University of Maryland
The Interaction of Industrial Organization and Finance
Gordon M. Phillips,
The primary topics of the course concern the interaction between the firm’s real decisions and its financial decisions in different equilibrium industrial organization settings. This course involves a fair amount of microeconomics and industrial organization in addition to finance. Both theoretical articles and empirical articles will be covered and discussed. We will emphasize the link between theoretical and empirical research in both industrial organization and corporate finance.
NOTE: Please carefully read and outline the first 6 starred articles before our 1st class.
We will primarily be using articles for the course. During the course we will cover in depth the * articles – approximately 4-6 articles per session. Please read these carefully. You will also be responsible for turning in 2-page write-ups on 2 of the articles each week, beginning with the 2nd session. For some weeks I indicate which articles to choose from with the words “handin”. I would like you to choose 1 theoretical article and 1 empirical article. The write-up should not just summarize the article. It should identify what the major contribution is, identify the solution technique or econometric methodology used, discuss in depth any potential limitations (modeling limitations or unrealistic assumptions or methodological problems) of the papers and also discuss how one could extend the paper by identifying unanswered questions.
The course grade will be based on these handin “referee reports”, participation in class (with some presentations possible) total 50%, and a final exam (50%).
There are some recommended text books that gather some of the classic articles together that may be useful to you. These textbooks are:
Financial Markets and Incomplete Information, Sudipto Bhattacharya and George Constantinides, editors, Rowman and Littlefield, 1989.
The Modern Theory of Corporate Finance, Clifford W. Smith, ed., McGraw-Hill, 1990.
In addition, to supplement your microeconomics training, you may want to purchase the following book on Industrial Organization. It has very good presentations of basic industrial organization modeling. It is:
The Theory of Industrial Organization, Jean Tirole, MIT Press.
Also useful is:
The Theory of Corporate Finance, Jean Tirole,
Class Schedule and Reading Assignments
We will cover about 4-6 articles in depth for each session in depth and give an overview of some of the others. (* articles indicate the in depth articles) Each section will have background material which gives some finance citations which do not consider the interaction of finance and industry product markets. These background materials are not distributed in the course but you should consult these citations to understand fully the more advanced articles.
In general, I have tried to organize articles within sections by development of "themes" in the literature. Thus, articles do not necessarily proceed chronologically within sections - but do in most cases proceed chronologically by class session.
Section 1: Theory of the Firm: From Perfect Markets to Contracting Problems and Information Problems
a. Transaction Costs and Agency Theories of the Firm (Session 1)
* Williamson, Oliver E., 1967, Hierarchal control and optimum firm size, Journal of Political Economy, 75: 123-138.
* -----, 1971, The vertical Integration of production: Market failure considerations, American Economic Review, 61, 112-123.
* -----, Oliver E., 1983, Transaction-Cost Economics: The Governance of Contractual Relations, Journal of Law and Economics, 233-261.
Also, “Transaction Cost Economics” , Handbook of Industrial Organization , Chapter 3, Volume 1.
* Jensen, M. and
*Klein, Benjamin, Robert Crawford, and Armen A. Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process, Journal of Law and Economics 21, 1978, 297–326.
* Masten, Scott E., 1993, Transaction Costs, Mistakes, and Performance, Managerial and Decision Economics, 14, 119-129.
The following article will be finished on Session 2.
* Holmstrom and Tirole, 1989, The Theory of the Firm, Handbook of Industrial Organization, Chapter 2. Volume 1.
b. Firm Ownership, Incomplete Contracts and the Property Rights Theory of the Firm (Session 2)
*handin Grossman, Sanford and Oliver Hart, 1986, The costs and benefits of ownership: A theory of vertical and horizontal integration, Journal of Political Economy 94, 691-719.
* handin Hart, Oliver and J. D. Moore, 1990, Property Rights and the Nature of the Firm, Journal of Political Economy, 98, 1119-58.
* Whinston, Michael, On the transaction cost determinants of vertical integration, Journal of Law, Economics, and Organization, 2003
Rajan, Rajhuram, G. and Luigi Zingales, 1998, Power in a theory of the firm, Quarterly Journal of Economics 113, 387-432.
