McGill University / Prof.

deMotta

Corporate Finance (Fine 707)

INSTRUCTOR:
Instructor
Prof. de Motta

Phone
398-4029

Email
adolfo.demotta@mcgill.ca

Office Hours
By appointment

COURSE DESCRIPTION:
I will assume that students have had prior exposure to Microeconomics and Game Theory. The
course will review theoretical contributions to Corporate Finance. Specifically, the class will
consist of two parts: (I) Fundamentals of Contract Theory (II) Corporate Finance
EVALUATION SCHEME:
1)
2)
3)
4)

Two problem sets worth 10% of the grade.

Three referee reports worth 15% of the grade
Midterm 35% of the grade
Final examination worth 40% of the grade.

Note: All students MUST register for credit-No auditors will be allowed.

MAIN BOOKS
Bolton, Patrick, and Mathias Dewatripont, 2005, Contract Theory (MIT Press, Cambridge, MA).
*Salanie, B., (1998) The Economics of Contracts, A Primer, MIT Press.
*Tirole, J. (2005) Theory of Corporate Finance, Princeton University Press.

PART I: Fundamentals of Contract Theory

*Salanie, B., (1998) The Economics of Contracts, A Primer, MIT Press.
Bolton, Patrick, and Mathias Dewatripont, 2005, Contract Theory (MIT Press, Cambridge, MA).
Stole, L. (1997) Lectures on the Theory of Contracts and Organizations, Unpublished manuscript.
1.

Moral Hazard and Incentives Contracts

Grossman, S, and O. Hart (1983) An Analysis of the Principal-Agent Problem, Econometrica,
51, pp. 7-45.
Holmstrom, B. (1979) Moral Hazard and Observability, Bell Journal of Economics, 10, pp. 74-91.
Holmstrom, B. (1982) Moral Hazard in Teams, Bell Journal of Economics, 13, pp.324-340.
Holmstrom, B. (1982) Managerial Incentive Problems: A Dynamic Perspective, in Essays in
Economics and Management in the Honor of Lars Wahlbeck.

McGill University / Prof. deMotta

Holmstrom, B., and P. Milgrom (1987) Aggregation and Linearity in the Provision of
Intertemporal Incentives, Econometrica, 55.
Holmstrom, B., and P, Milgrom (1991) Multi-Task Principal Agent Analyses, Journal of Law,
Economic and Organization, 7.
Innes, R., (1990) Limited Liability and Incentive Contracting with Ex-ante Action Choices, Journal
of Economic Theory, 52, pp. 45-67
Lazear, E., and S. Rosen (1981) Rank Order Tournaments as Optimal Labor Contracts, Journal of
Political Economy.
Mas-Colell, A., M. Whinston and J. Green (1995) Microeconomic Theory, Chapter 14.
Sappington, D. (1983) Limited Liability Contracts Between Principal and Agent, Journal of
Economic Theory, 29, pp. 1-21.
1.

Incomplete Contracting and the Theory of the Firm

Grossman, S, and O. Hart (1986) The Costs and Benefits of Ownership: A Theory of Vertical
and Lateral Integration, Journal of Political Economy.
Hart, O. (1995) Firms, Contracts and Financial Structure Chapters 2-4.
Hart, O. and J. Moore (1990) Property Rights and the Nature of the Firm, Journal of Political
Economy, 98.
Holmstrom, B. and P. Milgrom (1994) The Firm as an Incentive System, American Economic
Review.

2.

Mechanism Design and Self-selection Contracts (Adverse Selection)

Akerlof, G. (1970) The Market for Lemons: Quality and the Market Mechanism, Quarterly
Journal of Economics, 84, pp. 488-500.
Baron D., and R. Myerson (1982) Regulating a Monopolist with Unknown Costs, Econometrica.
Mas-Colell, A., M. Whinston and J. Green (1995) Microeconomic Theory, Chapters13 and 23.

PART II: Corporate Finance and Financial Intermediation

*Tirole, J. (2005) Theory of Corporate Finance Princeton University Press.
Hart, O. (1995) Firms, Contracts, and Financial Structure, Oxford University Press.
1.

Capital Structure

a.

