Showing papers on "Capital structure published in 1997"
TL;DR: This article found that leverage increases in the aftermath of entrenchment-reducing shocks to managerial security, including unsuccessful tender offers, involuntary CEO replacements, and the addition to the board of major stockholders.
Abstract: We study associations between managerial entrenchment and firms' capital structures, with results generally suggesting that entrenched CEOs seek to avoid debt. In a cross-sectional analysis, we find that leverage levels are lower when CEOs do not face pressure from either ownership and compensation incentives or active monitoring. In an analysis of leverage changes, we find that leverage increases in the aftermath of entrenchment-reducing shocks to managerial security, including unsuccessful tender offers, involuntary CEO replacements, and the addition to the board of major stockholders.
1,247 citations
TL;DR: In this paper, the authors apply these findings to analyze some basic issues in corporate finance under the assumption that managers are excessively optimistic about the firm's prospects, which provides a much firmer foundation for free cash flow theories of debt.
Abstract: Considerable psychological evidence supports the existence of excessive optimism in the general population. I apply these findings to analyze some basic issues in corporate finance under the assumption that managers are excessively optimistic about the firm's prospects. A managerial optimism theory delivers empirical predictions that are highly consistent with the data, including the basic pecking order capital structure predictions that otherwise require informational asymmetries. Managerial optimism is most promising, however, as an alternative foundation for agency cost theories of corporate finance. The managerial optimism assumption aligns agency conflicts between managers and outside security holders with a well-established cognitive bias, instead of the less plausible and empirically unsupported assumption that managers knowingly destroy corporate wealth because they receive utility from empire-building. Among other things, this provides a much firmer foundation for free cash flow theories of debt.
689 citations
TL;DR: This article analyzed the efficiency implications of strategic debt service, showing that it can eliminate both direct bankruptcy costs and agency costs of debt and found that strategic debt servicing can account for a substantial proportion of the premium on risky corporate debt.
Abstract: When firms experience financial distress, equity holders may act strategically, forcing concessions from debtholders and paying less than the originally-contracted interest payments. This article incorporates strategic debt service in a standard, continuous time asset pricing model, developing simple closed-form expressions for debt and equity values. We find that strategic debt service can account for a substantial proportion of the premium on risky corporate debt. We analyze the efficiency implications of strategic debt service, showing that it can eliminate both direct bankruptcy costs and agency costs of debt. THE CONTINGENT CLAIMS LITERATURE on corporate debt initiated by Merton (1974) interprets risky debt as a portfolio comprising the safe asset plus a short position in a put option written on the value of the firm's underlying assets. Under appropriate assumptions about asset return distributions, this interpretation implies simple, closed-form expressions for risky bond prices. However, empirical evidence suggests that risk premia on corporate debt significantly exceed those implied by Merton's model, except if one includes unrealistically high bankruptcy costs. Recent research has suggested two approaches whereby the high, observed risk premia may be rationalized. 1. Franks and Torous (1989) document the fact that, in many bankruptcy settlements, junior claimants including equityholders receive a greater share of residual value than is consistent with absolute priority. Longstaff and Schwartz (1995) incorporate such departures from absolute priority in a contingent claims model, taking the allocation of the bankrupt firm's residual value among stakeholders as exogenously given. They show that risk premia prior to bankruptcy may be significantly boosted by expectations of deviations from absolute priority. 2. An alternative approach takes as its starting point the observation that, in many cases, debtholders in distressed firms are persuaded by equityholders to accept concessions prior to formal bankruptcy proceedings. Bergman and Callen (1991) study the extraction of such concessions by equityholders in a static model of capital structure determination. Anderson and Sundaresan (1996) include such concessions in a binomial pricing model and examine the design of debt contracts.
519 citations
TL;DR: In this paper, the authors investigate the impact of transactions costs on leverage choices by financially distressed firms when they restructure their debt out of court and show that transactions costs are much higher when debt is restructured out-of-court.
