Showing papers on "Capital structure published in 1992"

The firm as a nexus of treaties

Abstract: Part 1 Knowledge - its acquisition, sharing and/or asymmetry: the participatory generation of information rents and the theory of the firm, Masahiko Aoki common knowledge and the co-ordination of economic activities, Jacques Cremer profit sharing, information and employment, Matti Pohjola. Part 2 Vertical integration and the strategic management of the enterprise: what is vertical integration?, Michael H.Riordan vertical integration, transaction costs and "learning by using", Kurt Lundgren the firm as a nexus of internal and external contracts, Torger Reve. Part 3 Issues of labour organization: the viability of worker ownership - an economic perspective on the political structure of the firm, Henry Hansmann intellectual skill and the role of employees as constituent members of large firms in contemporary Japan, Kazuo Koike the implicit contract for corporate law firm associates - "ex post" opportunism and "ex ante" bonding, Robert H.Mooking. Part 4 Finance and the political structure of the firm: capital structure as a mechanism of control - a comparison of financial systems, Erik Berglof long-term contracts in financial markets, Hakan Lindgren the principle of external accountability in competitive markets, Herbert Gintis union militancy and plant designs, Kar Ove Moene can transaction cost economics explain trade associations?, Marc Schneiberg and J.Rogers Hollingsworth.

Determinants of capital structure.

Abstract: This study analyzes the determinants of hospital capital structure in a new market setting that are created by the financial pressures of prospective payment and the intense price competition among hospitals Using California data, the study found hospital system affiliation, bed size, growth rate in revenues, operating risk, and asset structure affected both short- and long-term debt borrowings In addition, percentage of uncompensated care, profitability, and payer mix influenced short-term borrowings while market conditions and ownership affected long-term borrowings Most significant of all is the finding that smaller hospitals tend to borrow more, possibly because they cannot generate funds internally

Executive Incentive Plans, Corporate Control, and Capital Structure

Abstract: Agency theory recognizes that the interests of managers and shareholders may conflict and that, left on their own, managers may make major financial policy decisions, such as the choice of a capital structure, that are suboptimal from the shareholders' standpoint. The theory also suggests, however, that compensation contracts, managerial equity investment, and monitoring by the board of directors and major shareholders can reduce conflicts of interest between managers and shareholders. This research investigates the relationship between the firm's capital structure and 1) executive incentive plans, 2) managerial equity investment, and 3) monitoring by the board of directors and major shareholders. This paper finds a positive relationship between the firm's leverage ratio and 1) percentage of executives' total compensation in incentive plans, 2) percentage of equity owned by managers, 3) percentage of investment bankers on the board of directors, and 4) percentage of equity owned by large individual investors. These findings are consistent with the predictions of agency theory, suggesting, in turn, that capital structure models that ignore agency costs are incomplete.

Measuring the Agency Cost of Debt

Abstract: We adapt a contingent claims model of the firm to reflect the incentive effects of the capital structure and thereby to measure the agency costs of debt. An underlying model of the firm and the stochastic features of its product market are analyzed and an optimal operating policy is chosen. We identify the change in operating policy created by leverage and value this change. The model determines the value of the firm and its associated liabilities incorporating the agency consequences of debt. THE OPTIMAL CAPITAL STRUCTURE for a firm is now widely regarded to be determined by a broad range of factors including a mix of tax effects, the various agency problems associated with different securities, and the various costs of issuing securities, including the costs created by adverse selection. While the existence of a theoretical optimum has been demonstrated in a variety of papers, a less explored area has been the construction of detailed models that enable us to measure each of the relevant factors for a particular company and thereby to determine the actual optimal mix for that firm. This gap in our understanding is particularly glaring in the case of agency costs. In order to allow a careful modelling of strategic relations, the parameters of most agency models are either so simplified that it is impossible to associate them with measurable parameters of a real world case, or else the models simply abstract from certain critical factors-such as a robust measure of price risk-that must be incorporated into any real application. For example, although we now understand that sinking funds, dividend restrictions, and other bond covenants help to resolve the conflict of interest between bondholders and equity, we do not yet have much in the way of models with which to determine the optimal parameters of these very covenants. Contingent claims models can provide a consistent framework for multiperiod valuation that properly accounts for risk, but they usually abstract from the agency factors entering capital structure decisions. When using a contingent claims model to value a firm's securities it is common to take the value of the firm itself as governed by an exogenously defined stochastic process. The value of the firm's securities are then derived from this underlying value, and, as Merton (1974) points out in his paper on the pricing of risky debt, the Modigliani-Miller theorem obtains so that the value of the firm is independent of the value and the type of debt. In order to apply the contingent claims techniques to a setting in which agency problems are central, some adaptation is necessary. In this paper we

