Showing papers on "Capital structure published in 2004"
TL;DR: In this article, the authors consider the effect of share price changes on market-valued leverage and conclude that firms do have target capital structures, as opposed to market timing or pecking order considerations, which explains a majority of the observed changes in capital structure.
Abstract: The literature provides conflicting assessments about how firms choose their capital structures, with the "tradeoff", pecking order, and market timing hypotheses all receiving some empirical support. Distinguishing among these theories requires that we know whether firms have long-run leverage targets and (if so) how quickly they adjust toward them. Yet many previous researchers have relied on empirical specifications that fail to recognize the potential impact of adjustment costs on a firm's observed leverage. Likewise, few researchers have incorporated the effect of share price changes on market-valued leverage. We estimate a relatively general, partial-adjustment model of firm leverage decisions, and conclude that firms do have target capital structures. The typical firm closes more than half the gap between its actual and its target debt ratios within two years. 'Targeting' behavior as opposed to market timing or pecking order considerations explains a majority of the observed changes in capital structure.
1,556 citations
TL;DR: In this article, a study of firm-level corporate governance practices across emerging markets, and a greater understanding of the environments under which corporate governance matters more is provided, and the authors provide evidence showing that firms can partially compensate for ineffective laws, and enforcement by establishing good governance, and providing credible investor protection.
1,429 citations
TL;DR: The authors empirically examined whether firms engage in dynamic rebalancing of their capital structures, while allowing for costly adjustment, and found that firms respond to changes in their equity value, due to price shocks or equity issuances, by adjusting their leverage over the two to four years following the change.
Abstract: We empirically examine whether firms engage in dynamic rebalancing of their capital structures, while allowing for costly adjustment. We begin by showing that the presence of adjustment costs has significant implications for the dynamic behavior of corporate financial policy and the interpretation of previous empirical results. Then, after confirming that financing behavior is consistent with the presence of adjustment costs, we use a dynamic duration model to show that firms behave as though adhering to a financial policy in which they actively rebalance their leverage to stay within an optimal range. We find that firms respond to changes in their equity value, due to price shocks or equity issuances, by adjusting their leverage over the two to four years following the change. The presence of adjustment costs, however, often prevents this response from occurring immediately, resulting in shocks to leverage that have a persistent effect. Our evidence suggests that this persistence is more likely a result of optimizing behavior in the presence of adjustment costs, as opposed to indifference towards capital structure.
1,234 citations
TL;DR: In this article, the determinants of capital structure and types of financing used around business start-ups utilizing a survey that reduces the confounding effects of survivorship bias are examined both in the choice and in the magnitude of finance use.
1,002 citations
TL;DR: For example, this article found that stock returns can explain about 40 percent of debt ratio dynamics over one to five-year horizons, while other proxies play a much lesser role in explaining capital structure.
Abstract: U.S. corporations do not issue and repurchase debt and equity to counteract the mechanistic effects of stock returns on their debt‐equity ratios. Thus over one‐ to five‐year horizons, stock returns can explain about 40 percent of debt ratio dynamics. Although corporate net issuing activity is lively and although it can explain 60 percent of debt ratio dynamics (long‐term debt issuing activity being most capital structure–relevant), corporate issuing motives remain largely a mystery. When stock returns are accounted for, many other proxies used in the literature play a much lesser role in explaining capital structure.
897 citations
TL;DR: The authors explored the determinants of capital structure of Chinese-listed companies using firm-level panel data and found that the capital choice decision decision of Chinese firms seems to follow a new Pecking order (retained profit, equity, and long-term debt).
781 citations
TL;DR: In this article, a calibrated dynamic trade-off model with adjustment costs is used to simulate firms' capital structure paths and the results of standard cross-sectional tests on this data are found to be qualitatively and quantitatively consistent with those reported in the empirical literature.
Abstract: In the presence of frictions firms adjust their capital structure only infrequently. As a consequence, in a dynamic economy the leverage of most firms, most of the time, is likely to differ from the optimum leverage at the time of readjustment. This paper explores the empirical implications of this observation. A calibrated dynamic trade-off model with adjustment costs is used to simulate firms' capital structure paths. The results of standard cross-sectional tests on this data are found to be qualitatively - and, in some cases, even quantitatively - consistent with those reported in the empirical literature. In particular, the standard interpretation of some test results would lead to the rejection of the model used to generate the data. The framework can explain a number of observed puzzles related to leverage. In particular, in the simulated cross-sectional samples leverage: (a) is inversely related to profitability; (b) can be largely explained by stock returns; (c) is mean-reverting. The results suggest that, in the presence of infrequent adjustment, cross-sectional properties of economic variables in dynamics may be fundamentally different from those derived assuming that they are always at their target levels. Taken together, the results suggest a rethinking of the way capital structure tests are conducted.
