Showing papers on "Capital structure published in 1985"

Valuation Effects of Corporate Debt Offerings

Abstract: This paper analyzes the effect of corporate debt offerings on stock prices. Straight debt offerings have non-positive price effects, while convertible debt offerings have significantly negative effects. Public utility mortgage (non-convertible) bond offerings have marginally negative effects, and the effect is significantly negative when the proceeds are used to finance the utility’s investment program. Cross-sectional regressions reveal no relation between offer-induced price effects and offering size, rating, post-offer changes in abnormal earnings or debt-related tax shields. The evidence is inconsistent with theories predicting that the price effects of capital structure changes go in the direction of the leverage change.

On the Relevance of Debt Maturity Structure

Abstract: In this paper, we present a tax-induced framework to analyze debt maturity problems. We show that under some modifications of the existing U.S. tax code, debt maturity is irrelevant even in the presence of taxes and bankruptcy costs that yield an optimal capital structure. If this restrictive structure is relaxed, and assuming the Miller [15] equilibrium does not prevail, tax reasons would usually imply the existence of an optimal debt maturity structure. If there exists a gain from leverage, then an increasing term structure of interest rates, adjusted for default risk, results in long-term debt being optimal. A decreasing term structure, under similar circumstances, renders short-term debt optimal. In the absence of agency costs, a Miller [15]-type result emerges at equilibrium and irrelevance prevails. We also argue that agency costs could again reverse the irrelevance and imply a firm-specific optimal debt maturity structure. THERE HAS BEEN EXTENSIVE discussion in the literature concerning the existence of an optimal debt maturity structure. Kraus [13] states, without proof, that efficient capital markets preclude the existence of an optimal debt maturity. Stiglitz [20] demonstrates the irrelevance of debt maturity, but in an economic environment in which the entire financing decision is irrelevant due to the absence of taxes and bankruptcy costs. In contrast, Morris [16] argues that the issuance of short-term debt can reduce the risk to stockholders and thereby increase equity value, if the covariance between the net operating income and future interest rates is positive. This result by Morris is obtained even in the absence of taxes and when there is no probability of default. The discrepancy between Morris and Stiglitz arises because Morris uses the Bogue and Roll [31 multiperiod Capital Asset Pricing Model to incorporate uncertain future interest rates, which implicitly assumes that investors cannot diversify away intertem

The Effect of Voluntary Sell-off Announcements on Shareholder Wealth

Abstract: Sell-off activities arise when a firm sells part of its assets (e.g., a segment, a division, etc.) but continues to exist in essentially the same form. This study investigates the effect of voluntary sell-offs on stock returns. From a sample of over 1000 sell-off events (first public announcements), the evidence shows that both sellers and buyers earn significant positive excess returns from these transactions. The excess returns earned by buyers are smaller than those earned by sellers. There is also evidence that sell-off announcements are preceded by a period of significant negative returns for the sellers which suggests that the sellers, on average, performed poorly prior to their sell-off activities. SUBSTANTIAL RESEARCH HAS BEEN undertaken in recent years on mergers, acquisitions, tender offers, capital structure changes, and other financial planning topics. This research has considerably expanded our knowledge about the association of these decisions with the welfare of the stockholders involved in these transactions.' Selling a portion of the firm's assets is another important financial planning decision.2 This paper investigates the effect of voluntary sell-off announcements on shareholder wealth. A sell-off is defined as selling part of a firm's assets (e.g., a segment, a division, etc.), while the firm continues to exist in essentially the same form as that prior to the sell-off. This study does not examine the effects of involuntary (ordered by the government) sell-offs and other similar activities such as spin-offs, leveraged buy-outs, liquidations, reorganizations, etc.3