Taxes and Capital Structure: Evidence from Firms’ Response to the Tax Reform Act of 1986

Abstract: While the theoretical relation between taxes and capital structure has been extensively analyzed, the empirical evidence on this issue has thus far been inconclusive. One of the main difficulties confronting previous empirical studies of the cross-sectional relationship between taxes and leverage was the control of intervening variables. The Tax Reform Act of 1986 (TRA), which drastically changed the tax regime, provides a unique opportunity to assess the interaction between taxes and leverage decisions in a controlled environment. The authors test the relationship between leverage and certain tax-related variables for a large sample of companies in the years surrounding the enactment of TRA. The results support the tax-based theories of capital structure. The findings indicate that there exists a substitution effect between debt and nondebt tax shields, and that both corporate and personal tax rates affect leverage decisions. Coauthors are Dan Givoly, Aharon R. Ofer, and Oded Sarig. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Security Interests, Misbehavior, and Common Pools

Abstract: The Modigliani-Miller Theorem on the irrelevance of corporate capital structure is perhaps the best-known result in modern finance Simply put, the theorem states that, under certain assumptions, the market value of a firm is independent of its capital structure Under the stylized assumptions of the theorem, substituting equity for debt or adding layers of debt to the capital structure of a firm, as occurred during much of the 1980s, has no affect on the firm's value' The theorem applies not only to the mix of debt and equity, but also to the mix of debt itself, such as between secured and unsecured or senior and subordinated debt2 Understanding existing patterns of debt and equity therefore begins with the Modigliani-Miller Theorem One must identify which of the theorem's assumptions do not hold and explain why relaxing them leads to the patterns of debt and equity that currently exist Much scholarship has examined the assumption that changes in capital structure do not affect the way in which a firm uses its assets3 There is little reason to think that this assumption is true It is now well-understood that equityholders may choose different projects if debt is present than they would otherwise: equityholders enjoy all of the benefits of successful projects but share the losses from unsuccessful ventures with creditors

Are Debt and Leases Substitutes

Abstract: Lease valuation models often begin with the assumption that leases and debt are substi? tutes. This paper demonstrates that, because leasing is a mechanism for selling excess tax deductions, it can motivate the lessee firm to increase the proportion of debt in its capital structure relative to an otherwise identical firm that does not use leasing. Thus, debt and leases can be complements. We also show that a competitive lessor will use diversification to reduce risk and increase the probability that tax deductions are fully utilized so that it can lower lease payments.

Capital Structure as an Optimal Contract Between Employees and Investors

Abstract: The ex ante optimal contract between investors and employees is derived endogenously and is interpreted in terms of debt, equity, and employees' compensation. Although public equity financing is feasible in this model through verified accounting income, debt is needed to force value-enhancing restructuring before the income realizes. The optimal debt level, however, is lower than that which maximizes the value of the firm when there is nonmonetary restructuring-related cost to employees. The paper explains how stock prices react to exchange offers, how earnings can be diluted by a decrease in leverage, and why employees' claims are generally senior to those of investors. New testable implications about leverage and compensation levels are derived. INVESTORS AND EMPLOYEES ARE the most important stakeholders in the firm. The contractual arrangements involving employees and investors should play a major role in the theory of the firm. This paper explicitly analyzes the contracting problem between employees and investors. It shows that the firm's capital structure can be a part of the optimal contract. The extant finance literature has studied the role of capital structure in mitigating the agency problem between employees and investors (see Jensen and Meckling (1976)). Some economists, however, have asked why capital structure, in addition to compensation schemes, has to be used as an incentive device (see Hart and Holmstrom (1987), for example). One cannot answer this question without explicitly analyzing the optimal contracting problem. The existing economic literature on contracting mainly studies managerial "shirking" problems and "stealing" problems. In the models that deal with the shirking problem, employees have incentives to shirk, and the contract is structured to motivate them to work. The optimal contract derived is inter