Harris, M. and Raviv, A. (1992), “Financial Contracting Theory”, in J. Laffont (ed.) Advances in Economic Theory:. Sixth World Congress, Vol. II
* (handin) Kaplan, Steven N. and Per Stromberg, 2003, Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts, published, Review of Economic Studies.
*Allen, Jeff and Gordon Phillips, 2000, Corporate Equity Ownership, Strategic Relationships and Product Market Relationships, Journal of Finance. Paper available on SSRN (more complete version).
* C. Edward Fee and Charles Hadlock, Shawn Thomas, "Corporate Equity Ownership and the Governance of Product Market Relationships", Journal of Finance, 2006, vol. 61, issue 3, pages 1217-1251
Kale, Jayant and Husayn Shahrur , 2006, "Corporate capital structure and the characteristics of suppliers and customers" JFE.
c. Managerial Ownership and Firm Competition (Session 3)
* Hart, O., 1983, "The Market Mechanism as an
*Scharfstein, D., "Product Market Competition and Managerial Slack," Rand Journal of Economics. 1988, 19:147-155.
* Fershtman, Chaim and Kenneth L. Judd, "Equilibrium Incentives in Oligopoly," American Economic Review, 1987, 77, 927-940.
* Aggarwal, Rajesh, and Andrew Samwick, Executive Compensation, Strategic Competition, and Relative Performance Evaluation: Theory and Evidence,” Journal of Finance, 54 (December 1999), 1999-2043.
* Holger Meuller (NYU) and Xavier Giroud., recent Does Corporate Governance Matter in Competitive Industries?, http://www.stern.nyu.edu/%7Ehmueller/papers/pmc.pdf.
Section 2: Financing Decisions, Capital Structure and Product Markets
Miller, Merton H., 1988, "The Modigliani-Miller Propositions After Thirty Years," Journal of Economic Perspectives. 2:99-120. (with comments following by Joseph Stiglitz, Stephen Ross, Sudipto Bhattacharya, and Franco Modigliani.)
Part 1: External Contracting Problems, Intra-Industry Focus
a. Contracting and Capital Structure
*Myers, S., "The Capital Structure Puzzle," Journal of Finance. July, 1984, 39:575-592.
*Myers, Stewart C., and Nicholas S. Majluf, 1984, Corporate financing and investment decisions when the firm has information that investors do not have, Journal of Financial Economics} 13, 187-221
*Harris, Milton and Artur Raviv, 1991, "The Theory of Capital Structure," Journal of Finance. 46: 297-355.
*Maksimovic, Vojislav; Titman,
Part 2: Intra-Industry firm competition and Capital Structure (Sessions 5-6)
b. Financial Structure and Intra-Industry competition (Session 5)
* Brander, James A., and Tracy R. Lewis, 1986, "Oligopoly and financial structure," American Economic Review. 76, 956-970.
*----, (1988), "Bankruptcy costs and the theory of oligopoly," Canadian Journal of Economics 21(2), 221-243.
*Maksimovic, Vojislav, 1988, "Capital structure in repeated oligopolies," Rand Journal of Economics. 19, 389-407.
Glazer, Jacob, 1994, "The Strategic Effects of Long-Term Debt in Imperfect Competition," Journal of Economic Theory; 62(2), April 1994, pages 428-43.
*Phillips, Gordon, 1995, "Increased Debt and Industry Product Markets: An Empirical Analysis," Journal of Financial Economics, 37, 189-238. Download full PDF: Click Here.
Bresnahan, Timothy F., 1989, "Empirical studies of industries with
market power," In Handbook of Industrial Organization. ed. R. Schmalensee and R. Willig, North-Holland,
Phillips, Gordon, and Dan Kovenock, 1995, "Capital Structure and Product Market Rivalry: How Do We Reconcile Theory and Evidence?", with Dan Kovenock, American Economic Review, 1995, 85, 403-408. Download full PDF: Click Here.
Chevalier, Judith, 1995, "Do LBO Supermarkets Charge More? An Empirical Analysis of the Effects of LBOs on Supermarket Pricing," Journal-of-Finance; 50(4), September 1995, pages 1095-1112.
Campello, M., Capital Structure and Product Markets Interactions: Evidence from Business Cycles , Journal of Financial Economics 68 (3), 2003, pp. 353-378.
