Joao Amaro de Matos is Director of the Undergraduate Business Program in the School of Economics, Universidade Nova de Lisboa, Portugal. His teaching includes MBA and Ph.D. courses in Europe and Brazil, and he holds Ph.D.s in both Management and Physics.

"This is a well motivated book likely to have a market beyond Ph.D. students. The material is clearly exposited, and I recommend its use."—Sudipto Bhattacharya, London School of Economics

• List of Figures xi Preface xiii 01Intended Audience xiv 02Organization of the Text xv 03Acknowledgments .xvi PART I Foundations 1 1.Valuation 3 1.1. Valuation under Certainty 5 1.1.1. The Robinson Crusoe Economy 5 1.1.2. Time Preferences 7 1.1.3. Production Opportunities 8 1.1.4. The Role of Capital Markets 9 1.1.5. Consumption and Investment with Capital Markets 11 1.1.6. The Value of an Investment Project 14 1.1.7. Multiperiod Economy with Capital Markets 15 1.1.8. Exercises 17 1.2. Valuation under Uncertainty 18 1.2.1. One-Period Model 18 1.2.2. Value and the Absence of Arbitrage 22 1.2.3. Arbitrage Opportunities and Investment 23 1.2.4. Value and the Martingale Measure 24 1.2.5. Beta Values 26 1.2.6. Exercises 28 1.3. Multiperiods and Flexibility under Uncertainty 29 1.3.1. The Multiperiod Setting 30 1.3.2. Real Options 33 1.3.3. Some General Properties of Options 34 1.3.4. Exercises 37 2.Optimal Capital Structure 39 2.1. The MM Propositions 40 2.1.1. The Irrelevancy Statement 40 2.1.2. Cost of Capital 42 2.1.3. The MM Propositions with Taxes 44 2.1.4. Empirical Evidence 46 2.1.5. Exercises 47 2.2. Personal and Corporate Taxation 48 2.2.1. Demand for Bonds 49 2.2.2. Supply of Bonds 50 2.2.3. The Equilibrium 51 2.2.4. Comparing with MM 53 2.2.5. Changes in Taxations:An Alternative Equilibrium 54 2.2.6. Empirical Evidence 57 2.2.7. Exercises 58 PART II Agency and Information 59 3.Implications for Capital Structure 61 3.1. The Role of Agency Costs 62 3.1.1. Agency Costs of Outside Equity 64 3.1.2. Principal--Agent Problems 66 3.1.3. Agency Costs of Debt 71 3.1.4. Empirical Evidence 75 3.1.5. Exercises 77 3.2. Informational Asymmetries 78 3.2.1. Managers' Signaling because of Fee Schedules 79 3.2.2. When Managers Are Also Investors 82 3.2.3. Signals Conditioned by Investment Opportunities 85 3.2.4. Stock Repurchase as a Signal 89 3.2.5. Empirical Evidence 93 3.2.6. Exercises 95 4.Payout Policy 97 4.1. Dividend Policy 98 4.1.1. Another Irrelevancy Proposition 98 4.1.2. Alternative Valuations 100 4.1.3. Growth Rates 102 4.1.4. Relaxing Certainty 103 4.1.5. Dividends and Taxes 104 4.1.6. Empirical Evidence 105 4.1.7. Exercises 109 4.2. Dividends and Information 110 4.2.1. The Informational Content of Dividends 110 4.2.2. A Signaling Model 111 4.2.3. A Consistent Signaling Model 114 4.2.4. Empirical Evidence 116 4.2.5. Exercises 119 4.3. Stock Repurchases 119 4.3.1. Trends in Payout Policies 120 4.3.2. Reasons for Stock Repurchases 121 4.3.3. Empirical Evidence 122 5.Financial Contracting 125 5.1. Contracting and Allocation of Control 126 5.1.1. The Model 