Economics 329 Corporate Finance

Fall 2007 Mondays and Wednesdays 11:00 am – 12:20 pm in 107 PAC

Professor: Abigail Hornstein Office: 208 PAC Email: ahornstein@wesleyan.eduPhone: 685-3049 Office Hours: Mondays 4:15 – 6:15 pm; or by appointment Course Web Page: blackboard (through your e-portfolio) Course Assistant: Alpay Koralturk, akoralturk@wesleyan.edu, CA Sessions:

General Course Information

Purpose: The course aims to develop an understanding of the applications of the principles of economics to the study of financial markets, instruments, and regulations. The objective is to provide an understanding of the theory of corporate finance and how it applies to the real world. Students will explore the potential and limitations of financial theory in dealing with real-world problems. Assignments and Credit: Class participation 11% Problem Sets (5) 12% Equity Analyst Reports (3) 12% Research paper - topic selection 1% - proposal 4% - annotated bibliography 5% - final paper 20% Final Exam 35% Total 100% Readings: The required text is Ross, Westerfeld, and Jaffe, Corporate Finance, 8th Edition. ISBN 978-0-07-310590-1. The first three chapters are available online through the library’s e-reserve system (password = econ329) and a hard copy of the textbook is available at the reserve desk in Olin. Chapter numbers in the course schedule refer to this text. All other course readings will be made available through the electronic reserve system at Olin. The password for e-reserve is “econ329” (not case sensitive). Note: the Olin e-reserve system lists the readings in alphabetical order by author’s last name so you may have to search carefully to identify the proper reading for a given date.

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If students purchase international editions of our textbook, please note that the international editions of finance textbooks often have different examples (not a problem as the concepts can be applied world-wide!) and different questions (this is a problem!). So, if you buy an international edition, please check a U.S. copy before tackling the problem sets. I expect you to read the Wall Street Journal, New York Times or Financial Times daily. (Of the three, you will find the marginal cost of the NYT to be cheapest but the marginal value-added of the WSJ to be the highest. The FT would fall in between the two if you performed a cost-benefit analysis.) Additional short items will occasionally be handed out in class and/or made available on the course web page. There are two related textbooks that you may find helpful for reference. Both can be downloaded for free - at least as of late August 2007.

- Ivo Welch, A First Course in Corporate Finance, no publication date listed, http://welch.econ.brown.edu/book/ - in the author’s words, “the subject matters are mostly conventional, but the book’s exposition is very [sic] different from the traditional finance textbooks”. This is a great complement to our textbook; we will read chapter 24 (corporate governance).

- Keith Head, Elements of Multinational Strategy, forthcoming,

http://strategy.sauder.ubc.ca/head/book/book.pdf Head describes this book as an integration of “the academic study of international trade and foreign direct investment—the work I do when I’m not teaching—with the actual strategic and operational decisions of exporters and multinational enterprises.” Accordingly, students with interests in multinational corporate activity may find this book to be an interesting and useful supplement to our textbook.

Class Participation: Class attendance is expected. You are expected to complete all assigned readings before class. Moreover, you are expected to learn some of the material on your own: occasionally questions in problem sets may cover material before it is initially presented in class. I will use our class-time to focus on the most important topics as well as on those that are more difficult to comprehend. I will give a B for class participation to a student who regularly gives the answers to my questions thereby demonstrating that s/he has read and understood the required materials. I will give an A for class participation to a student who regularly asks insightful questions as well as giving the answers to my questions. If you know that you will have to be late and/or leave early, please let me know in advance. Additional credit towards class participation can be earned by attending the economic department’s weekly seminar series (Wednesdays at 4:10pm in PAC 125; particularly on 10/24, 10/31, 11/7 and 11/14). Problem Sets: Problem sets are designed to help you master the material, and to provide some feedback on your progress in the course. Note: problem sets will occasionally cover material before it is covered in class. There will be five problem sets and your four best problem set grades will be counted towards your course grade. Problem sets will be due at the beginning of the appropriate class session. As the solutions to the problem sets will be posted promptly, late problem sets will receive no credit. Grading will be on a check-plus, check, check-minus scale.

