Corporate Finance Seminar

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Economics 60, 187-243

Part II

Introduction: According to the survey firms do not have a specific target debt ratio. This is inline with the Pecking-order model, which assumes that firms do not target a specific debt ratio.

Discussion point: Therefore to what extent is the debt-equity trade off is determined by the benefits of debt with cost.

Explanation: Firms worry about their potential cost of distress in their debt decisions. Besides, external funds are less desirable because of informational asymmetries between management and investor. The Pecking-order theory assumes that a firm only use external financing only when internal funds are insufficient.

Shefrin, H.M., 2001 (fall), “Behavioral Corporate Finance”, Journal of Applied Corporate Finance 14, 113-124.

Introduction: Mispricing creates all kind of conflicts for managers. One of the problems is that the company stock’s can be overvalued which cause that the expected future returns are abnormally low and managers want to consider issuance of new equity.

Discussion point: What is the appropriate time horizon over which managers should be maximize shareholders value.

Explanation: When the company stocks are overvalued one can say that the shareholders are not planning to hold this stock for a long time. Then manager’s responsibility is to maximize wealth of the current shareholders by undertaking projects that will increase the current market value of the firm. However, when the current shareholder plan is to hold the stock for a long time than the manager may choose to maximize long-term value and skipped projects that increase value on the short term but harm the company in the long run.

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