Showing papers on "Capital structure published in 2000"

Testing the Pecking Order Theory of Capital Structure

Abstract: The pecking order theory of corporate leverage is tested against the static tradeoff theory of corporate leverage, using a broad cross-section of US firms over the period 1980-1998. A derivation of the conditional target adjustment framework is provided as a better empirical test of mean reversion. None of the predictions of the pecking order theory hold in the data. As predicted by the static tradeoff theory, robust evidence of mean reversion in leverage is found. This is true both unconditionally and conditionally on financial factors. Leverage is more persistent at lower levels than at higher levels. When debt matures, it is not replaced dollar for dollar by new debt and so leverage declines. Large firms increase their debt in order to support the payment of dividends. By contrast, small firms reduce their debt while they pay dividends.

Agency Costs and Ownership Structure

Abstract: We provide measures of absolute and relative equity agency costs for corporations under different ownership and management structures. Our base case is Jensen and Meckling’s ~1976! zero agency-cost firm, where the manager is the firm’s sole shareholder. We utilize a sample of 1,708 small corporations from the FRB0NSSBF database and find that agency costs ~i! are significantly higher when an outsider rather than an insider manages the firm; ~ii! are inversely related to the manager’s ownership share; ~iii! increase with the number of nonmanager shareholders, and ~iv! to a lesser extent, are lower with greater monitoring by banks. THE SOCIAL AND PRIVATE COSTS OF AN AGENT’S ACTIONS due to incomplete alignment of the agent’s and owner’s interests were brought to attention by the seminal contributions of Jensen and Meckling ~1976! on agency costs. Agency theory has also brought the roles of managerial decision rights and various external and internal monitoring and bonding mechanisms to the forefront of theoretical discussions and empirical research. Great strides have been made in demonstrating empirically the role of agency costs in financial decisions, such as in explaining the choices of capital structure, maturity structure, dividend policy, and executive compensation. However, the actual measurement of the principal variable of interest, agency costs, in both absolute and relative terms, has lagged behind. To measure absolute agency costs, a zero agency-cost base case must be observed to serve as the reference point of comparison for all other cases of ownership and management structures. In the original Jensen and Meckling agency theory, the zero agency-cost base case is, by definition, the firm owned solely by a single owner-manager. When management owns less than 100 percent of the firm’s equity, shareholders incur agency costs resulting from management’s shirking and perquisite consumption. Because of limitations imposed by personal wealth constraints, exchange regulations on the minimum numbers of shareholders, and other considerations, no publicly traded firm is entirely owned by management. Thus, Jensen and Meckling’s zero agency cost base case cannot be found among the usual sample of publicly

Ownership structure and economic performance in the largest european companies

Abstract: The paper examines the impact of ownership structure on company economic performance in 435 of the largest European companies. Controlling for industry, capital structure and nation effects we find a positive effect of ownership concentration on shareholder value (market -to- book value of equity) and profitability (asset returns), but the effect levels off for high ownership shares. Furthermore we propose and support the hypothesis that the identity of large owners—family, bank, institutional investor, government, and other companies—has important implications for corporate strategy and performance. For example, compared to other owner identities, financial investor ownership is found to be associated with higher shareholder value and profitability, but lower sales growth. The effect of ownership concentration is also found to depend on owner identity.

A Theory of Bank Capital

Abstract: Banks can create liquidity precisely because deposits are fragile and prone to runs. Increased uncertainty makes deposits excessively fragile, creating a role for outside bank capital. Greater bank capital reduces the probability of financial distress but also reduces liquidity creation. The quantity of capital influences the amount that banks can induce borrowers to pay. Optimal bank capital structure trades off effects on liquidity creation, costs of bank distress, and the ability to force borrower repayment. The model explains the decline in bank capital over the last two centuries. It identifies overlooked consequences of having regulatory capital requirements and deposit insurance. DOES BANK CAPITAL STRUCTURE MATTER, and if so, how should it be set? Most work on the subject extrapolates an answer from prior work on the capital structure of industrial firms. But bank assets and functions are not the same as those of industrial firms. In fact, one strand of the banking literature suggests banks have a role precisely because they do not suffer the asymmetric information costs of issuance faced by industrial firms (see Gorton and Pennacchi (1990)). Therefore, to really understand the determinants of bank capital structure, we should start by modeling the essential functions banks perform, and then ask what role capital plays. Using this approach, we can see that a bank's capital structure affects its liquiditycreation and credit-creation functions in addition to its stability. The consequent trade-offs imply an optimal bank capital structure. Because customers rely to different extents on liquidity and credit, bank capital structure also determines the nature of the bank's clientele. Our approach will help us better understand the impact of regulations such as minimum capital requirements, and also help suggest the consequences of different recapitalization policies in a banking crisis. We start by describing the functions a bank performs. Consider a world where a number of entrepreneurs each has a project in need of funding. Each entrepreneur has specific abilities vis 'a vis his project so that the cash flows he can generate exceed what anyone else can generate from it. An entrepreneur cannot commit his human capital to the project, except on a

