Syllabus for Financial Economics [8705], Fall 2020

The Macroeconomics of the Modern Corporation

The neoclassical view of the corporation is a description of a production technology: Y,K’ = F(K,L)

Most big firms now are multi-product, have establishments over multiple jurisdictions, managed as multi-division organizations and finance their operations using multi-layered securities (outside equity, retained earnings, various types of debt-like securities, inter-company loans, etc.)

Should we care about these details? Do they matter for

(i)  how firms are valued

(ii) how firms (and economy as a whole) will respond to changes in the regulatory environment---tax policy, anti-trust policy, trade/FDI policy?

I find these topics interesting because a lot of public policy debate surrounds these two questions but there are very few papers that do a good quantitative job at getting at them. More generally there is gap between the standard macro, international trade, and the public finance paradigms

The Neoclassical Firm

What are the predictions of the neoclassical theory for stock valuations and effects of taxes?

Assignment 1:

Construct the following time-series

  • (i)  aggregate market valuation of the US corporate sector relative to GDP over time

  • (ii)  aggregate dividends from the corporate sector relative to GDP over time

  • (iii) growth rate of aggregate real consumption (nondurables and services)

  • (iv)  risk-free rate over time

  • (v)   returns on hypothetical index that invests in the entire US corporate sector

Please be very clear about which data series you use for valuations, dividends: source, frequency, coverage (How do you deal with corporations that are not publicly traded?)

Plot and summarize the salient patterns (mean, std, correlations with GDP growth)

In Class: Use a standard RBC model  to write out the representative consumers’ problem and derive the Euler equations for bonds and stocks:

  • What restrictions do asset prices put on the SDF?

  • Derive and discuss HJ bounds

  • Derive and discuss the Campbell Shiller decomposition

Assignment 2: Construct the following time-series

  • (i)   growth rate of aggregate real consumption (nondurables and services)

  • (ii)   aggregate capital stock (and investment) in the US corporate sector relative to GDP over time

  • (iii) time series for taxes paid by corporations over time

  • (iv)  summary of empirical papers that use use “tax” shocks to estimate the effects of corporate taxes on investment

Please be very clear about which data series you use for constructing the capital stock

Describe what taxes are paid by corporations? Discuss the concept of tax rate that you use---average/marginal, and the base on which you pay the tax (taxable profits/dividends)

Plot and summarize the salient patterns (mean, std, correlations with GDP growth)

Class

Write out the representative firms’ problem and derive the Q equation

  • Is the return on investment equal to the return on the stock?

  • What is the role of adjustment costs?

  • What is the role of corporate taxes?

Discuss how does firm value and investment respond to changes in corporate taxes

The Multinational Firm:

What do the existing models of multinational firms have to say about valuations and effects of taxes

Most large firms are multinational. What are the ways of modeling multinational firms:

1.       FDI: McGrattan Prescott model multinational corporations as a collection of technologies that can be replicated at zero marginal costs across a specified set of locations. They call this non rivalrous input as technology capital.

2.       Trade: Helpman Antras etc think of multinational firms as internalizing offshoring decisions because of incomplete contracting.  Their basic environment is a Melitz model which features increasing returns (due to fixed costs), product differentiation, and firm-level heterogeneity. Ramondo and Rodrigues-clare modify a Eaton-Kortum model of trade to have multinational production

Taxation of Multinational Firms

1.       How are multinational firms taxed? Discuss institutional details

2.       What are the avenues of multinational corporations to move income across jurisdictions (profit shifting) and across time (repatriation)

3.       Do such avenues change the sensitivity of investment to changes in the cost of capital and/or the sensitivity of changes in cost of capital to changes in taxes different for multinationals?

Valuation of Multinational Firms

  • Are the risk exposures of multinational firms systematically different from other firms?