Corporate Finance I:Course Introduction & Overview

Paul Laux

September 2010

For this course, Teaching Notes, like this one, contain the text and graph-ics of classroom slides, along with additional explanation and comments. Ingeneral, bullet-pointed items are from the in-class slides. Slides are intendedto support the presentation, not to be a substitute for it. Thus, they are notself-contained and you need to be in class for a full understanding. In additionto copies of in-class slide information, these Teaching Notes often contain ad-ditional supporting text. Most often, this additional text reflects oral points Imake in class.

Special Note: This first Teaching Note contains the rules and requirementsfor this course, in Section 2. Section 2 is the Course Syllabus! This is the gov-erning document for grades! Study it well.

Learning Goals

• After this module (including studying the Teaching Note) you should:

– Have a “big picture” understanding of what corporate finance means

– Have an understanding of my approach to teaching corporate fi-nance

– Have a feel for my attitude as your corporate finance teacher

– Know the list of activities and responsibilities for this course

– Know the list of topics for this course

– Know how this course will be graded

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Contents

1 Course Concept 2

1.1 Definitions of corporate finance . . . . . . . . . . . . . . . . . . . 2

1.2 Philosophy & methods . . . . . . . . . . . . . . . . . . . . . . . . 6

2 Course Overview (Syllabus) 8

2.1 Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

2.2 Grading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

2.3 Calendars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

3 Professor 14

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1 Course Concept

1.1 Definitions of corporate finance

What do financial systems do?

The big picture is good place to start

• Levine (1997) summarizes the social functions of financial systems:

– facilitate the trading, hedging, diversifying & pooling of risk

– allocate resources

– monitor managers & exert corporate control

– mobilize savings

– facilitate the exchange of goods & services

• Which functions are performed by corporate finance?

What is corporate finance?

Techniques & Markets

for Managing & Understanding the Creation of Value for Owners

in Risky Environments,

especially via Contracting.

Techniques: One (incomplete) way to think of finance in general is as a col-lection of tools for analysis. Much of what we do in this class is oriented to-ward enhancing your analytical skill. Finance can also be thought of in termsof a set of tools for financing, that is, raising the funds necessary to operate anenterprise.

Markets: Markets and market prices, especially for stocks and other securi-ties, are the touch-stone of finance. Well-functioning financial markets are thebest source of information, benchmarking, and insights into value. That’s be-cause value is, by definition, what people say it is. And financial markets are

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the places where people meet to convincingly say what value is they say it withtheir pocketbooks.

Managing & Understanding: Finance goes beyond analytical tools to be amanagerial orientation. A recruiter for a major airline told me that he wantednew employees who had the value-creating orientation of finance hard-wiredinto their brains as a guiding philosophy. Finance is also an intellectual area inits own right, generating thoughts that have substantially changed the worldeconomy. One bit of evidence: during the 1990s, five Nobel Prizes in economicswere awarded to finance scholars.

Value: Finance focuses on measurable value. While not all value is cash, abasic tenet of finance is that all value can be expressed in terms of cash (i.e.,purchasing power). Think: how much would I pay for that?

Owners: Finance tends to think of an enterprise’s owners (such as its stockmarket investors) as the central stakeholders in whose interest the enterprise isoperated. This is a strong philosophical statement, for it puts owners in frontof employees, customers, community, etc. The tools and thinking of finance arealso of substantial importance for organizations with goals other than ownervalue maximization, such as not-for-profit agencies and NGOs.

Risk: Finance emphasizes tools for making decisions in risky situations, andhow stock market investors deal with risk. Risky situations are those where theoutcome is uncertain, though the probabilities of various possible outcomesmay be known.

Contracting: Finance focuses on the incentive-laden relationships betweenowners, other funding suppliers, managers and employees, and on the waythat these relationships can be molded in value-creating ways via contracts.Securities, such as stocks and bonds, are the central contract with which financeis concerned.

What are the key decisions in corporate finance?

The most essential of decisions regarding capital are how to obtain it andhow to satisfy the claimholders from whom it is obtained (financing decisionsand value-disbursement decisions) and how to employ it (investment deci-sions and operating decisions). The link between these decision areas and thebroader definition of finance is their purpose: maximizing value for owners.

Financing decisions. For a business organization, financial contracts such asstocks, bonds, loans, and other securities are marketed to (ultimately) individ-uals. Banks and other financial institutions may serve as crucial intermediaries,because of their special expertise, information, or large pool of available funds.

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Financial Management

FinancingDecisions

How shouldthe firm

 raise funds?