In Search of New Foundations

Abstract: In this paper I argue that corporate finance theory, empirical research, practical applications, and policy recommendations are deeply rooted in an underlying theory of the firm. I also argue that although the existing theories have delivered very important and useful insights, they seem to be quite ineffective in helping us cope with the new type of firms that is emerging. I outline the characteristics that a new theory of the firm should satisfy and how such a theory could change the way we do corporate finance, both theoretically and empirically. FOR A RELATIVELY YOUNG RESEARCHER like myself, there is a very strong tendency to look at the history of corporate finance and be overwhelmed by the giants of the recent past. A field that 40 years ago was little more than a collection of cookbook recipes that ref lected practitioners’ common sense is today a bona fide discipline, taught not only to future practitioners but also to doctoral students, both in business schools and in economic departments—a discipline whose ideas are now inf luencing other areas of economics, such as industrial organization, monetary policy, and asset pricing. The quality and the impact of the contributions that were made to the field during the last 40 years, and in particular in the period from the late 1970s to the late 1980s, justify the widespread feeling that the “golden age” of corporate finance is behind us. Two excellent recent surveys of the main areas of corporate finance reinforce this sense: the capital structure survey by Harris and Raviv ~1991! and the corporate governance survey by Shleifer and Vishny ~1997!. Both are very lucid categorizations of the existing literature. This lucidity is the product not only of the ability of their authors but also of the ripeness of the moment. Both surveys follow a period of intense activity in the field, and in a certain sense, they close it. It is especially noteworthy that, 10 years later, the survey by Harris and Raviv ~1991! would not necessitate any dramatic rewriting. Although there have certainly been important contributions afterward, they have been mostly empirical, and they have not undermined the conceptual framework underlying Harris and Raviv’s analyses.

Why Do Firms Repurchase Stock

Abstract: In this paper, I investigate the relations between stock repurchases and distribution, investment, capital structure, corporate control, and compensation policies over the 1977-96 period. I allow the significance of each motive to change over time to account for adjustments in the percentage of firms influenced by each motive. I find that, throughout the sample period, firms repurchase stock to take advantage of potential undervaluation and, in many periods, to distribute excess capital. However, firms also repurchase stock during certain periods to alter their leverage ratio, fend off takeovers, and counter the dilution effects of stock options.

Privatization in Emerging Economies: An Agency Theory Perspective

Abstract: The ineffectiveness of several privatized firms within emerging economies underscores the importance of agency theory issues and their impact on the privatization-performance relationship. The authors argue that weak governance and limited protection of minority shareholders intensify traditional principal-agent problems (perquisite consumption and entrenchment) and create unique agency problems (expropriation). The authors suggest that postprivatization performance can be enhanced by using appropriate ownership, management, and corporate structures that mitigate agency problems in the context of weak governance, and they highlight avenues for research.

Equity, bonds and bank debt : Capital structure and financial market equilibrium under asymmetric information

Abstract: This paper proposes a model of financial markets and corporate finance, with asymmetric information and no taxes, where equity issues, bank debt, and bond financing coexist in equilibrium. The relationship banking aspect of financial intermediation is emphasized: firms turn to banks as a source of investment mainly because banks are good at helping them through times of financial distress. This financial flexibility is costly since banks face costs of capital themselves (which they attempt to minimize through securitization). To avoid this intermediation cost, firms may turn to bond or equity financing, but bonds imply an inefficient liquidation cost and equity an informational dilution cost. We show that in equilib‐rium the riskier firms prefer bank loans, the safer ones tap the bond markets, and the ones in between prefer to issue both equity and bonds. This segmentation is broadly consistent with stylized facts.

