Table Of Content1950 to 1969
1964: Monte Carlo
1955: First leveraged methods introduced
buyout deal to finance
1950: Diners Club
becomes the first 1956: First employee 1964:Capital Asset
credit card in stock ownership plan Pricing Model 1967:First
widespread use (ESOP) (CAPM) introduced ATM machine
1950 1955 1960 1965 1969
1951: Net present 1960: Convertible 1965: Origins of
value (NPV) bonds issued modern hedge funds
calculations applied
to corporate finance
1958: Modigliani- 1969: Official
Miller theorem development
published assistance
(ODA) statistic
published
by the OECD
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Financing the Future
Market-Based Innovations
for Growth
Franklin Allen
Glenn Yago
Vice President, Publisher: Tim Moore
Associate Publisher and Director of Marketing: Amy Neidlinger
Wharton Editor: Steve Kobrin
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© 2010 Milken Institute
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Library of Congress Cataloging-in-Publication Data
Allen, Franklin, 1956-
Financing the future : market-based innovations for growth / Franklin Allen, Glenn Yago.
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ISBN 978-0-13-701127-8 (hbk. : alk. paper) 1. Finance. 2. Capital market. I. Yago, Glenn.
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Contents
Acknowledgments . . . . . . . . . . . . . . . . . . . . vi
About the Authors . . . . . . . . . . . . . . . . . . . . ix
About the Milken Institute . . . . . . . . . . . . . xi
Chapter 1 The Evolution of Finance . . . . . . . . . . . . . . 1
Chapter 2 A Framework for Financial Innovation:
Managing Capital Structure . . . . . . . . . . . . 27
Chapter 3 Innovations in Business Finance . . . . . . . . 51
Chapter 4 Innovations in Housing Finance . . . . . . . . 85
Chapter 5 Environmental Finance: Innovating
to Save the Planet . . . . . . . . . . . . . . . . . . . 117
Chapter 6 Financing the Developing World . . . . . . 149
Chapter 7 Financing Cures . . . . . . . . . . . . . . . . . . . . 185
Chapter 8 Six Cardinal Rules of Financial
Innovation . . . . . . . . . . . . . . . . . . . . . . . . . 215
Appendix The Black–Scholes Formula . . . . . . . . . . 225
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227
Acknowledgments
If our efforts to illuminate the applications of financial innovation
to long-standing social, economic, and environmental problems meet
with any success, it is due to the extraordinary assistance of our col-
leagues. We are indebted to many individuals who made this book
possible.
First and foremost, we’d like to thank Lisa Renaud, our editor at
the Milken Institute, for her unflagging assistance on this project.
Lisa moved us closer to achieving our goals for this volume, and we
are deeply grateful for her significant contribution to this book. With-
out her, it would never have come together.
Much gratitude also goes to Professors Jerry Wind and Steve
Kobrin of the Wharton School of the University of Pennsylvania and
of Wharton School Publishing, who encouraged this project and an
ongoing collaboration with the Milken Institute. We’d also like to
thankTinaHorowitzattheWhartonSchoolforhermanyefforts.Jim
BoydatPearsonhasbeenveryencouragingofthisprocess;wethank
himforhispatienceandtheopportunitytolaunchanewseries.
The Milken Institute supported all of the incredibly hard work
that went into this volume. Mike Klowden, the Institute’s president
and CEO, and Skip Rimer, its director of communications, advanced
this project from its inception. We are grateful for the resources they
allocated toward the labor-intensive process of editing, researching,
and writing. Karen Giles was also encouraging, but took no prisoners
in rallying us to create order out of chaos, carving out time for writing
and research amid our demanding schedules. She is a generous and
patient colleague. Patricia Reiter was the lead research analyst, pro-
viding bibliographic and research assistance. Her efforts have been
considerable and are much appreciated. Lisa Montessi has been an
extraordinary source of knowledge about financial innovations and
markets. Her commitment to documenting and creating an ongoing
record and legacy of financial innovation at the Milken Institute has
made our research possible. Jorge Velasco also provided timely
research assistance. Special thanks go to Caitlin Maclean, manager of
ACKNOWLEDGMENTS vii
our Financial Innovations Labs, for all her work on the many Lab
reports that served as important sources for this book.
We’d also like to thank other Milken Institute colleagues and
researchers who have been involved in our work on global capital mar-
kets and financial innovations: Martha Amram, Penny Angkinand,
James Barth, Komal Sri-Kumar, Joel Kurtzman, Tong Li, Wenling Lu,
Peter Passell, Jill Scherer, and especially Betsy Zeidman. Through
their interest, insights, and intelligence, they have been major contrib-
utors to this volume.
