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Analytical Methods for Lawyers

Analytical Methods for Lawyers. Finance Unit. Last updated 01 Mar 07. Schedule. Why the firm?. Theory of the Firm. Firm. Labor. Capital. Supplies. Equipment. Adam Smith “Wealth of Nations”. Land. Why not contracting?. Theory of the Firm. Capital. Labor. Entrepreneur. Supplies.

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Analytical Methods for Lawyers

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  1. Analytical Methods for Lawyers Finance Unit Last updated 01 Mar 07

  2. Schedule

  3. Why the firm?

  4. Theory of the Firm Firm Labor Capital Supplies Equipment Adam Smith “Wealth of Nations” Land

  5. Why not contracting?

  6. Theory of the Firm Capital Labor Entrepreneur Supplies Equipment Ronald Coase “Nature of the Firm” Land

  7. Theory of the Firm Capital Labor Entrepreneur Supplies Equipment Ronald Coase “Nature of the Firm” Land

  8. What is the modern public corporation?

  9. Separation of ownership/control Entrepreneurs (capitalist managers) Labor Capital Supplies Equipment Adolf Berle & Gardiner Means Land

  10. Separation of ownership/control Professional managers Capital (diffuse public ownership) Labor Supplies Equipment Adolf Berle & Gardiner Means Land

  11. What is ideal ownership – debt or equity?

  12. Optimal debt-equity mix Managers Equity Labor Debt Franco Modigliani & Merton Miller “Cost of Capital” Supplies Equipment Land

  13. Optimal debt/equity mix • Debt: • Priority • Fixed rate of return Net Assets Debt Optimal debt/equity? Equity • Equity: • Voting control • Residual returns

  14. Optimal debt/equity mix • Less debt: • Large equity cushion • Lower risk  lower cost Net Assets Debt Equity Optimal debt/equity? • More equity: • Low leverage • Lower returns  higher cost

  15. Optimal debt/equity mix • More debt: • Small equity cushion • Higher risk  higher cost Net Assets Debt Optimal debt/equity? Equity • Less equity: • High leverage • High returns  lower cost

  16. Modigliani & Miller

  17. Modigliani & Miller

  18. Modigliani & Miller

  19. Modigliani & Miller * Interest is deductible (debt subsidized by govt)

  20. How unify ownership and management?

  21. Leveraged firm Managers Outside debt Inside equity Labor Michael Jensen & William Meckling “Managerial Behavior” Supplies Equipment Land

  22. END

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