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Up to three people may cooperate on each problem set; when students submit joint problem sets all students will get the same grade. All assignments will be returned via the student boxes in the alcove next to the economics department office. (When multiple students cooperate on an assignment, the assignment will be returned to the box corresponding to the first student’s surname.) While you can use either a calculator or Excel to complete the problem sets, you will need a calculator for the final exam. I therefore recommend you use a calculator for at least some of the problem sets so that you are comfortable on the exam days. You will want to use a calculator that allows the calculation of growth rates (i.e., a yx button). If the calculator also has NPV and related functions, that will be even more convenient for you (particularly on exam days). If you are not familiar with a financial calculator, you may find one of these websites helpful: http://clem.mscd.edu/~mayest/calculators/calculator_tutorials_index.htm (or http://tinyurl.com/ncjr5) or http://www.buec.udel.edu/bowersh/finc311/instructions_for_using_a_financial_calculator.htm (or http://tinyurl.com/27t8cs). Equity Analyst Reports: Together with 2 or 3 colleagues you will analyze publicly-listed U.S. firms in an industry. You may define industry in several ways: using SIC codes, Fama-French classification, or popular interpretation (e.g., you could tell me a music recording firm, movie production studio, and tv broadcaster constitute “entertainment”). For reasons that will soon be apparent, financial institutions, insurance and real estate companies, as well as privately held and/or foreign companies, are not appropriate. I am also excluding from consideration a small number of industries that have been covered exhaustively in recent iterations of my finance courses: airlines, gas & oil, mining, restaurants, hotels, and computers. Each team of 3-4 students will work together throughout the semester to complete three group projects; all students on a team will receive the same grade. Reports will be graded: 0 (non-submission or seriously deficient), 1 (major errors), 2 (the ‘hurdle’ rate – defined p.352), 3 (minor errors) or 4 (positive NPV – defined in Ch. 6). In these assignments you will examine the economic fundamentals, financial performance and corporate strategy of firms in your industry. Sometimes you will use aggregate industry information, while at other times you may choose to examine a representative set of firms from your industry (one firm per member of the team). You will need historical Compustat data (obtained from Research Insight) to answer these questions. Computer work: Some of the homework assignments, as well as the equity analyst reports, will involve the use of Excel. Wesleyan subscribes to a comprehensive corporate finance database, Research Insight, through which you can retrieve Compustat data (i.e., annual accounting level data for publicly listed U.S. firms). Students are urged to attend two optional but exceedingly highly recommended instructional sessions. The first session will be a review of Excel and EViews; two meetings will be offered: Tuesday, September 18, 2:30-4pm, and Wednesday, September 19, 4:05-5:30pm. The second session is an introduction to Research Insight; two meetings will be offered: Tuesday, October 23, 2:30-4pm, and Wednesday, October 24, 4:05-5:30pm. Information about online registration for these sessions will be sent a week in advance. In addition, you may find it helpful to seek