Abstract: This study provides evidence that transactions costs discourage debt reductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged and one-in-three subsequently experience financial distress. Transactions costs are significantly smaller, hence leverage falls by more and there is less recurrence of financial distress, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures. THIS STUDY INVESTIGATES the impact of transactions costs on leverage choices by financially distressed firms. The "transaction" that I examine is the reduction in corporate debt pursuant to a Chapter 11 bankruptcy reorganization or out of court restructuring. Analysis of sample firms shows that transactions costs are much higher when debt is restructured out of court. When firms recontract this way, financial distress can be chronic: less debt is extinguished, leverage remains higher, and relatively more firms have to go back to their creditors to restructure their debt again in the future. Transactions costs are much smaller, hence debt falls significantly more, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures. Transactions costs are central in the ongoing academic debate about whether firms have optimal leverage ratios. Those who believe in target
451 citations
TL;DR: This paper examined whether sharp debt increases through leveraged buyouts and recapitalizations interact with market structure to influence plant closing and investment decisions of recapitalizing firms and their rivals. And they found that firms in industries with high concentration are more likely to close plants and less likely to invest.
Abstract: We examine whether sharp debt increases through leveraged buyouts and recapitalizations interact with market structure to influence plant closing and investment decisions of recapitalizing firms and their rivals. We take into account the fact that recapitalizations and investment decisions are both endogenous and may be simultaneously influenced by the same exogenous events. Following their recapitalizations, firms in industries with high concentration are more likely to close plants and less likely to invest. Rival firms are less likely to close plants and more likely to invest when the market share of leveraged firms is higher. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
398 citations
TL;DR: In this article, the effect of international activities on capital structure as measured by a debt ratio was investigated using a sample of 18,495 observations from the Compustat Tape, and they found that the debt-equity ratio is negatively related to both bankruptcy costs and growth options.
Abstract: This paper investigates the effect of international activities on capital structure as measured by a debt ratio. Prior studies have examined factors that affect the debt ratio for both multinational corporations (MNCs) and domestic corporations (DCs); however, the incremental explanatory power and the direct effect of the extent of international activities on capital structure have not been tested. This paper uses multiple regression analyses to add measures of international activities after controlling for measures pertinent to both MNCs and DCs. Using a sample of 18,495 observations from the Compustat Tape, we find 1) consistent with results reported by prior studies, the debt-equity ratio is negatively related to both bankruptcy costs and growth options; 2) after controlling for bankruptcy costs and growth options, MNCs have lower debt-equity ratios than DCs; 3) within the MNCs, the debt-equity ratio is positively related to the degree of internationalization, and this calls for further investigation.
181 citations
TL;DR: In this article, the authors compared the performance and capital structure of 81 corporations from Hong Kong, Malaysia, Singapore and Korea and found that both financial performance and the capital structure are influenced by the country of origin.
148 citations
TL;DR: In this article, the authors developed an option pricing model for calls and puts written on leveraged equity in an economy with corporate taxes and bankruptcy costs, which explains implied Black-Scholes volatility biases by relating them to the firm's structural characteristics such as leverage and debt covenants.
Abstract: We develop an option pricing model for calls and puts written on leveraged equity in an economy with corporate taxes and bankruptcy costs. The model explains implied Black-Scholes volatility biases by relating them to the firm's structural characteristics such as leverage and debt covenants. We test the model by comparing predicted pricing biases with biases observed in a large cross-section of firms with liquid exchange traded option contracts. Our empirical study detects leverage related pricing biases. The magnitudes of these biases correspond to those predicted by our model. We also find significant pricing biases for firms financed primarily by shortterm debt. This supports our model because short-term debt introduces net-worth hurdles similar to net-worth covenants. THE DIRECT LINK BETWEEN financing decisions at the firm level and the pricing of derivative securities has, with few exceptions, been ignored in the theoretical and empirical option pricing literature. Most finance literature treats the pricing of securities in the firm's capital structure and the pricing of options on these securities as separate research areas. Securities in the capital structure are priced using an assumption about the value process of the firm's assets; hedging arguments are invoked and the firm's debt and equity are priced as contingent claims.' Most equity option pricing literature, on the other hand, uses an exogenously specified equity price process as the basis for an option pricing formula.2
141 citations
Posted Content•
TL;DR: In this article, the authors identify the correpondence between the contractual choice and firm performance (e.g., measured by accounting rates of return or Tobin's Q), because contractual choices and performance outcomes are endogenously determined by exogenous and only partly observed changes in the firm's contracting environment.
