程序代写案例-BEEM117
时间:2021-05-01
BEEM117
UNIVERSITY OF EXETER
BUSINESS SCHOOL
May 2021
Economics of Corporate Finance
Module Convenor: Simone Meraglia
Duration: TWO HOURS + 30 minutes upload time
Format: PDF
No word count specified
Answer any 3 questions out of 4.
All questions are worth equal marks.
Materials to be supplied on request: None.
Approved calculators are permitted.
This is an open book exam.
1
Question 1
Suppose you are an investor seeking to find new opportunities to invest. You have identified
two firms: L1 Corporation and BT Enterprises. L1 Corporation is debt free, while BT
Enterprises is highly leveraged. Each firm is run by a manager/entrepreneur, who can exert
two levels of effort: high or low. The project undertaken by the manager of each firm yields
either a high return RS > 0 or a low return RF ≥ 0, with RF < RS . High effort by the
manager increases the probability that the firm realizes a high return.
(a) Suppose there are perfect capital markets, no taxes, and no bankruptcy. Suppose also
that you (and other outside investors) can perfectly observe the effort exerted by the
managers of the two firms, and you can write a contract specifying the effort you want
the managers to exert. Does the amount of leverage of each firm affect its market value?
Explain your answer. (30% of the marks)
(b) Suppose that L1 Corporation decides to pay dividends to its shareholders, whereas BT
Enterprises pays no dividends. Does the dividend policy of each firm affect its market
value? Explain your answer. (30% of the marks)
(c) Let us continue with the framework described in point (a) above (with no dividends).
Suppose now that you and other outside investors cannot observe the effort exerted by
the managers of the two firms. The project undertaken by the manager of each firm
yields either a high return RS > 0 or a low return RF > 0. Does the amount of leverage
of each firm affect its market value? Explain your answer. (40% of the marks)
BEEM117 2 TURN OVER
Question 2
An entrepreneur has to finance a project of fixed size I. The entrepreneur has “cash-on-hand”
A, where A < I. To implement the project, the entrepreneur (that is, the borrower) must
borrow I −A from lenders. If undertaken, the project either succeeds, in which case it yields
a return R > 0, or fails, in which case it delivers a zero return. The probability of success
depends on the effort exerted by the entrepreneur: if the entrepreneur exerts high effort, the
probability of success is equal to pH ; if the entrepreneur exerts low effort, the probability of
success is equal to pL, where ∆p = pH − pL > 0. If the entrepreneur exerts low effort, she
also obtains a private benefit B > 0, while there is no private benefit when the entrepreneur
exerts high effort. Define as Rb the amount of profit going to the entrepreneur, and as Rl
the amount of profit going to the lenders in case of success, where R = Rb +Rl. We assume
both players obtain zero in case the project fails. All the players are risk neutral and there is
limited liability for the entrepreneur. Lenders behave competitively, and both entrepreneur
and lenders receive zero if the project fails.
(a) Write down the “break-even constraint” for the lenders assuming that the entrepreneur
exerts high effort. (10% of the marks)
(b) Write down the entrepreneur’s “Incentive Compatibility Constraint” (ICb) and derive
the minimum level of Rb such that the entrepreneur exerts high effort. (10% of the
marks)
(c) What is the highest level of income that the entrepreneur can pledge to investors? (20%
of the marks)
(d) Compute the minimum level of cash-on-hand A the entrepreneur must have to be
financed. Why are entrepreneurs with low cash-on-hand likely to be denied financing?
Explain your answer. (20% of the marks)
(e) Consider now the case in which the entrepreneur has borrowed I − A from ‘initial’
lenders and has commited to pay them some Rl = R−Rb, where Rb must satisfy ICb.
However, before deciding whether to exert high or low effort, the entrepreneur faces the
opportunity to deepen the investment at a cost J . If undertaken, this new investment
raises the probability of success to pH + τ in case of high effort, and to pL+ τ in case of
low effort, for some τ > 0. Also, if the new investment is undertaken, the entrepreneur
receives a private benefit B′ in case she exerts low effort, where B′ > B. Let us assume
that τR− J < 0. Further, assume that pL + τ = pH . Suppose that, if the entrepreneur
undertakes the new investment, ‘initial’ investors have a right to keep Rl in case the
project succeeds. Should initial investors be worried about the fact that the entrepreneur
may undertake a new investment J? Explain. (20% of the marks)
BEEM117 3 TURN OVER
(f) Let us continue with the framework introduced in point (e). Can you derive a condition
under which the new project is undertaken? If undertaken, is effort high or low? (20%
of the marks)
BEEM117 4 TURN OVER
Question 3
An entrepreneur has to finance a project of fixed size I. The entrepreneur has no cash-on-
hand (A = 0). To implement the project, the entrepreneur must borrow I from lenders. If
undertaken, the project either succeeds, in which case it yields a return R > 0, or fails, in
which case it delivers a zero return. The entrepreneur (borrower) can be one of two types. A
“good” borrower has a probability of success equal to p. A “bad” borrower has a probability
of success equal to q, where p > q. Define as Rb the borrower’s level of compensation when the
project is financed and succeeds. All the players are risk neutral and there is limited liability
for the borrower. Lenders behave competitively, and both borrower and lenders receive zero
if the project fails.