127 5.1.2. Entrepreneur Control 129 5.1.3. Investor Control 131 5.1.4. Contingent Control 133 5.1.5. Financing Contracts 133 5.1.6. Exercises 134 5.2. Debt Contract Design 134 5.2.1. Extending the Model 134 5.2.2. The Case of Many Creditholders 137 5.2.3. The Choice of the Duration 139 5.2.4. The Effect of Seniority 146 5.2.5. Exercises 148 PART III Capital Restructuring 149 6.GoingPublic 151 6.1. The Going Public Decision 152 6.1.1. The Model 152 6.1.2. The Equilibrium 154 6.1.3. Empirical Evidence 160 6.1.4. Exercises 160 6.2. Underpricing and Information Asymmetries 160 6.2.1. Asymmetry between Issuers and Underwriters 162 6.2.2. Asymmetry between Investors 163 6.2.3. Reputation of Bankers and Uncertainty 165 6.2.4. How Underwriters Become Informed 167 6.2.5. Legal Liabilities 171 6.2.6. Empirical Evidence 172 6.2.7. Exercises 175 7.Going Private 177 7.1. Stock Repurchases 177 7.2. Leveraged Buyouts 179 7.2.1. The Mechanismof Leveraged Buyouts 179 7.2.2. A Model for MBOs 181 7.2.3. Empirical Evidence 186 7.2.4. Exercises 189 8.Mergers and Acquisitions 191 8.1. Tender Offers and the Free-Rider Problem 192 8.1.1. Largely Diffused Ownership 193 8.1.2. The Role of a Large Shareholder 196 8.1.3. Uncertain Outcome of a Takeover 199 8.1.4. The Optimal Size of a before a Takeover 201 8.1.5. Exercises 205 8.2. Merger Bids 205 8.2.1. Competition between Bidders 206 8.2.2. Choosing the Means of Payment 207 8.2.3. Cash as a Preemptive Instrument with Many Bidders 212 8.2.4. The Choice of Takeover Methods 214 8.2.5. Empirical Evidence 218 8.2.6. Exercises 223 PART IV Appendices 225 A. Optimization Principles 227 A.1. Unconstrained Optimization 227 A.2. Constrained Optimization 228 A.2.1. Equality Constraints 228 A.2.2. Inequality Constraints 231 B. Notions of Game Theory 233 B.1. Introduction 233 B.2. Informational Equilibrium 234 B.3. The Revelation Principle 238.Contents ix C. Suggested Solutions 241 C.1. Valuation 241 C.1.1. Valuation under Certainty 241 C.1.2. Valuation under Uncertainty 244 C.1.3. Valuation of Flexibility 250 C.2. Optimal Capital Structure 251 C.2.1. The MM Propositions 251 C.2.2. Personal and Corporate Taxation 255 C.3. Implications for Capital Structure 255 C.3.1. The Role of Agency Costs 255 C.3.2. Informational Asymmetries 260 C.4. Payout Policy 261 C.4.1. Dividend Policy 261 C.4.2. Dividend and Information 263 C.5. Financial Contracting 266 C.5.1. Contracting and Allocation of Control 266 C.5.2. Debt Contract Design 267 C.6. Going Public 268 C.6.1. The Going Public Decision 268 C.6.2. Underpricing and Information Asymmetries 268 C.7. Going Private 270 C.7.1. Leveraged Buyouts 270 C.8. Mergers and Acquisitions 271 C.8.1. Tender Offers and Free-Rider Problem 271 C.8.2. Merger Bids 276 Notes 279 Bibliography 285 Index 297

Joao Amaro de Matos is Director of the Undergraduate Business Program in the School of Economics, Universidade Nova de Lisboa, Portugal. His teaching includes MBA and Ph.D. courses in Europe and Brazil, and he holds Ph.D.s in both Management and Physics.