770 citations
TL;DR: In this paper, the determinants of capital structure of firms operating in the Asia Pacific region, in four countries with different legal, financial and institutional environments, namely Thailand, Malaysia, Singapore and Australia, were investigated.
675 citations
TL;DR: In this article, the authors analyzed the capital structures of foreign affiliates and internal capital markets of multinational corporations and found that higher local tax rates are associated with 2.8% higher debt/asset ratios with internal borrowing being particularly sensitive to taxes.
Abstract: This paper analyzes the capital structures of foreign affiliates and internal capital markets of multinational corporations. Ten percent higher local tax rates are associated with 2.8% higher debt/asset ratios, with internal borrowing being particularly sensitive to taxes. Multinational affiliates are financed with less external debt in countries with underdeveloped capital markets or weak creditor rights, reflecting significantly higher local borrowing costs. Instrumental variable analysis indicates that greater borrowing from parent companies substitutes for three-quarters of reduced external borrowing induced by capital market conditions. Multinational firms appear to employ internal capital markets opportunistically to overcome imperfections in external capital markets.
663 citations
TL;DR: In this article, the authors develop a framework for analyzing the impact of macroeconomic conditions on credit risk and dynamic capital structure choice and demonstrate that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase.
Abstract: This paper develops a framework for analyzing the impact of macroeconomic conditions on credit risk and dynamic capital structure choice. We begin by observing that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase. We then demonstrate that this simple observation has a wide range of implications for corporations. Notably, we show that our model can replicate observed debt levels and the countercyclicality of leverage ratios. We also demonstrate that it can reproduce the observed term structure of credit spreads and generate strictly positive credit spreads for very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity. A number of new predictions follow.
542 citations
TL;DR: In this article, the authors examine the degree to which the determinants of SMEs' capital structures differ between European countries and show that variations are likely to be due to country differences as well as firm-specific ones.
Abstract: The aim of this paper is to examine the degree to which the determinants of SMEs’ capital structures differ between European countries. The study is based on data for four thousand SMEs, five hundred from each of eight European countries. Regressions were run using short-term and long-term debt as dependent variables and profitability, growth, asset structure, size and age as independent variables. A key feature of this paper is the use of restricted and unrestricted regressions to isolate the country-effect from the firm-specific-effect. The results show that variations are likely to be due to country differences as well as firm-specific ones.
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TL;DR: The authors survey managers in 16 European countries on the determinants of capital structure and find that firms' financing policies are influenced by both their institutional environment and their international operations, and that firms determine their optimal capital structures by trading off costs and benefits of financing.
Abstract: We survey managers in 16 European countries on the determinants of capital structure. Financial flexibility and earnings per share dilution are primary concerns of managers in issuing debt and common stock, respectively. Managers also value hedging considerations and use "windows of opportunity" when raising capital. We find that although a country's legal environment is an important determinant of debt policy, it plays a minimal role in common stock policy. We find that firms' financing policies are influenced by both their institutional environment and their international operations. Firms determine their optimal capital structures by trading off costs and benefits of financing.
TL;DR: In this article, the authors examine whether market and operating performance affect corporate financing behavior because they are related to target leverage, and they find that dual issuers offset the deviation from the target resulting from accumulation of earnings and losses.
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TL;DR: In this article, the results of an international survey among 313 CFOs on capital budgeting, cost of capital, capital structure, and corporate governance were presented, and the results showed that the U.S. corporate finance practice appears to be influenced mostly by firm size, to a lesser extent by shareholder orientation, while national differences are weak at best.