Why Do Firms Repurchase Stock

Abstract: In this article, I investigate the relation between stock repurchases and distribution, investment, capital structure, corporate control, and compensation policies over the 1977-96 period. I allow the significance of each motive to change over time to account for adjustments in the percentage of firms influenced by each motive. I find that, throughout the sample period, firms repurchase stock to take advantage of potential undervaluation and, in many periods, to distribute excess capital. However, firms also repurchase stock during certain periods to alter their leverage ratio, fend off takeovers, and counter the dilution effects of stock options. Copyright 2000 by University of Chicago Press.

Environmental dynamism, capital structure and performance: a theoretical integration and an empirical test

Abstract: An ongoing argument in financial management has been how to craft a capital structure which maximizes shareholder wealth. This question has gained prominence within the strategic management field because of the apparent link between capital structure and the ability of firms to compete. By integrating models from organizational economics with the strategic management literature, we are able to theorize that a firm’s capital structure is influenced by environmental dynamism, and that the match between environmental dynamism and capital structure is associated with superior economic performance. Our large-scale empirical analyses provide supportive evidence for the proposition that competitive environments moderate the relationship between capital structure and economic performance. From a theoretical standpoint, these findings provide another link between capital structure and corporate strategy. More importantly, we are able to move the discussion beyond the limitations of financial risk and incorporate the strategy concept of decision making under uncertainty. For practical application, these findings offer informed advice for managers on how to craft a capital structure. Copyright © 2000 John Wiley & Sons, Ltd.

Industry Effects on the Determinants of Unquoted SMEs' Capital Structure

Abstract: This paper reports a study of 3500 unquoted, UK small and medium sized enterprises (SMEs). The objectives of the research were to test various hypotheses concerning the determinants of SME capital structure and to establish whether and how the relationship of these determinants to long- and short-term debt varied between industries. Long-term debt was found to be related positively to asset structure and company size and negatively to age; short-term debt was related negatively to profitability, asset structure, size and age and positively to growth. Significant variation across industries was found in most of the explanatory variables. The effect of growth on short-term debt, however, was consistent across industries whilst profitability had no effect on long-term borrowing in any industry.

What do we know about stock repurchases

Abstract: Stock repurchases by U.S. companies experienced a remarkable surge in the 1980s and ‘90s. Indeed, in 1998, the total value of all stock repurchased by U.S. companies exceeded for the first time the total amount paid out as cash dividends. And the U.S. repurchase movement has gone global in the past few years, spreading not only to Canada and the U.K., but also to countries like Japan and Germany, where such transactions were prohibited until recently. Why are companies buying back their stock in such amounts? After dismissing the popular argument that stock repurchases boost earnings per share, the authors argue that repurchases serve to add value in two main ways: (1) they provide managers with a tax-efficient means of returning excess capital to shareholders and (2) they allow managers to “signal” to investors their view that the firm is undervalued. Returning excess capital is value-adding for two reasons: First, it helps prevent companies from pursuing growth and size at the expense of profitability and value. Second, by returning capital to investors, repurchases (like dividends) play the critically important economic function of allowing investors to channel their investment from mature or declining sectors of the economy to more promising ones. But if stock repurchases and dividends serve the same basic economic function, why are repurchases growing more rapidly? Part of the explanation is that, because repurchases are taxed as capital gains and dividends as ordinary income, repurchases are a more tax-efficient way of distributing excess capital. But perhaps even more important than their tax treatment is the flexibility that (at least) open market repurchases provide corporate managers-flexibility to make small adjustments in capital structure, to exploit (or correct) perceived undervaluation of the firm's shares, and possibly even to increase the liquidity of the stock, which could be particularly valuable in bear markets. For U.S. regulators, the growth in open market stock repurchases raises some interesting issues. Perhaps most important, companies are not required to (and rarely do) furnish their investors with details about a given program's structure, execution method, number of shares repurchased, or even its duration. Policy regulators (and corporate executives as well) should consider some of the benefits provided by other systems, notably Canada's, which provide greater transparency and more guidelines for the repurchase process.