Reformulating Tax Shield Valuation: A Note

Abstract: Standard financial theory (in the absence of agency costs and personal taxes) implies that each dollar of debt contributes to the value of the firm in proportion to the firm's tax rate. To derive this result, incremental debt is assumed permanent. This paper shows that when the firm acts to maintain a constant market value leverage ratio, the marginal value of debt financing is much lower than the corporate tax rate. Since Hamada's [2] unlevering procedure for observed equity betas was derived under the assumption of permanent debt, we derive an unlevering procedure consistent with the assumption of a constant leverage ratio. IMPLICIT IN THE MODIGLIANI-MILLER [4] hypothesis regarding the effect of leverage changes on firm value is that the firm maintains a constant level of debt. The purpose of this paper is to examine the implications for tax shield valuation of maintaining a constant market value leverage ratio instead of a constant debt level. Assuming a constant leverage ratio instead of a constant debt level does not imply any change in the normative implications of capital structure theory. However, we show that when the firm's financing strategy is to maintain a constant market value leverage ratio, the marginal value of a change in debt level resulting from a change in this leverage ratio is much lower than the corporate tax rate. We also derive the relationship between the firm's equity beta and its unlevered beta under the assumption of a constant leverage ratio.

Vertical Information Transfers: The Association between Retailers' Sales Announcements and Suppliers' Security Returns

Abstract: Accounting research has documented an association between the occurrence of at least some types of disclosures made by a firm (e.g., earnings announcements, accounting changes, or capital structure changes) and that firm's security return. As yet, however, there is little evidence about the relation between information disclosures made by one firm and security prices of other firms, although cross-sectional relations among security prices, sometimes described as industry factors, are well documented (e.g., King [1966], Schipper and Thompson [1983], and Smith [1981]). One possible explanation for this cross-sectional association is that information disclosures made by one firm may provide relevant information about other firms. Recently, Foster [1981] examined the impact of earnings announcements on the security prices of other firms in the same industry. Foster documented statistically significant security returns for nonannouncing firms in ten industries at the time of "large" security returns for announcing firms within the same industry. These "intraindustry information transfers" suggest news releases of other firms within an industry are used in the determination of a given firm's security price.

Debt and Taxes and Uncertainty

Abstract: With a graduated personal tax schedule, Miller showed that there could be an equilibrium debt supply for the corporate sector as a whole. In the presence of uncertainty there is also a unique debt/equity ratio for each individual firm, and this ratio is related to the firm's operational risk characteristics. However, if firms merge and spin off in response to tax incentives, the identity of firms is ambiguous and only the corporate sector is a meaningful construct. These arguments are developed in both discrete and continuous models that employ extensions of the arbitrage-free pricing theory. IN HIS FAMOUS PAPER, "Debt and Taxes" (1977), Merton Miller [11] showed that the original Miller-Modigliani propositions on the irrelevance of capital structure were not necessarily overturned by considerations of taxation. Miller argued that with a broad enough span of progressivity in personal income taxation, the corporate tax advantage to the issuance of debt would be offset by the disadvantage to investors of receiving ordinary income on personal account. In equilibrium, the differential rates of return on equity and debt would be such that the marginal investor would be indifferent between purchasing debt instruments or equity. The margin would be determined by the total amount of debt issued by the corporate sector, but in a competitive world it would be unaffected by the debt issued by any one firm. As a consequence, the total supply of corporate debt would be determined in equilibrium, increasing to the point where aggregate corporate value was not enhanced by further debt financing, but any individual firm would be looking at prices set at the margin and would find itself indifferent between issuing debt or equity. The purpose of this article is to extend Miller's argument by recognizing the differences between debt and equity when the environment is not certain. We will not be concerned with what might be called corner questions, i.e., with whether or not there is a marginal investor or an internal equilibrium. To do so would obscure the basic points we have to make. Instead, we will examine models that have internal equilibria and ordinary neoclassical marginal interpretations. In related work, De Angelo and Masulis [5, 6] have also extended Miller's analysis, but their primary concern was with the effects of a more detailed treatment of the tax code and with the impact of bankruptcy. We will deal with such matters only in passing; our central concern is with the impact of uncertainty. Our main result is the finding that there is a relationship between the capital structure of the firm-as induced by tax effects-and ordinary (beta) measures

The Choice of Call Provision Terms: Evidence of the Existence of Agency Costs of Debt

