University of Maryland
School of Business
BMGT 808C
Interaction of Finance and Industrial Organization
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Gordon M. Phillips |
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, phone: 301-405-0347 |
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Advanced Corporate Finance Seminar |
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Fridays 3:45 - 6:15, VMH 4439 |
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 an assignment using Mathematica, a take-home midterm exam, a term paper, and a presentation of one to two article(s) from the reading list. The assignment will count for 10%, the midterm 20%, the presentations for 20%, overall class discussion 10%, and the term paper for 40%.
The term paper will be due on the last day of class. 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.
One note: the requirements for the paper will vary somewhat depending on your year in the program. If this is your first year, a literature review along with developing hypotheses and locating a data source will be sufficient.
For the Mathematica assignment, I will distribute an example program at the end of week 5. You will then follow the example and try out Mathematica and then try to solve/graphically illustrate an existing theoretical finance paper. The example will be from Varian, Hal, editor, Economic and Financial Modeling with Mathematica. Telos, 1993.
The other requirement of the course will be for you to present one or more of the papers that are listed on the course outline. Presentations will begin week 10 and will take up the 2nd half of the meeting.
The take home midterm will be given at the end of week 12. For the take-home midterm, I will provide some questions for you to answer. They will be related to the readings we have done.
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.
Note: Section 8 contains some useful more advanced econometric tools. We will spend at least one session about halfway through the course - probably after week 7 - discussing these methods. I do not plan on spending any time covering event study methodology in this course.
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
Weeks 2-3: External Contracting Problems, Intra-Industry Focus
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, 1998, Corporate Equity Ownership and Product Market Relationships, forthcoming Journal of Finance.
Kaplan, Steven N. and Per Stromberg, 1999, Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts, mimeo, University of Chicago.
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
Weeks 3-4:
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.
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.
Weeks 5-6:
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.
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.
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." with Vojislav Maksimovic., Journal of Finance, October, 1998, 53, 1495-1532
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, 1996, Executive Compensation, Strategic Competition, and Relative Performance Evaluation: Theory and Evidence," working paper, Dartmouth.
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: Industry Evolution and Finance: Theory and Tests,
Primary articles:
Week 7:
Jensen, Michael, 1993, "The modern industrial revolution and the challenge to internal control systems," AFA presidential address, Journal of Finance. 48, 831-880.
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.
Week 8:
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, 1996, "Technological Innovation and Initial Public Offerings," University of Maryland working paper.
Section 4: 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, 1998, Do Conglomerate Firms Allocate Resources Inefficiently?," working paper, University of Maryland.
-----, 1999, The Market for Corporate Assets: Who Engages in Mergers and Asset Sales and are there Efficiency Gains?, working paper, University of Maryland.
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
Section 5: Production Functions, Business Cycles and Labor Markets: Interaction with Financing Decisions.
Primary articles:
Week XX
Baily, Martin, Charles Hulten, and David Campbell, 1992, "Productivity Dynamics in Manufacturing Plants," Brookings Papers on Economic Activity: Microeconomics, pp. 187-267.
Davis, Steven and John Haltiwanger, 1992, "Gross Job Creation, Gross Job Destruction, and Employment Reallocation" Quarterly Journal of Economics; 107(3), August 1992, pages 819-63.
Abraham, Katharine and John Haltiwanger, 1995, "Real Wages and the Business Cycle" Journal of Economic Literature; 33(3), September, pages 1215-64.
Bartlesman, Eric, Martin Baily, and John Haltiwanger, 1994, "Downsizing and Productivity Growth: Myth or Reality?" National Bureau of Economic Research Working Paper: 4741.
Drymes and Bartlesman, 1994 working paper.
Week XX
Choe, Masulis and Nanda, 1994, "Common Stock Offerings Across the Business Cycle," Journal of Corporate Finance.
Hanka, 1996 working paper, Penn State University, Debt and the Terms of Employment, Journal of Financial Economics, 1998.
Sharpe, Steven, 1994, "Financial Market Imperfections, Firm Leverage, and the Cyclicality of Employment," American Economic Review; 84(4), September 1994, pages 1060-74.
Section 6: Dynamic Programming Methods and Tests
Rust, John, "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica; 55(5), September 1987, pages 999-1033.
-----, "A Dynamic Programming Model of Retirement Behavior," In: Wise, David A., ed. The economics of aging. National Bureau of Economic Research, Chicago and London: University of Chicago Press, 1989, pages 359-98.
Berkovec, J. and S. Stern, 1991, "Job Exit Behavior of Older Men," Econometrica, 59, 189-210.
Das, S., 1992, "A Micor-Econometric Model of Capital Utilization and Retirement: The Case of the U.S. Cement Industry," Review of Economic Studies, 59, 277-297.
Olley, G. Steven; Pakes, Ariel, "The Dynamics of Productivity in the Telecommunications Equipment Industry," National Bureau of Economic Research Working Paper: 3977, January 1992, published Econmetrica, 1996.
Levinsohn, James and Amil Petrin, 1999, When Industries Become More Productive, Do Firms? NBER working paper \#W6893.
Section 7: Real Options: theory and tests
Baldwin, C.Y. and R.S. Ruback, 1986, "Inflation, Uncertainty and Investment," Journal of Finance.
Brennan, Michael J. and Eduardo S. Schwartz, 1985, "Evaluating Natural Resource Investments," Journal of Business. 58, 135-157.
MacDonald, R. and D. Siegal, 1986, "The Value of Waiting to Invest," Quarterly Journal of Economics
Majd, Saman and Robert Pindyck, Time to Build, Option Value, and Investment Decisions, Journal of Financial Economics, 1987, 7–27.
Dixit, Avinash, 1989, "Entry and exit decisions under uncertainty," Journal of Political Economy. 97:3, 620-38.
Mauer, David C., Triantis, A., 1994, "Interactions of Corporate Financing and Investment Decisions: A Dynamic Framework," Journal of Finance; 49(4), pages 1253-77.
Quigg, Laura, 1993, "Dynamic Testing of Real Option Pricing Models" Journal of Finance.
Grenadier, Steven R., "Valuing Lease Contracts: A Real Options Approach," Journal of Financial Economics; 38(3), July 1995, pages 297-331.
Background and Foundations
Cox, J.C. and S.A. Ross, 1976, "The Valuation of Options for Alternative Stochastic Processes," JFE.
Merton, R.C., 1977, "On the Pricing of Contingent Claims and the Modigliani-Miller Theorem," JFE.
Cox, J.C., S.A. Ross, and M. Rubinstein, 1979, "Option Pricing: A Simplified Approach," JFE.
Mason, S.C. and R.C. Merton, 1985, "The Role of Contingent Claims Analysis in Corporate Finance ," in Recent Advances in Corporate Finance (E.I. Altman and M.G. Subrahmanyam, eds.), Richard D. Irwin: Homewood, IL.
Section 8. 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.