A multicriteria approach for evaluating the performance of industrial firms

Abstract: Multivariate techniques have been widely used for the explanation and prediction of the firm's behaviour. However, in practice, the comparative evaluation and ranking of companies is usually based on the consideration of a single measure of corporate success. But the definition of the most appropriate measure gave rise to a considerable debate. This paper tries to utilise the results of a multicriteria analysis, applied to a large sample of Greek pharmaceutical industries, in order to indicate how suitable some common financial ratios are as indices of the firm's overall performance. The results show that profitability constitutes the most representative measure for the differentiation and ranking of companies. Labour productivity and market share are the best indicators of the business' success, while business' failure is more closely related to ratios indicating long- and short-term solvency. This means that a sound capital structure is a necessary but not a sufficient enough condition to ensure the profitable and effective operation of the firm.

The impact of ownership and capital structure on managerial motivation and strategy in management buy‐outs: a cultural analysis

Abstract: This study examines, from a cultural perspective, owner-managers’and other stakeholders’interpretations of the partial fusion of ownership and control through high leverage in eight UK management buy-outs (MBOs). Owner-control and debt-control are interpreted as having positive effects on managerial motivation, organizational decision-making processes and implementation of cost reduction strategies and negative ones on fundamental changes in strategy and acquisition. These interpretations accord broadly with agency theory propositions but show that owner-managers place less emphasis on wealth incentive effects and more emphasis on the enabling and facilitating roles of collective ownership and the freedom it gives from inappropriate corporate control.

All-equity firms and the balancing theory of capital structure

Abstract: Despite the benefits of leverage, many firms exist that at some point in their corporate history had no debt. This study provides evidence that the balancing theory of capital structure can predict the behavior of such firms. All-equity firms allow a more precise measurement of firm market value and risk, and provide a less ambiguous relationship between independent variables and dependent variables than the firms used in previous studies. Using a logit function to avoid spurious correlation between the dependent and independent variables, we find that for most years during 1964–88 all-equity firms listed in the Compustat industrial file exhibited a consistently significant negative relationship between the Myers growth option variable and the probability of borrowing. Positively significant but less consistent relationships exist between the risk measures and the nondebt tax shields, and the probability of borrowing. These results do not qualitatively change when the data are aggregated over twenty years or over five-year subperiods. The tests are also conducted by industry according to the one-digit Standard Industrial Classification (SIC) code. Significant relationships are found in the 2000 and 3000 SIC code manufacturing industries.

A Finance Perspective on Entrepreneurship Research

Abstract: Entrepreneurship has been studied from numerous perspectives, most notably psychology, management, and marketing. Few studies, however, have utilized finance theory and methodology. Several finance based theories are explored as possible models for studying entrepreneurship, categorized as valuation and capital structure. Valuation theories and applications include such approaches as portfolio theory, capital asset pricing, efficient markets, and option pricing. The primary concepts of valuation theory are examined -- e.g., emphases on risk/return and time value of money -- as are the potential problems associated with the use of valuation theory. A second proposed approach is capital structure theory, which considers each of the following factors: leverage, taxes, and bankruptcy; agency costs; and information asymmetries. Potential limitations and implications of utilizing capital structure theory to examine entrepreneurial success are discussed, including the influence of factors like venture capital and the early stage growth/liquidity crisis. The implementation of chaos theory in studying entrepreneurship may also offer a different, valuable perspective. Overlapping areas of study for finance and entrepreneurship are identified as areas of opportunity for future research. (AKP)

Dividend policy and capital structure under the imputation tax system: some clarifying comments

Abstract: This paper analyses the effects of the imputation and capital gains taxes on the dividend and financing decisions of Australian companies. We develop a framework, consistent with Miller's [1977] approach, in which interactions between dividend and financing decisions can be explored. The significance of these interactions depends on both corporate dividend policy and on the relationship between personal and corporate income tax rates. We conclude that under imputation, dividend decisions are more important relative to capital structure decisions, than under the classical tax system. © 1992 Accounting and Finance Association of Australia and New Zealand

Managerial Objectives, Capital Structure, and the Provision of Worker Incentives

Abstract: Worker incentive schemes are invariably assumed to be administered by an owner-entrepreneur who has an incentive to understate worker performance after the event. While tournaments can overcome this problem, they discourage cooperation between workers. We show that a professional manager concerned with equality between workers and with avoiding bankruptcy rather than maximizing shareholder wealth will conduct a tournament that preserves individual effort incentives while promoting cooperation between workers. The theory predicts lower debt levels and more compressed pay scales as cooperation becomes more important. In the limit this becomes a group bonus scheme, supported by "blue-chip" debt.