Maximize Value for Owners

Value­disbursementDecisions

InvestmentDecisions

OperatingDecisions

How shouldthe firm

 pay out valueto claimants?

What long­livedresources should

the firmobtain?

How shouldthe firm use

long­ & short­livedresources?

When a firm raises money via financial contracts, it has decided to use ex-ternal financing. External financing is particularly important for growing firmswhose business model is in the early stages of being implemented. In contrast,mature firms use internal financing most of the time (and especially in civil lawcountries). That is, they rely on cash produced in the course of doing businessas the main source of funds to maintain and grow the business.

Investment Decisions. The funds raised pursuant to a firm’s financing deci-sions are invested in physical and human capital, i.e., productive assets, whichare used to generate goods and services for sale to individuals. When wespeak of the investment decision in managerial finance, we are referring to thedecision to invest in either tangible long-lived real resources (plant, property,equipment, and the like) or intangible long-lived real resources (patents, trade-marks, business relationships). This contrasts with an individual’s investmentdecision which might be centered around financial assets such as stocks andbonds, which are claims on the benefits generated by productive assets, as op-posed to the productive assets themselves. For a firm, the point of investmentdecisions is to choose assets that will generate cash revenue, and, ultimately,new value.

Operating Decisions. Coincident with and subsequent to its investment de-cision, the firm must decide how to employ the productive assets it has ob-tained. Additionally, it must make ongoing decisions about how to obtain anduse shorter-lived resources.

The point of operating decisions is to use long-lived assets, and to obtainand use shorter-lived resources, to generate value.

Value-disbursement Decisions. The firm that creates value will, at some point,need to pay it out to the parties who have financed it (and even to some par-ties who have not financed it, such as the government via taxes). Some dis-bursement decisions are essentially pre-determined at the time of a financing

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decision. An example of such a pre-determined disbursement decision is thedecision to make interest payments on a loan. Other disbursement decisionsare only loosely connected to the original financing decision. An example isthe decision to pay dividends.

The point of value-disbursement decisions may be to provide a stream ofcash benefits that is uniquely attractive to the firm’s suppliers of financing,or to signal confidence in the firm’s ability to generate cash. Alternatively,the value-disbursement decision may be simply the residual effect of the otherthree major decisions. Once a firm has decided on financing, investing, andoperating, the amount it can pay out to stockholders is completely determinedthe firm simply pays out what is left over.

CFA Program Corp Fin Candidate Body of Knowledge (CBOK) 2010

• Corporate Governance

• Dividend policy

• Capital investment decisions

• Business and financial risk (cost of capital)

• Financial policy (long & short term)

• M&A and corporate restructuring

CFA CBOK topics match to decision areas

Capital budgeting=⇒Investment

Cost of capital=⇒Financing, investment, operating & disbursement

Capital structure and leverage=⇒Financing

Financial policy=⇒Financing & disbursement

Dividends and payout policy=⇒Disbursement

Corporate governance=⇒All these and more

In keeping with IUL MSc Finance CFA goals, most topics are in course focus& drive the course schedule.

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1.2 Philosophy & methods

Philosophy

• Finance is

– Noble

∗ “Creation of value for owners in risky environments” leads tovalue creation, risk pooling, and risk management for all

– Intellectual

– Practical

• How to learn finance

– Look for common good behind the private good

– Scientific investigation

– Practice

Finance is noble

Classic question: “Does finance make a difference?” (Raymond Goldsmith in “Fi-nancial structure and development,” 1969)

Cross-country correlational evidence on finance & income (Levine, 1997)

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U.S. evidence from two examples: Walmart and K-mart (Madden, 2007)

How finance creates social welfare (Levine, 1997)

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Philosophy leads to teaching methods in this course

• How to learn finance (reprise)

– Look for common good behind the private good

– Scientific investigation

– Practice

• Three methods in our course

– Foundations via teaching notes/lectures/CFA practice,

– Practice via cases, &

– Implications of the Science of finance via research articles

2 Course Overview (Syllabus)

2.1 Activities

Course Materials

• Course website!

– Username: CorpFin Password: equity1

http://www.TheFinanceWorks.net/CorpFin/2010

• Cases

• Research articles

• Lecture notes, etc. on class web

• CFA Corp Fin Workbook

• Online CFA Quizzer

http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance

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Meetings

• Two major types of class meetings

– Managerial meetings

∗ Two sub-types: Foundations and Cases

– Scientific meetings

∗ Occasional research article explorations

• Are you a Ph.D. student?

– Extra responsibilities for Scientific meeting material

Why scientific meetings for managerial students?

