Showing papers on "Capital structure published in 1995"

What Do We Know about Capital Structure? Some Evidence from International Data

Abstract: We investigate the determinants of capital structure choice by analyzing the financing decisions of public firms in the major industrialized countries. At an aggregate level, firm leverage is fairly similar across the G-7 countries. We find that factors identified by previous studies as correlated in the cross-section with firm leverage in the United States, are similarly correlated in other countries as well. However, a deeper examination of the U.S. and foreign evidence suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.

Firms, Contracts, and Financial Structure

Abstract: This book provides a framework for thinking about economic instiutions such as firms. The basic idea is that institutions arise in situations where people write incomplete contracts and where the allocation of power or control is therefore important. Power and control are not standard concepts in economic theory. The book begins by pointing out that traditional approaches cannot explain on the one hand why all transactions do not take place in one huge firm and on the other hand why firms matter at all. An incomplete contracting or property rights approach is then developed. It is argued that this approach can throw light on the boundaries of firms and on the meaning of asset ownership. In the remainder of the book, incomplete contacting ideas are applied to understand firms' financial decisions, in particular, the nature of debt and equity (why equity has votes and creditors have foreclosure rights); the capital structure decisions of public companies; optimal bankruptcy procedure; and the allocation of voting rights across a company's shares. The book is written in a fairly non-technical style and includes many examples. It is aimed at advanced undergraduate and graduate students, academic and business economists, and lawyers as well as those with an interest in corporate finance, privatization and regulation, and transitional issues in Eastern Europe, the former Soviet Union, and China. Little background knowledge is required, since the concepts are developed as the book progresses and the existing literature is fully reviewed.

The Maturity Structure of Corporate Debt

Abstract: We provide an empirical examination of the determinants of corporate debt maturity. Our evidence offers strong support for the contracting-cost hypothesis. Firms that have few growth options, are large, or are regulated have more long-term debt in their capital structure. We find little evidence that firms use the maturity structure of their debt to signal information to the market. The evidence is consistent, however, with the hypothesis that firms with larger information asymmetries issue more short-term debt. We find no evidence that taxes affect debt maturity.

Managerial Entrenchment and Capital Structure Decisions

Abstract: We test the prediction that leverage is inversely associated with managerial entrenchment. We examine leverage levels and year-to-year changes for several hundred firms between 1984 and 1991. We find that leverage levels are positively related to CEO stock ownership and CEO stock option holdings, and negatively related to CEO tenure and board of directors size. While generally consistent with less entrenched CEOs pursuing more leverage, these results are subject to alternative interpretations. We therefore analyze year-to-year changes in leverage around exogenous shocks to corporate governance variables. We find that leverage increases after unsuccessful tender offers and â¬Sforcedâ¬? CEO replacements, and under certain conditions after the arrival of major stockholders. These relations have greater magnitude when the sample is restricted to low-leverage firms, even when 80% of firms are defined as low-leverage. The results are consistent with decreases in entrenchment leading to increases in leverage, and with the majority of firms having less debt than optimal.

Dynamic Capital Structure Under Managerial Entrenchment

Abstract: This paper develops a model in which debt serves to constrain inefficient investments of empire-building managers due to the consequent control implications of bankruptcy. Capital structure is voluntarily chosen by management, as a credible constraint which ensures sufficient efficiency to prevent takeover challenges. In particular, dynamic capital structure is derived as the optimal response of partially entrenched managers trading off empire-building ambitions with the need to retain the empire to realize these ambitions. Such capital structure is dynamically consistent; in the model, manages are free to readjust leverage each period. A policy of dividend payments coordinated with capital structure decisions follows naturally, as does implicatons for the level, frequency, and maturity structure of debt as a function of outside investment opportunities. Additionally, the model yields new testable implications for security design and changes in debt and empire building over a manager's career.

Capital Structure and Product-Market Competition: Empirical Evidence from the Supermarket Industry

Abstract: This paper establishes an empirical link between firm capital structure and product-market competition using data from local supermarket competition. First, an event-study analysis of supermarket leveraged buyouts (LBOs) suggests that a LBO announcement increases the market value of the LBO chain's local rivals. Second, the author shows that supermarket chains were more likely to enter and expand in a local market if a large share of the incumbent firms in the local market undertook LBOs. The study suggests that leverage increases in the late 1980s led to softer product-market competition in this industry. Copyright 1995 by American Economic Association.

