
Prefered - why does it exist? If it looks like debt and smells like debt, ut is not necessarily debt!
Super shares--letter stock

Does the Pecking Order still hold?  A mini lesson.

So if it is not the pecking order, what is it?  A closer look at debt financing

What else influences the type of debt a firm uses?
Denis and Mihov find that the largest determinant is the credit rating of the firm. In their
JFE article, they report that high quality firms are more likely to opt for a public issuance while medium rated firms take the
bank debt route and low credit rated firms go for private debt placements. However, credit quality is by no means the only
determinant.http://jfe.rochester.edu/02195.pdf

For example (Barclay and Smith 1995) report that riskier firms use shorter term debt and Petersen and Rajan 1994 fomd that bank relationships are especially important for smaller firms.

Kisgen reports that managers manage capital structure in a way to prevent downgrades and to get upgrades. For instance firms that "are near a change in credit rating" make moves to improve their rating by issuing less debt and retiring more debt.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=355680

Want still more on debt financing? Ok, but only since you are nice. ;)  Baker, Greenwood, and Wurgler report in a JFE piece that firms also time debt obligations. When long-term rates are low, the firms try to capture these “low” rates, by issuing longer-term debt. Which, while not surprising, may be further evidence that market efficiency is not market perfection and that the financing waves we see may make sense (and cents) after all.
http://jfe.rochester.edu/02219.pdf

Several papers have shown that capital structure does impact operations.  For instance a few papers have looked at grocery stores and leverage.  For instance after LBOs, stores raised their prices and another paper has found that those with high debt had more out of stocks.  

Capital Structure articles from the Blog.
Introduction to Security Issuance
Asquith and Mullins have the classic paper in this area. It is a tad dated (1986) but is still pretty much the gold standard.
Rights issues

Capital structure review--
Famous " Smith-Masulis " papers



  • The Dividend Cut heard around the World: The case of FPL: Soter, Brigham, and Evanson

  • Financing Corporate Growth—Cornell and Shapiro

  • Convertible Bonds: Matching Financial and Real Options

  •  What do we know about Stock Repurchases—Grullon and Ikenberry

  • Largely from chapters 14-20 in book

Week 3
   Raising capital continued--IPOs--some blog enries on IPOs

not on test 1

The flip side of security issuance---
    Dividends and Buybacks-- notes to follow

Dividends can act as a signal---Venkatesh

Do Dividends and Buybacks improve performance?  Maybe.

In an upcoming JF, Grullion and Michaely give us an in depth look at stock repurchases. They find more buybacks and that the buybacks reduce the free cash flow problem. They also find that buybacks apparently do not signal improved operating performance in the future.
Cool factoid:
"between 1984 and 2000 corporations spent approximately 26 percent of their annual earnings on repurchases." Additionally, the paper brings up some interesting questions. Probably the most interesting question is why stock repurchases lead to lower systematic risk?! My guess is that there is a confounding variable at work. Specifically, suppose that firms who have seen recent increases in slack (so lower leverage) are more apt to do buy backs. These same firms would be more likely than their peers (who have not seen their leverage drop) to have lower systematic risk. Which is a bit of a stretch, but is consistent with the finding.
http://www.afajof.org/Pdf/forthcoming/repurchases.pdf

On the other hand, in the Journal of Financial Intermediation, Hirtle finds that profitability at banks who do repurchases does in fact
increase following the repurchase.
http://www.olin.wustl.edu/jfi/vol12.htm#Repurchases


Leasing

Why lease?  

There are many reasons firms lease but in the end they mainly boil down to lower taxes or lower transaction costs.

Forbes has a very basic (does not really live up to their usual standards) look at leasing. One highlight: 

"The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without significantly affecting your cash flow"

     Other (admitedly biased) resources are Lease Source, SOKKIA 

Types of Leases: Operating vs Capital (Financial)

Comes down to which is cheaper.  Many financial calculators to help you decide.  Looking for positive NAL (Net Advantage to Lease)
      Calculator from Lease vs Buy,   Smith and Wakeman's 1985 paper still helps clarify my thinking on leasing more than just about anything else.

Derivatives: 

What are they?,  notes on how to price them using the Black Scholes formula, Put call parity

How to use them: DRAW PAYOFF DIAGRAMS!

Why use them? Speculating (leverage gives you much power), stock options can help align incentives (with some problems)

Hedging (operational hedging and  financial hedging) can lowers risk, can positively impact cashflows, lowers expected taxes, make it easier to monito management, and allow management to do what they do best and not worry about what is beyond their control.  Hedging can also allow firms better access to capital markets (SEE Simkins, Carter, and Rogers and Allayanis and Weston 1998)

Why studying them is important even if you do not personally plan to use them: 

Derivatives are explosive, zero-sum games.  Used correctly they can be powerful tools, used incorrectly they can blow up in your face.  Knowing this may allow you to prevent the problems from happening at your firm or firms you do business with.  

