Contents
Acknowledgements xi
Introduction 1
Overview of the Field and
Coverage of the Book 1
Approach 6
Prerequisites and Further Reading 7
Some Important Omissions 7
References 10
I An Economic Overview of
Corporate Institutions 13
1 Corporate Governance 15
1.1 Introduction: The Separation of
Ownership and Control 15
1.2 Managerial Incentives: An Overview 20
1.3 The Board of Directors 29
1.4 Investor Activism 36
1.5 Takeovers and Leveraged Buyouts 43
1.6 Debt as a Governance Mechanism 51
1.7 International Comparisons of
the Policy Environment 53
1.8 Shareholder Value or Stakeholder
Society? 56
Supplementary Section
1.9 The Stakeholder Society: Incentives and
Control Issues 62
Appendixes
1.10 Cadbury Report 65
1.11 Notes to Tables 67
References 68
2 Corporate Financing:
Some Stylized Facts 75
2.1 Introduction 75
2.2 Modigliani–Miller and the Financial
Structure Puzzle 77
2.3 Debt Instruments 80
2.4 Equity Instruments 90
2.5 Financing Patterns 95
2.6 Conclusion 102
Appendixes
2.7 The Five Cs of Credit Analysis 103
2.8 Loan Covenants 103
References 106
II Corporate Financing and
Agency Costs 111
3 Outside Financing Capacity 113
3.1 Introduction 113
3.2 The Role of Net Worth: A Simple Model
of Credit Rationing 115
3.3 Debt Overhang 125
3.4 Borrowing Capacity: The Equity
Multiplier 127
Supplementary Sections
3.5 Related Models of Credit Rationing:
Inside Equity and Outside Debt 130
3.6 Verifiable Income 132
3.7 Semiverifiable Income 138
viii Contents
3.8 Nonverifiable Income 141
3.9 Exercises 144
References 154
4 Some Determinants of
Borrowing Capacity 157
4.1 Introduction: The Quest for
Pledgeable Income 157
4.2 Boosting the Ability to Borrow:
Diversification and Its Limits 158
4.3 Boosting the Ability to Borrow:
The Costs and Benefits of
Collateralization 164
4.4 The Liquidity–Accountability Tradeoff 171
4.5 Restraining the Ability to Borrow:
Inalienability of Human Capital 177
Supplementary Sections
4.6 Group Lending and Microfinance 180
4.7 Sequential Projects 183
4.8 Exercises 188
References 195
5 Liquidity and Risk Management, Free
Cash Flow, and Long-Term Finance 199
5.1 Introduction 199
5.2 The Maturity of Liabilities 201
5.3 The Liquidity–Scale Tradeoff 207
5.4 Corporate Risk Management 213
5.5 Endogenous Liquidity Needs, the
Sensitivity of Investment to Cash Flow,
and the Soft Budget Constraint 220
5.6 Free Cash Flow 225
5.7 Exercises 229
References 235
6 Corporate Financing under
Asymmetric Information 237
6.1 Introduction 237
6.2 Implications of the Lemons Problem
and of Market Breakdown 241
6.3 Dissipative Signals 249
Supplementary Section
6.4 Contract Design by an Informed Party:
An Introduction 264
Appendixes
6.5 Optimal Contracting in the
Privately-Known-Prospects Model 269
6.6 The Debt Bias with a Continuum of
Possible Incomes 270
6.7 Signaling through Costly Collateral 271
6.8 Short Maturities as a Signaling Device 271
6.9 Formal Analysis of the Underpricing
Problem 272
6.10 Exercises 273
References 280
7 Topics: Product Markets and
Earnings Manipulations 283
7.1 Corporate Finance and Product Markets 283
7.2 Creative Accounting and Other
Earnings Manipulations 299
Supplementary Section
7.3 Brander and Lewis’s Cournot Analysis 318
7.4 Exercises 322
References 327
III Exit and Voice: Passive and
Active Monitoring 331
8 Investors of Passage: Entry, Exit, and
Speculation 333
8.1 General Introduction to Monitoring in
Corporate Finance 333
8.2 Performance Measurement and the
Value of Speculative Information 338
Contents ix
8.3 Market Monitoring 345
