CORPORATE FINANCIAL POLICY FINANCE 621 WINTER A 2006
Prof. Amy Dittmar
Class Time: T TH 10:20 – 12:40 & 2:10 – 4:30 Office: ER 7603 Office Hours: T & Th 1:00 – 2:00 or by appointment Class Location: P1016 Phone: 764-3108 E-mail: adittmar@bus.umich.edu
Course Objective The goal of a financial manger is to maximize the shareholder value. One of the ways that the financial manager achieves this is to set and evaluate a firm’s financial policy in a way that is consistent with this goal. In this class, we will learn how to determine different financial policies and how each impacts firm value. There are two sides to financial policy and the course will discuss both. The first centers on how a firm finances its investments and investigates both how capital structure impacts firm value as well as understanding the implications of issuing different securities. Thus we will study the following questions: how much debt should a firm have in order to maximize firm value; how does a firm issue equity (initially by going public and later once already public) and what are the implications from making this decision; how does an investment bank determines the price per share in an initial public offering. This will make-up about 2/3rd of the class. The second side of financial policy is what does a firm do if it has more cash than it needs. In this part of the class, we will study: how much cash is too much and what limits a firm should put on its cash reserves; if the firm has too much cash, should it distribute it to shareholders by increasing its dividend; when is it better to repurchase stock vs. pay a dividend? Understanding the issues that impact a firm’s financial policy is essential to those of you that want to be a financial manager or work for investment bank. It is also very important for those who will work in other disciplines because these issues impact the strategy and incentives of the firm. In this class we will investigate how financial policy impacts the strategy of the firm; F647 studies this topic in much more detail and allows the firms financial and strategic decisions to be jointly determined. F621 course is also vital for those of you interested in security design because we will study the core structure of debt and equity. In this course, I will introduce some new “hybrid” securities but we will focus our attention on traditional securities. F622 studies why a firm would choose to use hybrid securities. F621 is a pre-requisite for both of these courses; thus, this course is the foundations course for the other Corporate Finance courses. Because this course is a foundations course, we will cover a lot of material. However, our goal is not to brush the service of many topics but to dig deeply into financial policy. We are able to achieve this goal and still cover the breadth of material because this class is 2.25 credits and thus have time to cover more topics without sacrificing depth. It is important for you to realize that a 2.25 credit hour class will require 50% more work than a 1.5 credit hour class. We will also use many cases to achieve this goal. I will discuss the cases more below. Required Readings There are two types of reading in this class – both are required reading and should be done before each class. The first is “background reading,” which will complement the material covered in class by providing additional
explanations and examples. These include chapters from the text book, journal articles of topics not thoroughly covered in the text, and a case. The second type of material will be for class discussion. These are cases. The discussion cases will require you to read and analyze the case for in class discussion. The case and articles are provided for you in your course materials. Text: Financial Markets and Corporate Strategy, Grinblatt and Titman, Second Edition (GT in schedule) Course Packet: Includes all Articles, Background and Discussion Cases. Case Discussions and Participation This class will rely extensively on case discussion. For most topics, I will provide the foundation material and we will then apply this in a case. During the case discussions, participation of all students is required. I will begin each case by cold calling one student to begin the discussion (I will pick these cold-calls at random and as needed through out the discussion). Once the discussion has begun, I will participate and facilitate the discussion but the success of the learning experience lies as much with you as with me. I believe that this is our class room and we all impact what and how well we learn. Preparation and participation is essential. You will note that on the schedule there are “discussion cases” and one “background case.” The description of the case discussion requirements refers to the “discussion cases.” I will use the background case to explain the material and may ask a few questions, but these cases will not be the focus of the class. Your participation need not be limited to case discussions; I encourage you to participate in the course at all times. Many of you come from diverse backgrounds and may have exposure to many of the issues and cases discussed. Please share these with the class, as we can all benefit from you sharing these experiences. Seating Arrangements Each student is required to have his or her name card visible at every class meeting. You are free to choose your own seat, but on the 3rd class meeting I will set the seating arrangements. You are required to sit in this seat for the rest of the term. You may find it helpful to choose a seat with the rest of your group. Course Communication I encourage you to use email to communicate with me about any issues relating to the class. I will respond to your emails promptly. Please put F621 in the subject line when you sent these emails. I will also meet with individual or groups of students during office hours and by appointment: Tuesdays and Thursdays 1:00 – 2:00 or by appointment in ER 7603. I will also use C-tools for announcements, http://ctools.umich.edu. Assignments You will do much of your work in this class in groups. You are expected to form a group of 4 people. Each group must submit a list of group member names to me by the 3rd class meeting via Ctools. At this time, the group should also state their first, second, and third choice for which cases the group will prepare for the short and detailed case reports. I will try to assign each group their higher choice for the detailed case and a lesser choice for the short case. Of course, multiple groups may request the same case, so I reserve the right to assign a case not requested to a group. As these conflicts arise, I will base my decisions on “first-come, first-serve.” You will work on both case (short and detailed) reports with this group. I know that each of you are quite busy and often have conflicts with group meetings. However, NO other commitments are an excuse for shirking your part of the group work. If you have a conflict, you must find a way to pick up slack so that you pull your own weight. At the end of the course, I will have each group member fill out a peer evaluation. If a group consistently indicates that one member did less than 100% of what was expected, that person will receive a lower grade on both case write-ups. If you do 50% of the work, you will get 50% of the grade – no exceptions. All assignments should be submitted via Ctools for electronic submission. All assignments are due before the class time to which they are assigned. Homework: You will have 2 homework assignments. The homework assignments will help solidify the foundation