The Priority Structure of Corporate Liabilities

Abstract: Most discussions of corporate capital structure effectively assume that all debt is the same. Yet debt differs by maturity, covenant restrictions, conversion rights, call provisions, and priority. Here, we examine priority structure across a sample of 4995 COMPUSTAT industrial firms from 1981 to 1991. We analyze the variation in the use of capital leases, secured debt, ordinary debt, subordinated debt, and preferred stock both as a fraction of the firm's market value and as a fraction of total fixed claims. Our evidence provides consistent support for contracting cost hypotheses, mixed support for tax hypotheses, and little support for the signaling hypothesis.

Corporate Capital Structure Decisions: Evidence from Leveraged Buyouts

Abstract: We analyze the composition of the financing packages used in a large sample of leveraged buyout transactions in order to test a set of hypotheses developed in the prior literature about the determinants of corporate capital structure decisions. We focus in particular on the role of agency costs, bankruptcy risks, and tax considerations. We find evidence that all three have an impact, both on the degree of leverage employed in the transactions and on the attributes of the borrowings undertaken. The impacts are manifest in systematic relationships between the proportion and type of debt in the buyout financing package and the target firm's earnings rate, earnings variability, growth prospects, and its tax and liquidity position. 0 The logic and consequences of leveraged buyouts (LBOs), both for the participants involved and for the economy as a whole, have been widely debated in the academic literature and the popular business press. In a leveraged buyout, a group of investors acquires the public interest in a firm's common equity, primarily with borrowed funds, and takes the firm private. We offer here some further evidence on the nature of these transactions, with particular emphasis on the composition of the LBO financing package. Our objective is to attempt to explain why the observed financing choices were made by individual firms-by identifying the relationships between the characteristics of the target firms and the types of financings that were employed in their acquisition. We detect some clear patterns in the data, many of which we believe have broader implications for the design of corporate capital structures. In particular, we find evidence that LBO financing decisions appear systematically to be affected by the target firm's growth prospects, the level and variability of its return on assets, its pre-buyout liquidity position, and by tax considerations and post-buyout restructuring plans. We find similar evidence of systematic influences on the

The capital structure and investment decisions of the small owner-managed firm: Some exploratory issues

Abstract: In the burgeoning literature on small firm financing, the problem of underidentification in respect to the supply of, and demand for, capital has not been fully resolved. In an attempt to progress this issue, the current paper looks at some of the issues influencing the demand for finance in small firms which are owner-managed. The paper is primarily exploratory in nature and argues that a greater emphasis might usefully be placed on the cost of capital dimension in future research into small business financing. In particular, it is suggested that where the objective of an owner-manager is to maintain control of the firm, interdependent investment and financing strategies may be chosen to control the small firms cost of capital. This in turn indicates that the tendency for some small firms to invest sub-optimally and exhibit slower than average growth may not be primarily determined by limitations on their supplies of finance. On the demand side, it may well be that in addition to equity aversion, a suboptimal capital structure decision is made in the form of a reduced demand for debt. In other words, given the level of equity that an owner-manager chooses, debt may not be fully expanded to the capacity limit consistent with value maximisation.

Capital Structure and Product-Market Rivalry: How Do We Reconcile Theory and Evidence?

Abstract: This paper presents empirical evidence on the interaction of capital structure decisions and product market behavior. We examinine when firms recapitalize and increase the proportion of debt in their capital structure. The evidence in this paper shows that firms with low productivity plants in highly concentrated industries are more likely to recapitalize and increase debt financing. This finding suggests that debt plays a role in highly concentrated industries where agency costs are not significantly reduced by product market competition. Following the empirical evidence we introduce the "strategic investment" effect of debt and argue that this effect, in conjunction with agency costs, appears to fit the data.

Agency costs, taxes and debt: The UK evidence

Abstract: This paper provides an empirical examination of the impact of the corporation tax and agency costs on firms' capital structure decisions. Our evidence suggests that the agency costs are the main determinants of corporate borrowing. Consistent with the agency theory, we find that firms that have fewer growth options have more debt in their capital structure. Moreover, our results show that debt mitigates the free cash flow problem and that firms that are more likely to be diversified and less prone to bankruptcy are highly geared. the negative effect of insider shareholding on leverage disappears, however; when all the agency mechanisms are accounted for. In addition, we find that, in the long run, companies that are tax exhausted exhibit significantly lower debt ratios than tax-paying firms. However, in the short run, firms' capital structure decisions are not affected by taxation.