Abstract: Firms are governed by a network of relationships representing contractual arangements for financing, capital structure, and managerial ownership and compensation, among others. For any of these contracted arrangements, it is difficult to identify the correpondence between the contractual choice and firm performance (e.g., measured by accounting rates of return or Tobin's Q), because contractual choices and performance outcomes are endogenously determined by exogenous and only partly observed changes in the firm's contracting environment.
133 citations
TL;DR: In this paper, the authors show how entry and exit of firms in a competitive industry affect the valuation of securities and optimal capital structure, and how, given a trade-off between tax advantages and agency costs, a firm will optimally adjust its leverage level after it is set up.
Abstract: This article shows (1) how entry and exit of firms in a competitive industry affect the valuation of securities and optimal capital structure, and (2) how, given a trade-off between tax advantages and agency costs, a firm will optimally adjust its leverage level after it is set up. We derive simple pricing expressions for corporate debt in which the price elasticity of demand for industry output plays a crucial role. When a firm optimally adjusts its leverage over time, we show that total firm value comprises the value of discounted cash flows assuming fixed capital structure, plus a continuum of options for marginal increases in debt. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
126 citations
TL;DR: In this article, the authors discuss a model that combines internal and external control mechanisms in a firm in which assets can have alternative uses that are in some states more profitable than the current one.
TL;DR: In this paper, countervailing incentives lead both high and low-cost jims to choose the same capital structure in equilibrium, thus decoupling capital structure from private information.
Abstract: The regulatedjirm's choice of capital structure is affected by countervailing incentives: the jirm wishes to signal high value to capital markets to boost its market value while also signalling high cost to regulators to induce rate increases. When the jim's investment is large, countervailing incentives lead both high- and low-cost jims to choose the same capital structure in equilibrium, thus decoupling capital structure from private information. When investment is small or medium-sized, the model may admit separating equilibria in which high-cost jirrns issue greater equity and low-cost jims rely more on debt jinancing.
TL;DR: In this paper, the effects of an earnings disclosure on security prices under an assumption of limited liability were formalized and various nonlinear relations between equity prices and earnings under a variety of capital structure assumptions and if possible, the relations attained to results from the existing empirical literature.
Abstract: . We formalize the effects of an earnings disclosure on security prices under an assumption of limited liability. We derive various nonlinear relations between equity prices and earnings under a variety of capital structure assumptions and. if possible, we tie the relations attained to results from the existing empirical literature. We also characterize how debt prices respond to earnings when holders of debt have limited liability. Finally, we analyze how changes in the degree of leverage and conversion features of debt affect the relation between price and earnings.
Posted Content•
TL;DR: In this article, the effects of an earnings disclosure on security prices under an assumption of limited liability were formalized and various non-linear relations between equity prices and earnings under a variety of capital structure assumptions were derived.
Abstract: We formalize the effects of an earnings disclosure on security prices under an assumption of limited liability. We derive various non-linear relations between equity prices and earnings under a variety of capital structure assumptions and, if possible, tie the relations attained to results from the existing empirical literature. We also characterize how debt prices respond to earnings when holders of debt have limited liability. Finally, we analyze how changes in the degree of leverage and conversion features of debt affect the relation between price and earnings.