*Campello, M., Debt Financing: Does it Boost or Hurt Performance in Product Markets? Journal of Financial Economics, 2006.
Chevalier, Judith, 1995, "Debt and product market competition: Local market entry, exit, and expansion decisions of supermarket chains." American Economic Review, 85, 415-35.
*Kovenock, Dan and Phillips, Gordon, 1997, "Capital Structure and Product Market Rivalry: An Examination of Plant Closing and Investment Decisions," with Dan Kovenock, Review of Financial Studies, 1997, Volume 10:3. . Download PDF file: Click Here
Khanna, Naveen and Sheri Tice, 2005, “Pricing, Exit, and Location Decisions of Firms: Evidence on the Role of Debt and Operating Efficiency”, Journal of Financial Economics.
* Maksimovic, Vojislav and Josef Zechner, 1991, "Debt, Agency Costs, and Industry Equilibrium," Journal of Finance, 46: 1619-1644.
*Maksimovic, Vojislav and Gordon Phillips 1998, "Asset Efficiency and the Reallocation Decisions of Bankrupt Firms." Journal of Finance, October, 1998, 53, 1495-1532. Download paper in Adobe PDF Format:
*Mackay, Peter and Gordon Phillips, 2005, "How Does Industry Affect Firm Financial Structure?" Click here to download in Adobe PDF Format., Review of Financial Studies.
*Stomper, Alexander, Christine Zulehner, and Pegaret Pichler, "Why leverage affects pricing", RFS 2008. Available at: http://homepage.univie.ac.at/Christine.Zulehner/pricing.pdf
* David Matsa, 2007, Capital Structure as a Strategic Variable: Evidence from Collective Bargaining,. (Click to find paper)
Bresnahan, Timothy, 1982, "The oligopoly solution concept is identified," Economic Letters. 10, 87-92.
Fudenburg, Drew and Jean Tirole, 1986, "A signal jamming' theory of predation" Rand Journal of Economics. 17, 366-376.
Poitevin, Michel, 1989, "Financial signaling and the "deep-pocket" argument," Rand Journal of Economics. 20, 26-40.
Rotemberg, Julio J. and David S. Sharfstein, 1990, "Shareholder Value Maximization and Product Market Competition," RFS, 3:367-91.
(review) Maksimovic, V., 1995, Financial Structure and Product Market
Competition, in Jarrow, R., Maksimovic V. and
Zingales, Luigi, 1998, "Survival of the fittest or the fattest? Exit and financing in the trucking industry,.Journal if Finance.
Other articles on capital structure:
1. Rajan, Raghu and Luigi Zingales, 1995, “What do We Know about Capital Structure,? Some Evidence from International Data”, Journal of Finance 50, 1421-1460.
2. Graham, John R. and C.R. Harvey, 2001, The theory and practice of corporate finance: The evidence from the field, Journal of Financial Economics
3. Shyam-Sunder, Lakshmi and Stewart Meyers, Testing Static Trade-Off Against Pecking Order Models of Capital Structure, Journal of Financial Economics, 1999.
4. Frank, Murray Z., and Vidhan K. Goyal, 2003, Testing the pecking order theory of capital structure, Journal of Financial Economics 67, 217-248.
5. Gomes, A., and G. Phillips, 2007, Why do public firms issue private and public securities? working paper.
7. Hennessy, Chris, and Toni Whited, 2005, “Debt Dynamics,” Journal of Finance 60 (2005): 1129-1165
8. Hennessy, Chris, and Toni Whited, 2006, "How Costly is External Financing? Evidence from a Structural Estimation." forthcoming, Journal of Finance.
Section 3: Mergers and Acquisitions (2-3 sessions)
Jensen, Michael, 1993, "The modern industrial revolution and the challenge to internal control systems," AFA presidential address, Journal of Finance. 48, 831-880.
Ravenscraft and F. Scherer, 1987, Competition; Mergers, Sell-offs, and Economic Efficiency.
Jensen M. and Richard Ruback. 1983. “The Market for Corporate Control: The Scientific Evidence,” Journal of Financial Economics, 11.
*Jensen, M. 1986. “Agency Costs of Free Cash Flow, Corporate Finance and Takeovers.” American Economic Review. 76, pp. 323-329.