Overview and Review of the Basic Models

McGill University / Prof. deMotta

Daniel, K., and S. Titman (1995) Financing Investment Under Asymmetric Information, in R.
Jarrow et al (eds.), Handbooks in Operations Research and Management Science: Finance, Elsevier
Science, chap. 23.
Jensen, M., and W. Meckling (1976) Theory of the Firm: Managerial Behavior, Agency Costs
and Ownership Structure, Journal of Financial Economics, 3, pp. 305-60.
Leland, H., and D. Pyle (1977) Informational Asymmetries, Financial Structure and Financial
Intermediation, Journal of Finance, 32, pp. 371-387.
Miller, M., and F. Modigliani (1961) Dividend Policy, Growth and the Valuation of Shares, Journal
of Business, 34:411-433.
Modigliani, F., and M. Miller (1958) The Cost of Capital, Corporation Finance, and the Theory
of Investment, American Economic Review, 48:261-297.
Myers, S. (1977) Determinants of Corporate Borrowing, Journal of Financial Economics, 5,
pp. 147-175.
Myers, S. (1984) The Capital Structure Puzzle, Journal of Finance, 39, pp. 572-92.
Myers, S., and N. Majluf (1984) Corporate Financing and Investment Decisions When Firms
Have Information That Investors Do Not Have, Journal of Financial Economics, 13:187-221.
Ross, S. (1977) The Determination of Financial Structure: The Incentive-Signaling Approach,
Bell Journal of Economics, 8, 23-40.
Stiglitz, J. (1974) On the Irrelevance of Corporate Financial Policy, American Economic
Review, 66, pp. 851-866.
Zwiebel, J. (1996) Dynamic Capital Structure under Managerial Entrenchment, American Economic
Review, 86, 1197-1215.
b. Capital Structure: The Security Design Approach
Allen, F. and D. Gale (1988) Optimal Security Design, Review of Financial Studies, 1, pp. 229-264.
Aghion, P., and P. Bolton (1992) An Incomplete Contracts Approach to Financial Contracting,
Review of Economic Studies, 59, pp. 473-94.
Dewatripont, M. and J. Tirole (1994) A Theory of Debt and Equity: Diversity of Securities and
Manager Shareholder Congruence, Quarterly Journal of Economics, 109.
Gale, D., and M. Hellwig (1985) Incentive-Compatible Debt Contracts: The One-Period Problem,
Review of Economic Studies, 52, pp.647-63.
Hart, O. (1995) Firms, Contracts, and Financial Structure, Oxford University Press, chap. 5 and
6.
Hart, O. and J. Moore (1995) Default and Seniority: An Analysis of the Role of Hard Claims in
Constraining Management, American Economic Review, 85.
Myers, S. (2000) Outside Equity, Journal of Finance, 3, pp. 1005-37.
Townsend, R. (1979) Optimal Contracts with Costly State Verification, Journal of Economic
Theory, 20.

McGill University / Prof. deMotta

c.

Models of Debt Structure

Berglof, E. an E-L vonThadden (1994) Short-Term vs. Long-Term Interests: Capital Structure with
Multiple Investors, Quarterly Journal of Economics, 109.
Bolton, P. and D. Scharfstein, (1996) Optimal Debt Structure and the Number of Creditors,
Journal of Political Economy, 104, pp. 1-25.
Diamond, D. (1989) Reputation Acquisition in Debt Markets, Journal of Political Economy,
97, pp. 828-862.
Diamond, D. (1991) Debt Maturity Structure and Liquidity Risk, Quarterly Journal of Economics,
106, pp. 709-737.
Shleifer A. and R. Vishny (1992) Liquidation Values and Debt Capacity: A Market Equilibrium
Approach, Journal of Finance, 47.

2.

Corporate Governance

a.

Overview
Becht, M., P. Bolton and A. Roell (2003) Corporate Governance and Control, in G. Constantinides et
al (eds.), Handbook of the Economics of Finance, Elsevier Science.
Shleifer, A. and R. Vishny (1997) A Survey of Corporate Governance, Journal of Finance, pp. 737783.

b. Takeovers and the Market for Corporate Control

Grossman, S., and O. Hart (1980) Takeover Bids, the Free-Rider Problem, and the Theory of
the Corporation, Bell Journal of Economics, 11, pp. 42-64.
Grossman, S., and O. Hart (1988) One-Share-One-Vote and the Market for Corporate
Control, Journal of Financial Economics, 20, pp. 175-202.
Shleifer, A., and R. Vishny (1986) Large Shareholders and Corporate Control, Journal of Political
Economy, 94, pp. 461-488.
Shleifer, A. and R. Vishny (1988) Value Maximization and the Acquisition Process, Journal of
Economic Perspectives, 21, pp. 7-20.
c.

The Role of the Stock Market

Holmstrom, B. and J. Tirole (1991) Market Liquidity and Performance Monitoring, Journal of
Political Economy, pp. 61-80.
Stein, J. (1988) Takeover threats and Managerial Myopia, Journal of Political Economy, 96, pp. 6180.
Stein, J. (1989) Efficient Capital Markets: Inefficient Firms: A Model of Myopic Corporate
Behavior, Quarterly Journal of Economics, 104, pp.655-669.
Scharfstein, D. and J. Stein (1990) Herd Behavior and Investment, American Economic
Review, 80, pp. 465-479.

