University of Maryland

School of Business

BMGT 808C

Interaction of Finance and Industrial Organization

Gordon M. Phillips

phone: 301-405-0347

Advanced Corporate Finance Seminar

Fridays 2:00 – 4:40, VMH 4534

Course Outline

The objective of the course is to provide you with a background in some new topics in corporate finance. We will discuss both theory and empirical work, emphasizing the links between the two. The primary topics of the course concern the interaction between the firm’s real decisions and its financial decisions in different equilibrium settings. This will involve a fair amount of microeconomics in addition to finance.

We will primarily be using articles for the course. 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.

The course grade will be based on presentations in class and EITHER two tests (one at the end of each section) OR 1 term paper.

If you do a term paper the term paper will be due on January 5th (by email). In the paper, you should review the literature on some question that you find interesting, state hypotheses to be tested and if you are doing empirical work gather and use some of the data. Some summary statistics and simple tests at this point may be sufficient. The idea is to start some research that may turn into a dissertation. If you are doing theoretical work, you should present the structure of the model and begin to develop the implications of your model. For empirical work, one approach is pick a paper or papers for which you could replicate the results. If you are unable to settle on something interesting, I may be able to suggest some ideas.

Class Schedule and Reading Assignments

We will spend several weeks on each of 5 sections. We will cover 2-3 articles in depth for each weekly class meeting in depth and give an overview of some of the others. 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.

Week 1: Introduction: From Perfect Markets to Theories of the Firm & Contracting Problems

Jensen, M. and W. Meckling, "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure," Journal of Financial Economics. 1976, 3:305-360.

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.)

Stiglitz, Joseph E., 1974, On the Irrelevance of Corporate Financial Policy, American Economic Review, 851-865.

Williamson, Oliver E., 1983, Transaction-Cost Economics: The Goverence of Contractual Relations, Journal of Law and Economics, 233-261.

Other: Masten, Scott E., 1993, Transaction Costs, Mistakes, and Performance, Managerial and Decision Economics, 14, 119-129.

Section 1: Financing Decisions, Capital Structure and Product Markets

Week 2: External Contracting Problems, Intra-Industry Focus

a. Firm Ownership:

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.

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.

Rajan, Rajhuram, G. and Luigi Zingales, 1998, Power in a theory of the firm, Quarterly Journal of Economics 113, 387-432.

Harris, Milton and Artur Raviv, 1990 "Financial Contracting Theory," Journal of Finance.

Allen, Jeff and Gordon Phillips, 2000, Corporate Equity Ownership, Strategic Relationships and Product Market Relationships, Journal of Finance. Paper available on SSRN.

Kaplan, Steven N. and Per Stromberg, 1999, Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts, published, Review of Economic Studies.

b. Contracting and Capital Structure

Myers, S., "The Capital Structure Puzzle," Journal of Finance. July, 1984, 39:575-592.

Harris, Milton and Artur Raviv, 1991, "The Theory of Capital Structure," Journal of Finance. 46: 297-355.

Titman, Sheridan, 1984, "The effect of capital structure on a firm's liquidation decision," Journal of Financial Economics, Vol. 13, 137-151.

Maksimovic, Vojislav; Titman, Sheridan, "Financial Policy and Reputation for Product Quality," Review of Financial Studies; 4(1), 1991, pages 175-200.

Section 2: Financial Structure, Managerial Compensation and Intra-Industry firm competition

a. Financial Structure and Intra-Industry competition

Week 3:

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.

Bolton, Patrick and David S. Scharfstein, 1990, "A theory of predation based on agency problems in financial contracting," American Economic Review. 80, 93-106.

Phillips, Gordon, 1995, "Increased Debt and Industry Product Markets: An Empirical Analysis," Journal of Financial Economics, 37, 189-238. 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.

Week 4:

Glazer, Jacob, 1994, "The Strategic Effects of Long-Term Debt in Imperfect Competition," Journal of Economic Theory; 62(2), April 1994, pages 428-43.

-----, 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, "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

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?" with Peter MacKay. Click here to download in Adobe PDF Format., Review of Financial Studies.

b. Managerial Ownership and Firm Competition

Hart, O., 1983, "The Market Mechanism as an Incentive Scheme," Bell Journal of Economics. 366-82.

