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Journal ArticleDOI

Corporate Choice Among Long-Term Financing Instruments

01 Aug 1970-The Review of Economics and Statistics (MIT Press)-Vol. 52, Iss: 3, pp 225-235
About: This article is published in The Review of Economics and Statistics.The article was published on 1970-08-01. It has received 132 citations till now. The article focuses on the topics: Term (time).
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Journal ArticleDOI
TL;DR: In contrast to previous empirical work, out tests explicitly account for the fact that firms may face impediments to movements toward their target ratio, and that the target ratio may change over time as the firm's profitability and stock price change as mentioned in this paper.
Abstract: When firms adjust their capital structures, they tend to move toward a target debt ratio that is consistent with theories based on tradeoffs between the costs and benefits of debt. In contrast to previous empirical work, out tests explicitly account for the fact that firms may face impediments to movements toward their target ratio, and that the target ratio may change over time as the firm's profitability and stock price change. A separate analysis of the size of the issue and repurchase transactions suggests that the deviation between the actual and the target ratios plays a more important role in the repurchase decision than in the issuance decision.

1,969 citations

Journal ArticleDOI
TL;DR: In this article, an empirical study of security issues by UK companies between 1959 and 1974 focuses on how companies select between financing instruments at a given point in time, and the results are consistent with the notion that these target debt levels are themselves a function of company size, bankruptcy risk, and asset composition.
Abstract: This empirical study of security issues by UK companies between 1959 and 1974 focuses on how companies select between financing instruments at a given point in time. It throws light on a number of interesting questions. First, it demonstrates that companies are heavily influenced by market conditions and the past history of security prices in choosing between debt and equity. Second, it provides evidence that companies appear to make their choice of financing instrument as if they have target levels of debt in mind. Finally, the results are consistent with the notion that these target debt levels are themselves a function of company size, bankruptcy risk, and asset composition. AN IMPORTANT QUESTION FACING companies in need of new finance is whether to raise debt or equity. In spite of the continuing theoretical debate on capital structure, there is relatively little empirical evidence on how companies actually select between financing instruments at a given point in time. Furthermore, almost none of the existing empirical evidence is based on British data. Sametz's [31] comment that "we know very little about how the great non-routine financial decisions are made" is still no understatement. In this paper, we develop a descriptive model of the choice between equity and long term debt. The coefficients of the model are estimated using logit analysis applied to a sample of 748 issues of equity and debt made by UK companies over the period 1959-70. The predictive ability of the model is tested on a holdout sample of 110 equity and debt issues made between 1971 and 1974. The study throws some light on a number of interesting questions such as whether companies behave as though they have target debt ratios; whether they have similar targets for the composition of their debt; whether market conditions or the company's historical share price performance affects their choice of instrument; and whether debt ratios or the choice of financing instrument are influenced by other factors such as operating risk, company size, the composition of the company's assets, and the rate at which retentions are generated. The study also provides a direct answer to the following question: given that we know that a company is in need of new long term or permanent capital, how accurately can we predict whether the company will issue equity or debt.

1,213 citations


Cites background or methods or result from "Corporate Choice Among Long-Term Fi..."

  • ...8 Baxter and Cragg [4] did not restrict their study to the choice between debt and equity issues, but looked in addition at other types of security....

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  • ...Baxter and Cragg [4] analyzed 230 security issues8 made in 1950-65 using logit and probit analysis....

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  • ...Our focus here (following Baxter and Cragg [4], Martin and Scott [24], and Taub [42]) is simply on modelling the choice between equity and debt on those occasions when firms resort to the long term capital market....

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  • ...See Theil [43] for an introductory discussion of logit and probit analysis, and Baxter and Cragg [4], Cragg and Baxter [13], Taub [42], and White and Turnbull [47] for applications in the finance area....

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  • ...37 is comparable with the figures obtained by Baxter and Cragg [4]....

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Journal ArticleDOI
TL;DR: The authors investigated the ability of the pecking-order model, the agency model, and the timing model to explain firms' decisions whether to issue debt or equity, the shock price reaction to their decisions and their actions afterward.

1,054 citations

Journal ArticleDOI
TL;DR: In this article, the authors provide evidence of substantial tax effects on the choice between issuing debt or equity; most studies fail to find significant effects, and the relationship between tax shields and debt policy is clarified.
Abstract: This paper provides clear evidence of substantial tax effects on the choice between issuing debt or equity; most studies fail to find significant effects. The relationship between tax shields and debt policy is clarified. Other papers miss the fact that most tax shields have a negligible effect on the marginal tax rate for most firms. New predictions are strongly supported by an empirical analysis; the method is to study incremental financing decisions using discrete choice analysis. Previous researchers examined debt/equity ratios, but tests based on incremental decisions should have greater power. NEARLY EVERYONE BELIEVES TAXES must be important to financing decision, but little support has been found in empiricial analyses. Myers (1984) wrote, "I know of no study clearly demonstrating that a firm's tax status has predictable, material effects on its debt policy. I think the wait for such a study will be protracted" (p. 588). A similar conclusion is reached by Poterba (1986). Recent studies that fail to find plausible or significant tax effects include Titman and Wessels (1988), Fischer, Heinkel, and Zechner (1989), Ang and Peterson (1986), Long and Malitz (1985), Bradley, Jarrell, and Kim (1984), and Marsh (1982).1 This paper provides clear evidence of substantial tax effects on financing decisions. The research differs from prior studies in two important ways. First, I clarify the relationship between tax shields and the incentive to use debt. Theory predicts that firms with low expected marginal tax rates on their interest deductions are less likely to finance new investments with debt. Tax shields should matter only to the extent that they affect the marginal tax rate on interest deductions. However, although deductions and credits always lower the average tax rate, they only lower the marginal rate if they cause the firm to have no taxable income and thus face a zero marginal rate on interest deductions (tax exhaustion).2 Other papers have ignored the fact that most tax shields have only

1,051 citations

Posted Content
TL;DR: The authors found that non-debt tax shields "crowd out" interest deductibility, thus decreasing the desirability of debt issues at the margin, and showed the importance of controlling for confounding effects which other papers ignored.
Abstract: A new empirical method and data set are used to study the effects of tax policy on corporate financing choices Clear evidence emerges that non-debt tax shields "crowd out" interest deductibility, thus decreasing the desirability of debt issues at the margin Previous studies which failed to find tax effects examined debt-equity ratios rather than individual, well-specified financing choices This paper also demonstrates the importance of controlling for confounding effects which other papers ignored Results on other (asymmetric information) effects on financing decisions are also presented

1,040 citations