TL;DR: In this article, the authors argue that debt restructuring costs should be lower when there is less competition among creditors, and that the size and determinants of direct financial distress costs are important for two reasons.
Abstract: How much does it cost to restructure a firm's debt? What factors can explain differences in restructuring costs across firms? The central thesis of the paper is that restructuring costs should be lower when there is less competition among creditors. Understanding the size and determinants of direct financial distress costs is important for two reasons. Under the "static trade-off" theories of capital structure, financial distress costs can be an important determinant of firms' optimal capital structures. Documenting the nature of financial distress costs is essential to understanding and testing these theories. Also, the debt restructuring process has been criticized for becoming increasingly inefficient and costly. Understanding the determinants of restructuring costs is necessary before policymakers can discuss ways to reduce these costs.
TL;DR: In this paper, the authors test for shareholder wealth effects of announcements of plans to increase R&D expenditures and determine whether the effect can be predicted when the announcing firm's capital structure is considered.
Abstract: Studies that test for shareholder wealth effects of announcements of plans to increase R&D expenditures find an average positive effect, but also a significant cross-sectional variation. This study determines whether the effect can be predicted when the announcing firm's capital structure is considered. Results suggest a positive relation between the debt ratio and the R&D induced abnormal stock returns. These results are robust using different industry-adjusted and unadjusted measures of capital structure and while controlling for several potentially influential variables. In addition, the gains to shareholders do not seem to be wealth transfers from bondholders. This evidence provides support to the debt-monitoring hypothesis.
TL;DR: In this paper, the authors investigate the effect of debt finance on free cash flow and show that incentive contracts that tie the managers' pay to stockholder wealth are often a superior solution to the free-cash flow problem.
Abstract: This article investigates the claim that debt finance can increase firm value by curtailing managers' access to "free cash flow." We first show that incentive contracts that tie the managers' pay to stockholder wealth are often a superior solution to the free cash flow problem. We then consider the possibility that the manager can trade on secondary capital markets. Liquid secondary markets are shown to undermine management incentive schemes and, in many cases, to restore the value of debt finance in controlling the free cash flow problem. THE FUNDAMENTAL INSIGHT OF the agency approach to corporate finance is that a firm's financial structure affects real decisions. While there is little doubt that financial policies have a variety of real effects, some classic agency models have recently been criticized for failing to allow management compensation to be jointly determined along with the firm's financial structure.1 The force of this critique is highlighted by analyses such as Dybvig and Zender (1991) and John and John (1993) in which management incentive contracts completely sever the link between a firm's real and financial policies, so that capital structure is either irrelevant or is determined solely by factors such as taxes. Management incentive schemes lead to capital structure irrelevance by motivating executives to make choices that maximize total firm value, regardless of the structure of claims on its cash-flows. Persons (1994) shows that this commitment role is undermined if shareholders are able to renegotiate man
TL;DR: In this article, the authors investigated the capital structure and dividend policies of a sample of large publicly traded Indonesian firms and found that the firms operate as if there exists an optimal debt ratio.
Abstract: This paper investigates the capital structure and dividend policies of a sample of large publicly traded Indonesian firms. The survey results show that our sample firms seem to have good access to different sources of funds, especially banks and the equity market. There is no evidence that asymmetric information with the banks is a significant problem. The firms expect the banks to fairly assess their future prospects, charge reasonable, if not low, interest rates on loans, and commit to provide resource to the firms in the event of insolvency. There is, however, some support that the firms operate as if there exist an optimal debt ratio. Overall, our results would be consistent with a world of large profitable firms that have good access to major alternative sources of funds, and yet, these firms are willing, for financing at the margin, to use their superior information to their advantage. Our regression results generally confirm the survey data. The excess debt capacity model shows the most satisfactory results.
TL;DR: In this article, a model of the equity takeover premium is developed that demonstrates a direct link between the percentage premium paid to target shareholders and the target firm's capital structure and asset structure.