Jensen, M. 1988. "Takeovers: Their Causes and Consequences." Journal of Economic Perspectives. 2, pp. 21-48.
Jarrell, Gregg, James Brickley, and Jeffrey Netter. 1988. “The Market for Corporate Control: The Empirical Evidence Since 1980,” Journal of Economic Perspectives, Winter: 49-68.
Kaplan, S. 1989. “The Effects of Management Buyouts on Operations and Value.” Journal of Financial Economics. 24, pp. 217-254.
*(hand in) Kaplan and Weisbach, 1992. The Success of Acquisitions: Evidence from Disvestitures, Journal of Finance.
(hand in) Maksimovic, Phillips, Prabhala, 2008,
Andrade, Gregor, Mark Mitchell and Erik Stafford. 2001. “New Evidence and Perspectives on Mergers.” Journal of Economic Perspectives. May.
Steve and Bengt Holmstron,
2001, Corporate Governance and Merger Activity in the
Jovanovic, Boyan and Rousseau, 2002, The Q-Theory of Mergers, American Economic Review
.* Maksimovic,. V. and G. Phillips, 2001, The Market for Corporate Assets: Who Engages in Mergers and Asset Sales and are there Efficiency Gains?, In Adobe PDF Format., Journal of Finance, December, 2001, 2019-2065
* Yang, Liu, 2008, “The Real Determinants of Asset Sales, Journal of Finance.
******** (2nd session of M&A)
* Shleifer, A., and R. W. Vishny, 1992, Liquidation values and debt capacity: A market equilibrium
approach, Journal of Finance 47, 1343-1366.
* Schlingemann, F. P., R. M. Stulz, and R. A. Walkling, 2002, Divestitures and the liquidity of the market for corporate assets, Journal of Financial Economics 64, 117-144.
* Ortiz-Molina and Phillips, Asset Liquidity and the Cost of Capital, working paper. Available at: http://www.smith.umd.edu/faculty/gphillips/Papers/AssetLiquidity.pdf
* Almeida, Heitor, Murillo Campello, and Dirk Hackbarth, 2009, Liquidity
mergers, Unpublished Working Paper,
* Rhodes-Kropf, Matthew, David Robinson, “The Market for Mergers and the Boundary of the Firm.” http://www.nber.org/~confer/2004/si2004/cf/rhodeskropf.pdf, Journal of Finance. 2008.
* Hoberg and Phillips, "Competition and Product Market Synergies in Mergers and Acquisitions,", working paper available at: http://www.smith.umd.edu/faculty/gphillips/Papers/synergies.pdf
**** 3rd (possible session on M&A, inefficient M&A)
*Shleifer, Andrei and Robert Vishny, “Stock Market Driven Acquisitions”. Paper available on SSRN. Journal of Financial Economics.
*Rhodes-Kropf, Matthew, and S. Viswanathan, Market Value and Merger Waves," 2003. Accepted Journal of Finance Full Text PDF
*Dong, Ming, David Hirshleifer, Scott Richardson, and Siew Hong Teoh, 2003, "Does Investor Misvaluation Drive the Takeover Market?" http://www.cob.ohio-state.edu/fin/dice/papers/2003/2003-7.pdf, Journal of Finance, 2006.
* Rhodes-Kropf, Matthew, David Robinson, and S. Vishwanthan, 2005, “Merger Waves and Merger Activity: The Empirical Evidence.” Available at: http://www-1.gsb.columbia.edu/faculty/mrhodeskropf/PDFpapers/mergers_test.pdf, Journal of Financial Economics
Sara Moeller, Rene Stulz and Frederick Schlingemann, “Wealth destruction on a massive scale? A study of acquiring-firm returns in the recent merger wave,” Journal of Finance, 2005 757-782
Section 4: (2 – 3 hour sessions) The Theory of the Firm: Conglomerate Firms, Theory and Tests
Part 1: Conglomerates and the Theory of the Firm
*** SEE also survey by Maksimovic and Phillips: Conglomerate Firms and Internal Capital Markets, Handbook of Empirical Finance, editor: Espen Eckbo.
*Williamson, Oliver, Chapter 2: Internal Firm Organization and limits to Firm Size, In: Oliver Williamson, Corporate Control and Business Behavior, also: Chapter 7: The Multidivisional Form Innovation, & Chapter 9: Applications of the Multidivision Form Hypothesis.
