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Lecture notes Advanced Corporate Finance
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Advanced Corporate FinanceTilburg University, summary of the lectures
1
,Part 1: Capital Structure Basics
1. Miller, Merton H. (1988) – lecture 1 and 2
2. Panier, F., F. Perez-Gonzales and P. Villanueva (2015) – lecture 3
Part 2: Capital Structure Recent Developments
1. M. R. Roberts and A. Sufi, (2009) – lecture 4
2. Brav, O. (2009) – lecture 5
Part 3: Dividend Policy
1. Von Eije, H., and W. L. Megginson – lecture 6
2. Farre-Mensa, J, R. Michaely and M. Schmaltz – lecture 6
Part 4: Corporate Governance and Financial Development
1. King, R. G. and R. Levine (1993) – lecture 7
2. La Porta, R, F. Lopez de Silanes, A. Shleifer and R. Vishny (1998) – lecture 8
3. Dyck, A. and L. Zingales (2004) – lecture 8
Part 5: Political Connections
1. Fisman, R. (2001) – lecture 9
2. Khwaja, A. I. and A. Mian (2005) – lecture 9
Part 6: Banks and Banks’ Mergers
1. Focarelli, D. and F. Panetta (2003) – lecture 10
2. Panetta, F., Schivardi, F., and Shum, M. (2009) – lecture 11
Part 7: Corporate Financing under Asymmetric Information
1. Karlan, D. and J. Zinman (2009) – lecture 12
2. Hertzberg, A., J.M. Liberti and D. Paravisini (2010) – lecture 13
Part 8: Mortgage Crisis
1. Mian, A. and A. Sufi (2009) – lecture 14
2. Keys, B.J., T. Mukherjee, A. Seru and V. Vig (2010) – lecture 15
Part 9: Rating agencies
1. Ashcraft, A., P. Goldsmith-Pinkham and J. Vickery (2010) – lecture 16
2. Sufi, A. (2009) – lecture 17
Part 10: Bankruptcy Law and its Effect on Credit and Innovation
1. Bae, K.-H. and V.K. Goyal (2009) – lecture 18
2. Acharya, V.V. and K.V. Subramanian (2009) – lecture 19
2
,Hoorcollege 1 28/08/17
How to study
1. On the exam, you will be asked to comment on academic articles (not in the reading list), and
to solve simple exercises related to what we have seen in class.
2. Not learn by heart, but understand what you are doing
What are you going to learn
Part I: Back to the basics
The first topic of this course is capital structures. Modigliani and Miller have provided a powerful
theory, in which they assume a perfect world and observe what happens if we take down a building
block of this perfect world. In other words, one by one we are going to remove the building blocks of
this theory. We will do this with the help of the trade off theory and the pecking order theory.
A review of finance source
How to finance your investments. We can distinguish internal sources and external sources of financing.
Internal finance sources are:
1. Internal capital
a. Retained earnings
Retained earnings Profits not payed back to shareholders but used to finance investment, current
expenses, et cetera.
External finance sources are:
2. External capital
a. Debt
– Debtholders have a contract specifying that their claims must be paid in full
before the firm can make payments to equity holders (seniority)
– Usually debtholders do not have voting rights
– Debt is a senior claim to equity
b. Equity
– Equity holders receive a dividend only after debtholders claims are satisfied
– Equity holders have the right to vote at the general meeting of shareholders
The difference between debt and equity regarding payments is that the company has the obligation
(contractual enforceable) to pay debtholders, whereas it has the right to pay shareholders. Moreover,
shareholders have a residual claim on the income of the company (junior claim). This is bad in the event
of liquidation, since there is a chance that you do not receive anything. The disadvantage of debt is that
you always receive fixed payments, even in good times. This means that debtholders do not profit from
flourishment of the company in good times. On the contrary, shareholders do profit from better financial
states of companies. Moreover, debtholders do not have voting rights at general meetings and can
therefore not decide about the company’s future policy. One exemption is that debtholders can vote
when company find itself in an event of bankruptcy. Shareholders can always vote in general meetings.
Characteristics of debtholders
1. Debt is always senior to equity. However, equity may result in higher claims in good times.
2. Debtholders do not have voting rights, whereas equity holders do.
3
, Characteristics of shareholders
1. Limited liability (shareholders are only liable with the invested amount)
2. Residual claim
Leverage definition
The academic leverage is written as:
𝐷𝑒𝑏𝑡 𝐷𝑒𝑏𝑡
or 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦
The industry leverage is often written as
𝐷𝑒𝑏𝑡
𝐸𝐵𝐼𝑇
The leverage ratio is usually indicated with 3x, 4x, … which means that that with 3x, it takes three years
of earnings levels and we will pay back our debt. Remember that EBIT is earnings before interest and
taxes. Let’s now take a look at the academic leverage:
𝐷𝑒𝑏𝑡 𝐷𝑒𝑏𝑡
or 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦
The leverage can change because of:
1. Debt is issued or paid back
2. Equity is issued or repurchased
How do the effects influence the leverage ration?
1. Debt issuance → more debt compared to equity → increase in leverage ratio
2. Debt paid back → less debt compared to equity → decrease in leverage ratio
3. Equity issuance → more equity compared to debt → decrease in leverage ratio
4. Equity repurchased → less equity compared to debt → increase in leverage ratio
Does finance matter for firm value?
Does finance matter for firm value? Take the easiest framework and your answer is no. Shareholder
value or stakeholder value does not change with the leverage ratio. Value is created by the quality of
your investment. Thus, the easy framework of Modigliani and Miller conclude that capital structure
does not matter.
Modigliani-Miller irrelevance theorem (1958, 1961)
The Modigliani-Miller irrelevance theorem makes the strong assumption that capital structures do not
matter for firm value. The irrelevance theorem is based on four assumptions:
1. Perfect financial markets
a. Competition: individuals and firms are price takers
b. Frictionless: no transaction costs, et cetera
c. All agents are rational
2. All agents have the same information
3. A firm’s cash flows do not depend on its financial policy (e.g. bankruptcy costs)
4. No taxes
4
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