• The problem of Brocca’s patient (“tan”)

– “When all you have is a hammer, the whole world looks like a nail”

• Need to compare apples to apples?

– Or oranges to tangerines?

• Financial economics has been an exception among the social sciences innot using the scientific literature/experiments to teach

– Like carpentry for architects, instead of design and material sciencefor architects

What to do (& how assessed)

• Read CFA workbook material (tested)

• Practice CFA problems (tested)

• Prepare business cases & answer Prep Questions (turned in)

• Read research articles & answer Prep Questions (turned in)

• Develop takeaways for articles (tested)

• Attend class—every time (recorded & tested)

• Be an active listener (helps you “get it”)

• Try to be a contributor! (noted by me)

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2.2 Grading

General policies

• Guideline: ISCTE-IUL “curve” policy

– May be deviations to the high side∗ If warranted by very strong class-wide performance

– No deviations to the low side

• Grading based on a mix of demonstrated knowledge and demonstratedfull-engagement in the learning process

– That means exams count, & participation counts too

Graded course activities & grade weights

• Midterm exam 25 %

• Final exam 25% (Exames de primera epoca)

• Case Prep Questions 35%

– marked based on: lack of good faith effort (6), good faith effort (14)or standout (18)

– expect 14– written in groups of four– group members evaluate each other at conclusion of course, with

grade impact

• Scientific article Prep Questions 15%

– marked based on: lack of good faith effort (6), good faith effort (14)or standout (18)

Attendance

• Missed meeting: Deduct 1/2 point on course grade

• Two absences may be excused, upon written request and explanation

– BUT only one scientific meeting will be excused– Additional absences must bear the deduction unless I receive a for-

mal written request from a Directora do Mestrado em Finanças at-testing to a serious medical emergency or family emergency.

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Second-sitting exam policy (Exames de segunda epoca)

• Grade depends entirely the exam mark

• ALL course material is covered, including scientific meeting material infull

– The second-sitting exam is intended to be substantially more com-prehensive, deeper and more difficult than the standard exams

– This is necessary & fair because the second-sitting exam substitutesfor all class attendance, activities, contributions & demonstrated learn-ing, as well as the other exams

History

Ph.D. students: Additional duties

• With a partner (or at most two), discuss and write

– Four page synopsis of 4 additional related assigned articles

∗ Standard double-spaced, 12 pt font pages

– Specific articles noted later in this presentation

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2.3 Calendars

Main course calendar is on the web

http://TheFinanceWorks.net/CorpFin/2010

• Note there are 8 topics (including 2 for the exams)

• Note the dates of each topic

• Note due dates for assignments in red

• Note list of Teaching Notes, Readings, & Assignments

Exam schedule & structure

• Exams

– Midterm exam: 29 Oct

∗ 2 hours planned time; you will be allowed to extend the timesomewhat, within limits to be discussed later in the course

– Final exam: As schedule by MSc Program

– Exams structure (+/- 5%)

∗ 25% CFA-workbook-type questions∗ 25% case analysis questions∗ 25% foundations questions∗ 25% scientific questions

Case schedule

• Case discussions & Prep Qs due

– Vesuvio: 29 Sep (Pt 1), 4 Oct (Pt 2)

– Nike: 6 Oct

– Blaine Kitchen: 17 Nov

– Hampton Tools: 22 Nov

– Oracle: 26 Nov

– Waste Management: 3 Dec

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Scientific article schedule

• Article discussions & Prep Qs due

– Myers Majluf on investing & financing: 27 Sep

– Henderson Jegadeesh Weisbach on global issuance: 4 Oct

– Rajan Zingales on global capital structure: 15 Nov

– Gompers Ishii Metrick on corporate governance: 2 Dec

Ph.D. student additional duties

• Read, write 4-5 page synopsis of, discuss additional articles

– Krishnan Ergungor Laux Singh Zebedee on bank equity issuance:27 Sep

– Fama French on industry cost of capital: 4 Oct

– Byoun on capital structure tests: 15 Nov

– Polk Sapienza on catering to investors: 2 Dec

CFA Workbook Problems

• For your practice, not for turn-in

• Assigned problems or slightly alterred versions will be on the exams

– List of assigned problems is on the web

• Try to work some as we go along

– use the pre-midterm no class period as a time for major effort onthese problems

• Solutions are in the back of the CFA Workbook

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3 Professor

About me

• Link to our course website

http://TheFinanceWorks.net/CorpFin/2010

• Link to my general website

http://www.buec.udel.edu/laux

• Contact information

– Email: plaux@iscte.pt

– ISCTE-IUL Office: TBA

– U.S. phone: +1 302 250 4598 (VOIP & voicemail)

– Skype: paul_laux

• Biography

I am a Professor of Finance at the University of Delaware and, beginningin Fall 2010, Professor Catedrático Convidado at ISCTE-IUL. I have taught atISCTE regularly since 2003.