TL;DR: In this article, the authors developed a general model of borrowing constraints based on the idea of limited enforcement, where borrowing constraints arise as part of the optimal borrowing and lending contract, allowing for uncertainty and dynamic effects of the resulting credit constraints.
Abstract: In this paper we have developed a general model of borrowing constraints based on the idea of limited enforcement. I our model, borrowing constraints arise as part of the optimal borrowing and lending contract. Our model extends previous theories of borrowing and lending , such as Hart and Moore (1994) allowing for uncertainty and dynamic effects of the resulting credit constraints.
TL;DR: In this paper, the authors report the findings of a 1990 survey of a sample of NYSE firms conducted to learn about the managerial opinions and practices with respect to long-term financing decisions.
Abstract: This paper reports the findings of a 1990 survey of a sample of NYSE firms conducted to learn about the managerial opinions and practices with respect to longterm financing decisions. Relying on a hierarchy of financing sources is discovered to be a far more common practice among the sample firms than maintaining a target capital structure. The risk-return dimensions of the investment being financed are found to be the most important inputs in determining financing decisions. In spite of the perceived lack of fairness in the market pricing of their securities, the sample firms do not report making financing decisions to signal a need for reevaluation of their securities. Financial managers display a much greater flexibility with capital structure decisions than with either dividend policy decisions or investment decisions. The firms which attempt to maintain target capital structures are found to perceive the average debt ratios in their respective industries to be important determinants of their own debt ratios. The firms which follow financing hierarchies on the other hand, are found to view their firms' past profits and past growth to be important determinants of their debt ratios.
TL;DR: In this paper, the authors present an economic framework or "model" that can be used to simulate the effect of various capital structure choices on shareholders' value and identify an optimal debt-equity ratio (and percentage of fixed- versus floating-rate debt) that balances the value of the tax shield from debt against the increased risk of financial distress.
Abstract: In the past decade, many U.S. companies have launched aggressive share repurchase programs with the expectation that value can be created by returning excess capital to shareholders and moving the firm closer to its optimal capital structure. But how much capital does a company really need to support its business activities?
This article presents an economic framework or “model” that can be used to simulate the effect of various capital structure choices on shareholder value. The fundamental insight underlying the model is that judicious use of debt can add value by reducing corporate taxes and strengthening management incentives to increase efficiency, but that too much debt can result in a loss of business and perhaps a costly reorganization. Indeed, one of the key findings of the authors' recent research is that companies with highly leveraged balance sheets suffer disproportionately large losses in market share and value during industry downturns. As illustrated in a case study of a hypothetical general merchandiser, the model makes it possible to identify an optimal debt-equity ratio (and percentage of fixed- versus floating-rate debt)—one that balances the value of the tax shield from debt against the increased risk of financial distress.
Posted Content•
TL;DR: In this article, the authors studied the factors influencing the capital structure of Belgian corporate finance since 1984 using three different datasets, aggregate balance sheets, aggregate flows of funds and a large panel of individual firms followed up during 10 years, they are able to give some empirical evidence for the importance of institutional features in the choice of corporate financing decisions.
Abstract: This paper studies the factors influencing the capital structure of Belgian corporate finance since 1984. Using three different datasets, aggregate balance sheets, aggregate flows of funds and a large panel of individual firms followed up during 10 years, we are able to give some empirical evidence for the importance of institutional features in the choice of corporate financing decisions. At the aggregate level, large firms are generally more highly levered; however, in the past ten years we observe a clear reduction in bank debt and a sharp increase in financial assets. Small firms on the other hand are less highly levered but have shifted toward greater long-term debt in recent years. Using flows of funds, we find that small firms have corporate financing decisions that remain roughly constant through time with a clear dominance of self-finance. In contrast we note for large firms an increased reliance on external sources of finance. Possible explanations of these patterns are investigated in our econometric study of panel data. We find that Belgian firms rely primarily on internal funds which seems to confirm the ''pecking order'' story of Myers and Majluf (1984). We also find that the emergence of coordination centers in the late 1980's explain much of the changing financial structure of large Belgian firms. These structures allow a higher leverage while they reduce the proportion of bank finance. Finally, control considerations are shown to explain the high level of financial assets on large firms' balance sheets.
