Offering a unifying theoretical perspective not readily available in any other text, this innovative guide to econometrics uses simple geometrical arguments to develop students' intuitive understanding of basic and advanced topics, emphasizing throughout the practical applications of modern theory and nonlinear techniques of estimation. One theme of the text is the use of artificial regressions for estimation, reference, and specification testing of nonlinear models, including diagnostic tests for parameter constancy, serial correlation, heteroscedasticity, and other types of mis-specification. Explaining how estimates can be obtained and tests can be carried out, the authors go beyond a mere algebraic description to one that can be easily translated into the commands of a standard econometric software package. Covering an unprecedented range of problems with a consistent emphasis on those that arise in applied work, this accessible and coherent guide to the most vital topics in econometrics today is indispensable for advanced students of econometrics and students of statistics interested in regression and related topics. It will also suit practising econometricians who want to update their skills. Flexibly designed to accommodate a variety of course levels, it offers both complete coverage of the basic material and separate chapters on areas of specialized interest.

Estimation and Inference in Econometrics

This paper examines the relative importance of many factors in the capital structure decisions of publicly traded American firms from 1950 to 2003. The most reliable factors for explaining market leverage are: median industry leverage (+ effect on leverage), market-to-book assets ratio (−), tangibility (+), profits (−), log of assets (+), and expected inflation (+). In addition, we find that dividend-paying firms tend to have lower leverage. When considering book leverage, somewhat similar effects are found. However, for book leverage, the impact of firm size, the market-to-book ratio, and the effect of inflation are not reliable. The empirical evidence seems reasonably consistent with some versions of the trade-off theory of capital structure.

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Capital Structure Decisions: Which Factors Are Reliably Important?

Investor Psychology and Security Market Under- and Overreactions

We investigate the effect of growth opportunities in a firm's investment opportunity set on its joint choice of leverage, debt maturity, and covenants. Using a database that contains detailed debt covenant information, we provide large-sample evidence of the incidence of covenants in public debt and construct firm-level indices of bondholder covenant protection. We find that covenant protection is increasing in growth opportunities, debt maturity, and leverage. We also document that the negative relation between leverage and growth opportunities is significantly attenuated by covenant protection, suggesting that covenants can mitigate the agency costs of debt for high growth firms.

Growth Opportunities and the Choice of Leverage, Debt Maturity, and Covenants

Financial constraints are fundamental to empirical research in finance and economics. We propose two novel tests to evaluate how well measures of financial constraints actually capture constraints. We find that firms classified as constrained according to five popular measures do not in fact behave as if they were constrained: they have no trouble raising debt when their demand for debt increases exogenously and they use the proceeds of equity issues to increase payouts to shareholders. We propose an alternative proxy for financial constraints, based on Merton’s (1974) distance-to-default measure, which successfully identifies firms whose behavior is consistent with being constrained.

Do Measures of Financial Constraints Measure Financial Constraints

We examine whether performance-sensitive debt (PSD) is used to reduce hold-up problems in long-term lending relationships. We find that the use of PSD is more common in the presence of a long-term lending relationship and if the borrower has fewer financing alternatives available. In syndicated deals, however, the presence of a relationship lead arranger reduces the use of PSD, which is consistent with hold-up being of lesser concern in such cases. Further, supporting our hypothesis that hold-up concerns motivate the use of PSD, we find a substitution effect between the use of PSD and the tightness of financial covenants.

Hold-Up and the Use of Performance-Sensitive Debt

The widespread practice of managers speculating by incorporating their market views into firms' hedging programs ("selective hedging") remains a puzzle. Using a 10-year sample of North American gold mining firms, we find no evidence that selective hedging is more prevalent among firms that are believed to possess an information advantage. In contrast, we find strong evidence that selective hedging is more prevalent among financially constrained firms, suggesting that this practice is driven by asset substitution motives. We detect weak relationships between selective hedging and some corporate governance measures but find no evidence of a link between selective hedging and managerial compensation.

Why Do Firms Engage in Selective Hedging? Evidence from the Gold Mining Industry

This paper shows how the credit risk premium affects firms' optimal hedging strategies. The model predicts that if the credit risk premium is relatively small, firms use convex hedging strategies. If the credit risk premium is relatively large, firms use concave hedging strategies. Firms in between those two extremes use strategies that feature both convex and concave elements, e.g. collar strategies. Finally, firms that are unlevered, invest little and are exposed to few non-hedgeable risks are the most likely to use linear approximations of the optimal strategy. The model replicates essentially all observed hedging strategies in the gold mining industry.

Risk Management and the Credit Risk Premium

We examine the impact of managerial optimism on the inclusion of performance-pricing provisions in syndicated loan contracts (PSD). Optimistic managers may view PSD as a relatively cheap form of financing given their upwardly biased expectations about the firmâ€™s future cash flow. Indeed, we find that optimistic managers are more likely to issue PSD, and choose contracts with greater performance-pricing sensitivity than rational managers. Consistent with their biased expectations, firms with optimistic managers perform worse than firms with rational managers after issuing PSD. Our results indicate that behavioral aspects can affect contract design in the market for syndicated loans.

Managerial Optimism and Debt Contract Design: The Case of Syndicated Loans

We examine the determinants and information content of hedging change announcements by gold mining firms from 1991 to 2013. Hedging increases (decreases) are significantly more likely following negative (positive) gold and equity returns, and cause significant negative (positive) reactions in equity prices for both the announcing firm and industry. These findings support the prediction that firms hedge to alleviate financial distress. Our observation that firms increase hedging in low-value (high distress cost) states and decrease hedging in high-value (low distress cost) states provides an explanation for the mixed evidence on the relation between hedging and shareholder value. Announcements of hedging changes also cause significant reactions in gold prices, suggesting that markets believe some firms have credible gold price information. JEL Classification: G11; G14; G32; G39

Tim Adam

Papers

Hold-Up and the Use of Performance-Sensitive Debt

Why Do Firms Engage in Selective Hedging? Evidence from the Gold Mining Industry

Risk Management and the Credit Risk Premium

Managerial Optimism and Debt Contract Design: The Case of Syndicated Loans

Dynamic Risk Management: Evidence from Corporate Hedging Announcements