Abstract: An examination of the provisions of bond issues reveals that most bonds prohibit firms from calling the issue during the initial years, after which time the bond can be called at the option of the firm. A substantial number of firms, however, also reserve the right to call the issue during this initial period for purposes other than refinancing at a lower coupon rate. The additional flexibility which accompanies the option of early redemption can be used to reduce the agency costs of debt associated with future investment opportunities, informational asymmetry, and the risk incentive problem. Using a sample of newly issued bonds, statistical tests are performed to show that there are, in fact, differences between firms which do and do not reserve the right of early redemption. This paper shows that these differences provide empirical evidence which is consistent with the hypothesis that firms use the option of early redemption to reduce agency costs. ONE OF THE DECISIONS which a firm must make when it floats a bond issue concerns the use of a call provision. If a call provision is included in the bond, then the terms of the call provision must be specified such as the years to the first call, the initial call price, the call price in subsequent years, and the circumstances under which a call provision can be used.. Previous work in the area of call provisions focused on fluctuations in interest rates as the reason for their existence. It was shown by Krause [12], however, that in an efficient capital market any call provision decision based on interest rate uncertainty is irrelevant. Recent work in agency theory has shown that the existing contractual relationships between bondholders and stockholders may not be a zero-sum game. Under these circumstances, such financing decisions as capital structure, debt maturity, and call provisions may not be irrelevant. An examination of the call provisions of currently outstanding bond issues reveals an institutional feature which is often overlooked. Many bonds have a standard call provision which restricts the firm from calling the issue for a stated number of years, followed by a period during which firms have the option to call the bond at a stated call price. Another group of bond issues, however, contain a two-tiered type of call provision which allows the corporation to call the bond, for purposes other than refinancing at a lower coupon rate, during the initial years of the life of the bond. After this initial period the firm has the option of calling the bond issue for any purpose.'

Changes in capital structure, new equity issues, and scale effects

Abstract: This study determines the impact of a new issue of common stock on security holder wealth and the magnitude attributable to transaction costs, tax shield dilution, wealth transfers, and informational content. The empirical results indicate that shareholders of firms announcing new equity issues experience significant, abnormal, negative returns. The per share transaction cost accounts for 22.6 percent of the observed abnormal return. The tax shield dilution effect accounts for 7.8 percent. No evidence of a wealth transfer effect is found. Thus, approximately 70 percent of the abnormal return can be attributed to new unfavorable information that becomes available to the market.

Effects of Regulation on Utility Financing: Theory and Evidence

Abstract: standing of these cross-sectional variations might be afforded by the detailed examination of specific industry characteristics and their relationship to firms' financing patterns. The present study offers a methodology for approaching this issue. The first step is to assemble joint theories of industry and financial structure in order to identify the ways in which changing industry conditions might be associated with changes in financing. Evidence on such simultaneous changes can then be examined in an attempt to identify the most plausible joint theory. The methodology is used to investigate the effects of state commission regulation on the financing of electric utilities. This is a natural candidate for study since regulation is such a salient feature of the industry. In addition, the regulatory system imparts some interesting special features to the very nature of utility capital structures. Inherent in all capital structures, for example, are opportunities for shifting wealth between bondholders and shareholders, but under regulation these wealth-shifting opportunities are expanded to encompass consumers as well. Finally, the study of regulation has resulted in several relatively well-specified theories of why regulation is imposed and what its observable effects should be. In Section I, the different theories of capital structure and regulation are discussed and their joint implications are derived. The capital structure theories include the 'perfect capital market' theory, the 'debt capacity' theory and the 'financing hierarchy' theory. The regulatory theories include the 'public interest' or 'market failure' theory, the 'political economy' theory and the 'imperfect monitoring' theory. In Section II, financing data from the early days of state commission utility regulation are used to try to distinguish

On Mergers, Divestments, and Options: A Note

Abstract: In this note, a loss shared by the security holders of merging firms is pointed out: separate corporate entities provide double protection against future negative cash flows that are part of any production process (e.g., when customer or employee liabilities exceed future in? come), independent of whether or not debt is used in the corporate capital structure. A merger involves a relinquishment of this double protection in return for a less valuable single protection: limited liability in the merged corporation against combined negative cashflows.

