MSc Finance: Advanced Corporate Finance
Inhoudsopgave
MSc Finance: Advanced Corporate Finance .................................................................................................... 1
PART 1 ........................................................................................................................................................... 3
Lecture 1: Back to the basics .............................................................................................................................. 3
Lecture 2: Debt Covenants ............................................................................................................................... 12
Lecture 3: Private vs. Public firms..................................................................................................................... 23
Lecture 4: Payout Policy ................................................................................................................................... 34
Lecture 5: Moral Hazard................................................................................................................................... 42
Lecture 6: Law and Finance .............................................................................................................................. 53
Lecture 7: Political connections ........................................................................................................................ 71
PART 2 ......................................................................................................................................................... 77
Lecture 1: Banks and Banks' Mergers .............................................................................................................. 77
Lecture 2: FinTech lending................................................................................................................................ 92
Lecture 3: Asymmetric information .................................................................................................................. 99
Lecture 4: Mortgage crisis .............................................................................................................................. 116
Lecture 5: Rating Agencies ............................................................................................................................. 134
Lecture 6: Bankruptcy law .............................................................................................................................. 152
Q and A sessions ........................................................................................................................................ 159
Q&A 1 ............................................................................................................................................................. 159
Q&A 2 ............................................................................................................................................................. 160
Q&A 3 ............................................................................................................................................................. 165
Q&A 4 ............................................................................................................................................................. 168
Q & A 5 ........................................................................................................................................................... 172
Q & A 6 ........................................................................................................................................................... 174
Q&A 7 ............................................................................................................................................................. 177
Q&A 8 ............................................................................................................................................................. 180
Q&A 9 ............................................................................................................................................................. 181
Q&A 10 ........................................................................................................................................................... 183
Q&A 11 ........................................................................................................................................................... 186
Readings .................................................................................................................................................... 188
Panier, F., F. Perez-Gonzales and P. Villanueva, 2015, “Capital Structure and Taxes: What Happens When You
(Also) Subsidize Equity?” Working Paper, Stanford University....................................................................... 188
M. R. Roberts and A. Sufi, 2009, "Control Rights and Capital Structure: An Empirical Investigation, Journal of
Finance, 64, pp. 1657-1695 ............................................................................................................................ 188
,Access to Capital, Capital Structure, and the Funding of the Firm – Omer Brav ............................................ 189
Assignment referee report ............................................................................................................................. 193
House prices, home equity-based borrowing and the US household leverage crisis...................................... 193
,PART 1
Lecture 1: Back to the basics
A review of Finance Source
- Internal capital
o Retained earnings: profits not payed back to the shareholders but used to
finance investment, current expenses, etc.
- External capital
o Debt: an amount of money borrowed by one party from another.
§ A debt arrangement gives the borrowing party permission to borrow
money under the condition that is to be paid back at a later date,
usually with interest.
§ Usually debtholders don’t have voting rights.
§ Debt is a senior claim to equity. Before any payment to equity, first
the DH need to be satisfied. Repayment of principal or interest.
§ IR is predetermined.
o Equity: equity holders are compensated with a dividend. The value of
dividend is not predetermined. If a company is doing very well, the dividend
can be very, very large. The dividend payment will depend on the
performance of the company (not the case for debt).
§ Equity holders receive their claims only after satisfaction debtholder.
§ Equity holders have the right to vote at the general meeting of
shareholders.
Academic leverage: D/E or D/TA
- How much debt the company has taken on.
Industry leverage: D/EBIT
- More widely used in the industry. When you are going to resolve the assignment, you
need to use industry leverage.
Usually indicated with 3x, 4x…
3x = three years of earnings levels and we will pay back debt.
