About the course
Joel Stern is one of the giants in financial theory and corporate policy. He has advised almost 5,000 firms in his career in the United States, Europe, South Africa, India, Singapore, Indonesia, Malaysia, Australia and New Zealand, and firms in Mexico, Guatemala, Colombia and Chile. He has taught his course, The Theory and Policy of Modern Finance, for more than 40 years using the five major theories in modern finance, as well as the three minor theories. The purpose of the course is to explore how the theories can be applied in the real world, what are their limitations, and where are the most likely successes.
His approach focuses on the six key variables that determine a firm’s “fair” value. This approach has been used by him and his firms, Stern Value Management (SVM) and Stern Solutions Capital Partners (SSCP), to price IPOs, divestitures and potential acquisition candidates, and in every case the objective is to avoid overpayment. He even recommends that IPOs be fully valued, unlike the recent Ali Baba IPO that went public at a price in the mid $60s but the first trade was above $90. Giving away one-third of the firm on the part that went public does not serve anybody very well, no matter what investment bankers and the clients have to say on the subject. They simply did not know how to price the deal.
Additionally, he and his colleagues have developed an approach that replicates the Moody’s and S&P Bond Rating systems. They have identified the five key variables. This is useful to all firms that might use a private placement of debt to finance their business. How does the issuing firm know if they are getting the funds at a fair rate of interest. The approach they call the Bond Rating Credit Score does the job almost perfectly. Then, of course, are the issues of dividend policy, share buybacks and the like, because many practitioners claim that managing the right-hand side of the balance sheet is a way to significantly increase a firm’s fair value. Joel Stern thinks that is not true. That most of what happened is a mirage.
In his course he shows why and when and where to use share buybacks. One of his most successful was with a New York Stock Exchange listed company whose shares had increased from $14 to $41 within one year of a new CEO taking over, an alumnus from General Electric.
However, the firm was still estimated to be undervalued, with a fair value estimate of $71 a share. The question was how to get there. Instead of doing a share buyback at $41, SVM recommended a European-style Dutch auction that was carried out in a price range of $43-55 and, of course, the shares immediately rose to $55 and stayed there for the full month. Then SVM recommended that a straight tender be done at $71 with a full explanation as to why management felt that was the fair value of the firm. Once again the shares leapt from $55 to $71 in one day, and the shares never fell below that price. This was an effective way for management and the board to not only convey the firm’s expectations regarding the future, but a way to make sure that the shares got there and stayed there, so that in future the firm could issue its own shares as a currency in doing deals, instead of simply relying on cash or debt.
The Theory and Policy of Modern Finance deals with many, many other issues, including how investor relations should be used by publicly traded firms; how family-owned businesses that are privately held should manage the human capital inside their firms in order to attract the same quality that can be attracted by publicly traded firms that could use shares or share options to entice them. Finally, there is the entire issue of incentive compensation and the design of incentive contracts at all levels of the firm. This is one of SVM’s specialties. The last topic taught in the course deals with convertible debentures. They are not what they seem, since they are really a straight subordinated debt with a non-detachable warrant or option on the ordinary equity. Most people do not attach a significantly high enough cost to the equity that is being given away so that often people think that the cost of issuing convertibles is the best of a two-way street, protected on the downside by the yield on the debt, and on the upside by the movement in the price of the ordinary shares. Joel Stern shows the weakness in this argument in the course. Thus, the course covers Valuation theory, Options Pricing, Arbitrage Pricing, Agency theory, and Signalling theory, as the five major theories in finance.