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Transactions
Rutgers University, Newark School of Law
Guseva, Yuliya

Transactions Outline – Fall 2013
Professor Yuliya Guseva
Classes 1 and 2: Start Up Corporation and Raising Capital
1)      Guseva’s Steps to Completing a Hypothetical: You need four steps to complete a hypothetical
a.       Market: Look at the Market
b.      Position and Objectives: Identify the Client’s Position in that market and her objectives
c.       Organization: Bring the objectives under the umbrella of her organization
d.      Technical Issues: Look at the technical issues of implementation, which often refers to contractual design
2)      Porter’s Five Forces: This is a framework for industry analysis and business strategy development that determines the competitive intensity and attractiveness (profitability) of the market
a.       Unattractive industry: An unattractive industry is one in which the combination of these five forces would drive down overall profitability
b.      Five Forces
                                                               i.      Input Suppliers: Suppliers may refuse to work with a firm or charge excessively high prices for unique resources
                                                             ii.      Buyers: Whether there are many buyers or less buyers
                                                            iii.      Competition: The intensity of competitive rivalry may be a major determinant of the competitiveness of the industry
                                                           iv.      Substitute Goods: The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives
1.       Constantly Changing: The goods that are considered substitutes are constantly changing
                                                             v.      Barriers to Entry: Obstacles that make it difficult to enter a given market
1.       Attractive: Where entry barriers are high and exit barriers are low
3)      Analyzing Financials
a.       Income Statement: An income statement shows how the company performed over a period of time
                                                               i.      Profits + Losses
b.      Statement of Cash Flows: A statement of cash flows shows your liquidity
                                                               i.      Money coming in and money coming out
c.       Balance Sheet: The balance sheet is the general financial position of the company
                                                               i.      Assets v. Liabilities + Shareholders’ Equity
4)      Types of Assets
a.       Current Assets: The following quantifies a company’s total current assets
                                                               i.      Cash
                                                             ii.      Accounts Receivable and Allowance for Doubtful Accounts
1.       Accounts Receivable: A legally enforceable claim for payment to a business by its customers for goods supplied or services rendered in the execution of the customer’s order
2.       Allowance for Doubtful Accounts: Amount owed to a business or individual that is written off by the creditor as a loss (deduct this)
                                                            iii.      Inventory: Raw materials, work in process, and finished goods
1.       Valuing Inventory: There are two accounting techniques used to value inventory
a.       LIFO: Last in-last out – Most recently produced items are recorded as sold first
b.      FIFO: First in-first out – The oldest inventory items are recorded as sold first but do not mean that the exact oldest physical object has been tracked or sold
                                                           iv.      Prepaid expenses: prepaid expenses are benefits not yet received
1.       Insurance: Insurance is the most important prepaid expense
a.       If you forget to pay and it’s in default: Foreclosure or self-help repossession may render it unusable
2.       PMSI: Purchase Money Security Interest. It was a conditional sale
b.      Fixed Assets: Property, Plant and Equipment
                                                               i.      Fixed Assets Net Depreciation = Cost – Accumulated Depreciation
c.       Intangibles
5)      Liabilities: The obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provisions of services or other yielding of economic benefits in the future
a.       Current Liabilities: Everything within a year
                                                               i.      Accounts Payable: Money owed by a business to its suppliers
                                                             ii.      Notes Payable: Debts created by formal legal instruments
                                                            iii.      Accrued Expenses: Wages, Interests, etc.
                                                           iv.      Income Taxes Payable: Government levies imposed on individuals that varies with income and profits
b.      Long-term Liabilities: Everything past 365 days
c.       Shareholders’ Equity: The remaining interest in the assets of a company, spread among individual shareholders of common or preferred stock
                                                               i.      Investment (or capital stock and additional paid-in capital in excess of the stated value of each share): The buying and holding of shares of stock on a stock market by individuals and firms in anticipation of income from dividends and capital gains, as the value of the stock rises
                                                             ii.      Retained Earnings: the portion of net income of a corporation that is retained by the corporation rather than distributed to shareholders as dividends, or as the amount available to the corporation for distribution to shareholders
6)      Financial Statement Ratios: The process of understanding the risk and profitability of a firm through analysis of reported financial information.
a.       Working Capital: A financial metric that represents operating liquidity available to a business.