Here are just a few of the debacles,: Orange County, Barings, LTCM, Bankers Trust (although this argues for being stupid!)             
                         
Week 4--
Reading the entrails, a look at Implied Volatilies (there are hundreds of others but I might as well use my one ;) )

  • OPEC paper (Horan, Peterson, and Mahar 2004)--Finds that IV increases prior to meetings by OPEC, decreases once assymetry is resolved

  •  Godbey and Mahar (RIF, Forthcoming 2004) found that IVs increased for firms audited by Andersen during Enron problems--

  •  Real Options--Football example  Rodney Paul and me.

  • Implied volatility is a good forecast of actual future volatilty, but not perfect and its predictive abilty declines with volume (that is when options do not trade much, the IV is not as informative.  (Godbey and Mahar 2007)


In sum, Derivatives are powerful tools.  Used correctly they help greatly, used incorrectly they really can hurt!

Long Term Capital Management is a particularly good case dealing at least some with derivatives.  If no one selects it as a case to present in week 5, we will spend some time going over it in class. 

  from erisk.com LTCM
  from The Risk Institute Long Term Capital Management case
  the view from the Fed's Patrick Parkinson
  the cry for more regulation was not widely accepted.


Corporate Governance 

Talk about hot topics!  Corporate Governance has been on the front page of all major papers and has attracted much attention in academic world as well.  It boils down to conflicts within the Nexus.  Generally this focuses on manager and shareholder conflicts. 

Here are a few notes on the topic from past newsletters, a speech by Alan Greenspan on the topic, an  independent study paper by Joe Haller (former SBU MBA student) and a class project on the topic from Andy Bubbs (former SBU student).

Does governance matter? Definitely, but it is often difficult to measure how much it matters. For instance looking at studies that show separate CEO-Chair positions are often driven by multiple factors and the choice is somewhat endogenous. 

However there is much evidence suggests that governance matters.  Looking at cross listing literature, Nofsinger and Weaver (2003) report that that one reason firms cross list (especially to the US) is to increased investor protections--Caveat, htis is not universally held. Additionally, there is much other international evidence (where the difference between strong and weak governance is more pronounced than in the US) that shows that governance does matter.  For example  Black, Jang, and Kim report that shareholder wealth is strongly positively related to strong governance.  Similarly Black finds the same evidence in looking at Russian Firms.   And a whole bunch of people do the same for Chinese firms.

Practically, governance issues often come down to disagreements about Executive pay, shareholder voting, poison pills and other areas of entrenchment..


Transparency and Governance

 Where does auditing fit into this?  Can't improve things unless we know what is going on. 

Better earnings quality and transparency lead to lower underpricing in IPOs.

 Chaney and Phillpich (JAR 2002)  find that stock prices dropped as Andersen's reputation worsened.  Also Callen and Morel as well who find that with a similar results with a slightly different sample,  Godbey and Mahar (RIF 2004) find that auditor reputation helps mitigate the information asymmetry problem.
(FWIW this is an early edition of the paper, I am not sure how to get around copyright laws, so I just put up working papers)

What is Wrong with Corporate Governance? 

See Enron, Adelphia, Tyco, NYSE, etc., etc.  The list goes on and on.  We will talk about some of the cases in class.  

Lack of transparency is likely the most severe problem. 

What is Right with Corporate Governance?

Overall US system seems to be best there is.  Sure there are problems, but better than alternatives. The problems

A few sites that you may find useful:

Executive Compensation

Executive compensation notes

Much of both the level and form of pay can be quickly summarized in these simple models.

LOWER---------------------Level of Pay----------------------------------HIGH

Assets in place                                                                                Growth options
Small                                                                                                 Large
Regulated                                                                                  Unregulated

            ---------------------------Form of Pay---------------------------

Straight Salary is a higher proportion                                          Market-based pay is more important
                                                                                                            

Assets in place                                                                      firms with many growth options
Small Firms                                                                                         larger firms
Rgulated Firms                                                                                   unregulated firms
 

The SEC's information on executive compensatation 

Executive Compensation Resources
the AFL-CIO's site, while biased, is a good resource

Papers

Erickson,Hanlon, and Maydew---GREAT!!!!
A look at where we have failed---ok, so it is cynical and somewhat anti-market
It's the form,. not the level--Jensen and Murphy

Blog entries

Required Readings:

Adelphia:

Springfield Power Case 

Week 5

Market for corporate Control (mergers, takeovers, etc)

The Market for Corporate Control:  in some ways this is what happens if internal measures do not work.