Comparing corporate capital structures around the globe

Abstract: The article presents an analysis of the corporate financial structures in developing countries based on a database compiled by the International Finance Corp's Economics Department Corporate investment is a vitally important part of total investment There are links between corporate behavior and macroeconomic stability, on the one hand, and the health of financial institutions and the macroeconomy on the other There are also obvious links between issues of corporate finance and broader issues regarding the kind of financial systems that support long-term economic growth Specific to the firm itself are considerations such as profitability, earnings volatility, and the nature of its capital assets and markets Corporations in developed countries have a wide range of choices for financing investment After internal funding, new debt provided the next highest source of financing Within this category, bank loans provided far more financing than did corporate bonds Japan was the largest user of bank funding, financing 50% of its capital needs from this source Despite the recent concerns over high degrees of gearing, use of internal funds has actually increased in the last two decades compared to the overall postwar era US corporate experience highlights the dynamic nature of financing decisions, especially the revision that occurred during the 1980s

Tax Incentives and Capital Structures: The Case of the Dividend Reinvestment Plan

Abstract: This study investigates the impact of 1981 tax legislation (Internal Revenue Code (IRC) Section 305(e)) creating tax deferral for dividend reinvestment plans (DRPs) of qualifying utility companies. The intent of the legislation was to assist public utilities in raising new equity capital by encouraging reinvestment of dividends in qualifying firms. The effectiveness of this legislation is in doubt for at least two reasons. First, the tax benefits to any taxpayer were only $750 for single returns and $1,500 for joint returns. Second, clientele arguments (Miller [1977] and Miller and Scholes [1982]) suggest that taxpayers subject to low marginal rates would be typical investors in utility stocks. Both conditions imply that the economic incentives associated with dividend deferral might be small. Our results indicate that the second condition-low marginal rate taxpayers holding utility stocks-is not observed. Specifically, we observe a positive share price reaction at announcements related to

Bankruptcy, Warranties and the Firm's Capital Structure

Abstract: This paper examines the role of capital structure as an instrument for shifting risk between real and financial markets. The author considers a firm whose contractual agreements involve both consumers and debtholders and shows that if consumers are risk averse, whereas equity and debtholders are risk neutral, the firm uses its capital structure to shift risk away from consumers. The optimal allocation of risk across real and financial markets leads the firm to be fully equity financed. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Optimum Capital Structure Redefined

Abstract: Within a dynamic framework of capital growth and income generation, optimum capital structure of a firm is redefined under two alternative hypotheses. By the optimum control theory, it is shown that under conditions of perfect competition optimum equity/debt ratio of a firm can be uniquely determined in intertemporal maximization models of investor behavior. The result is new, but it is juxtaposed in the vast body of existing literature and finally compared with the Lintner-Sau and Modigliani-Miller models.

Corporate growth, corporate strategy, and the choice of capital structure

Abstract: The interaction between a firm's strategic decisions and its financial policies has become an increasingly frequent topic in the managerial economics literature. We examine here a dimension of that interaction that has not previously been addressed, and suggest a new framework for defining the manner in which choices of strategy and choices of capital structure might be jointly determined, in an environment where upward pressures on factor costs and product prices are the norm.

On the Capital Structure of Leveraged Buyouts

Abstract: A signalling hypothesis of LBO capital structure is examined, wherein the promoters of an LBO unambiguously convey their commitment to generate and distribute free cash flow to investors by assuming debt service obligations high enough to exhaust free cash flow during the initial phase of the LBO operation. The signalling equilibrium results in an equity value consistent with the promoters' expectations concerning free cash flow and permits them to keep the value released by the LBO. The model admits positive probability of default in equilibrium, but equity values are shielded from the costs of financial distress by the adoption of a strip financing arrangement. The promoters have an incentive to adopt strip financing and investors find it not optimal to unbundle the securities making up the strip. Properties similar to those of strip financing are identified in a number of common financial structures and instruments.

Small Business Capital Structure Choice

Abstract: A simple single-period model of entrepreneurial capital structure choice under conditions of informational asymmetry is developed. The uncertain terminal cash flow generated by a business venture is assumed to depend on both the amount of effort provided by the entrepreneur and the quality of the business venture. External financing induces the effort-averse entrepreneur to reduce the amount of effort he exerts. However, by astute choice of capital structure, the entrepreneur can mitigate this effect. It is shown that this entails financing high quality ventures with debt and low quality ventures with equity. This explains the predominance of debt in the capital structures of small firms.