Capital Structure Change and Decreases in Stockholders' Wealth: A Cross-sectional Study of Convertible Security Calls

Abstract: This paper is a cross-sectional analysis of the relationship between common stock price reactions to announcements of convertible security calls and variables that represent possible determinants of changes in common stockholders' wealth. The variables are measures of the following effects of convertible security calls: (1) the change in interest expense tax shields, (2) the potential redistribution of wealth from common stockholders to preferred stockholders and debt holders,(3) the decrease in the value of conversion privileges heldby convertible security holders, (4) the relative increase in shares outstanding and (5) the change in earnings per share. A significant relationshipis found only between the measure of the reduction in interest expense tax shields and the stock price response to call announcements.The apparent corporate tax effect is consistent with some combination of effects due to (1) a reduction in interest expense tax shields and (2) unfavorable information about the calling firm's value of earnings prospects that is conveyed by a call of convertible securities.The evidence is consistent with theories of capital structure that imply optimal financial leverage depends on earnings prospects and with theories that imply reductions in leverage convey unfavorable information about firm value.

The Effect of Forward Markets on the Debt-Equity Mix of Investor Portfolios and the Optimal Capital Structure of Firms.

Abstract: This paper demonstrates that the various market imperfections that have been suggested to explain observed portfolio choices and capital structures can be circumvented if securities (e.g., options) can be traded that simulate forward contracts on stock. It is shown that if the risk-adjusted returns to bondholders exceed the returns to stockholders (to reflect personal tax differences) tax-exempt investors will prefer a combination of these synthetic forward purchases and corporate bonds to purchasing stock directly. They will not, as has been suggested, include stock in their portfolios for diversification purposes when they can alternatively purchase securities that simulate forward contracts. It is also shown that firms that can sell synthetic forward positions on their own stock can essentially guarantee that sufficient funds will be available to meet their bond obligations. This gives firms the opportunity to increase their debt levels without increasing the possibility of bankruptcy and the corresponding administrative and agency costs.

Taxes, Capital Structure, and Bondholder Clienteles

Abstract: Despite much recent progress, financial theory has yet to explain the connection, if any, between the U.S. tax code and many observed characteristics of corporate bonds.' Empirically, why is there no single tax rate equating yields on corporate bonds with yields on tax-exempt municipal bonds of apparently identical risks and maturities?2 Specifically, why does the spread in yields between corporate and municipal bonds divided by the yield on corporates, a conventional measure of the marginal tax rate on corporates, decrease with increasing risk and maturity? More generally, why are different types of bonds evidently held by clienteles of investors in Tax clienteles for corporate bonds are identified in a competitive financial equilibrium. Under an asymmetric corporate income tax with interest preceding principal, state-contingent bonds with higher coupon yields are issued by firms with higher pretax cash inflows per dollar of nondebt tax shield, purchased by investors in lower tax brackets, and implicitly priced at lower marginal tax rates. On these bonds all investors earn tax-induced 'surpluses. By contrast, all other bonds have implicit tax rates typically equal to the corporate rate and yield for many investors no tax-induced surpluses. * We gratefully acknowledge the helpful comments of George Constantinides, Kose John, Merton Miller, Jim Scott, Marti Subrahmanyam, and participants in seminars at Baruch, Chicago, Columbia, Houston, Michigan, NYU, Rutgers, USC, Washington, Wharton, the American Finance Association, the Western Finance Association, and the Johnson Symposium on Taxes and Finance at Wisconsin. George Constantinides was especially helpful. 1. The most notable contribution is Miller (1977). Other recent papers include Chen and Kim (1979); Kim, Lewellen, and McConnell (1979); DeAngelo and Masulis (1980a, 1980b); Taggart (1980); Kim (1982); Auerbach and King (1983); and Talmor, Haugen, and Bornea (1985). Black (1971) anticipates an equilibrium with clienteles. 2. Schaefer (1982a) identifies tax-induced clienteles of bondholders in the British gilt market. Van Horne (1982) reports that implicit tax rates vary over time as the supply of discount bonds changes. Additional evidence is cited in Trczinka (1982).