*Lang, Larry, and Rene Stulz, 1994, Tobin's q, Corporate Diversification, and Firm Performance, Journal of Political Economy. v102 n6 December 1994, pp. 1248-80.
*Berger, Philip G. and Eli Ofek, 1995, Diversification’s effect on firm value, Journal of Financial Economics, 39-65.
*Shin, H. and Rene Stulz, 1997, Are Internal Capital Markets Efficient, Quarterly Journal of Economics.
*Lamont, Owen, 1997, Cash Flow and Investment: Evidence from Internal Capital Markets, Journal of Finance
David S. and Jeremy Stein, 1997, The Dark Side of Internal Capital Markets: Divisional Rent Seeking and Inefficient Investments, mimeo, MIT.
Scharfstein, David S., 1997, The Dark Side of Internal Capital Markets II, mimeo, MIT.
*Rajan, Raghuram G., Henri Servaes and Luigi Zingales, 2000, The Cost of Diversity: The Diversification Discount and Inefficient Investment, JF.
Khanna, Naveen and Tice, Sheri, 2001, "The Bright Side of Diversification", Journal of Finance, 2001.
*(Handin) Maksimovic,. V. and G. Phillips, 2002, Journal of Finance, Do Conglomerate Firms Allocate Resources Inefficiently?," In Adobe PDF Format. Journal of Finance, April, 2002, 721-767
Graham, J., M. Lemmon and J. Wolf, 2002, “Does Corporate Diversification Destroy Value?” Journal of Finance 57, 695-720
Schoar, Antoinette, The Effect of Diversification on Firm Productivity, The Journal of Finance, December 2002, Vol. 62 (6), 2379-2403.
Campello, M., 2002, Internal Capital Markets in Financial Conglomerates: Evidence from Small Bank Responses to Monetary Policy , Journal of Finance 57 (6), pp. 2773-2805.
(present) Whited, Toni, 2001, “"Is It Inefficient Investment that Causes the Diversification Discount? Journal of Finance.
Also look at the following working papers recently presented at NBER 1999 summer institutue. Link to NBER working papers, Summer 1999, three papers on conglomerates and resource allocation, (1. Judy Chevalier, 2. Jose Campa and Simi Kedia, and Lamont and Polk) see: http://nber.nber.org/~confer/99/si99/cfprg.htm (papers 2 and 3 were published in JF and JFE respectively.) You might want to compare early working papers with final published papers.
*Inderst, and H. Meuller, 2003, “Internal vs. External Financing: An Optimal Contracting Approach,” Journal of Finance.
Villalonga, B., 2004, “Diversification Discount or Premium? New Evidence from the Business Information Tracing Series”, Journal of Finance 59, 479 – 506.
* Campa and Kedia, 2002, Explaining the Diversification Discount, Journal of Finance, papers and proceedings.
* Villalonga, B., 2004, “Does Diversification Cause the Diversification Discount”, Financial Management 33, 5-23
Dimitrov, Valentin and Sheri Tice, 2006, “Corporate Diversification and Credit Constraints: Real Effects Across the Business Cycle”, Review of Financial Studies, Vol 19, Issue 4, pp. 1465-1498.
Santalo, Juan and Manuel Becerra, 2007, Competition from Specialized Firms and the Diversification-Performance Linkage, forthcoming Journal of Finance. Available Journal of Finance forthcoming papers.
Section 5: Product Market Competition and Asset Prices (,1 week)
* Kewei Hou & David T. Robinson, 2006. "Industry Concentration and Average Stock Returns," Journal of Finance, 61, 1927-1956.
* Gasper, Jose and Massimo Massa, 2006, Idiosyncratic Volatility and Product Market Competition, Journal of Business, 79 3125-152.
*Peress, Joel, 2010, Product Market Competition, Insider Trading, and Stock Market Efficiency, forthcoming Journal of Finance, 2010.