I earned my Ph.D. from Vanderbilt University in the late 1980s for researchin the structure of the Nasdaq Stock Market. From Vanderbilt, I joined theFinance Department at the University of Texas. At Texas, I taught Investmentsand Derivative Assets courses to MBA students over the next six years. I alsofocused on developing my research program on trading in financial markets.

In the early 1990s, I worked on futures issues as a staffer at the Commod-ity Futures Trading Commission, and later moved to Case Western ReserveUniversity’s Finance Department in 1994. As a markets and trading specialist,I became an increasingly active consultant during the next few years. I con-sulted for a number of securities exchanges and government organizations,like the Nasdaq Stock Market, the Chicago Stock Market, the Sydney FuturesExchange, Equiserve, and the Government of Australia. I served as the Direc-tor of the MBA Program at Case in the late 1990s.

Around the middle/late 1990’s, I began to develop some different researchand teaching interests. An interest in Corporate Finance led me to teach the

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core corporate finance course at the Case Western’s Full-Time and EveningMBA Programs. An interest in Law & Finance and in Corporate Governanceled me to take a faculty appointment at the Case Western Law School (no, Iam not a lawyer). Also during the mid-1990s, I began to teach internationally:executives in Mexico, MBAs in Hungary, and occasionally visiting executivesfrom other countries in the U.S. My research interest in international financealso dates from this period. An example is my article in the Journal of Inter-national Business Studies on the exchange rate risk management practices atlarge U.S. corporations.

During 2003, I was the Fulbright Chair in Banking at ISCTE. Since then, Ihave continued to teach International Finance in Portugal about once a year,either in ISCTE’s Executive MBA Program, its Master of Finance Program, orits Master in International Management Program. Beginning in 2009, I beganto teach Corporate Finance in the Master Program at ISCTE-IUL.

In 2004, I joined the Finance Department at the University of Delaware.Delaware is the legal home of most large U.S. corporations, the University andCollege showed a special interest in international education, and the Depart-ment has a stake in corporate governance, so I looked at the move as an oppor-tunity to further my work in many of the areas mentioned above. I initiallyserved as Department chairperson, in an effort to move the Department inthose directions and also toward MBA/executive program development, be-fore returning full-time to teaching and research.

My recent research work is at the intersections of corporate governance,financial markets and corporate finance, especially on the ways that informa-tion about firms is conveyed to financial markets. For example, one of myrecent articles (in the Journal of Financial and Quantitative Analysis) demon-strates the importance of properly-crafting the statements the prospectus atthe time of a security issue — else the stock market may even penalize the firmfor doing a good thing. Another strain of my recent research demonstrateshow corporate governance choices can enhance short-term traders’ interest ina firm’s stock, ultimately leading to better pricing for the stock. The articledemonstrating this result for U.S. stocks was published in The Journal of Fi-nance. Another recent article (in the Journal of International Money and Fi-nance) shows how countries’ economic success can be enhanced by allowingcross-border portfolio flows. Other recent research (in The Journal of FinancialIntermediation) concerns bank financing, and my projects currently underwayconcerns boards, financing events, executive compensation, and transparency.Ongoing work in several projects concerns raising capital, corporate boards,and executive compensation.

My non-research professional work fits with these things and is close to ourcourse; for example, in summer 2006 I worked for the International FinanceCorporation of the World Bank, lecturing on corporate governance in Bosnia

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and Albania. Over spring and summer 2007, I taught international finance toMBAs in Bosnia and to Master of Finance students in Portugal. In the sum-mer of 2008, I taught International Finance to International Business studentsin Portugal on a Fulbright Senior Scholar Fellowship (my second Fulbright).One of my Bosnian courses involved substantial work in cross-continental vir-tual teams of European and U.S. students—that’s partly how I know that ourvirtual meeting work in this course can be successful! Most recently, I haveserved over the past couple of years as a consultant to a currency and interestrate risk management firm with offices in the U.S., Europe, and Asia.

I’ll do my best for you. I will expect the same from you. In fact, I think themost important thing to know about succeeding in any of my courses is thatbeing fully engaged and active is the path to success.

I’m very happy to have the opportunity to work with you and your col-leagues. Please let me know of any way I can be helpful to your learning oryour career.

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