Effects of worker attitudes on production costs and the value of capital input

Abstract: In earlier papers we have defined and demonstrated the feasibility of estimating an index of worker performance, based on indicators of worker attitude, in the context of an equilibrium translog cost function.1 We repeat some of the background material here in compressed form. The objective of this paper is to investigate the worker-attitude phenomenon in the context of a model of the production process that explicitly recognises disequilibrium in the fixity of the capital stock during the production period.2 This approach, while it begs certain unresolved questions, is preferable to the equilibrium approach for investigation of the effect of worker attitudes on the capital requirements in US automobile manufacturing.3 We chose the disequilibrium model with two objectives. First, the capital structure of auto assembly and parts manufacturing plants is largely fixed during a particular model year. Since the model year does not coincide exactly with the calendar year, there will be some blurring of this effect, but the fixed-capital model is far preferable for this industry to the instantaneous-adjustment assumption. Second, in the equilibrium model the bias in technical change for capital in this instance induced by the effects of worker attitudes -is constrained so as to be balanced by offsetting effects in the use of other factors. The disequilibrium model, on the other hand, constrains only the variable factors in this way. While the demand (or share) equation for capital is not estimated directly, the effect of altered worker attitude can be simulated using the estimated model.4 Our earlier study found a substantial capital-using bias in the effect of worker attitudes on the equilibrium translog cost function.

Assessing the financial characteristics of multi-institutional organizations.

Abstract: The prospective pricing of health services is precipitating greater attention to financial characteristics and greater development of multi-institutional organizations (MIOs). This study compares the financial characteristics of 1,590 MIO hospitals with 2,819 freestanding hospitals by ownership type: church-operated, other not-for-profit, and investor-owned. Using 1981 data from the American Hospital Association, the hospitals' capital structure and profitability are measured using three financial ratios: total assets-to-equity, return on equity, and operating margin. The results indicate both greater leverage and greater profitability among MIO hospitals, particularly in the investor-owned sector. The implications of these findings are discussed relative to financial performance by hospital ownership type in the future.

Bankruptcy Costs: Evidence from Small-Firm Liquidations:

Abstract: This paper examines the economic significance of bankruptcy cost by analysing the duration, costs and claimholder losses disclosed in the public record relating to a sample of 408 Australian corpor...

Information Technology, Capital Structure and the Nature of Technical Change

Abstract: This paper presents statistical evidence on (1) the importance of "soft" capital spending items like marketing and R&D investments, and (2) the dominant service content of production in the modern manufacturing firm. It pictures the firm as a dominantly information processing entity that has been gradually shifting its competitive base from process cost efficiency toward a product technology. The paper, hence, argues (3) that during the post-war period technical change has been gradually pivoting in a relatively more (hardware) capital saving direction.

Equity and costs.

Abstract: want power for its own sake. For their part, the public health experts and state officials voiced suspicioiis that hospitals were mainly interested in the operation for its prestige and the attendant effects of patient referrals, research funding, and attraction of talented physicians and trainees. Historically, the hospitals have won the large majority of such battles, leading their opponents to feel helpless before what they see as a technological juggernaut. The waters were also poisoned by the difficulties the hospitals experienced in drawing up a proposal to work together. For a time, it appeared that one hospiral would attempt to go it alone, with the state's blessing. Hospitals satisfactorily resolved their differences behind the scenes, and the differences among those representing the hospitals, the insurance industry, public health academics, and the state were at least fully aired and moderated. The Task Force eventually reached unanimous agreement. This achievement is rather remarkable. While some may question the utiliry and cost-effectiveness of ad hoc blue ribbon panels, this one was certainly worthwhile. Ideally, the work should have consumed less than an entire year, but the panel brought together some v e n busy peoplc-distinpished surgeons, such as Paul Russell and Francis Moore, and repre. sentatives of all parties concerned, e.g., the general public, the insurance industry. religion, and law. Testimony was solicited from outside experts as well, including Arnold Relman, M.D., Editor of the New EnglatrdJouniaI 01 Medicine, Gerald Austen. M.D., Surgeon-in-Chief at Massachusetts General Hospital, and Harvey Fineberg, M.D., Dean of the Harvard School of Public Health. Important data were supplied by Roger Evans, Ph.D., of t h e Battelle Human Affairs Research Center in Seattle and Director of the National Heart Transplant Study, scheduled for release i n early 1985. In addition to its broad base and painstaking research, the Task Force deserved commendation for holding all of its 16 meetings in public. In regard to the Task Force's findings, it is hard to criticize the Report's assertion that heart and liver transplantations are very expensive undertakings. However, almost no data are available on the cost of a policy of not doing these transplantations. The costs of dying from end-stage heart disease are examined in the forthcoming National Heart Transplant Study, but policy decisions in Massachusetts, as elsewhere, have had to be made prior to the release of this information. More discussion in the Report of the problems of organ shortage might have been helpful, in case the New England Organ Bank proves unable to obtain the needed number of donor hearts and livers despite its record of success in kidney procurement. Among the possibilities might be the passage of presumed consent legislation, requiring a \"yes or no\" on a driver's license, or requiring physicians to broach the subject with families of potential donors. However, like discussions of the place of the artificial heart and of inter-species transplants, these issues can be addressed in the future.