Abstract: textIn this paper we present the results of an international survey among 313 CFOs on capital budgeting, cost of capital, capital structure, and corporate governance. We extend previous results of Graham and Harvey (2001) by broadening their sample internationally, by including corporate governance, and by applying multivariate regression analysis. We document interesting insights on how theoretical concepts are applied by professionals in the U.K., the Netherlands, Germany, and France and compare these results with the U.S. We discover compelling variations between large and small firms across all markets. While large firms frequently use present value techniques and the capital asset pricing model when assessing the financial feasibility of an investment opportunity, CFOs of small firms still rely on the payback criterion. Regarding debt policy we document more subtle disparities across firms and national samples. We also find substantial variation in corporate governance structures, which turn out to be more oriented at shareholder wealth in the Anglo-Saxon countries. Corporate finance practice appears to be influenced mostly by firm size, to a lesser extent by shareholder orientation, while national differences are weak at best.
TL;DR: In this article, the authors focus on emerging market firms for which pyramid ownership structures create potentially extreme managerial agency costs and conduct powerful new tests of whether debt can mitigate the effects of agency and information problems.
TL;DR: This article found that firms covered by fewer analysts are less likely to issue equity as opposed to debt, but when they do so, it is in larger amounts, and that these firms depend more on favorable market conditions for their equity issuance decisions.
Abstract: We provide evidence that analyst coverage affects the pattern of security issuance. First, firms covered by fewer analysts are less likely to issue equity as opposed to debt. They issue equity less frequently, but when they do so, it is in larger amounts. Moreover, these firms depend more on favorable market conditions for their equity issuance decisions. Although all firms issue larger amounts of equity after favorable stock returns, this tendency is more pronounced for less covered firms. Finally, debt ratios of firms followed by fewer analysts are more affected by Baker and Wurgler's (2002) external finance-weighted average market-to-book ratio than those of firms followed by more analysts. These results are consistent with market timing behavior in the presence of information asymmetry, as well as behavior implied by dynamic adverse selection models of equity issuance.
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TL;DR: The authors survey managers in 16 European countries on the determinants of capital structure and find that firms' financing policies are influenced by both their institutional environment and their international operations, and that firms determine their optimal capital structures by trading off costs and benefits of financing.
Abstract: We survey managers in 16 European countries on the determinants of capital structure. Financial flexibility and earnings per share dilution are primary concerns of managers in issuing debt and common stock, respectively. Managers also value hedging considerations and use "windows of opportunity" when raising capital. We find that although a country's legal environment is an important determinant of debt policy, it plays a minimal role in common stock policy. We find that firms' financing policies are influenced by both their institutional environment and their international operations. Firms determine their optimal capital structures by trading off costs and benefits of financing.
TL;DR: In this article, the results of an international survey among 313 CFOs on capital budgeting, cost of capital, capital structure, and corporate governance were presented, and the results showed that the U.S. corporate finance practice appears to be influenced mostly by firm size, to a lesser extent by shareholder orientation, while national differences are weak at best.
Abstract: In this paper we present the results of an international survey among 313 CFOs on capital budgeting, cost of capital, capital structure, and corporate governance. We extend previous results of Graham and Harvey (2001) by broadening their sample internationally, by including corporate governance, and by applying multivariate regression analysis. We document interesting insights on how theoretical concepts are applied by professionals in the U.K., the Netherlands, Germany, and France and compare these results with the U.S. We discover compelling variations between large and small firms across all markets. While large firms frequently use present value techniques and the capital asset pricing model when assessing the financial feasibility of an investment opportunity, CFOs of small firms still rely on the payback criterion. Regarding debt policy we document more subtle disparities across firms and national samples. We also find substantial variation in corporate governance structures, which turn out to be more oriented at shareholder wealth in the Anglo-Saxon countries. Corporate finance practice appears to be influenced mostly by firm size, to a lesser extent by shareholder orientation, while national differences are weak at best.
TL;DR: This article found that banks that use the loan sales market for risk management purposes rather than to alter their holdings of loans hold less capital than other banks; however, they also make more risky loans (loans to businesses) as a percentage of total assets.
Abstract: We test how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits, and risk. We find that banks that rebalance their loan portfolio exposures by both buying and selling loans – that is, banks that use the loan sales market for risk management purposes rather than to alter their holdings of loans – hold less capital than other banks; they also make more risky loans (loans to businesses) as a percentage of total assets than other banks. Holding size, leverage and lending activities constant, banks active in the loan sales market have lower risk and higher profits than other banks. Our results suggest that banks that improve their ability to manage credit risk may operate with greater leverage and may lend more of their assets to risky borrowers. Thus, the benefits of advances in risk management in banking may be greater credit availability, rather than reduced risk in the banking system.