"This is a well motivated book likely to have a market beyond Ph.D. students. The material is clearly exposited, and I recommend its use."—Sudipto Bhattacharya, London School of Economics

• List of Figures xi Preface xiii 01Intended Audience xiv 02Organization of the Text xv 03Acknowledgments .xvi PART I Foundations 1 1.Valuation 3 1.1. Valuation under Certainty 5 1.1.1. The Robinson Crusoe Economy 5 1.1.2. Time Preferences 7 1.1.3. Production Opportunities 8 1.1.4. The Role of Capital Markets 9 1.1.5. Consumption and Investment with Capital Markets 11 1.1.6. The Value of an Investment Project 14 1.1.7. Multiperiod Economy with Capital Markets 15 1.1.8. Exercises 17 1.2. Valuation under Uncertainty 18 1.2.1. One-Period Model 18 1.2.2. Value and the Absence of Arbitrage 22 1.2.3. Arbitrage Opportunities and Investment 23 1.2.4. Value and the Martingale Measure 24 1.2.5. Beta Values 26 1.2.6. Exercises 28 1.3. Multiperiods and Flexibility under Uncertainty 29 1.3.1. The Multiperiod Setting 30 1.3.2. Real Options 33 1.3.3. Some General Properties of Options 34 1.3.4. Exercises 37 2.Optimal Capital Structure 39 2.1. The MM Propositions 40 2.1.1. The Irrelevancy Statement 40 2.1.2. Cost of Capital 42 2.1.3. The MM Propositions with Taxes 44 2.1.4. Empirical Evidence 46 2.1.5. Exercises 47 2.2. Personal and Corporate Taxation 48 2.2.1. Demand for Bonds 49 2.2.2. Supply of Bonds 50 2.2.3. The Equilibrium 51 2.2.4. Comparing with MM 53 2.2.5. Changes in Taxations:An Alternative Equilibrium 54 2.2.6. Empirical Evidence 57 2.2.7. Exercises 58 PART II Agency and Information 59 3.Implications for Capital Structure 61 3.1. The Role of Agency Costs 62 3.1.1. Agency Costs of Outside Equity 64 3.1.2. Principal--Agent Problems 66 3.1.3. Agency Costs of Debt 71 3.1.4. Empirical Evidence 75 3.1.5. Exercises 77 3.2. Informational Asymmetries 78 3.2.1. Managers' Signaling because of Fee Schedules 79 3.2.2. When Managers Are Also Investors 82 3.2.3. Signals Conditioned by Investment Opportunities 85 3.2.4. Stock Repurchase as a Signal 89 3.2.5. Empirical Evidence 93 3.2.6. Exercises 95 4.Payout Policy 97 4.1. Dividend Policy 98 4.1.1. Another Irrelevancy Proposition 98 4.1.2. Alternative Valuations 100 4.1.3. Growth Rates 102 4.1.4. Relaxing Certainty 103 4.1.5. Dividends and Taxes 104 4.1.6. Empirical Evidence 105 4.1.7. Exercises 109 4.2. Dividends and Information 110 4.2.1. The Informational Content of Dividends 110 4.2.2. A Signaling Model 111 4.2.3. A Consistent Signaling Model 114 4.2.4. Empirical Evidence 116 4.2.5. Exercises 119 4.3. Stock Repurchases 119 4.3.1. Trends in Payout Policies 120 4.3.2. Reasons for Stock Repurchases 121 4.3.3. Empirical Evidence 122 5.Financial Contracting 125 5.1. Contracting and Allocation of Control 126 5.1.1. The Model 127 5.1.2. Entrepreneur Control 129 5.1.3. Investor Control 131 5.1.4. Contingent Control 133 5.1.5. Financing Contracts 133 5.1.6. Exercises 134 5.2. Debt Contract Design 134 5.2.1. Extending the Model 134 5.2.2. The Case of Many Creditholders 137 5.2.3. The Choice of the Duration 139 5.2.4. The Effect of Seniority 146 5.2.5. Exercises 148 PART III Capital Restructuring 149 6.GoingPublic 151 6.1. The Going Public Decision 152 6.1.1. The Model 152 6.1.2. The Equilibrium 154 6.1.3. Empirical Evidence 160 6.1.4. Exercises 160 6.2. Underpricing and Information Asymmetries 160 6.2.1. Asymmetry between Issuers and Underwriters 162 6.2.2. Asymmetry between Investors 163 6.2.3. Reputation of Bankers and Uncertainty 165 6.2.4. How Underwriters Become Informed 167 6.2.5. Legal Liabilities 171 6.2.6. Empirical Evidence 172 6.2.7. Exercises 175 7.Going Private 177 7.1. Stock Repurchases 177 7.2. Leveraged Buyouts 179 7.2.1. The Mechanismof Leveraged Buyouts 179 7.2.2. A Model for MBOs 181 7.2.3. Empirical