Corporate financial patterns in industrializing economies : a comparative international study

Abstract: In the first large-scale comparative studies of corporate financing patterns of large firms in leading developing countries (DCs), Singh and Hamid (1992) and Singh (1995) arrived at some rather surprising conclusions. This research showed that although there are variations in corporate financing patterns among developing countries, in general, corporations in the sample countries rely very heavily on (a) external funds, and (b) new share issues on the stockmarket to finance the growth of their net assets. These findings are opposite to what most economists would predict. In view of the low level of development of DC capital markets and their greater imperfections, one would expect these corporations to rely much more on internal, rather than external finance. Moreover, for the same reasons, one would also expect them to resort to the stockmarket to a very small degree, if at all, to raise finance. The Singh and Hamid conclusions also run contrary to the "pecking order" pattern of finance which is thought to characterize advanced country corporations, whereby the latter mostly use retained profits to finance their investment needs; if more finance is required, they have recourse to banks or long-term debt, and go to the stockmarket only as a last resort.

The Capital Structure Puzzle Revisited

Abstract: Corporate finance researchers have long been puzzled by low corporate debt ratios given debt's corporate tax advantage. This article recognizes that firm value typically reflects a growing stream of earnings, while current debt reflects a nongrowing stream of interest payments. Debt to value is therefore a distorted measure of corporate tax shielding. Even with very small debt- related costs, this may explain the observed magnitude and cross- sectional variation of debt ratios. Since this variation may be independent of tax shielding, debt ratios provide an inappropriate framework for empirically examining the trade-off theory of capital structure. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Capital Structure and Product-Market Rivalry: How Do We Reconcile Theory and Evidence?

Abstract: This paper presents empirical evidence on the interaction of capital structure decisions and product market behavior. We examine when firms recapitalize and increase the proportion of debt in their capital structure. The evidence in this paper shows that firms with low productivity plants in highly concentrated industries are more likely to recapitalize and increase debt financing. This finding suggests that debt plays a role in highly concentrated industries where agency costs are not significantly reduced by product market competition. Following the empirical evidence we introduce the "strategic investment" effects of debt and argue that this effect, in conjunction with agency costs, appears to fit the data.(This abstract was borrowed from another version of this item.)

Insurance Cycles: Interest Rates and the Capacity Constraint Model

Abstract: Insurance profits exhibit cyclical behavior that has been attributed to capital market constraints. The authors show that changes in interest rates simultaneously affect the insurer's capital structure and the equilibrium underwriting profit. Depending upon asset and liability maturity structure, capital market access, and reinsurance availability, insurers will be differently affected by changing interest rates. The authors find that the average market response to changing interest rates roughly tracks market clearing prices. These 'cyclical' effects are enhanced for firms with mismatched assets and liabilities and more costly access to new capital and reinsurance. This evidence supports the capacity constraint hypothesis. Copyright 1995 by University of Chicago Press.

Capital Structure Choice when Managers are in Control: Entrenchment versus Efficiency

Abstract: Recent capital structure theories have emphasized the role of debt in minimizing the agency costs that arise from the separation between ownership and control. In this paper we argue that capital structure choices themselves are affected by the same agency problem. We show that, in general, the shareholders' and the manager's capital structure choices differ not only in their levels, but also in their sensitivities to the cost of financial distress and taxes. We argue that only the managerial perspective can explain why firms are generally reluctant to issue equity, why they issue it only following a stock price run-up, and why Corporate America recently deleveraged under the same tax system that supposedly generated the increase in leverage in the 1980s.