Leverage can change because of:
1. Debt issued/paid back
2. Equity issued/paid back
Modigliani-Miller irrelevance theorem
Assumptions:
1. Perfect financial markets:
a. Competitive: individuals and firms are price-takers
b. Frictionless: no transaction costs, etc.
c. All agents are rational, no subject to behavioral biases
2. All agents have the same information
3. No bankruptcy costs
4. No taxes
Original propositions:
, 1. MM- proposition I: a firm’s total market value is independent of its capital structure.
a. Value firm: present discounted value of FCF.
b. When a firm issues debt and equity securities, it splits its CFs into two
streams:
i. Safe stream to bondholders
ii. Risky stream to stockholders
c. Firm is determined by the real assets, the ability of the firm to generate FCFs.
d. Firms can’t change their value by splitting CFs into two different streams.
e. Capital structure is irrelevant.
f. Vu = Ve = EBIT/ru
g. Vl = D + E = [Int + (EBIT – Int)]/ru
h. Ve = Vl - B
2. MM-proposition II: a firm’s cost of equity increases with its debt to equity ratio.
a. WACC: average cost of capital that a company is expected to pay on average
to all its security holders to finance its assets or investments.
b. WACC = D/ (D +E) rd + E/ (D+E) re
c. Re = (WACC – rd) D/E + WACC
d. WACC > rd, re is increasing with D/E
e. Intuition: increasing debt makes equity riskier, increasing expected returns
investors demand.
f. Debt generates risk
i. Higher D ratios lead to greater risk and higher required returns to
compensate for the additional risk.
ii. Two types of risk:
1. Business risk – typical enterprise risk
a. Intrinsic risk that your company has, NOT related to
debt!
2. Financial risk – risk of the equity investment
a. The additional risk placed on the common stockholders
as a result of the decision to finance with debt.
i. Debt is senior to equity
ii. If the company is liquidated
1. Debtholders have the right to a fixed
claim – the amount of their debt
2. Gain or losses are taken over by SHs
b. Leverage increases SH risk
c. Leverage also increases the ROE (to compensate for
higher risk)
)
d. 𝛽𝑙 = 𝛽𝑢 (1 + * )
3. Dividend irrelevance: a firm’s total MV is independent of its dividend policy.
a. Discussed in other lecture ;).
4. Investor indifference: individual investors are indifferent to all firms’ financial
policies.
a. Win-win fallacy: “debt is better because some investors prefer D to E”.
i. Opposite of MM
b. Different investors prefer different consumption streams:
i. They may prefer different financial assets
Inhoudsopgave
MSc Finance: Advanced Corporate Finance .................................................................................................... 1
PART 1 ........................................................................................................................................................... 3
Lecture 1: Back to the basics .............................................................................................................................. 3
Lecture 2: Debt Covenants ............................................................................................................................... 12
Lecture 3: Private vs. Public firms..................................................................................................................... 23
Lecture 4: Payout Policy ................................................................................................................................... 34
Lecture 5: Moral Hazard................................................................................................................................... 42
Lecture 6: Law and Finance .............................................................................................................................. 53
Lecture 7: Political connections ........................................................................................................................ 71
PART 2 ......................................................................................................................................................... 77
Lecture 1: Banks and Banks' Mergers .............................................................................................................. 77
Lecture 2: FinTech lending................................................................................................................................ 92
Lecture 3: Asymmetric information .................................................................................................................. 99
Lecture 4: Mortgage crisis .............................................................................................................................. 116
Lecture 5: Rating Agencies ............................................................................................................................. 134
Lecture 6: Bankruptcy law .............................................................................................................................. 152
Q and A sessions ........................................................................................................................................ 159
Q&A 1 ............................................................................................................................................................. 159
Q&A 2 ............................................................................................................................................................. 160
Q&A 3 ............................................................................................................................................................. 165
Q&A 4 ............................................................................................................................................................. 168
Q & A 5 ........................................................................................................................................................... 172
Q & A 6 ........................................................................................................................................................... 174
Q&A 7 ............................................................................................................................................................. 177
Q&A 8 ............................................................................................................................................................. 180
Q&A 9 ............................................................................................................................................................. 181
Q&A 10 ........................................................................................................................................................... 183
Q&A 11 ........................................................................................................................................................... 186
Readings .................................................................................................................................................... 188
Panier, F., F. Perez-Gonzales and P. Villanueva, 2015, “Capital Structure and Taxes: What Happens When You
(Also) Subsidize Equity?” Working Paper, Stanford University....................................................................... 188
M. R. Roberts and A. Sufi, 2009, "Control Rights and Capital Structure: An Empirical Investigation, Journal of
Finance, 64, pp. 1657-1695 ............................................................................................................................ 188
,Access to Capital, Capital Structure, and the Funding of the Firm – Omer Brav ............................................ 189
Assignment referee report ............................................................................................................................. 193
House prices, home equity-based borrowing and the US household leverage crisis...................................... 193
,PART 1
Lecture 1: Back to the basics
A review of Finance Source
- Internal capital
o Retained earnings: profits not payed back to the shareholders but used to
finance investment, current expenses, etc.