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assistance from the QAC tutors. Tutors are available Mon-Fri 2-5pm, Mon-Thurs 7-10pm, and Sun 6-10pm; the QAC is in PAC 100. If you prefer to use different data-sources for your work, that is fine, so long as you feel comfortable operating without formal technical support. Research Paper: Your paper will be an in-depth exploration of any topic in corporate finance. The paper should be about 15-20 pages long (not including references, appendices or exhibits), double-spaced, 12 point font, with one-inch margins. (Note: all written deliverables should follow this formatting.) The paper has four stages: topic selection, proposal, annotated bibliography, and the final paper. Topic selection: A 1-2 paragraph email should be sent to me no later than 4pm on Mon., October 1st. In the event that multiple students propose similar topics, I’ll help them find ways to differentiate their topics. Students may find it helpful to meet with me to refine the topic. Proposal: A 2-3 page paper proposal is due no later than 4pm on Wed., October 10th. It should describe the topic of your paper, contain a short outline of what you expect to be the major sections of your paper, and can include a tentative bibliography of works that you have already consulted or plan to consult in the course of your research. Annotated bibliography: A 2-4 page summary is due no later than 4pm on Mon., November 12th. This should include a brief (one or two paragraph) summary of at least five relevant written analyses on your topic area. Please include a full citation of all sources in your bibliography. The sources in the bibliography should be primarily academic or policy-oriented analysis of your proposed topic area (e.g., journal articles or working papers); newspaper or magazine articles generally are not sufficient; wikipedia and its ilk are unacceptable. While you may include some of the assigned readings for this course, you are expected to rely primarily on outside articles. Four is the bare minimum for the proposal; I expect to see between six and ten, and will grade the proposals accordingly. Final paper: Evaluation will be based primarily on the quality of your analysis. However, I expect your paper to be well-written and free of any grammatical, logical, or spelling errors. You are encouraged to take advantage of the writing workshop on campus. Turnitin: The 15-20 page paper is due no later than 4pm on Fri, December 7th. In addition to submitting your papers directly to me, all papers must also be submitted by you to the class folder on turnitin.com by midnight on the appropriate due dates. I have already set up folders for the proposal, bibliography and final paper. (Obviously, if you have non-computer-readable attachments, you will not need to upload those into the system.) For instructions on how to use turnitin.com, you can go to the Wesleyan library website at http://www.wesleyan.edu/libr/turnitin/ and follow their instructions for students. Once you have set up your account, you need to “enroll” in this course. Our class ID number is 1981096 and the password is “econ329”. Exams: The final exam will be held during the time slot set by the registrar: Mon., December 17, 7:00 pm – 10:00 pm. The exam will be given at this time only. Please do not enroll for this course if you cannot attend the exam as scheduled.

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Review sessions and extra office hours will be scheduled prior to the final exam. Attendance is recommended but optional. Stay tuned! Honor Code: All work submitted for a grade in this course must be your own original work. You are encouraged to discuss the assignments with your fellow students, but in accordance with the Honor Code, submitting another person’s work as your own would constitute plagiarism and will not be tolerated. The research paper cannot be submitted in another course without express prior permission from both me and the instructor of the other course. If you have any questions about the application of the honor code, please contact me. Missed Assignments: Should a personal emergency necessitate missing a scheduled exam or paper submission deadline, contact me as soon as possible prior to the relevant date to arrange for an alternative. Any such absence requires written certification from the Deans’ Office. Unexcused absences from the final exam will result in a failing grade for the course. Contact: E-mail is my preferred way of being contacted. Normally I will respond within a day, excluding illness and travel. Placing in the subject of your email the phrase “ECON 329” plus a description of your message will likely result in a faster reply than a blank or generic subject. My office is room 208 PAC. I will be available for questions during office hours and by appointment. If the door is open you should feel free to drop in, but understand that sometimes we may need to schedule a later appointment. If the door is closed, I am either not in or not available to meet with students.

Course Schedule

Below is a list of topics to be covered in the course, and approximate dates for the material. Most readings are from the Ross, Westerfeld, and Jaffe textbook; all other readings are available from the library’s e-reserve system. Numbered readings are required; other readings are optional but highly recommended. Assignments will be available on-line, and are due as indicated below. Check the course blackboard for revisions to this schedule. Materials are added to the course blackboard as the course progresses, including class lessons, handouts, homework assignments, links, articles, and sample tests. Date

Topic Readings

Deliverable

Wed., Sept. 5 Overview 1. Ch. 1 • Coase, Ronald, 1937, “The nature of the firm,” Economica, 4(16),

pp. 386-405.

Mon., Sept. 10 Financial statements 1 1. Ch. 2

Wed., Sept. 12 Financial statements 2 1. Ch. 3 (particularly Sections 3.4-3.7) 2. For alternative industry classification scheme that is widely used in

finance research see http://tinyurl.com/2ef8ql or http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/ftp/Industry_Definitions.zip (same page just different routes)

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3. Graham, Harvey, and Rajgopal, “Value destruction and financial reporting decisions,” Financial Analysts Journal, November/ December 2006, pp. 27-39.

• Greenberg, “Choosing accounting lets firms play even more games,” Wall Street Journal, April 28, 2007, p. B3.

• Richardson, “Companies fall behind in cash management,” Wall Street Journal, June 19, 2007, p. C3.

• Greenberg, “How expensing for options throws analysts off course,” Wall Street Journal, January 20, 2007, p. B3.