                                                               i.      Current Ratio: This ratio measures whether a firm has enough resources to pay its debts over the next 12 months
1.       Equation: Current assets / Current Liabilities
2.       Acceptable Ratio: 1.4 to 1
                                                             ii.      Net Working Capital: Net working capital is current assets – current liailities
b.      Debt to Equity: A financial ratio indicating the relative portion of shareholders’ equity and debt used to finance a company’s assets
                                                               i.      Healthy Ratio: 0.7
c.       Conclusions
                                                               i.      A healthy moderately profitable small business with some cash reserves and a low debt ratio
                                                             ii.      Any expansion will require additional external financing
7)      Miller-Modigliani Corollary: Under a certain market price process, in the absence of taxes, bankruptcy costs, agency costs and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed
a.       Transaction Costs: Helps determine a firm’s capital structure and how it finances its activities
                                                               i.      No effect on firm value: Absent frictions, whether capital is obtained externally across a market or internally through retained earnings does not affect firm value
b.      Types of Lenders
                                                               i.      Secured v Unsecured
                                                             ii.      Equity v Debt
c.       Corporate financial structure: May be irrelevant for the firm’s value (No Bankruptcy Risk + No Taxes)
8)      Capital Structure Puzzle, Myers
a.       Static Trade Off Hypothesis: The cost of financing increases with asymmetric information
b.      Pecking Order Theory: The benefit of raising the money is greater than the true value of new shares less the market value of the new shares
                                                               i.      Firms strongly prefer to set target dividend payout ratios so that normal rates of equity investment can be met by internally generated funds
c.       Starting Point: It is easier to start off with some form of debt
9)      Bob Scott’s Theory: Exclusive financing agreements coupled with blanket security interests are superior to alternative mechanisms
a.       Worries of a Creditor: Every creditor worries about conversion and asset substitution, risky transactions and other creditors
b.      Banks: Banks are the way to go
                                                               i.      Mechanism: Blanket security (present + after acquired assets) + exclusivity
10)   Debt, Default and Bonding:
a.       Jensen and Meckling: A corporation is a nexus of contracts
                                                               i.      Cluster of Agreements: A cluster of explicit and implicit agreements between all those that participate in the corporation’s business
                                                             ii.      Contract Terms: Terms of those contracts are influenced by transaction costs
                                                            iii.      Monitoring and bonding options
b.      Banks: Endogenous and exogenous risks => Interest rate
                                                               i.      Plus Covenants: Affirmative/positive and negative
                                                             ii.      Default Clauses
                                                            iii.      Security: Better to be overcollateralized
Class 3: The Decision to Produce Internally or Contract Out
1)      Basic Law and Economics Problems: The theory of incomplete contracts – importance of contingencies and contract flexibility
a.       Transaction Costs:
                                                               i.      Information Asymmetry
                                                             ii.      Agency Costs
                                                            iii.      Moral Hazard
                                                           iv.      Free Riding
2)      Information Asymmetry: Information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other.
a.       Information Completeness: A contract should preferably include all pertinent information         
                                                               i.      Problems: It is costly to produce and process
1.       Bounded Rationality
2.       Who is the Most Efficient Producer?
a.       Seller, buyer, third party
b.      Who should bear the cost
c.       How to economize
3.       S(p) = D(p, N(p))
b.      Example:
                                                               i.      Buyers know the average quality of pool but not the quality of a particular car
1.       Offer: They base the offer on the average quality
                                                             ii.      Sellers: Know quality of the car
1.       Below average: Willing to sell at average price
2.       Above average: Hold car off the market
3.       Average quality falls: Buyers then recognize this
c.       Solutions
                       

rtant for industry organization
1.       Reputational problems will lead to a loss of business since opportunism is analogous to fraud
                                                             ii.      Klein’s Response: Changes in demand caused GM to invest more in Fisher and the old price formula set in the contract allowed Fishers to receive exorbitant returns on their investment
13)   Conclusions:
a.       Hold-Up: A holdup may be usefully defined as occurring when one transactor takes advantage of a locked-in trading partner to appropriate relationship-specific quasi-rents
b.      When Possible: Since contract terms are inherently imperfect and transactor reputational capital is limited, transctors know when they design their contractual arrangements that there is some probability that they may be placed in the position where unanticipated events push the contractual relationship outside the self-enforcing range and a holdup will occur
                                                               i.      Goal of Contractual Specification: To economize on the reputational capital necessary to make a contractual relationship self-enforcing in the widest range of post-contract circumstances
c.       Conclusion:
                                                               i.      Reputation contracts do work but they are limited
                                                             ii.      Less parties know each other: The weaker their reputational concerns
                                                            iii.      Watch out for market changes
                                                           iv.      Preserve exit options
14)   Coase on Contracts:
a.       All contracts are incomplete
b.      Most long-term contracts are renegotiated at some point
c.       Important Issue in Transaction Cost: Who holds the residual property rights
15)   Vertical Integration v Contract
a.       Vertical Integration
                                                               i.      Technology Changes
                                                             ii.      Integration is costly
                                                            iii.      Internal flexibility v external flexibility
b.      Risks of Contracting
                                                               i.      Holdup
                                                             ii.      Price Risk
                                                            iii.      Lack of coordination of productive functions lead to delays
c.       Advantages of Vertical Integration
                                                              i.      Internal Benefits
1.       Integration economies reduce costs by eliminating steps, reducing duplicate overhead and cutting costs
2.       Improved coordination of activities reduces inventorying and other costs
3.       Avoid time-consuming tasks, like price shopping, communicating design details or negotiating contracts
                                                            ii.      Competitive Benefits
1.       Avoid foreclosure to inputs services or markets
2.       Improved marketing
3.       Opportunity to create product differentiating
4.       Superior control of firm’s new economic environment
5.       Create credibility for new products
6.       Synergies could be created by coordinating vertical activities skillfully
d.      Disadvantages
                                                              i.      Internal Costs
1.       Need for overhead to coordinate vertical integration increased costs
2.       Burden of excess capacity from unevenly balanced minimum efficient scale plants
3.       Poorly organized vertically integrated firms do not enjoy synergies that compensate for higher costs
                                                            ii.      Competitive Dangers
1.       Obsolete processes may be perpetuated
2.       Creates exit barriers
3.       Links firm to sick adjacent business
4.       Lose access to information from suppliers or distributors
5.       Synergies created through integration may be overrated
6.       Managers integrated before thinking through the most appropriate way to do so
Class 4 and 5: Contract Interpretation, Performance and Breach
1)      Analytical Matrix as stated by Guseva:
a.       Coase Continuum
                                                              i.      Short term?
                                                            ii.      Long term?
b.      Client’s Expectations and Objectives:
                                                              i.      Relationship?