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material, from which we will build on in the cases. These homework assignments can be alone or in groups. This group can be the same or different from the case report group. Please put all group members names on the homework. Unlike the case report group, there will be no peer evaluation for the homework group since you are not required to do these assignments in groups and are not required to work with any set group. Short Case Report: Each group will choose one of the discussion cases to write up a short 2 page report (see explanation under assignments for how these are chosen). The 2 page limit is not flexible. Part of this assignment is determining how to incorporate the key aspects of the case in a limited space. In this report, you should describe which issues are most important and discuss each. You may include graphs or tables but these must be incorporated into the 2 pages. Detailed Case Report – Each group will choose one of the discussion cases to write up a detailed report (see explanation under assignments for how these are chosen). The detailed report will analyze all aspects of the case. You should not limit yourselves to the financial strategies discussed in the case. I urge you to think critically about the alternatives discussed in the case and consider new alternatives. You may want to meet with me after your group has discussed the issues but before you prepare your report. I will NOT provide any answers – in fact, as we will learn in our discussions, there is rarely one clear answer – but meeting may prevent you from wasting time on a dead end. You are required to turn in a report that is contained in one document (i.e. one Word document with all tables etc… embedded). There is no space requirement in these write ups, but conciseness and clarity will be rewarded. Each report should begin with a one page executive summary. You should then present your analysis and finally make a policy recommendation. All recommendations should be strongly supported with financial analysis. In addition to turning in your written report, each group should prepare no more than 3 slides that discuss the alternative financial policies the firm should (have) consider(ed), make a recommendation or evaluate the choice the firm made (if the case is written after the policy is set) and substantiate the recommendation. The group will present these slides in class as part of the case discussion. In general, the class will first discuss the firm’s strategy and performance and financial policy leading up to the issue at large in the case. Then, the assigned group will present and lead a discussion of the alternatives, as well as present a recommendation. The group should be prepared to defend this recommendation in further classroom discussion. Participation – Class Participation is required and will be evaluated based on quality of the comments during case discussions. Please note that I expect EVERY student to come to class familiar with the case, having thought about and analyzed the alternatives presented, and considered other alternatives. Final Exam – The final exam will be a take-home exam, provided for you at the end of the last class and due at the University scheduled Final Exam time – February 21st at 12:30 (10:20 section) and February 21st at 4:00 (2:10 section). You should submit the final via C-tools. All exams are to be completed individually and students are prevented from discussing the exam before the due date with any other student or instructor. Any discussion of the exam outside of class will be considered a violation of the honor code and the student will – at a minimum – receive a zero on the exam. Grade determination. Homework Short Case Report Detailed Case Report Final Exam Participation
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10% 10% 30% 30% 20%
Class Schedule
Note: All Case write ups and homework assignments are due BEFORE class begins. Case assignments and homework assignments are indicated below with a .
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Section A: Introduction Jan 10th Unit 1 – Course Plan and Types of Financial Instruments Read: GT Chapters 1, 2, and 3.0-3.5
Section B: How Much Debt Relative to Equity Should a Firm Have to Maximize Shareholder Value? Jan 12th Unit 2 - Capital Structure in a “Perfect” Capital Market Read: GT Chapter 14.0-14.3 Unit 3 – The Effect of Taxes on Capital Structure and Firm Value Read: GT Chapters 13 and 14.4-14.10 Read: Graham, John, 2001, Estimating the tax benefits of debt, Journal of Applied Corporate Finance 14 (1), 42-54. Background Case: Debt Policy at UST Inc. Group for Cases and Preference for short and detailed case due Assignment Due: Capital Structure Irrelevancy Assignment Due Unit 4 – Value Implications of Capital Structure Policy Discussion Case (1): American Home Products Unit 5 – Bankruptcy costs and the Impact of Capital Structure on Incentives Read: GT Chapter 16 and 17.0-17.3 Discussion Case (2): The Loewen Group, Inc (Abridged) Unit 6 – Estimating the Optimal Capital Structure Read: Graham, John R., 2002, How Do CFOs Make Capital Budgeting and Capital Structure Decisions?, Journal of Applied Corporate Finance 15, 8-23 Discussion Case (3): Diageo PLC
Jan 17th
Jan 19th
Jan 24th
Jan 26th
Section C: What are the Costs of Issuing Equity? Jan 31st Unit 7 – Information Asymmetry and Issuing Seasoned Equity Read: GT Chapter 19 (except 19.4) Discussion Case (4): Stone Container Corp Unit 8 – Going Public - The Decision to Go Public and Pricing of IPOs Read: Ritter, Jay, 1998, Initial Public Offerings, Contemporary Finance Digest, Vol. 2, No. 1, pp. 5-30. Unit 9 – Going Public - The Decision to Go Public and Pricing of IPOs Discussion Case (5): Preparing for the Google IPO
Feb 2nd
Feb 7th
Section D: How Much Cash Does a Firm Need and What Should it Do if it has Too Much? Feb 9th Unit 10 –Cash Policy and Agency Problems Read: GT Chapter 18.0-18.4
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Read: Opler, Tim, Lee Pinkowitz, Rene Stulz, and Rohan Williamson, Corporate Cash Holdings, Journal of Applied Corporate Finance 14 (1), 55-66. Discussion Case (6): Sealed Air Corp’s Leverage Recapitalization (A) Feb 14thUnit 11 – Distribution Policy: Dividends Read: GT Chapters 15 and 19.4 Discussion Case (7): FPL Group Feb 16thUnit 12 – Distribution Policy: Stock Repurchases Read: Grullon, Gustavo and David Ikenberry, 2000, What do we know about stock purchases, Journal of Applied Corporate Finance 13 (1), 31-51 Discussion Case (8): General Motors 1993-1996 Assignment Due: Dividend Policy Assignment Due
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