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.

Background articles:

Bresnahan, Timothy F., 1989, "Empirical studies of industries with market power," In Handbook of Industrial Organization. ed. R. Schmalensee and R. Willig, North-Holland, Amsterdam.

-----, 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.

Maksimovic, V., 1995, Financial Structure and Product Market Competition, in Jarrow, R., Maksimovic V. and W. Ziemba, (eds.), Handbook of Finance, North-Holland.

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.

Zingales, Luigi, 1998, "Survival of the fittest or the fattest? Exit and financing in the trucking industry,.Journal if Finance.

Section 3: Mergers and Acquisitions, Industry Evolution and Finance: Theory and Tests,

Primary articles:

Weeks 5/6: Mergers and Acquisitions

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 Conseque nces." 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.

Kaplan and Weisbach, 1992. The Success of Acquisitions: Evidence from Disvestitures, Journal of Finance.

Andrade, Gregor, Mark Mitchell and Erik Stafford. 2001. “New Evidence and Perspectives on Mergers.” Journal of Economic Perspectives. May.

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

Kaplan, Steve and Bengt Holmstron, 2001, Corporate Governance and Merger Activity in the U.S.: Making Sense of the 1980s and 1990s

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

Ming Dong, 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

Rhodes-Kropf, Matthew, David Robinson, “Merger Waves and Merger Activity: The Empirical Evidence.” Available at: http://www-1.gsb.columbia.edu/faculty/mrhodeskropf/PDFpapers/mergers_test.pdf

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

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

Section 4: (Week 7): Industry Life-Cycle

Klepper, Steven; Graddy, Elizabeth, "The Evolution of New Industries and the Determinants of Market Structure," Rand Journal of Economics; 21(1), Spring 1990, pages 27-44.

Jovanovic, Boyan; MacDonald, Glenn-M., "Competitive Diffusion," Journal of Political Economy; 102(1), February 1994, pages 24-52.

-----, "The Life Cycle of a Competitive Industry," Journal of Political Economy; 102(2), April 1994, pages 322-47.

Klepper, Steven, 1996, "Entry, Exit, Growth, and Innovation over the Product Life Cycle," American Economic Review, 86:3, pp. 562-583.

Maksimovic V. and P. Pichler, 1998, "Technological Innovation and Initial Public Offerings," Review of Financial Studies.

Maksimovic and Phillips, The Industry Life Cycle and Acquisitions and Investments: Does Firm Organization Matter? Forthcoming, Journal of Finance, 2007, Available at: http://www.rhsmith.umd.edu/finance/gphillips/papers/industry_life_cycle.pdf

.

Section 5: Conglomerates and The Theory of the Firm

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.

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, 1997, The Cost of Diversity: The Diversification Discount and Inefficient Investment, working paper.

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

Schoar, Antoinette, The Effect of Diversification on Firm Productivity, The Journal of Finance, December 2002, Vol. 62 (6), 2379-2403.

Campa, J. and Simi Kedia, 2002, Explaining the Diversification Discount, Journal of Finance.

Schoar, Antoinette, The Effect of Diversification on Firm Productivity, The Journal of Finance, December 2002, Vol. 62 (6), 2379-2403.

Villalonga, B., 2004, Does Diversification Cause the “Diversification Discount”? Financial Management, 5-27.

Maksimovic,. V. and G. Phillips, 2007, "Conglomerate Firms and Internal Capital Markets," Download here or E-mail authors for latest version. Forthcoming Handbook of Corporate Finance: Empirical Corporate Finance, ed. B. Espen Eckbo, Handbooks in Finance Series, Elsevier/North-Holland.

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.)

Section 6. Some Useful Econometric Methods:

i. Intra-Industry Empirical Methods and Econometric Methods

Bresnahan, T., "Empirical Studies of Industries with Market Power," Handbook of Industrial Organization, North Holland, 1989.

ii. Panel Data

Hsiao, C. Analysis of Panel Data. Cambridge University Press, 1886.

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. Cambridge University Press, 1982.

McFadden, D., "Econometric Analysis of Qualitative Response Models," Handbook of Econometrics. vol 2, Chapter 24.