Vacuum of Fact or Vacuous Theory: A Reply to Professor Kripke

Abstract: In 1979, Thomas Jackson and Anthony Kronman asked the related questions why debtors offered security in personal property and whether a security interest would increase the welfare of a debtor and all of its creditors, taken as a group.' These questions inspired a vigorous debate.' The participants have taken as their starting point the Modigliani & Miller irrelevance proposition that if capital markets are perfect, information is perfect, all actors have homogeneous expectations, bankruptcy costs are zero, and no taxes exist, a firm cannot increase its value by altering its capital structure. A change in the mix of a firm's debt, from unsecured debt to secured, is an alteration in its capital structure. Since such a change cannot increase the firm's value and since it is costly for firms to offer security, the irrelevance proposition predicts that no secured debt will be issued. Because secured debt is common, participants in the "security interest debate" therefore proceed in two ways: they relax the strong assumptions that Modigliani & Miller made to see whether the new models thereby obtained predict security, or they add additional factors-moral hazard, risk aversion, and the like-to see whether models so derived can explain the ob-

Debt and taxes: empirical evidence

Abstract: The literature currently proposes several capital structure theories whose predictions are generally mutually exclusive. Empirical testing to date has been subject to serious conceptual and econometric problems. The present study, which is carried out on a cross-section of industrial firms, attempts to overcome several deficiencies in earlier studies. Although the results are more consistent with Miller's 1977 hypothesis that the value of the firm is independent of leverage in the absence of leverage-related costs than they are with those theories which predict a value-maximizing optimum debt level, there is significant evidence that the value of the firm may be negatively related to leverage over a broad range of debt usage.

The Boston Consulting Group's strategic menagerie

Abstract: In this, the first in a series of three articles which summarize the Boston Consulting Group's approach to setting strategy, problems of funding growth and allocating resources around a portfolio of products or strategic business units are highlighted. The relationships between the stage of the product life cycle, the funding requirements of a business, and the alternatives for generating funds are explored. Growth and risk issues are highlighted and the maximum sustainable rate of growth from internally generated sources is derived. The impact of the experience curve on capital structure, production costs, and competitive position emphasizes the interaction between life cycle position, cost position, profitability, and cash flow. This logically leads to the Boston Consulting Group's Growth Share Matrix as a basis for resource allocation around a portfolio of businesses. Optimum cash flow and investment criteria are arrived at.

Discretionary managerial behaviour effects of savings and loan conversions: competitive implications for the industry in a deregulated environment

Abstract: Under the Depository Institution Deregulation and Monetary Control Act of 1980 (DIDMC) regulatory obstructions that once limited portfolio imbricaion among financial intermediaries have been removed. The resulting brisk competition has caused financial intermediaries to restructure their portfolios altering traditional risk–return relationships. A corresponding need for capital restructuring is implied. If risk and capital structure are related, minimum equity financial intermediaries may find it necessary to adjust their capital structures as portfolio risk increases. The present research investigates the managerial behaviour implications for the thrift industry as it attempts to strengthen its capital structure with equity infusions from conversions.