*Hoberg and Phillips, ""Real and Financial Industry Booms and Busts"", forthcoming Journal of Finance, 2010, available on. : http://www.smith.umd.edu/faculty/gphillips/Papers/New_Era_Hoberg_Phillips.pdf
Section 6: Industry Life-Cycle
Klepper, Steven; Graddy,
Jovanovic, Boyan; MacDonald, Glenn-M., "Competitive Diffusion," Journal of Political Economy; 102(1), February 1994, pages 24-52.
*(hand-in) -----, "The Life Cycle of a Competitive Industry," Journal of Political Economy; 102(2), April 1994, pages 322-47.
*(hand-in) Klepper, Steven, 1996, "Entry, Exit, Growth, and Innovation over the Product Life Cycle," American Economic Review, 86:3, pp. 562-583.
(briefly) Maksimovic V. and P. Pichler, 1998, "Technological Innovation and Initial Public Offerings," Review of Financial Studies.
Matt Speigel and Heather Tookes,
“"Dynamic Competition, Innovation and Strategic Financing," working
*(hand in) Maksimovic and Phillips, The Industry Life Cycle and Acquisitions and Investments: Does Firm Organization Matter? Journal of Finance, 2008, Available at: http://www.rhsmith.umd.edu/finance/gphillips/papers/industry_life_cycle.pdf
Section 7 (not covered, but may be of interest): Financial Crisis and Corporate Finance
(*) Deciphering the Liquidity and Credit Crunch 2007-08, Journal of Economic Perspectives, 2009, 23(1), 77-100, slides. NBER 08 longer version http://www.princeton.edu/~markus/research/papers/liquidity_credit_crunch.pdf
Investment and Financial Crisis:
(* ) Campello, Murillo, Graham, John R. and Harvey, Campbell R., January 2009, The Real Effects of Financial Constraints: Evidence from a Financial Crisis, Click on title.
(* Handin) Duchin, Ran, Oguzhan Ozbas, and Berk Sensoy, 2008, Costly External Finance, Corporate Investment, and the Subprime Mortgage Credit Crisis, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1286204
Banks and credit market competition:
(* Handin) Acharya, Viral V., Gromb, Denis and Yorulmazer, Tanju, Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking(September 1, 2008). Available at SSRN: http://ssrn.com/abstract=1275136
(*handin) ELENA LOUTSKINA, PHILIP STRAHAN,
An alternative perspective on competition:
(* Handin) Astrid A. Dick and Andreas Lehnert, Personal Bankruptcy and Credit Market Competition, forthcoming Journal of Finance.
Liquidity, Lending and Credit Crises
(*overview on liquidity) Allen,
(*) Diamond, Douglas W., and Raghuram G. Rajan. 2001. “Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking.” Journal of Political Economy, 109(2): 287-327.
(* Handin) Diamond, Douglas W., and Raghuram G. Rajan. 2005. “Liquidity Shortages and Banking Crises.” Journal of Finance, 60(2): 615-647
(* ) Krishnamurthy, Arvind, 2008, Amplification Mechanisms in Liquidity Crises, working paper.
Section 8. Some Useful Econometric Methods:
i. Intra-Industry Empirical Methods and Econometric Methods
"Empirical Studies of Industries with Market Power," Handbook of
ii. Panel Data
C. Analysis of Panel Data.
Blundell, Richard, Stephen Bond, and Costas Meghir, 1995, "Econometric Models of Company Investment, In: Handbook of Panel Data.
Chamberlain, G., "Multivariate Regression Models for Panel Data," Journal of Econometrics. 1982, vol. 18, pp. 4-46.
Chamberlain, G., "Panel Data," Handbook of Econometrics. Volume I, Chapter 22.
Maddala, G.S. "The Use of Variance Component Models in Pooling Cross Section and Times Series Data," Econometrica. 1971, pp. 341-358.
Mundlak, Y. "Empirical Production Function Free of Management Bias," Journal of Farm Economics. 1961, pp. 45-56.
iii. Simultaneous and Nonlinear Equations
Amemiya, T., "Nonlinear Regression Models," Handbook of Econometrics. Z. Grilliches and M.D. Intrilligator (eds.), Vol. I, pp. 333-389.
iv. Qualitative Response and Limited Dependent Variables
Maddala, G. Limited
Dependent and Qualitative Variables in Econometrics.
McFadden, D., "Econometric Analysis of Qualitative Response Models," Handbook of Econometrics. vol 2, Chapter 24.