Off line Readings:

Is American Corporate Governance Fatally Flawed? –Merton Miller


Takeovers: 

  • Merger: absorption of firm A by firm B...in end all are mergers

  • Acqusition of stock: Purchase either in open marget or tender offer

  • Acquistion of Assets

  • Proxy contest

  • Tax implications: if deal is seen as a table event: trigger capital gain, if not then no taxes now.
       also steeped up depreciation

Types

Horizontal merger_acquiring competitor
Conglomertae merger--diversifying
Vertical mergers--taking over a supplier or distributor.  Why?  Be careful!  

Fan and Goyal find that there are postivie abnormal returns from vertical acqustions.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296435

   Takeover waves (and types)
   

History lesson

1898 to early 1900s--Horizontal mergers  
1920s--vertical mergers
1940s--regulatory driven
1960s conglomeration
1980s Leveraged bust ups
late 1990s to now: tech and regulatory as well as vertical

These in  part of can be explained by the Agency costs and by stock price overvaluation.  

These latter hypotheses won support from Gugler, Mueller, and Yurtoglu (2003)

  Hostile or Friendly?

   LBO--Opler finds improved performance following deal.  Why?  Best guess is better incentives

   Laws

   How a merger can create value

  1. Economies of scale

  2. Economies of vertical integrtaion (lower Transaction costs) 

  3. Combining compliemtary assets (drug company and sales force)

  4. Synergy

  5. Marketing or distribution

  6. Market power--Esp with horizontal mergers

  7. Elimination of poor management

  8. Access to a. materials    b. customers, c. capital

Generally overall value is created.  Most of this goes to shareholders of target.

From Jensen and Ruback (1983)

                       Target %      Bidder %
Tender offer     30%                4%
Merger             20                   0 %
Proxy contest    8%                  NA

Unsuccesful bids may have value if they improve management or if they put firm in play.  Bradley, Desai, and Kim (1983) fidn that those firms who do not receive another bid give up their abnormal returns in 2 years.

How a merger can destroy value

    Dissynergy--Comment and Jarrell---can you say deworsifcation

   Megginson, Morgan, and Nail find that focus decreasing (i.e diversifiying deals) destroy value.

   Maybe they destroy value by signalling overvaluation?  That is one interpretation of  Loughran and Vijh (1997)

    Corporate culture
  Chrysler

  Hostile vs friendly

    Hostile deals get the publicty

     Most deals are friendly

how to fight acquistions

  • Pre--Maximize Shareholder value!

shark repellants

Super majority
Fair Price Amendments
Staggered Boards
Posion Pills

  • Post offer (i.e. you are in play!)

Asset restructuring --selling crown's jewels,
one time dividend
Buyback--possibly greenmail
Litigation-sue everyone
Make it political
Pac men and White Knights

Other forms of restructring:
    Carve-outs--selling a division (generally part of division) to public in form of IPO
    Spin-offs--giving shares to existing shareholders
    Tracking stock

Key questions

  • Parachutes: Good or bad?

  • Why do we allow managers to fight takeovers?

Discussion of Junk Bonds and Milken

International differences

Corporate Ownership and control in the UK, Germany, and France—Franks



Break time

Multinational finance

Why do business internationally?

Benefits

Risks
    Country Risk-unexpected changes in country's business environment

Political from taxes to nationalization, protectionsim, and expropriation
Financial--currency risk--MUCH easier to hedge

Hedging --why?  

net or by division?

What to hedge?
Transaction exposure--easy
Operating Exposure-more difficult
Translation exposure-marginal usefulness


Differences
Cultural
Legal and infrastructure
Investor protections  
Insider trading laws
Bribery
Environmental
Should US laws pertain to US firms?
Government involvement

How to do business internationally

Continuum from using agents to foreign branches to licencing (franchising) to Joint Venture/Merger


International Corporate finance

International Capital Budgeting
Raising capital internationally
Blocked funds
Cost of capital
Taxes
Mergers and Acquistions
Executive pay--A look at Japan--from Kato


Case: NatWest Takeover Battle-definitely not the final version.
         An excel file of stock prices--just hit cancel when it asks for a password
         A longer and earlier version (sorry for mistakes) but it has more tables

Catch-up/review
Trends in finance
What we know what we do not know
Tying it back together

Using finance in life


Final:  Noon start.  2:30 hours to take it.


 

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