Evidence 186 7.2.4. Exercises 189 8.Mergers and Acquisitions 191 8.1. Tender Offers and the Free-Rider Problem 192 8.1.1. Largely Diffused Ownership 193 8.1.2. The Role of a Large Shareholder 196 8.1.3. Uncertain Outcome of a Takeover 199 8.1.4. The Optimal Size of a before a Takeover 201 8.1.5. Exercises 205 8.2. Merger Bids 205 8.2.1. Competition between Bidders 206 8.2.2. Choosing the Means of Payment 207 8.2.3. Cash as a Preemptive Instrument with Many Bidders 212 8.2.4. The Choice of Takeover Methods 214 8.2.5. Empirical Evidence 218 8.2.6. Exercises 223 PART IV Appendices 225 A. Optimization Principles 227 A.1. Unconstrained Optimization 227 A.2. Constrained Optimization 228 A.2.1. Equality Constraints 228 A.2.2. Inequality Constraints 231 B. Notions of Game Theory 233 B.1. Introduction 233 B.2. Informational Equilibrium 234 B.3. The Revelation Principle 238.Contents ix C. Suggested Solutions 241 C.1. Valuation 241 C.1.1. Valuation under Certainty 241 C.1.2. Valuation under Uncertainty 244 C.1.3. Valuation of Flexibility 250 C.2. Optimal Capital Structure 251 C.2.1. The MM Propositions 251 C.2.2. Personal and Corporate Taxation 255 C.3. Implications for Capital Structure 255 C.3.1. The Role of Agency Costs 255 C.3.2. Informational Asymmetries 260 C.4. Payout Policy 261 C.4.1. Dividend Policy 261 C.4.2. Dividend and Information 263 C.5. Financial Contracting 266 C.5.1. Contracting and Allocation of Control 266 C.5.2. Debt Contract Design 267 C.6. Going Public 268 C.6.1. The Going Public Decision 268 C.6.2. Underpricing and Information Asymmetries 268 C.7. Going Private 270 C.7.1. Leveraged Buyouts 270 C.8. Mergers and Acquisitions 271 C.8.1. Tender Offers and Free-Rider Problem 271 C.8.2. Merger Bids 276 Notes 279 Bibliography 285 Index 297

Joao Amaro de Matos is Director of the Undergraduate Business Program in the School of Economics, Universidade Nova de Lisboa, Portugal. His teaching includes MBA and Ph.D. courses in Europe and Brazil, and he holds Ph.D.s in both Management and Physics.

"This is a well motivated book likely to have a market beyond Ph.D. students. The material is clearly exposited, and I recommend its use."—Sudipto Bhattacharya, London School of Economics

• List of Figures xi Preface xiii 01Intended Audience xiv 02Organization of the Text xv 03Acknowledgments .xvi PART I Foundations 1 1.Valuation 3 1.1. Valuation under Certainty 5 1.1.1. The Robinson Crusoe Economy 5 1.1.2. Time Preferences 7 1.1.3. Production Opportunities 8 1.1.4. The Role of Capital Markets 9 1.1.5. Consumption and Investment with Capital Markets 11 1.1.6. The Value of an Investment Project 14 1.1.7. Multiperiod Economy with Capital Markets 15 1.1.8. Exercises 17 1.2. Valuation under Uncertainty 18 1.2.1. One-Period Model 18 1.2.2. Value and the Absence of Arbitrage 22 1.2.3. Arbitrage Opportunities and Investment 23 1.2.4. Value and the Martingale Measure 24 1.2.5. Beta Values 26 1.2.6. Exercises 28 1.3. Multiperiods and Flexibility under Uncertainty 29 1.3.1. The Multiperiod Setting 30 1.3.2. Real Options 33 1.3.3. Some General Properties of Options 34 1.3.4. Exercises 37 2.Optimal Capital Structure 39 2.1. The MM Propositions 40 2.1.1. The Irrelevancy Statement 40 2.1.2. Cost of Capital 42 2.1.3. The MM Propositions with Taxes 44 2.1.4. Empirical Evidence 46 2.1.5. Exercises 47 2.2. Personal and Corporate Taxation 48 2.2.1. Demand for Bonds 49 2.2.2. Supply of Bonds 50 2.2.3. The Equilibrium 51 2.2.4. Comparing with MM 53 2.2.5. Changes in Taxations:An Alternative Equilibrium 54 2.2.6. Empirical Evidence 57 2.2.7. Exercises 58 PART II Agency and Information 59 3.Implications for Capital Structure 61 3.1. The Role of Agency Costs 62 3.1.1. Agency Costs of Outside Equity 64 3.1.2. Principal--Agent Problems 66 3.1.3. Agency Costs of Debt 