TL;DR: In this paper, the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment was analyzed and the model showed that manager-shareholder conflicts can explain the low debt levels observed in practice.
Abstract: This article analyzes the impact of managerial discretion and corporate control mechanisms on leverage and firm value within a contingent claims model where the manager derives perquisites from investment. Optimal capital structure reflects both the tax advantage of debt less bankruptcy costs and the agency costs of managerial discretion. Actual capital structure reflects the trade-off made by the manager between his empire-building desires and the need to ensure sufficient efficiency to prevent control challenges. The model shows that manager-shareholder conflicts can explain the low debt levels observed in practice. It also examines the impact of these conflicts on the cross-sectional variation in capital structures.
TL;DR: In this article, the authors review the theory, empirical challenges, and current evidence pertaining to each approach and conclude that behavioral approaches help to explain a number of important financing and investment patterns.
Abstract: Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help to explain a number of important financing and investment patterns. The survey closes with a list of open questions.
TL;DR: In this article, the authors analyze the interactions between a firm's production and financing decisions as a tradeoff between the tax benefits of debt and financial distress costs and demonstrate that a traditional all-equity manufacturing company can improve its performance significantly by making real and financial decisions together.
Abstract: This paper develops models to make production and financing decisions simultaneously in the presence of demand uncertainty and market imperfections. While the Modigliani and Miller propositions demonstrate that a firm's investment and financing decisions can be made independently in a perfect capital market, our models illustrate how a firm's production decisions are affected by the existence of financial constraints. We analyze the interactions between a firm's production and financing decisions as a tradeoff between the tax benefits of debt and financial distress costs. Our numerical examples illustrate that a traditional all-equity manufacturing company can improve its performance significantly by making real and financial decisions together. The results illustrate greater firm value sensitivity to production decisions than to financing decisions and that low-margin producers face significant risk in not coordinating production and financing decisions.
TL;DR: This article analyzed the determinants of the capital structure of 1054 UK companies from 1991 to 1997, and the extent to which the influence of these determinants are affected by time-invariant firm-specific heterogeneity.
Abstract: This article analyses the determinants of the capital structure of 1054 UK companies from 1991 to 1997, and the extent to which the influence of these determinants are affected by time-invariant firm-specific heterogeneity. Comparing the results of pooled OLS and fixed effects panel estimation, significant differences in the results are found. While the OLS results are generally consistent with prior literature, the results of our fixed effects panel estimation contradict many of the traditional theories of the determinants of corporate financial structure. This suggests that results of traditional studies may be biased owing to a failure to control for firm-specific, time-invariant heterogeneity. The results of the fixed effects panel estimation find larger companies to have higher levels of both long-term and short-term debt than do smaller firms, profitability to be negatively correlated with the level of gearing, although profitable firms tend to have more short-term bank borrowing than less profitabl...
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TL;DR: In this article, the authors analyzed determinants of capital structure of listed companies in the Czech Republic during the period from 2000 to 2001 and found that leverage is positively correlated with tax and negatively correlated with non-debt tax shields, albeit on a lower level of statistical significance.
Abstract: This paper analyses determinants of capital structure of listed companies in the Czech Republic during the period from 2000 to 2001. In general, leverage of Czech listed firms is relatively low if measured in book value, but it is relatively high if measured in market value. According to our results, leverage of a firm is positively correlated with size and it is negatively correlated with profitability and tangibility. There is the negative relationship between leverage measured in market value and growth opportunities. Moreover, leverage is positively correlated with tax and negatively correlated with non-debt tax shields, albeit on a lower level of statistical significance. This study also provides evidence concerning the relationship between leverage and industry classification.
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TL;DR: In this article, the authors use a dynamic adjustment model and panel data methodology on a sample of UK and US firms to specifically establish the determinants of a time-varying optimal capital structure.
Abstract: The common approach in empirical capital structure research has been to study the determinants of optimal leverage by studying the association between observed leverage and a set of explanatory variables. This approach has two major shortcomings. First, the observed leverage need not necessarily be the optimal leverage. Second, the empirical analyses, being effectively non-dynamic, are unable to shed any light on the nature of dynamic capital structure adjustment by firms. In this paper, we use a dynamic adjustment model, and panel data methodology on a sample of UK and US firms to specifically establish the determinants of a time-varying optimal capital structure. In addition, the model allows for the possibility that at any point in time firms' observed leverage may not be optimal, and that firms differ in their speed of adjustment towards the optimal capital structure, which itself may be changing over time for the same firm. We also attempt to identify factors determining the speed of adjustment. We find that firms typically have capital structures that are not at the target, and that they adjust very slowly towards the target.
