Page 1 of 5 Corporate Finance 1. Theoretical Approaches 1.1. Corporate Finance in Arrow-Debreu World ? Complete market, perfect market, perfect competition, symmetric information, private consumption ? Risk: risk sharing, risk pooling, technology shocks, individual vs aggregate shocks ? Lucas (1978): existence of equilibrium asset price ? Merton: continuous-time pricing model ? Option pricing ? Capital structure: debt/equity ratio ? Mehra-Prescott (1985): equity premium puzzle ? Incomplete market Page 2 of 5 1.2. Asymmetric Information ? Akerlof (1970): market failure due to asymmetric information. ? Spence (1973): signaling ? Rothchild-Stiglitz (1976): screening ? Myerson (1979): revelation principle and mechanism design 1.3. Agency Problems ? Mirrlees (1974), Holmstrom (1978): unverifiable investment, IC conditions ? Standard contract theory: revenue-sharing contract. ? Multi-agent contract ? Optimal linear contract ? Dynamic contract 1.4. Incomplete Contract Approach ? Hart, Moors, Grossman: allocation of control rights is an alternative mechanism ? Coase, Williamson: transaction costs ? Option contract: ex-post option Page 3 of 5 ? Ex-ante efficiency vs ex-post efficiency, negotiation, renegotiation, bargaining powers, cooperative game theory 2. Various Business Formats 2.1. Corporation ? Reality (Berle–Means 1932): large modern corporations tend to have separated ownership and control. ? Separation of management and ownership ? Separation of income and control rights ? Economists: ownership and control should be bundled together. 2.2. Equity Joint Venture ? Popular in foreign direct investment ? Incentive and risk sharing issues ? Choice for a long-term cooperation? 2.3. Contractual Joint Venture ? Popular in the initial stage of foreign direct investment Page 4 of 5 ? Incentive and risk sharing issues ? No need for law protection? ? Choice for a short-term cooperation? 2.4. Venture Capital ? Popular in high-tech industries. ? Cross-border venture capital, a new trend? 2.5. Franchising ? Popular in retails and food chains. ? Transaction costs of management, asymmetric information, and incentives 2.6. Partnership ? A dying format? Dominated by the corporation format? 2.7. Outsourcing ? What are the issues? Page 5 of 5 3. Applications 3.1. Venture Capital ? Popular mechanisms: staged financing, options, convertible securities, warrants, board representations, voting rights, IPO ? Importance: E.g., in Jiangsu province, 99% of firms, 80% of output and 65% of labor depend on venture capital 3.2. Foreign Direct Investment ? 合资, 合营, 合作, 独资, franchising, outsourcing ? Purpose: understanding and policy analysis 3.3. Private-Public Partnership ? Purpose: partial privatization for roads, bridges, tunnels, railways, water, electricity, airlines ? Mechanisms: ownership arrangement, regulation, tax incentives, price control, lease, purchase guarantee