McGill University / Prof. deMotta

3.

Product and Capital Markets Interactions

Bolton, P., and D. Scharfstein (1990) "A Theory of Predation Based on Agency Problems in
Financial Contracting," American Economic Review, 80:93-106.
Chevalier, J. (1995) "Capital Structure and Product Market Competition: An Empirical Study of
Supermarket LBOs," American Economic Review, 85:206-56.

4.

IPOs
Ritter, J. (2003) Investment Banking and Securities Issuance, in G. Constantinides et al (eds.),
Handbook of the Economics of Finance, Elsevier Science.
Ritter, J. (1991) The Long-Run Underperformance of IPOs, Journal of Finance, 46:3-27.
Rock, K. (1986) Why New Issues are Underpriced, Journal of Financial Economics, 15:187212.
Welch, I. (1992) Sequential Sales, Learning and Cascades, Journal of Finance, 47:695-732.

5.

Dividends
Allen, F. and R. Michaely (2003), Payout Policy, in G. Constantinides et al (eds.), Handbook of
the Economics of Finance, Elsevier Science.
Battacharya, Sudipto (1979) Imperfect Information, Dividend Policy, and ''The Bird in the Hand'
Fallacy, Bell Journal of Economics, 10:259-270

6.

Internal Capital Markets

De Motta, A. (2003) Managerial Incentives and Internal Capital Markets Journal of Finance, v.
LVII, no. 3, pp. 1193-1220.
Gertner, R., D. Scharfstein, and J. Stein (1994) Internal vs External Capital Markets, The Quarterly
Journal of Economics, 109, pp.1211-1230
Harris, M., and A. Raviv (1996) The Capital Budgeting Process: Incentives and Information, The
Journal of Finance, Vol. LI, No. 4, pp.1139-1174
Lang, L., and R. Stulz (1994) Tobin's q, Corporate Diversification, and Firm Performance, Journal of
Political Economy, 102, pp.1248-1280}
Scharfstein, D., and J. Stein (2000) The Dark Side of Internal Capital Markets: Divisional RentSeeking and Inefficient Investment, The Journal of Finance, Vol. LV, No. 6, pp.2537-2564
Stein, J. (1997) Internal Capital Markets and the Competition for Corporate Resources, The
Journal of Finance, Vol. LII, No. 1, pp.111-134
Stein, J. (2003) Agency Information and Corporate Investment, in G. Constantinides et al (eds.),
Handbook of the Economics of Finance, Elsevier Science.

7.

Financial Intermediation
Diamond, D. and P. Dybvig (1983), Bank Runs, Deposit Insurance, and Liquidity, Journal of
Political Economy, 91, pp. 401-419.

McGill University / Prof. deMotta

Diamond, D. (1984) Financial Intermediation and Delegated Monitoring, Review of Economic
Studies, 51, pp. 393-414.
Diamond, D. (1991) Monitoring and Reputation: The Choice between Bank Loans and Directly
Placed Debt, Journal of Political Economy 99, pp. 689-721.
Morris, S. and H. Shin "Global Games: Theory and Applications," in Advances in Economics
and Econometrics (Proceedings of the Eighth World Congress of the Econometric Society), edited
by M. Dewatripont, L. Hansen and S. Turnovsky. Cambridge, England: Cambridge University
Rajan, R. (1992) Insiders and Outsiders: The Choice between Relationship and Arms Length
Debt, Journal of Finance, 47, pp. 1367-1400.
Bouvard, Matthieu, Pierre Chaigneau, and Adolfo de Motta, Transparency in the Financial
System: Rollover Risk and Crises. WP
Sharpe, S. (1990) Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model
of Customer Relationships, Journal of Finance 45, pp. 1069-1087.
8.

Information Disclosure
Adams, R., and D. Ferreira (2007) A Theory of Friendly Boards, Journal of Finance 62, pp. 217-250.
Almazan, Andres, Sanjay Banerji, and Adolfo de Motta, Attracting Attention: Cheap Managerial
Talk and Costly Market Monitoring, Journal of Finance, v. LXIII, no. 3, pp. 13991436, June
2008.
Bhattacharya, S., (1980) Nondissipative Signalling Structures and Dividend Policy, Quarterly
Journal of Economics 95, pp. 1-24.
Crawford, V., and J. Sobel (1982) Strategic Information Transmission, Econometrica 50,
1431-1451.
Stocken, P., (2000) Credibility of Voluntary Disclosure, RAND Journal of Economics 31, pp. 359374.
Verrecchia, R., (2001) Essays on Disclosure, Journal of Accounting and Economics 32, 97-180.