8.4 Monitoring on the Debt Side:
Liquidity-Draining versus
Liquidity-Neutral Runs 350
8.5 Exercises 353
References 353
9 Lending Relationships and
Investor Activism 355
9.1 Introduction 355
9.2 Basics of Investor Activism 356
9.3 The Emergence of Share Concentration 366
9.4 Learning by Lending 369
9.5 Liquidity Needs of Large Investors and
Short-Termism 374
9.6 Exercises 379
References 382
IV Security Design:
The Control Right View 385
10 Control Rights and Corporate
Governance 387
10.1 Introduction 387
10.2 Pledgeable Income and the Allocation
of Control Rights between Insiders and
Outsiders 389
10.3 Corporate Governance and Real Control 398
10.4 Allocation of Control Rights among
Securityholders 404
Supplementary Sections
10.5 Internal Capital Markets 411
10.6 Active Monitoring and Initiative 415
10.7 Exercises 418
References 422
11 Takeovers 425
11.1 Introduction 425
11.2 The Pure Theory of Takeovers:
A Framework 425
11.3 Extracting the Raider’s Surplus:
Takeover Defenses as Monopoly Pricing 426
11.4 Takeovers and Managerial Incentives 429
11.5 Positive Theory of Takeovers:
Single-Bidder Case 431
11.6 Value-Decreasing Raider and the
One-Share–One-Vote Result 438
11.7 Positive Theory of Takeovers:
Multiple Bidders 440
11.8 Managerial Resistance 441
11.9 Exercise 441
References 442
V Security Design:
The Demand Side View 445
12 Consumer Liquidity Demand 447
12.1 Introduction 447
12.2 Consumer Liquidity Demand:
The Diamond–Dybvig Model and
the Term Structure of Interest Rates 447
12.3 Runs 454
12.4 Heterogenous Consumer Horizons and
the Diversity of Securities 457
Supplementary Sections
12.5 Aggregate Uncertainty and Risk Sharing 461
12.6 Private Signals and Uniqueness in
Bank Run Models 463
12.7 Exercises 466
References 467
x Contents
VI Macroeconomic Implications and
the Political Economy of
Corporate Finance 469
13 Credit Rationing and
Economic Activity 471
13.1 Introduction 471
13.2 Capital Squeezes and Economic Activity:
The Balance-Sheet Channel 471
13.3 Loanable Funds and the Credit Crunch:
The Lending Channel 478
13.4 Dynamic Complementarities:
Net Worth Effects, Poverty Traps,
and the Financial Accelerator 484
13.5 Dynamic Substitutabilities:
The Deflationary Impact
of Past Investment 489
13.6 Exercises 493
References 495
14 Mergers and Acquisitions, and
the Equilibrium Determination
of Asset Values 497
14.1 Introduction 497
14.2 Valuing Specialized Assets 499
14.3 General Equilibrium Determination of
Asset Values, Borrowing Capacities,
and Economic Activity:
The Kiyotaki–Moore Model 509
14.4 Exercises 515
References 516
15 Aggregate Liquidity Shortages and
Liquidity Asset Pricing 517
15.1 Introduction 517
15.2 Moving Wealth across States of Nature:
When Is Inside Liquidity Sufficient? 518
15.3 Aggregate Liquidity Shortages and
Liquidity Asset Pricing 523
15.4 Moving Wealth across Time:
The Case of the Corporate
Sector as a Net Lender 527
15.5 Exercises 530
References 532
16 Institutions, Public Policy, and
the Political Economy of Finance 535
16.1 Introduction 535
16.2 Contracting Institutions 537
16.3 Property Rights Institutions 544
16.4 Political Alliances 551
Supplementary Sections
16.5 Contracting Institutions,
Financial Structure, and
Attitudes toward Reform 555
16.6 Property Rights Institutions:
Are Privately Optimal Maturity
Structures Socially Optimal? 560
16.7 Exercises 563
References 567
VII Answers to Selected Exercises,
and Review Problems 569
Answers to Selected Exercises 571
Review Problems 625
Answers to Selected Review Problems 633
Index 641