Project flexibility, agency, and competition : new developments in the theory and application of real options

Abstract: 1. (Introduction) Real Options Analysis: Development and New Contributions PART I: OPTIMAL CONTINGENT POLICIES AND THE VALUE OF FLEXIBILITY 2. Real Options and Rules of Thumb in Capital Budgeting 3. Investment in Flexible Technologies under Uncertainty 4. Expandability, Reversibility, and Optimal Capacity Choice 5. Entry and Exit Strategies under Non-Gaussian Distributions 6. Evaluating Research and Development Investments PART II: AGENCY, CONTRACTS, AND INCENTIVES 7. A Self-Enforced Dynamic Contract for Processing of Natural Resources 8. Bidding for the Antamina Mine: Valuation and Incentives in a Real Options Context 9. Agency, Costs, Underinvestment, and Optimal Capital Structure: The Effect of Growth Options to Expand PART III: FLEXIBILITY IN NATURAL AND ENVIRONMENTAL RESOURCE INVESTMENTS 10. Valuation of Natural Resource Investments with Stochastic Conscience Yields and Interest Rates 11. A Compound Option Model for Evaluating Multi-Stage Natural Resource Investments 12. Optimal Extraction of Nonrenewable Resources when Costs Cumulate 13. Real Options and the Timing of Emission Limits under Ecological Uncertainty PART IV: STRATEGIC OPTIONS AND PRODUCT MARKET COMPETITION 14. Competitive Investment Decisions: A Synthesis 15. Equilibrium Time To Build: A Real Options Approach 16. Strategic Sequential Investments and Sleeping Patents 17. The Ship Lay-Up Option and Equilibrium Freight Rates

Is the "Leverage Effect" a Leverage Effect?

Abstract: The "leverage effect" refers to the well-established relationship between stock returns and both implied and realized volatility: volatility increases when the stock price falls. A standard explanation ties the phenomenon to the effect a change in market valuation of a firm's equity has on the degree of leverage in its capital structure, with an increase in leverage producing an increase in stock volatility. We use both returns and directly measured leverage to examine this hypothetical explanation for the "leverage effect" as it applies to the individual stocks in the SP it is too small with measured leverage for individual firms, but much too large for OEX implied volatilities; the volatility change associated with a given change in leverage seems to die out over a few months; and there is no apparent effect on volatility when leverage changes because of a change in outstanding debt or shares, only when stock prices change. In short, our evidence suggests that the "leverage effect" is really a "down market effect" that may have little direct connection to firm leverage.

A Two-Factor Hazard Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads

Abstract: This paper proposes a two-factor hazard rate model, in closed form, to price risky debt. The likelihood of default is captured by the firm's non-interest sensitive assets and defaultfree interest rates. The distinguishing features of the model are threefold. First, the impact of capital structure changes on credit spreads can be analyzed. Second, the model allows stochastic interest rates to impact current asset values as well as their evolution. Finally, the proposed model is in closed form, enabling us to undertake comparative statics analysis, compute parameter deltas of the model, calibrate empirical credit spreads, and determine hedge positions. Credit spreads generated by our model are consistent with empirical observations.

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.

An Empirical Approach to the Financial Behaviour of Small and Medium Sized Companies

Abstract: This paper shows how the financial behaviour of small and medium sized companies is influenced by size and business sector. This idea underlies two research approaches to capital structure: (i) credit rationing, and (ii) the pecking order theory. Both approaches are based on asymmetric information and have been widely developed over the past two decades. An analysis has been carried out on 1000 Valencian companies that were randomly selected from the state company registry. These companies were divided by size before analysis. As an innovation, the investigation implements a multivariate MANOVA model that takes into account two key variables in the financing of small and medium firms. Our results show that size influences company self-financing strategies, and that business sector influences short-term financial policy.

