Extra Study Materials

1) Reminder: if you are planning to come to office hours, please try to email me the past exam questions you want to go over beforehand so that I can read through them.

2) Here is a list of previous exam questions that I would not spend too much time on because they are moral hazard questions (or include a moral hazard red herring).
2011 #1,2
2010 #2
2007 #1
2006 #1
2004 #2


3) Below is a problem set and solution key from last year.  The last two problems are cheap talk problems.

problem set
solutions

4) Professor Morgan has provided a few extra problems to practice with:

Question 1: The Modigliani-Miller theorem provides conditions where a firm’s capital structure is irrelevant to its investment decisions. Yet, in practice, a firm’s capital structure does seem to profoundly affect investment decision making as well as the valuation placed on the company in capital markets. Using tools and concepts from the field of contract theory, offer some explanations for the following questions.

1. What determines the optimal stake in a company for outside equity to take in an owner-operated firm? How does the structure of the stake (debt versus equity) affect this decision?

2. What determines when a firm should make a seasoned equity offering (i.e. sell additional equity in the capital market after previously issuing equity at some point in the past)? How should markets respond to seasoned equity offerings in determining the valuation of a firm?

3. A firm is competing with several other firms in trying to acquire some other company that is on the market. What determines the optimal bidding strategy? How should the market respond to a successful acquisition in terms of the share price for the acquirer and the target?

4. Suppose that a firm is selling some assets and faces bidders offering equity stakes. When would it prefer to sell for equity versus selling in exchange for cash or debt? 

In formulating your answers, please describe one or more of the key economic tradeoffs associated with each of the questions and describe how these tradeoffs are affected by some of the details of the situation. In particular, your answers should focus on how the organization will react to changes in its balance sheet in terms of effort undertaken in the organization, projects pursued or not pursued, and acquisitions pursued or not pursued.

In doing so, you may, at your discretion, provide a “toy model” to illustrate your answer. You may also, at your discretion, highlight key existing work illuminating the tradeoffs you have identified.

And

Question 2: (All work and no play makes Jack an investment banker) There are two types of investment banking analysts, high or low with probabilities .8 and .2 respectively. Analysts can choose two levels of work intensity, normal and psychotic. Partners in investment banks observe levels of intensity (but not types) and then decide between the actions fire or promote. The analysts payoffs are the sum of two elements: she obtains 2 units if she is promoted and 2 units if she works at her preferred level of intensity. Low types prefer to work at a normal intensity level; whereas high types prefer to work at a psychotic intensity level. The partner receives a payoff one for firing low types and a payoff of one for promoting high types. Otherwise, the partner’s payoff is zero.

Use the notion of weak perfect Bayesian equilibrium to answer the following questions.

            a. Characterize the set of separating equilibria (if any) in this game. If there are no such equilibria, then prove that this is the case.

            b. Characterize the set of pooling equilibria (if any) in this game. If there are no such equilibria, then prove that this is the case.

            c. Use belief-based refinements to argue that at least one of the above equilibria is unreasonable. (You can be somewhat informal in these arguments should you wish.)