- External capital
o Debt: an amount of money borrowed by one party from another.
§ A debt arrangement gives the borrowing party permission to borrow
money under the condition that is to be paid back at a later date,
usually with interest.
§ Usually debtholders don’t have voting rights.
§ Debt is a senior claim to equity. Before any payment to equity, first
the DH need to be satisfied. Repayment of principal or interest.
§ IR is predetermined.
o Equity: equity holders are compensated with a dividend. The value of
dividend is not predetermined. If a company is doing very well, the dividend
can be very, very large. The dividend payment will depend on the
performance of the company (not the case for debt).
§ Equity holders receive their claims only after satisfaction debtholder.
§ Equity holders have the right to vote at the general meeting of
shareholders.
Academic leverage: D/E or D/TA
- How much debt the company has taken on.
Industry leverage: D/EBIT
- More widely used in the industry. When you are going to resolve the assignment, you
need to use industry leverage.
Usually indicated with 3x, 4x…
3x = three years of earnings levels and we will pay back debt.
Leverage can change because of:
1. Debt issued/paid back
2. Equity issued/paid back
Modigliani-Miller irrelevance theorem
Assumptions:
1. Perfect financial markets:
a. Competitive: individuals and firms are price-takers
b. Frictionless: no transaction costs, etc.
c. All agents are rational, no subject to behavioral biases
2. All agents have the same information
3. No bankruptcy costs
4. No taxes
Original propositions:
, 1. MM- proposition I: a firm’s total market value is independent of its capital structure.
a. Value firm: present discounted value of FCF.
b. When a firm issues debt and equity securities, it splits its CFs into two
streams:
i. Safe stream to bondholders
ii. Risky stream to stockholders
c. Firm is determined by the real assets, the ability of the firm to generate FCFs.
d. Firms can’t change their value by splitting CFs into two different streams.
e. Capital structure is irrelevant.
f. Vu = Ve = EBIT/ru
g. Vl = D + E = [Int + (EBIT – Int)]/ru
h. Ve = Vl - B
2. MM-proposition II: a firm’s cost of equity increases with its debt to equity ratio.
a. WACC: average cost of capital that a company is expected to pay on average
to all its security holders to finance its assets or investments.
b. WACC = D/ (D +E) rd + E/ (D+E) re
c. Re = (WACC – rd) D/E + WACC
d. WACC > rd, re is increasing with D/E
e. Intuition: increasing debt makes equity riskier, increasing expected returns
investors demand.
f. Debt generates risk
i. Higher D ratios lead to greater risk and higher required returns to
compensate for the additional risk.
ii. Two types of risk:
1. Business risk – typical enterprise risk
a. Intrinsic risk that your company has, NOT related to
debt!
2. Financial risk – risk of the equity investment
a. The additional risk placed on the common stockholders
as a result of the decision to finance with debt.
i. Debt is senior to equity
ii. If the company is liquidated
1. Debtholders have the right to a fixed
claim – the amount of their debt
2. Gain or losses are taken over by SHs
b. Leverage increases SH risk
c. Leverage also increases the ROE (to compensate for
higher risk)
)
d. 𝛽𝑙 = 𝛽𝑢 (1 + * )
3. Dividend irrelevance: a firm’s total MV is independent of its dividend policy.
a. Discussed in other lecture ;).
4. Investor indifference: individual investors are indifferent to all firms’ financial
policies.
a. Win-win fallacy: “debt is better because some investors prefer D to E”.
i. Opposite of MM
b. Different investors prefer different consumption streams:
i. They may prefer different financial assets