Are Scale Economies in Banking Elusive or Illusive

Abstract: This paper explores how to incorporate banks' capital structure and risk-taking into models of production. In doing so, the paper bridges the gulf between (1) the banking literature that studies moral hazard effects of bank regulation without considering the underlying microeconomics of production and (2) the literature that uses dual profit and cost functions to study the microeconomics of bank production without explicitly considering how banks' production decisions influence their riskiness. Various production models that differ in how they account for capital structure and in the objectives they impute to bank managers—cost minimization versus value maximization—are estimated using U.S. data on highest-level bank holding companies. Modeling the bank's objective as value maximization conveniently incorporates both market-priced risk and expected cash flow into managers' ranking and choice of production plans. Estimated scale economies are found to depend critically on how banks' capital structure and risk-taking is modeled. In particular, when equity capital, in addition to debt, is included in the production model and cost is computed from the value-maximizing expansion path rather than the cost-minimizing path, banks are found to have large scale economies that increase with size. Moreover, better diversification is associated with larger scale economies while increased risk-taking and inefficient risk-taking are associated with smaller scale economies.

Why Does Capital Structure Choice Vary with Macroeconomic Conditions

Abstract: This paper develops a calibrated model that explains the pronounced counter-cyclical leverage patterns observed for firms that access public capital markets, and relates these patterns to debt and equity issues. Moreover, it explains why leverage and debt issues do not exhibit this pronounced behavior for firms that face more severe constraints when accessing capital markets. In the model, managers issue a combination of debt and equity to finance investment by weighting the trade-off between agency problems and risk sharing. During contraction, leveraged managers receive a relatively small share of wealth, resulting in a relative increase in household demand for securities. Securities markets clear as managers that are not up against their borrowing constraints increase leverage while satisfying the agency condition that they maintain a large enough portion of their firm's equity.

Small Firms' Use of Financial Leverage: Evidence from the 1993 National Survey of Small Business Finances

Abstract: This research examines capital structure theory as it applies to small, privately held firms. We hypothesized that, given the fine line between the firm and the firm owner in small firms, lenders should take both the characteristics of the firm and those of the borrower into consideration. Our findings reveal that leverage is predominantly a function of firm characteristics rather than owner characteristics. The owner's educational level, however, was a positive predictor of external debt, suggesting that lenders may use education as a proxy for human capital. INTRODUCTION In recent years the importance of small businesses to the United States economy has been widely recognized. According to the U.S. Small Business Administration (The Facts About Small Business, 1997), small businesses employ 53 percent of the workforce. In addition they contribute 47 percent of sales and 51 percent of gross domestic product. Small businesses have become the major source of new jobs as well as product and service innovations. Key issues for small businesses include financing, growth, profitability, and ownership structure. These concerns, and others, are addressed by research in the areas of small firm and entrepreneurial finance, both of which are producing a rapidly growing set of findings. Some of the most interesting questions in small firm finance research relate to the extent to which the principles of corporate finance "fit" the small firm. Almost every undergraduate business major includes a business finance course in which we teach theories of present value, risk, capital structure, cost of capital, and capital budgeting, typically within the framework of a corporate environment. Do these theories and principles, which were developed within the context of the large, publicly owned firm, appear to fit when we apply them to small firms which vastly outnumber large ones? This paper explores the relevance of current theories pertaining to capital structure and leverage while attempting to identify factors contributing to small firm use of debt as a financing source. Prior research on capital structure, of which there is a considerable quantity, focuses heavily on the use of debt within the context of publicly held, relatively large, corporations. There are few studies addressing the issue of capital structure in small firms, and many of those rely on a relatively small sample of firms. This study explores small firm capital structure using a very large, national data sample. It is our hypothesis that the use of debt in small firms is determined by characteristics of the firm owner as well as by characteristics of the firm. This is consistent with the notion that, for small firms, the financial affairs of the firm are inseparable from those of its owner. CAPITAL STRUCTURE THEORY Modigliani and Miller's (1958) theory of capital structure is based on the notion that firms will select the mix of debt and equity that minimizes their weighted average cost of capital, thereby maximizing the value of the firm. Because interest expense is tax deductible, debt tends to be favored over equity as a source of capital. It therefore follows that firms, in principle, act to minimize the cost of capital and maximize the value of the firm by financing exclusively with debt. This view assumes that there are no real resource costs associated with the issuance or exchange of securities, financial distress, or even bankruptcy and financial reorganization.1 In the case of privately held small businesses, however, the decision to finance with debt rather than equity may be driven by necessity rather than choice, because small firms do not have the same access to capital, particularly equity capital, that larger public firms do. Small firms are not able to issue publicly held debt or equity or even commercial paper because of their size and the high cost of issuing securities. As a result, small firms tend to be heavily reliant on debt in the form of bank financing and trade credit. …

