Dynamical Corporate Finance: An Equilibrium Approach

Description

The way in which leverage and its expected dynamics impact on firm valuation is very different from what is assumed by the traditional static capital structure framework. Recent work that allows the firm to restructure its debt over time proves to be able to explain much of the observed cross-sectional and time-series variation in leverage, while static capital structure predictions do not. The purpose of this book is to re-characterize the firm’s valuation process within a dynamical capital structure environment, by drawing on a vast body of recent and more traditional theoretical insights and empirical findings on firm evaluation, also including asset pricing literature, offering a new setting in which practitioners and researchers are provided with new tools to anticipate changes in capital structure and setting prices for firm’s debt and equity accordingly. Contents 1 Introduction 1.1 Introduction 1.2 The Realm of Corporate Finance 1.3 Equilibrium Approach, Market Structure and Corporate Governance 1.3.1 Building on the Neoclassical Synthesis 1.3.2 Market Completeness, Pricing Kernel and the Objective of the Firm 1.4 Roadmap 1.4.1 Plan of the Book 1.4.2 Prerequisites References 2 The Value of the Firm and Its Securities 2.1 Notation and Basic Setting 2.1.1 Budget Constraints and Policies 2.1.2 Default and Bankruptcy Procedures 2.2 The Modigliani and Miller Theorems 2.2.1 Irrelevance of Dividend Policy 2.2.2 The Irrelevance of Financing Policy 2.2.3 Debt Tax Shield and Bankruptcy Costs 2.3 Capital Structure and Corporate Governance 2.3.1 Investment Decisions and Agency Costs 2.3.2 Optimal Investments, Capital Budgeting and Debt Overhang 2.3.3 The Value of Corporate Governance 2.3.3.1 Dispersed Ownership, Take-overs and Threat of Replacement 2.3.3.2 Concentrated Ownership, Entrepreneurs and Minorities 2.4 A General Expression for the Value of the Firm 2.4.1 Abstract Securities 2.4.2 Restructuring, Renegotiation and Liquidation Procedures 2.4.3 The Value of the Firm 2.4.4 Dividends, Buybacks and Expected Equity Returns 2.5 Related Literature References 3 Borrowing Constraints, Debt Dynamics and Investment Decisions 3.1 Collateral Constraints and Optimal Capital Structure 3.1.1 Secured Debt and Flotation Costs 3.1.2 Strict Individual Rationality and Absence of Default Risk 3.1.3 The Value of the Firm, Optimal Capital Structure and The Weighted Average Cost of Capital 3.2 Perfect Product Market Competition and Optimal investment-Financing Decisions 3.2.1 The Value of the Unlevered Firm 3.2.2 Optimal Investment and Financing Decisions 3.3 Financial Returns and the Investment CAPM 3.3.1 Fundamentals and Securities Returns 3.3.2 Capital Budgeting and WACC 3.3.3 The Hamada Equation 3.3.4 The Investment CAPM and the Cross-Section of Equity Returns 3.4 Debt Agency Costs and the Trade-off Theory 3.5 Related Literature References 4 Imperfect Competition, Working Capital and Tobin's Q 4.1 The Limits of Perfect Product Markets Competition 4.2 Monopolistic Competition and Market Power 4.2.1 Timing of Decisions and Optimal Price Setting 4.2.2 Optimal Investment and Financing Decisions 4.2.3 Constant Price Elasticity of Demand and the Value of the Firm 4.3 Imperfect Competition and the Cross-Section of Stock Returns 4.3.1 Tobin's Q, Expected Stock Returns and Residual Income 4.3.2 Empirical Considerations 4.4 Equilibrium Models and Security Analysis 4.4.1 A Simple Quantitative Model 4.4.2 Expected Fundamentals 4.4.3 Stock Market Multiples and Valuation Models 4.5 Related Literature References 5 Continuous Time Models, Unsecured Debt and Commitment 5.1 General Setting and Valuation 5.1.1 The Setting 5.1.2 The Value of the Firm and Its Securities 5.2 The Hamilton–Jacobi–Bellman Approach 5.2.1 Risk-Neutral Valuation 5.3 Commitment, Optimal Default and the Static Trade-off Theory of Capital Structure 5.3.1 Option to Default and Expected Default Time 5.3.2 The Optimal Default Boundary 5.3.3 Optimal Static Capital Structure 5.3.4 Credit Spreads in the Leland Model 5.4 Endogenous Investment and Agency Costs of Capital Structure 5.4.1 Debt Overhang 5.4.2 Risk-Shifting 5.5 Related Literature References 6 Dynamic Capital Structure without Commitment 6.1 Commitment, Time Consistency and Debt Capacity 6.2 A Discrete Time Model 6.2.1 The Leverage Ratchet Effect 6.2.2 The Coase Conjecture 6.3 The Continuous Time Case 6.3.1 An Irrelevance Result 6.3.2 Global Optimality and the Leverage Ratchet Effect 6.3.3 The Value of the Firm 6.3.4 Leverage Dynamics 6.3.5 Positive Recovery Values 6.4 Endogenous Investment and The Cost of Capital 6.4.1 Debt Overhang 6.4.2 Risk Shifting 6.4.3 The Weighted Average Cost of Capital 6.5 Related Literature References 7 Extensions 7.1 A Quantitative Corporate Finance Model 7.1.1 Model Set-Up 7.1.2 Optimal Production and Pricing Decisions 7.1.3 Optimal Investment and Financing Decisions 7.2 Borrowing Constraints 7.2.1 The Model 7.2.2 The Cross-Section of Stock Returns 7.3 An Introduction to Numerical Solution Methods and Structural Econometrics 7.3.1 Discrete Dynamic Programming 7.3.2 The case of Defaultable Debt 7.3.3 The Generalized Method of Moments 7.4 Non-Markov Perfect Equilibria 7.4.1 The Setting 7.4.2 Constant Leverage Policies 7.4.3 Time-Consistent Constant Leverage Policies 7.4.4 Limits to Tax-Deductibility of Interest Expenses 7.4.5 Final Considerations Appendix References