Mon., Sept. 17 Discounted cash flow (DCF) valuation

1. Ch. 4 • “25 questions on DCF valuation” by Aswath Damodaran:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/valquestions.htm

EARs: Group name, members and industry preferences (pick 2-3)

Tues., Sept. 18, 2:30-4pm or Wed., Sept. 19, 4:05-5:30pm: Working with Excel and EViews – A Review Sessions in PAC 100. Online registration in the week prior. Wed., Sept. 19 Bond valuation 1. Ch. 5: Sections 5.1-5.3 and Appendix 5a (online) 2. Ch 20: Sections 20.2-20.3

• Ch 20: Sections 20.1, 20.4, 20.5 • www.nasdbondinfo.com –click ‘smart bond investing’ for a good

overview of many related issues – in particular, “understanding risk”

Problem set 1

Mon., Sept. 24 Stock valuation 1. Ch. 5: Sections 5.4-5.9 2. Lewellen, 2004, “Predicting returns with financial ratios,” Journal of

Financial Economics, 74, pp. 209-235.

Wed., Sept. 26

Net present value (NPV) and other investment rules 1. Ch. 6

EAR #1

Mon., Oct. 1

NPV and investment rules 1. Finish Ch. 6 2. Graham and Harvey, “How do CFOs Make Capital Budgeting

Decisions?,” Journal of Applied Corporate Finance, Spring 2002, pp. 8-23.

3. Danielson and Scott, “The Capital Budgeting Decisions of Small Businesses,” Journal of Applied Finance, Fall/Winter 2006, pp. 45-56.

Capital investment decisions

4. Ch. 7

1-2 paragraph email with your tentative paper topic

Wed., Oct. 3

Capital investment decisions 1. Finish Ch. 7

Risk analysis and capital budgeting 2. Ch. 8

Problem set 2

Mon., Oct. 8 Capital investment decisions continued 1. Mini-case “Goodweek Tires, Inc.” (pp 227-228; Chapter 7) –

students should be prepared to discuss all the questions in class

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Risk analysis, real options and capital budgeting

2. Finish Ch. 8 • Review the following sections of Wonnacott & Wonnacott (the

textbook you probably used in Econ 300): 1.1, 3.2-3.4, 3.6. In addition, chapter 21 on decision trees may be helpful.

Wed., Oct. 10

Risk and return 1. Ch. 9 – this chapter is self-explanatory and we will probably not

devote class time to the material contained therein. However, you are expected to read this chapter (unlikely to take you more than half an hour, if that much).

• Note: it may be helpful to review Ch. 4 of Wonnacott & Wonnacott. Please think about why the normal distribution is assumed in much corporate finance research as this will be helpful in reading the empirical literature.

Corporate capital budgeting decisions

2. Greene, Hornstein, White and Yeung, 2007, “Multinationals do it better: Evidence from capital budgeting,” unpublished working paper.

3. Hornstein and Zhao, 2007, “Do corporate expenditures reflect information sharing? Multi-unit firms, inter-unit coordination, and corporate capital budgeting decisions,” unpublished working paper.

Research paper proposals

Mon., Oct. 15 No class: fall break

Wed., Oct. 17 No class: professor at Financial Management Association conference.

Mon., Oct. 22 Capital asset pricing model (CAPM) 1. Ch. 10: Sections 10.4-10.8 • Note: Sections 10.1-10.3 are a review of Chs. 4 & 5 (particularly

section 5.4) from Wonnacott & Wonnacott.

Tues., Oct. 23, 2:30-4pm or Wed., Oct. 24, 4:05-5:30pm: Using Financial Data – Research Insight. Sessions in PAC 100. Online registration in the week prior. Wed., Oct. 24

CAPM continued 1. Finish Ch. 10 2. Appendix 10a (online) 3. Bowman and Bush, “Using Comparable Companies to Estimate the

Betas of Private Companies,” Journal of Applied Finance, Fall/Winter 2006, pp. 71-81.

Arbitrage pricing theory

4. Ch. 11: Sections 11.1-11.5

Problem set 3

Mon., Oct. 29 Arbitrage pricing theory 1. Ch. 11: Sections 11.6-11.7 2. Mini case “The Fama-French Multifactor Model and Mutual Fund

Returns” (p. 341; chapter 11) – students should be prepared to discuss questions 1, 3-5.

