FINANCIAL MARKETS AND DECISIONS II

ECONOMICS BEE 3034 2016

Lecturer Prof. David Kelsey, Office, Streatham Court 1.21;

tel. 72-2536. Office hoursThursdays, 3-5pm.

GENERAL REFERENCES

• P. Milgrom and J. Roberts, Economics, Organization and Manage-ment, Prentice Hall 1992.

• G. M. Constantinides (Editor), et al. Handbook of the Economics of Finance, North Holland Amsterdam.

  • Very expensive at £150, but worth buying if you are wealthy. (Volume 1 is the most relevant.)

• J. Tirole, The Theory of Corporate Finance, MIT Press, 2005.

  • Somewhat more advanced.

• Berk and DeMarzo, Corporate Finance, Pearson, 2007.

  • covers most of the material, however the terminology may be unfamiliar as it is a finance book rather than an economics book.

Method of Assessment Two hour written examination 70%essay 30%.

COURSE ORGANISATION The course consists of 20 hours of lectures plus fortnightly tutorials.

COURSE OUTLINE AND READING LIST

1. The Modigliani-Miller TheoremsTypes of securities issued by firms, the Modigliani-Miller Theorems, dividend policy, effect of taxes.

   • *Modigliani, F. and M. Miller, (1958), "The cost of capital and the theory of investment", American Economic Review, 48, 261-297.

   • Miller, M., (1988), "The Modigliani-Miller Propositions After Thirty Years." Journal of Economic Pespectives, 2, 99-120.

   • Tirole Ch. 2.

   • *Milgrom and Roberts, Ch.14.

   Myers, S.C. (2001), "Capital Structure", Journal of Economic Perspectives, 15, 81-102.

   • Allen, F. and R. Michaely, (2003), `Payout Policy', in G. M. Constantinides (Editor), et al. Handbook of the Economics of Finance, North Holland Amsterdam.

2. Moral Hazard and Incentives Moral hazard and incentive contracts, the informativeness principle, the incentive intensity principle and the monitoring intensity principle.

   • *McMillan, J. Games Strategies and Managers, Oxford University Press, Chs. 8,9.

   • *Milgrom and Roberts Ch.7.

3. Incentive effects of Debt and EquityEffect of financing on incentives to supply effort and avoid bankruptcy. Past debt reduces the incentive for future investment.

   • *Milgrom and Roberts, Ch.15.

   • Tirole Ch. 3.

   • Myers, S., (1977),`Financing of corporations', in G. M. Constantinides (Editor), et al. Handbook of the Economics of Finance, North Holland Amsterdam.

   • Myers, S., (1977), "Determinants of Corporate Borrowing" Journal of Financial Economics, 5, 147-175.

   • Stein, J.C. (2001) `Agency, Information and Corporate Investment', in G. M. Constantinides (Editor), et al. Handbook of the Economics of Finance, North Holland Amsterdam.

4. The Market for Lemons Analysis of a simple model of a market with asymmetric information.

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   • *Akerlof, G.A. (1970) `The market for "lemons": qualitative uncertainty and the market mechanism', Quarterly Journal of Economics, 84: 488-500.

   • *Kreps, A Course in Microeconomic Theory, pp 625-629.

   • Milgrom and Roberts pp.149-154.

5. Adverse Selection and the Debt-Equity RatioFinancial signalling, models, the implications for investment, adverse selection and investment.

   • *Tirole Ch. 6.

   • Milgrom and Roberts, Ch.15.

   • *Ross, S. (1977), "The Determination of Financial Structure: The Incentive Signalling Approach," Bell Journal of Economics, 8, 23-40.

   • Myers, S.C. (2001), "Capital Structure", Journal of Economic Perspectives, 15, 81-102.

6. Takeovers The Free Rider Problem in takeovers, free cash flow theory, takeover defences, divestitutres.

   • Jensen, M. (1986) " Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers" , American Economic Review, Papers and Proceedings, 76, 323-329.

   • Symposium on Takeovers Journal of Economic Persepctives, 1988 vol. 2, pp. 3-82.

   • Jarrell Brickley, Netter, (1988) "The Market for Corporate Control" Journal of Economic Persepctives, 49-68.

   • Andrei Shleifer, Robert W. Vishny (1988) Value Maximization and the Acquisition Process Journal of Economic Persepctives, 7-20.

   • Michael C. Jensen (1988) Takeovers: Their Causes and Consequences Takeovers Journal of Economic Persepctives,

   • F. M. Scherer, (1988) Corporate Takeovers: The Efficiency Arguments Corporate Takeovers: The Efficiency Arguments Journal of Economic Persepctives,

   • Grossman, S. and O. Hart, (1980), "Takeover Bids, the Free Rider Problem and the Theory of the Corporation", , Bell Journal of Economics, 11, 42-64.

   • *Milgrom, and Roberts, Ch. 15.

7. Incomplete Contracts and the Hold-up Problem The Hold Up problem, Asset Specificity, Implications for the structure of the firm.

   • *O., Hart, Firms Contracts and Financial Structure, OUP. 1995, Ch. 2.

   • Milgrom and Roberts, Ch.9.

   • Brickley, Smith and Zimmerman, (1997), Managerial Economics and Organisational Architecture, Irwin, Ch. 15.

8. The Objective Function of the FirmExpected Utility Theory (review), Competitive Insurance Markets, the Fisher Separation Theorem, implications for corporate governance.

   • *F. Milne, Finance Theory and Asset Pricing, 2nd Edition OUP., 2003.Ch. 2.

   • Milgrom and Roberts, p. 448-451.

   • J. Eichberger and I. Harper, Financial Economics, OUP., 1997, Ch. 3 and Secs 5.1 and 5.2.

   • Gravelle and R. Rees, Microeconomics, 2nd Edition, Longman 1992. Ch. 19.

   • Green, H.A.J. Consumer Theory, Penguin, 1971, Ch.13,14,15.

TEXTBOOK PURCHASE As can be seen there is no single textbook which covers all the material. The most useful book to buy would be Milgrom and Roberts.

* Denotes essential reading