The Choice Among Long‐Term Financing Instruments for Public Utilities

Abstract: This study examines the decision of regulated utilities to raise new financing via common stock, debt, or preferred stock offerings. We develop several logit models to test how a set of relevant variables affects the issuing choice. These variables include the level of insider ownership, regulatory climates, measures of aggregate market conditions, bankruptcy risk, deviations from the long-and short-term target ratios, asset composition, etc. In addition, this paper tests whether the cross-sectional level of debt ratio is related to some of these same factors. Our findings indicate that U.S. electric utilities are not influenced by market timing when making a choice among long-term financing instruments. However, our results do show that ownership structure variables, such as the number of directors and officers, seem to have a significant negative influence upon the choice of common stock, thus lending support to Friend and Lang's finding. In addition, capital structure seems to matter for utilities.

How financial liberalization in Indonesia affected firms' capital structure and investment decisions

Abstract: How did financial liberalization affect Indonesian firms? The authors analyzed real and financial indicators for the establishments in their panel of Indonesian manufacturing establishments for 1981-88. Their sample was not representative, but their evidence shows that economic reform had favorable effect on the performance of smaller firms. Liberalization helped reallocate domestic credit toward smaller firms to a level roughly proportionate to their contribution to value-added. Moreover, other firms were successful in replacing expensive domestic credit with cheaper foreign credit, releasing some domestic credit to establishments that lacked access to it. Nominal and real interest rates rose to very high levels, but real returns to capital assets remain high and have increased substantially for small and medium-size exporting establishments. For all groups, higher rates of financial leverage gave rise to extremely high returns on owned equity. Medium-size firms - both conglomerate and non-conglomerate - have had the highest rates of return to capital, financial leverage, and returns to equity. Financial reform has had a significant impact on firm's real and financial choices. Shifting from administrative allocations of credit to market-based allocations has increased borrowing costs, particularly for smaller firms, but it has also widened access to finance. The net effect appears to have been a decrease in the degree of market segmentation and a relaxation of financial constraints to the benefit of investment activity.

The concise guide to company finance and its management

Abstract: Financial environment defining the project and methods of appraisal decision-making in project appraisal further problems in project appraisal introduction to risk in project appraisal capital asset pricing model and project appraisal risk analysis market efficiency equity share capital long-term debt finance capital structure policy dividend policy management of working capital short- and medium-term sources of finance management of cash management of debtors inventory management mergers and acquisitions.

Market Reaction to Capital Structure Changes and its Association with Profits, Cashflow and Dividends

Abstract: We provide evidence of stock market performance prior to announcements of the assuance or retirement of securities which is consistent with Myers and Majluf [1984] and Miller and Rock [1985]. Stocks of firms issuing seasoned common equity are significantly over‐valued in the market prior to the issue, but in the year following, decline to their original level. Stocks of firms issuing convertible debt also are over‐valued, but to a lesser degree than that of firms issuing seasoned equity. Stock of firms issuing straight debt appears to be neither over‐valued nor undervalued. The after‐market firm performance, measured by earnings, cash flows or dividends, is consistent with Miller and Rock. We document a decline in after‐market performance for firms issuing convertible or straight debt and an improvement for those repurchasng shares. However, contrary to predictions, we find that firms issuing seasoned equity do not have lower earnings or cash flows in the following year, and increase their rate of dividend payment as well. We document evidence indicating that firms issue equity to maintain or increase dividends. The market anticipates the dividend increase and shows no response to announcements of dividend changes following an equity issue. However, we are unable to explain why the market reacts in such a negative manner to equity issues, when the after‐market performance of the firm is as expected.

Wage negotiations and capital structure: a strategic bargaining approach

Abstract: We analyse the relations between firm''s debt and bargained wage level and its implications for the optimal choice of the capital structure. Similarly to Hart and Moore (1991), we place the analysis of the feasible debt contracts in a strategic bargaining setting, in which both the management and the workforce of the firm have human capital specificities in production. We obtain that debt repayments constrain wage levels, providing an advantage for debt financing. Moreover, either under investment can arise, due to wealth constraints, or on the contrary, firms may borrow more than what is required by the production process.