Ownership and capital structure of chilean conglomerates: facts and hypotheses for governance*

Abstract: In this paper we provide an accurate descriptive analysis of consolidated ownership and capital structures in Chilean conglomerates, emphasizing the implications of these structures for corporate governance. We avoid double counting investments made through pyramid schemes, and consider the universe of non-financial firms registered at the Superintendencia de Seguros y Valores (SVS). We find that economic groups are the predominant form of corporate structure in Chile, and that the most common way of separating control from cash-flow rights in Chilean conglomerates is through pyramid schemes. These schemes have proven to be successful in raising external funding. Controllers of Chilean conglomerates rely in a relatively small number of people in order to conduct business, and these people participate exclusively as board members of corporations affiliated to their group. However, controllers of Chilean conglomerates hold more equity than strictly needed for control, suggesting that cash-flow benefits associated to subsidiaries are relatively large. Finally, pension funds and ADRs constitute a significant minority shareholder in Chilean groups.

Are Scale Economies in Banking Elusive or Illusive? Evidence Obtained by Incorporating Capital Structure and Risk-Taking Into Models of Bank Production

Abstract: This paper explores how to incorporate banks' capital structure and risk-taking into models of production. In doing so, the paper bridges the gulf between (1) the banking literature that studies moral hazard effects of bank regulation without considering the underlying microeconomics of production and (2) the literature that uses dual profit and cost functions to study the microeconomics of bank production without explicitly considering how banks' production decisions influence their riskiness. Various production models that differ in how they account for capital structure and in the objectives they impute to bank managers - cost minimization versus value maximization - are estimated using U.S. data on highest-level bank holding companies. Modeling the banks' objective as value maximization conveniently incorporates both market-priced risk and expected cash flow into managers' ranking and choice of production plans. Estimated scale economies are found to depend critically on how banks' capital structure and risk-taking is modeled. In particular, when equity capital, in addition to debt, is included in the production model and cost is computed from the value-maximizing expansion path rather than the cost-minimizing path, banks are found to have large scale economies that increase with size. Moreover, better diversification is associated with larger scale economies while increased risk-taking and inefficient risk-taking are associated with smaller scale economies.

External capital structure: theory and evidence*

Abstract: Recent years have witnessed a change in the composition of capital flows to developing countries, and FDI and equity flows have been playing an increasing role. In this paper we discuss the challenges for international macroeconomics that these developments pose and characterize stylized facts associated with the structure of external liabilities in developing countries, focusing in particular on FDI and equity stocks.

Asset Substitution, Debt Pricing, Optimal Leverage and Maturity

Abstract: I suggest a continuous time model for debt and equity valuation where leverage and maturity structure are chosen optimally by the firm's management. The capital structure decision involves trading off the tax benefits of leverage, financial distress costs and the agency costs associated with risk shifting incentives. Closed form solutions for the values of corporate securities, the levered firm and agency costs are obtained. I provide quantitative illustrations of how the capital structure decision is influenced by the potential for asset substitution. I show that in a typical scenario, a firm could afford to take on an additional 20% of leverage and use distinctly longer term debt maturity if asset substitution were ruled out. Furthermore I show that when deviations from the Absolute Priority Rule in bankruptcy are present, management is encouraged to increase risk ex post but will compensate ex ante by reducing leverage and using shorter maturity debt.

Operating leases and the assessment of lease–debt substitutability

Abstract: Operating leases are estimated in the current paper to be approximately thirteen times larger than finance leases, on average. In recognition of this, the paper investigates the degree of substitutability between leasing and non-lease debt using a comprehensive measure of leasing, improving on the partial measures used in prior research. Operating lease liabilities are estimated using the ‘constructive capitalisation’ approach suggested by Imhoff, Lipe and Wright (1991, Accounting Horizons 5, pp. 51–63), modified to incorporate company-specific and UK-relevant assumptions. The results imply that leasing and debt are partial substitutes, with £1 of leasing displacing approximately £0.23 of non-lease debt, on average, consistent with the argument that lessors bear some risks which are not inherent in debt contracts. These findings suggest that substitution effects are not uniform across lease types.