Assume pR > I > qR.
(a) Suppose first that lenders have complete knowledge of the borrower’s type. Write down
the lenders’ break-even constraint when the borrower is (i) “good” or (ii) “bad”. (10%
of the marks)
(b) What is the highest level of compensation each type of borrower can obtain? Do both
types of borrower obtain financing? (10% of the marks)
(c) Suppose now that lenders cannot observe the borrower’s type. Lenders believe the
borrower is “good” with probability α, and “bad” with probability 1−α. Comment on
the effect of asymmetric information on (i) the availability of credit to both types of
borrower, and (ii) if a loan is granted, on the compensation the two types of borrower
obtain from undertaking the project. (20% of the marks)
(d) Suppose now that the entrepreneur already owns a project that, without further
investment, will succeed with probability p or q, yielding profit R. As before, suppose
that investors do not know the probability of success. Investors put probability α on p
and (1− α) on q. Define m = αp+ (1− α)q.
If the true probability of success is p, are the assets in place over-valued or under-valued?
Explain. (20% of the marks)
(e) Let us continue with the framework in part (d). At a cost I, the probability of success
can be raised by an amount τ > 0 (the new probabilities are then p+ τ and q + τ),
where:
τR > I.
The entrepreneur initially owns all shares. However, she has no cash-in-hand, therefore
the investment must be financed by issuing new shares.
BEEM117 5 TURN OVER
Write down the lenders’ break-even constraint in a pooling equilibrium (in which both
types of entrepreneur issue new shares). (10% of the marks)
(f) What is the ”good” borrower (entrepreneur)’s utility from not issuing shares? Determine
the condition(s) under which a pooling equilibrium exists. In a pooling equilibrium, do
we observe a ”Negative Stock Price Reaction” upon the announcement of an equity
issue? Explain. (30% of the marks)
BEEM117 6 TURN OVER
Question 4
Consider a firm run by an “incumbent” manager. Suppose the incumbent manager has the
opportunity to invest in one of two different projects, Project 1 or Project 2. The incumbent
manager has a higher ability in managing Project 1 rather than Project 2. Also, if the
incumbent is fired by shareholders, she is replaced by an “alternative” manager whose ability
to manage Project 1 is lower than the incumbent’s ability.
Suppose the investment in a project is irreversible, and the shareholders’ choice of the
incumbent manager salary (as well as their decision on whether to fire her) is taken after
the investment is made. Also, assume the incumbent manager has a stake in the firm she
runs, but she does not fully control it.
(a) Suppose none of the projects gives the manager a direct utility. According to Shleifer
and Vishny (1989), which of the two projects should the incumbent manager choose?
What is the economic rationale behind this choice? Explain. (30% of the marks)
(b) Suppose the incumbent manager chooses the size of the investment in her preferred
project. Do you expect the manager to select the investment size that maximizes the
firm’s market value? If not, does the manager over-invest or under-invest with respect
to the efficient investment size? Explain your answer. (40% of the marks)
(c) Suppose now that, unlike in Shleifer and Vishny (1989), the manager’s compensation is
a fixed salary w¯, which does not vary with the size of the investment chosen either by
the incumbent manager or by the alternative manager. Suppose also that the manager
owns a positive fraction θ ∈ (0, 1) of the shares of the company, but she does not fully
control it (that is, θ < 1). Do you expect the incumbent manager to select the investment
size that maximizes the firm’s market value? If not, does the manager over-invest or
under-invest with respect to the efficient investment size? Explain your answer. (30%
of the marks)
BEEM117 7 END OF PAPER















































































































































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