TL;DR: In this paper, the authors test Friend and Hasbrouck's theory and find evidence that supports it and find that the amount of debt in the sample firms' capital structures declines as the percentage of the firm's common stock held by the CEO and other officers and directors increases.
Abstract: In previous research, Friend and Hasbrouck theorized that managerial insiders (officers and directors) have a personal incentive to cause the firm to use less than the optimal amount of debt in its capital structure. They suggested this occurs because officers and directors have a large proportion of their personal wealth invested in the firm in the form of common stock holdings and firm‐specific human capital. This makes managerial insiders reluctant to use the optimal amount of debt financing for the firm because of the additional bankruptcy risk higher levels of debt engender. I test FH’s theory and find evidence that supports it. Specifically, the amount of debt in our sample firms’ capital structures declines as the percentage of the firm’s common stock held by the CEO and other officers and directors increases. A direct relationship is found between blockholder share ownership and our sample firms’ debt/equity ratio. This suggests that monitoring by blockholders is effective in controlling the subop...
TL;DR: This article examined whether security issues and repurchases adjust the capital structure toward the target and found that only debt reductions are initiated to offset the accumulated deviation from target leverage, and that even firms that have target debt ratios can engage in timing the equity market.
Abstract: The paper examines whether security issues and repurchases adjust the capital structure toward the target. The time‐series patterns of debt ratios imply that only debt reductions are initiated to offset the accumulated deviation from target leverage. The importance of target leverage in earlier debt‐equity choice studies is driven by the subsample of equity issues accompanied by debt reductions. Unlike debt issues and reductions, equity issues and repurchases have no significant lasting effect on capital structure. Therefore, even firms that have target debt ratios can engage in timing the equity market.
TL;DR: In this article, the authors explain why project finance in general and why large projects in particular merit separate academic research and instruction, and present significant opportunities to study the relationship among structural attributes (i.e., high leverage, contractual details, and concentrated equity ownership), managerial incentives, and asset values, as well as improve current practice in this rapidly growing field of finance.
Abstract: Despite the fact that more than $200 billion of capital investment was financed through project companies in 2001, an amount that grew at a compound annual rate of almost 20% during the 1990s, there has been very little academic research on project finance. The purpose of this article is to explain why project finance in general and why large projects in particular merit separate academic research and instruction. In short, there are significant opportunities to study the relationship among structural attributes (i.e., high leverage, contractual details, and concentrated equity ownership), managerial incentives, and asset values, as well as improve current practice in this rapidly growing field of finance.
TL;DR: In this article, the authors examine the impact of the U.S. bankruptcy procedure on the valuation of corporate securities and capital structure decisions and provide closed-form solutions for corporate debt and equity values when defaulting firms can either liquidate their assets or renegotiate outstanding debt under court protection.
Abstract: We examine the impact of the U.S. bankruptcy procedure on the valuation of corporate securities and capital structure decisions. We provide closed-form solutions for corporate debt and equity values when defaulting firms can either liquidate their assets or renegotiate outstanding debt under court protection. We show that the possibility to renegotiate the debt contract (i) has an ambiguous impact on leverage choices and (ii) increases credit spreads on corporate debt. The sharing rule of cash flows during bankruptcy has a large impact on optimal leverage. By contrast, credit spreads on corporate debt show little sensitivity to this very parameter.
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TL;DR: This article found that FDI and portfolio equity as a share of countries' total external liabilities are positively and significantly associated with indicators of educational attainment, natural resource abundance, and especially, institutional quality.
Abstract: A widespread view holds that countries that finance themselves through foreign direct investment (FDI) and portfolio equity, rather than bonds and loans, are less prone to crises. But what determines countries` external capital structures? In a cross section of emerging markets and developing countries, we find that equity-like liabilities (FDI and, especially, portfolio equity) as a share of countries` total external liabilities (or as a share of GDP) are positively and significantly associated with indicators of educational attainment, natural resource abundance, and especially, institutional quality. These relationships are robust to attempts to control for possible endogeneity, suggesting that better institutional quality may help improve countries` capital structures. The results might also provide an explanation for the observed correlation between institutional quality and the frequency of crises.