TL;DR: In this paper, debt choices of New Zealand corporate firms during pre-reform (1982-1985) and post-reformation (1986-1989) periods are analysed and compared.
Abstract: The extensive 1980's deregulation of New Zealand financial markets is exploited to provide a unique test of capital structure theory. Specifically, debt choices of New Zealand corporate firms during pre-reform (1982–1985) and post-reform (1986–1989) periods are analysed and compared. However, consistent with evidence from other countries, existing hypotheses are able to explain relatively little of the cross-sectional variation in either long- or short-term debt usage. More significantly, this lack of explanatory power is consistent across pre- and post-reform periods.
01 Jan 1997
TL;DR: In this paper, the authors examined the impact of local government on the capital structure of Chinese rural enterprises through its capital investment and its influence on the REs' access to bank loans and the extent to which outstanding payments of taxes and other dues to government serve as an informal credit in the total capital of REs.
Abstract: Chinese rural enterprises (REs) have continued to grow rapidly since the end of the 1970s, and today these enterprises account for half of China’s industrial output, up from nine per cent in 1978. As a market-oriented nonstate sector, the development of the REs has significantly contributed to both China’s impressive post-reform economic growth and its transition away from a centrally planned economy. This thesis focuses on examining the following important, yet poorly understood, issues of the development of Chinese REs: patterns of local government investment decision-making and impact of local government on the capital structure of the REs through its capital investment and its influence on the REs’ access to bank loans and on the extent to which outstanding payments of taxes and other dues to government serve as an informal credit in the total capital of REs. the phenomenon of soft budget constraints in the RE sector; how it is affected by local government ownership of REs, and what the major sources of budget softness are among local government investment, bank loans, informal credits such as inter-firm arrears, and payment of taxes. the nature and characteristics of transaction costs facing REs and how economic and institutional factors such as the level of economic development, degree of marketisation, the role of local government as well as informal institutions may have affected these costs. The empirical studies of this thesis are based on a set of detailed data from a survey of 630 REs which was undertaken in Sichuan and Zhejiang provinces in 1990. The results of these studies show that in many respects of their operation, REs – especially those owned by local governments – tend to follow rules of neither a planned nor a market system, but those of somewhat in between.
TL;DR: In this paper, the authors examined the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage, and found that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage.
Abstract: This paper examines the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage. Polish firms had extremely low leverage levels, suggesting a growing stock market and a potential reluctance of banks to grant loans to old and risky firms. The empirical exercise finds that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage. Finally, shareholder concentration has a neutral or even a beneficial influence on firm leverage. The nature of ownership may be primarily responsible for this finding.
TL;DR: In this article, the authors present an empirical analysis of an important element of capital structure of the restaurant industry which is represented by SIC code 58, eating and drinking places, and analyze the role of size, earning volatility, profitability and growth opportunities.
Abstract: This paper presents an empirical analysis of an important element of capital structure of the restaurant industry which is represented by SIC code 58, eating and drinking places. The study focuses on explaining important characteristics affecting the capital structure of US restaurant firms. This is a cross-sectional analysis which assesses the role of size, earning volatility, profitability, growth opportunities, asset structure, non-debt tax shields, franchising, and leasing expense on various leverage ratios.
Posted Content•
TL;DR: In this paper, the authors examined the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage, and found that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage.
Abstract: This paper examines the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage. Polish firms had extremely low leverage levels, suggesting a growing stock market and a potential reluctance of banks to grant loans to old and risky firms. The empirical exercise finds that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage. Finally, shareholder concentration has a neutral or even a beneficial influence on firm leverage. The nature of ownership may be primarily responsible for this finding.