Teaching Project Finance: An Overview of the Large-Scale Investment Course at Harvard Business School

SUBJECT AREAS: project finance, course overview, corporate finance, teaching Large-Scale Investment (LSI) is a case-based course about project finance that is designed for second-year MBA students. Project finance involves the creation of a legally independent project company financed with nonrecourse debt for the purpose of investing in a single purpose industrial asset. In 2001, firms financed almost $220 billion worth of capital expenditures through project companies, an amount that has grown and will continue to grow rapidly in the years ahead. As the name implies, the course focuses primarily on large projects those costing $500 million or more because they provide a clear window on how managers make important structural decisions and how those decisions, in turn, affect firm value and performance. At the same time, large projects often encounter financial distress witness EuroTunnel, EuroDisney, Dabhol, and Iridium, yet are critical to economic growth and prosperity in both developed and developing markets. The central theme of the course is that structure matters, which stands in sharp contrast to the neoclassical view of the firm as a black box production function and the assumption underlying Modigliani and Miller's first irrelevance proposition that financing and investment are separable and independent activities. Through this course, students learn how structure affects managerial incentives to create value and manage risk. Ultimately, students learn how to increase value through both investment and financing choices. Project companies provide a particularly powerful laboratory in which to study the determinants and implications of various structural attributes because they are, as newly created companies, less influenced by the vagaries of history. Moreover, the size of the investments (75% of projects cost more than $100 million) and the time it takes to structure them (one to five years) ensures that managers have the opportunity and the economic incentive to make careful, value enhancing structural decisions. Finally, as standalone entities, it is easier to observe the structural choices and outcomes. The intellectual challenge for students is to understand how financial structure affects managerial incentives and project value. A thorough understanding of these relationships, however, requires advanced finance theories. For this reason, the course introduces more advanced theories of capital structure, corporate governance, and risk management as well as more advanced valuation and credit assessment tools. This note describes the course's key themes, structure, and content. It is designed for educators interested in teaching a course on project finance. Although several business schools now have project finance courses (Columbia, HBS, Kellogg, LBS, NYU, etc.), the field is still relatively new and much of the pedagogical material has only recently become available. Instead of creating a new project finance course, the material described in this note can also be used to create a module in an existing course on corporate finance, international finance, or financial institutions. Alternatively, it can be used to create courses on emerging market corporate finance, risk management, and energy finance. In summary, the material is quite flexible and has broad applications across many academic disciplines. Given the pedagogical nature of this note, it is only available to academic instructors.