71 3.1.4. Empirical Evidence 75 3.1.5. Exercises 77 3.2. Informational Asymmetries 78 3.2.1. Managers' Signaling because of Fee Schedules 79 3.2.2. When Managers Are Also Investors 82 3.2.3. Signals Conditioned by Investment Opportunities 85 3.2.4. Stock Repurchase as a Signal 89 3.2.5. Empirical Evidence 93 3.2.6. Exercises 95 4.Payout Policy 97 4.1. Dividend Policy 98 4.1.1. Another Irrelevancy Proposition 98 4.1.2. Alternative Valuations 100 4.1.3. Growth Rates 102 4.1.4. Relaxing Certainty 103 4.1.5. Dividends and Taxes 104 4.1.6. Empirical Evidence 105 4.1.7. Exercises 109 4.2. Dividends and Information 110 4.2.1. The Informational Content of Dividends 110 4.2.2. A Signaling Model 111 4.2.3. A Consistent Signaling Model 114 4.2.4. Empirical Evidence 116 4.2.5. Exercises 119 4.3. Stock Repurchases 119 4.3.1. Trends in Payout Policies 120 4.3.2. Reasons for Stock Repurchases 121 4.3.3. Empirical Evidence 122 5.Financial Contracting 125 5.1. Contracting and Allocation of Control 126 5.1.1. The Model 127 5.1.2. Entrepreneur Control 129 5.1.3. Investor Control 131 5.1.4. Contingent Control 133 5.1.5. Financing Contracts 133 5.1.6. Exercises 134 5.2. Debt Contract Design 134 5.2.1. Extending the Model 134 5.2.2. The Case of Many Creditholders 137 5.2.3. The Choice of the Duration 139 5.2.4. The Effect of Seniority 146 5.2.5. Exercises 148 PART III Capital Restructuring 149 6.GoingPublic 151 6.1. The Going Public Decision 152 6.1.1. The Model 152 6.1.2. The Equilibrium 154 6.1.3. Empirical Evidence 160 6.1.4. Exercises 160 6.2. Underpricing and Information Asymmetries 160 6.2.1. Asymmetry between Issuers and Underwriters 162 6.2.2. Asymmetry between Investors 163 6.2.3. Reputation of Bankers and Uncertainty 165 6.2.4. How Underwriters Become Informed 167 6.2.5. Legal Liabilities 171 6.2.6. Empirical Evidence 172 6.2.7. Exercises 175 7.Going Private 177 7.1. Stock Repurchases 177 7.2. Leveraged Buyouts 179 7.2.1. The Mechanismof Leveraged Buyouts 179 7.2.2. A Model for MBOs 181 7.2.3. Empirical Evidence 186 7.2.4. Exercises 189 8.Mergers and Acquisitions 191 8.1. Tender Offers and the Free-Rider Problem 192 8.1.1. Largely Diffused Ownership 193 8.1.2. The Role of a Large Shareholder 196 8.1.3. Uncertain Outcome of a Takeover 199 8.1.4. The Optimal Size of a before a Takeover 201 8.1.5. Exercises 205 8.2. Merger Bids 205 8.2.1. Competition between Bidders 206 8.2.2. Choosing the Means of Payment 207 8.2.3. Cash as a Preemptive Instrument with Many Bidders 212 8.2.4. The Choice of Takeover Methods 214 8.2.5. Empirical Evidence 218 8.2.6. Exercises 223 PART IV Appendices 225 A. Optimization Principles 227 A.1. Unconstrained Optimization 227 A.2. Constrained Optimization 228 A.2.1. Equality Constraints 228 A.2.2. Inequality Constraints 231 B. Notions of Game Theory 233 B.1. Introduction 233 B.2. Informational Equilibrium 234 B.3. The Revelation Principle 238.Contents ix C. Suggested Solutions 241 C.1. Valuation 241 C.1.1. Valuation under Certainty 241 C.1.2. Valuation under Uncertainty 244 C.1.3. Valuation of Flexibility 250 C.2. Optimal Capital Structure 251 C.2.1. The MM Propositions 251 C.2.2. Personal and Corporate Taxation 255 C.3. Implications for Capital Structure 255 C.3.1. The Role of Agency Costs 255 C.3.2. Informational Asymmetries 260 C.4. Payout Policy 261 C.4.1. Dividend Policy 261 C.4.2. Dividend and Information 263 C.5. Financial Contracting 266 C.5.1. Contracting and Allocation of Control 266 C.5.2. Debt Contract Design 267 C.6. Going Public 268 C.6.1. The Going Public Decision 268 C.6.2. Underpricing and Information Asymmetries 268 C.7. Going Private 270 C.7.1. Leveraged Buyouts 270 C.8. Mergers and Acquisitions 271 C.8.1. Tender Offers and Free-Rider Problem 271 C.8.2. Merger Bids 276 Notes 279 Bibliography 285 Index 297