Integrated Risk Management: Techniques and Strategies for Reducing Risk

Abstract: Integrated Risk Management: Techniques and Strategies for Reducing Risk, by Neil A. Doherty (New York: McGraw-Hill, 2000). Reviewer: Nicos A. Scordis, The College of Insurance, New York City Neil Doherty's book Integrated Risk Management begins by answering the question of why risk management programs add value to firms. Cash-flow smoothing cannot justify corporate risk management programs. The rate of return shareholders require from a firm depends on the covariance of the firm's cash-flow with broad market movement, not its overall cash-flow volatility, or variance. In general, risk managers reduce cash-flow volatility by insuring and hedging perils shareholders can eliminate themselves at lower cost by holding diversified portfolios of assets. The cashflow volatility shareholders cannot diversify is the unavoidable trapping of a business venture promising its shareholders a rate of return above the "risk-free" rate of government bonds. When risk managers reduce volatility associated with this nondiversifiable or systematic part of cash flow, they change the covariance of the firm's cash flow to broad market movements. Any reduction in systematic risk, however, is accompanied by reductions in the shareholder's return, according to traditional financial theory. If shareholders value a risk management program, it is because it mitigates the frictional costs created by cash-flow volatility. One frictional cost is management's unwillingness or inability to make optimal capital investment decisions. Another frictional cost is that progressive tax codes, together with the tax treatment of business expenses, create higher tax bills for firms with volatile taxable cash flows. Thus a risk management program may realize value for shareholders by making possible a program of optimal capital investments and by reducing tax bills. But there are alternative ways to mitigate suboptimal investment and reduce taxes. Doherty explores these alternatives and shows how they may have an effect on the value of a firm, as compared to a traditional risk management program. For example, managers can reduce the amount of interest-bearing debt in a firm's capital structure, and shareholders can alter the compensation structure of managers. Reductions in the leverage of the firm and changes in the incentives of managers have the same effect on the tendency for suboptimal investment as a risk management program. As for reducing taxes, managers can enter into operating leases, accelerate depreciation schedules, boost R&D spending, or increase the amount of interest-bearing debt in the firm's capital structure. Increases in these tax shields have the same effect as a risk management program on the firm's tax bill. Doherty explores these alternatives to illustrate the dual nature of integrated risk financing. …

An examination of capital structure in the restaurant industry.

Abstract: Examines the capital structure decisions of restaurant firms. Hypothesizes that these decisions are based upon a financial “pecking‐order” as well as the position of the firm in the financial growth cycle. Using ratios from publicly‐traded restaurant firms in the USA and ordinary least squares regression models, the results tend to support the notion that both the pecking‐order and the financial growth cycle influence financing decisions. However, the results also indicate that there may be separate factors affecting long‐term and short‐term debt decisions made by restaurant managers.

An Applied Econometricians' View of Empirical Corporate Governance Studies

Abstract: The economic analysis of corporate governance is en vogue. In addition to a host of theoretical papers, an increasing number of empirical studies analyze how ownership structure, capital structure, the structure of the board and the market for corporate control influence firm performance. This is not an easy task, and indeed, for reasons explained in this survey, empirical studies on corporate governance have more than the usual share of econometric problems. Aim of this paper is a critical survey of the recent empirical literature on corporate governance - in order to show which methodological lessons can be learned for future empirical research in the field of corporate governance, paying particular attention to German institutions and data availability.

Dynamics in the Determinants of Capital Structure in the UK

Abstract: In this paper we analyse the dynamics in the capital structure for UK companies from 1991 to 1997. We observe significant changes in the relative importance of the various debt elements over time, as well as changes in the relationship between gearing and the level of growth opportunities, company size, profitability and tangibility. Our results suggest that the nature of the credit market in the UK has changed significantly during the 1990s, with large companies using less bank finance, and banks increasingly lending to smaller firms. At the same time, bank debt appears to have become more closely related to corporate profitability and collateral values.