• Markowitz, 1952, “Portfolio Selection,” Journal of Finance, 7(1), pp. 77-91.

Risk, cost of capital and capital budgeting

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3. Ch. 12: Sections 12.1-12.2 Wed., Oct. 31

Risk, cost of capital and capital budgeting 1. Finish Ch. 12 2. Appendix 12a (online)

Corporate financing decisions and efficient capital markets

3. Ch. 13: Sections 13.1-13.4

EAR #2

Mon., Nov. 5 Corporate financing decisions and efficient capital markets 1. Finish Ch. 13 • Chan, 2003, “Stock price reaction to news and no-news: Drift and

reversal after headlines,” Journal of Financial Economics,” 70(2), pp. 223-260.

Long-term financing

2. Ch. 14 (particularly Sections 14.4-14.5)

Wed., Nov. 7 Capital structure 1. Ch. 15

Mon., Nov. 12

Capital structure 1. Ch. 16 2. Fama and French, 2005, “Financing decisions: Who issues stock?,”

Journal of Financial Economics, 76, pp. 549-582. • Myers, 1984, “The capital structure puzzle,” Journal of Finance,

39(3), pp. 575-592.

Annotated bibliography

Wed., Nov. 14

Capital structure 1. Finish Ch. 16 2. Appendices 16a and 16b (online) • Leary and Roberts, 2005, “Do firms rebalance their capital

structures?,” Journal of Finance, 60, pp. 2575-2619. Valuation and capital budgeting for the levered firm

3. Ch. 17: Sections 17.1-17.3

Problem set 4

Mon., Nov. 19 Capital structure continued 1. Mini-case “McKenzie Corporation’s Capital Budgeting” (p 487;

Chapter 16) – students should be prepared to discuss all the questions in class

Valuation and capital budgeting for the levered firm

2. Finish Ch. 17 • Note: Appendix 17a (online) is not assigned reading but many

students may find it very interesting as LBOs are increasingly common.

Dividends

3. Ch. 18: Sections 18.1-18.3

Wed., Nov. 21 No class – Thanksgiving!

Mon., Nov. 26 Dividends 1. Finish Ch. 18 • Note: the book supposedly has an Appendix 18a (online). I can’t find

it but the title “stock dividends and stock splits” suggests this would

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be a very useful read. • Talley, “Why stock splits have declined,” Wall Street Journal,

February 21, 2007, p. B5A. Equity issuances

2. Ch. 19: Sections 19.1-19.5

Wed., Nov. 28

Equity issuances 1. Finish Ch. 19 2. “Anatomy of an IPO,” Red Herring, June 2000. • Silva and Currie, “Blackstone’s lengthy list: Initial public offering

counts 17 underwriters; effort to squash criticism?,” Wall Street Journal, June 14, 2007, p. C12.

• Kaplan, Sensoy and Stromberg, 2005, “What are firms? Evolution from birth to public companies,” NBER working paper 11581.

• Dittmar and Thankor, 2007, “Why do firms issue equity?,” Journal of Finance, 62(1), pp. 1-54.

Corporate governance

3. Welch, 2006, “Chapter 24 – Corporate Governance,” A First Course in Corporate Finance.

4. Becht, Bolton and Röell, 2002, “Corporate governance and control,” NBER working paper 9371, pp. 5-9, 108-114.

• Morck and Steier, 2005, “The global history of corporate governance – An introduction,” NBER working paper 11062.

EAR #3

Mon., Dec. 3 Impact of SOX 1. Piotroski and Srinivasan, 2007, “The Sarbanes-Oxley act and the

flow of international listings,” unpublished working paper. 2. Doidge, Karolyi and Stulz, 2007, “Has New York become less

competitive in global markets? Evaluating foreign listing choices over time,” NBER working paper 13079.

Wed., Dec. 5

To be determined…

Problem set 5

Friday, Dec. 7, 4pm

Research papers due

Mon., Dec. 10 Conclusion 1. Brealey, Myers and Allen, 2006, “Chapter 35 – What we do and do

not know about finance,” Principles of Corporate Finance (8th edition).

Mon., Dec. 17, 7-10pm

Final exam – good luck!

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