We have learned much from the leading minds who have
advanced this field, including the late Merton Miller, Douglas Gale,
Michael Jensen, Stewart Myers, Robert Merton, Robert J. Shiller,
Michael Spence, Elena Carletti, Eugene Kandel, Naomi Lamoreaux,
Ross Levine, Bradford Cornell, Myron Scholes, Steven Kaplan, Peter
Tufano, Josh Lerner, Stuart Gilson, Jun Qian, and Lawrence White.
A number of pioneers in financial innovation have passed away in
recent years, but their legacies continue to shape our world and our
thinking about the uses of capital. Current and future financial inno-
vators stand on the shoulders of giants like Georges Doriot, who
invented venture capital; Louis Kelso, who advocated worker capital-
ism; Martin Dubilier, who went from crisis management to restruc-
turing troubled companies through leveraged buyouts; George E.
Stoddard, who devised real estate transactions known as sale-lease-
backs to provide financing to companies that had trouble gaining
access to traditional sources of capital; Walter J. Lopp II, who created
municipal bond insurance and the concept of tax-exempt financing
for pollution-control projects; Walter Wriston, whose innovations
extended from negotiable certificates of deposits to ATM networks;
Richard A. Musgrave, whose work in public finance enabled us to
allocate financial resources for social needs; and many others.
Discussions and debates with many current practitioners have
informed this book project. At the Milken Institute, we’ve made a
habit of assembling leading financial innovators so that we can learn
from their experiences and insights. They include Lewis Ranieri,
Richard Sandor, Muhammad Yunus, Alan Patricof, Sir Ronald
Cohen, Jacqueline Novogratz, Mary Houghton, Leo Melamed,
viii FINANCINGTHEFUTURE
Wayne Silby, Shari Berenbach, Sucharita Mukherjee, Chris Larsen,
and Bert van der Vaart.
Finally, we’d like to thank Michael Milken for his vision as a
financial and social innovator in many fields, especially our own.
Without his inspiration, interest, and support, the publication of this
book would not have been possible. He’s always wisely said that the
best investor is a good social scientist—that investors need to under-
stand how to enable people to realize their hopes and dreams, a
processthatultimatelycreateseconomicgrowthandprosperity.But,
sincenotallsocialscientistsaregoodinvestors,wearegratefulforhis
ongoingsupportofcriticalandindependentresearchinthisfield.His
work has inspired us not only to popularize financial innovations and
explore the questions that surround them, but also to find practical
usesforthem.
We are grateful to the organizations that have supported research
on financial innovations at the Milken Institute, including the Ford
Foundation, the Bill & Melinda Gates Foundation, Google.org, the
German Marshall Fund, the Packard Foundation, the F. B. Heron
Foundation, the Koret Foundation, the U.S. Department of Com-
merce, the U.S. Department of Agriculture, the Minority Business
Development Agency, and others.
With all this assistance, however, none of this would have been
accomplished without the trust, equity, and bonds in our families, to
whom we are indebted.
Franklin Allen, The Wharton School
of the University of Pennsylvania
Glenn Yago, Milken Institute
About the Authors
Franklin Allenis the Nippon Life Professor of Finance and Professor
of Economics at the Wharton School of the University of Pennsylva-
nia, where he has been on the faculty since 1980. A current codirector
of the Wharton Financial Institutions Center, he was formerly vice
dean and director of Wharton Doctoral Programs, as well as executive
editor of the Review of Financial Studies, one of the nation’s leading
academic finance journals. Allen is a past president of the American
Finance Association, the Western Finance Association, the Society for
Financial Studies, and the Financial Intermediation Research Society.
His main areas of interest are corporate finance, asset pricing, finan-
cial innovation, comparative financial systems, and financial crises. He
is a coauthor, with Richard Brealey and Stewart Myers, of the eighth
and ninth editions of the textbook Principles of Corporate Finance.
Allen received his doctorate from Oxford University.
Glenn Yagois director of Capital Studies at the Milken Institute. He
is also a visiting professor at Hebrew University of Jerusalem and
directs the Koret–Milken Institute Fellows program. Yago’s work
focuses on the innovative use of financial instruments to solve long-
standing economic development, social, and environmental challenges.
His research and projects have contributed to policy innovations fos-
tering the democratization of capital to traditionally underserved
markets and entrepreneurs in the United States and around the
world. Yago is the coauthor of several books, including The Rise and
Fall of the U.S. Mortgage and Credit Markets, Global Edge, Restruc-
turing Regulation and Financial Institutions, and Beyond Junk
Bonds. He was a professor at the State University of New York at
Stony Brook and at the City University of New York Graduate Center.
Yago earned his Ph.D. at the University of Wisconsin, Madison.