Equity ownership structure, leverage, and productivity: Empirical evidence from Japan☆

Abstract: We focus here on the influence of equity ownership structure on leverage and also attempt to discriminate between competing hypotheses regarding the net influence of leverage on firm efficiency. In the case of Japan, institutional shareholders have been noted in particular for their active voice in firm affairs, and these major equity-holders are often also major debtholders. Such arrangements may serve to minimize both conflicts between managers and shareholders and between debtholders and shareholders. On the other hand, high levels of intercorporate ownership may insulate management and debtholders from shareholder influence and increase leverage. We observe a strong negative relationship between both institutional ownership and leverage and between leverage and productivity in Japan, and this seems to support the reputation of financial institutions in Japan for having a positive influence on the firms in which they own shares. We also find a strong positive influence of intercorporate shareholding on leverage, which may reflect the alignment of management and debtholders in the absence of an active equity influence. In all, it seems that ownership structure and agency costs are both important determinants of capital structure in Japan, and that an active equity influence is associated with both reduced leverage and positive productivity residuals. While we find no evidence that high leverage tends to increase efficiency, we do observe an important influence of equity ownership structure on leverage. These findings appear to support an agency theory of capital structure based on both conflicts between management and shareholders and between shareholders and debtholders.

Financial and Industrial Structure with Agency

Abstract: A sub game perfect Nash equilibrium is characterized for an industry with dissipative costs of agency. In sequence, firms can enter the industry, raise capital with external debt and/or equity, invest in a capital-intensive technology or dissipate capital in perquisites, and finally produce output. For plausible values of two critical parameters, some, firms forego in equilibrium investments with positive net present values. Although more managers would like their firms to invest in the capital-intensive technology, they cannot raise the required cash in the capital market. In equilibrium, the industry can have both a profitable core of large, secure, capital intensive firms, with some debt but no unique optimal capital structure, and a competitive fringe of small, risky, labor-intensive firms. Even as the cost of entry converges to zero, capital-intensive firms can earn extraordinary profits, while all labor-intensive firms fail. With costly agency, access to capital can become a barrier to entry. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

The impact of institutional stockholders and managerial interests on the capital structure of firms

Abstract: When the self-interests of management and stockholders conflict, this is likely to manifest itself in different attitudes towards risk. Managers are hypothesized to desire low levels of debt in the firm's capital structure, while outside stockholders, who hold diversified portfolios, will tolerate higher debt ratios. Empirical results provide evidence in support of the hypotheses. The presence of institutional investors constrains management's discretion in setting capital structure and a positive relationship is identified between their fractional and dollar-value ownership of a firm and debt-assets ratios. Institutional investors will act in a manner that is consistent with the goals of other outside stockholders.

Signaling with Convertible Debt

Abstract: We test whether the conversion price (ratio) is viewed by the stock market as a credible signal of the firm's future earnings prospects (Kim (1990)) and, subsequently, whether convertible debt serves as backdoor equity financing (Stein (1992)). Examining the conversion price in relation to current stock prices and a priori growth expectations produces an average expected time of less than 1.5 years for convertible bonds to be at-the-money. Thus, as Stein suggests, convertibles appear to be a method of drawing equity into a firm's capital structure. We also find that the size of the firm's announcement period abnormal returns is positively related to the expected time for the convertible to become at-the-money. Given these relationships, we conclude that convertible debt issue announcements, on average, send an equity-like signal to the market.

Sustainable growth rate of firms in financial distress

Abstract: Sustainable growth rate defines the rate at which a company’s sales and assets can grow if the company sells no new equity and wishes to maintain its capital structure. The traditional formula assumes that the firm can increase its indebtedness. Many private firms and most firms in financial distress have limited or no access to debt markets. While distressed firms may prefer a no growth strategy, external pressures such as inflation or demand increases may cause their sales to rise exogenously. A new sustainable growth rate formula is developed that describes how much growth the firm with no new debt capacity can endure.

Global Financial Management

Abstract: GLOBAL MARKETS. Exchange Rates and Global Financial Management. Exchange Rates, Goods Prices, and the Global Economy. Global Finance, Interest Rates, and Exchange Rates. Forward Exchange and Interest Rates. CORPORATE FINANCING IN THE GLOBAL MARKET. Global Debt Financing. Currency Swaps. Topics in Structured Global Financing and the Use of Options. CORPORATE EXPOSURE TO FOREIGN EXCHANGE RISK. Operating Exposure to Exchange Rate Risk. Capital Structure and Exposure to Foreign Exchange Risk. Accounting Issues in Corporate Exposure to Foreign Exchange Risk. GLOBAL CAPITAL BUDGETING AND OTHER TOPICS. Introduction to Capital Budgeting in Global Financial Management. Exchange Rate Forecasting and Global Capital Budgeting. Multicurrency Exposure Issues. Index.