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Columbus' Egg: The Real Determinant of Capital Structure
TL;DR: This paper showed that the typical firm's capital structure is not caused by attempts to time the market, by attempting to minimize taxes or bankruptcy costs, or by any other attempt at firm-value maximization.
Abstract: This paper shows that managers fail to readjust their capital structure in response to external stock returns. Thus, the typical firm's capital structure is not caused by attempts to time the market, by attempts to minimize taxes or bankruptcy costs, or by any other attempts at firm-value maximization. Instead, capital structure is almost entirely determined by lagged stock returns (which, when applied to ancient equity values, predict current equity value and with it debt equity ratios). Consequently, one should conclude that capital structure is determined primarily by external stock market influences, and not by internal corporate optimizing decisions.
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TL;DR: This paper found that higher sensitivity of CEO wealth to stock volatility is associated with riskier policy choices, including relatively more investment in R&D, more focus on fewer lines of business, and higher leverage.
Abstract: This paper provides empirical evidence of a strong relation between the structure of managerial compensation and both investment policy and debt policy. Higher sensitivity of CEO wealth to stock volatility (vega) is associated with riskier policy choices, including relatively more investment in R&D, more focus on fewer lines of business, and higher leverage. These results are consistent with the hypothesis that higher vega in the managerial compensation scheme gives executives the incentive to implement policy choices that increase risk. Our results also indicate that these investment and financial policy choices are among the primary mechanisms through which vega affects stock price volatility.
75 citations
TL;DR: In this article, the authors examine how these problems have played out in five cases and describe how governments and regulators can quantify the extent of the problems and, using option-pricing techniques, value the customer and taxpayer guarantees involved.
Abstract: Many private infrastructure projects mix regulation that subjects the private company to considerable risk, a government or regulator that is reluctant to see the company go bankrupt, and high leverage on the part of the company. If all goes well, equityholders make a profit, debtholders are repaid, customers pay no more than they expected, and the government is not called on to bail the company out. If all goes badly enough, however, the prospect of bankruptcy will loom. Unwilling to see the company go bankrupt, however, the regulator will have to permit an unscheduled price increase, or the government will have to inject taxpayers' money into the firm. In other words, the combination means customers and taxpayers bear more risk than would appear from the regulations governing the private infrastructure project. The authors examine how these problems have played out in five cases. Then they describe how governments and regulators can quantify the extent of the problems and, using option-pricing techniques, value the customer and taxpayer guarantees involved. Finally, the authors analyze three options for mitigating the problem: making bankruptcy a more credible threat, limiting the private operator's leverage, and reducing the private operator's exposure to risk. The authors conclude that appropriate policy depends on the tax system, the feasibility of enforcing bankruptcy, and the benefits of risk transfer from taxpayer to the private sector.
63 citations
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TL;DR: In this article, the authors document the build-up of regulatory and market equity capital in large U.S. bank holding companies between 1986 and 2000, and attribute the capital increase to enhanced market incentives to monitor and price large banks' default risk.
Abstract: We document the build-up of regulatory and market equity capital in large U.S. bank holding companies between 1986 and 2000. During this time, large banking firms raised their capital ratios to the highest levels in more than 50 years. Since 1995, essentially none of the 100 largest U.S. banking firms have been constrained by regulatory capital standards. Nor do these firms appear to be protecting themselves explicitly against falling below supervisory minimum capital standards. Variation in bank equity ratios reliably reflects portfolio risk, and we attribute the capital increase to enhanced market incentives to monitor and price large banks' default risk.
48 citations
TL;DR: In this paper, the authors test the assumptions of trade-off theory and pecking order theory regarding corporate leverage, and apply a linear model upon a balanced panel data-set of 2,370 French SMEs over the period 2002-2010.
Abstract: We test the assumptions of trade-off theory (TOT) and pecking order theory (POT) regarding corporate leverage. The dependent variable being the debt ratio, we apply a linear model upon a balanced panel data-set of 2,370 French SMEs over the period 2002–2010. In accordance to TOT, trade credit acts as a signal to creditors who have no private information about the firm and access to credit relies on guarantees. The relationship between corporate leverage and the profitability of SMEs as well as growth opportunities support POT. However, the relationship between corporate leverage and the age of SMEs, as well as their size, remains inconclusive with respect to both theories.
46 citations
TL;DR: In this article, the role of economic policy uncertainty in influencing firm performance and leverage as a form of financing decisions, in the presence of herding in the emerging markets is examined.
Abstract: This study examines the role of economic policy uncertainty (EPU) in influencing firm performance and leverage as a form of financing decisions, in the presence of herding in the emerging markets o...
9 citations