Showing papers on "Capital structure published in 2010"
TL;DR: A review of tax research can be found in this article, which surveys four main areas of the literature: (1) the informational role of income tax expense reported for financial accounting, (2) corporate tax avoidance, (3) corporate decision-making including investment, capital structure, and organizational form, and (4) taxes and asset pricing.
1,436 citations
TL;DR: In this paper, the authors investigate the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms and employ nonparametric data envelopment analysis (DEA) methods to empirically construct the industry's best practice frontier and measure firm efficiency as the distance from that frontier.
Abstract: This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.
714 citations
Journal Article•
TL;DR: In this paper, the authors extend Lazaridis and Tryfonidis's findings regarding the relationship between working capital management and profitability and find statistically significant relationship between the cash conversion cycle and profitability, measured through gross operating profit.
Abstract: The paper seeks to extend Lazaridis and Tryfonidis’s findings regarding the relationship between working capital management and profitability. A sample of 88 American firms listed on New York Stock Exchange for a period of 3 years from 2005 to 2007 was selected. We found statistically significant relationship between the cash conversion cycle and profitability, measured through gross operating profit. It follows that managers can create profits for their companies by handling correctly the cash conversion cycle and by keeping accounts receivables at an optimal level. The study contributes to the literature on the relationship between the working capital management and the firm’s profitability.
577 citations
Posted Content•
TL;DR: This paper examined the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries and found that firms in countries that are viewed as more corrupt tend to use less equity and more debt, especially short-term debt, while firms operating within legal systems that provide better protection for financial claimants tend to have capital structures with more equity, and relatively more longterm debt.
Abstract: This study examines the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries. We find that a country's legal and tax system, the level of corruption and the preferences of capital suppliers explain a significant portion of the variation in leverage and debt maturity ratios. Our evidence indicate that firms in countries that are viewed as more corrupt tend to use less equity and more debt, especially short-term debt, while firms operating within legal systems that provide better protection for financial claimants tend to have capital structures with more equity, and relatively more long-term debt. In addition, the existence of an explicit bankruptcy code and/or deposit insurance is associated with higher leverage and more long-term debt. We also find that firms tend to use more debt in countries where there is a greater tax gain from leverage, while firms in countries with larger government bond markets have lower leverage, suggesting that government bonds tend to crowd out corporate debt. Countries with more extensive defined benefit pension funds have higher debt ratios and longer debt maturities, whereas those with more extensive defined contribution fund activities have lower debt ratios. In addition, debt ratios are lower in countries that limit the bond holdings of pension funds. Finally, we do not find a significant association between financing choices and the size of the insurance industry.
529 citations
TL;DR: In this article, the authors derive a firm's optimal capital structure and managerial compensation contract when employees are averse to bearing their own human capital risk, while equity holders can diversify this risk away.
Abstract: We derive a firm’s optimal capital structure and managerial compensation contract when employees are averse to bearing their own human capital risk, while equity holders can diversify this risk away. In the presence of corporate taxes, our model delivers optimal debt levels consistent with those observed in practice. It also makes a number of predictions for the cross-sectional distribution of firm leverage. Consistent with existing empirical evidence, it implies persistent idiosyncratic dierences in leverage across firms. An important new empirical prediction of the model is that, ceteris paribus, firms with more leverage should pay higher wages.
528 citations
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TL;DR: In this paper, the authors investigate the capital structure choices that firms make in their initial year of operation, using restricted-access data from the Kauffman Firm Survey Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less extensively on friends and family-based funding sources This fact is robust to numerous controls for credit quality, industry and business owner characteristics.
Abstract: This paper investigates the capital structure choices that firms make in their initial year of operation, using restricted-access data from the Kauffman Firm Survey Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less extensively on friends and family-based funding sources This fact is robust to numerous controls for credit quality, industry, and business owner characteristics The heavy reliance on external debt underscores the importance of well functioning credit markets for the success of nascent business activity
518 citations
01 Nov 2010
TL;DR: In this article, a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies is presented.
Abstract: I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to the macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the "credit spread puzzle" and "under-leverage puzzle" in a unified framework. The model generates interesting dynamics for financing and defaults, including "credit contagion" and market timing of debt issuance. It also provides a novel procedure to estimate state-dependent default losses.
514 citations
TL;DR: This article showed that low-quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants.
Abstract: Using a novel data set that records individual debt issues on the balance sheets of public firms, we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation. Relative to high credit quality firms, low credit quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants. We discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts.
494 citations
TL;DR: In this paper, a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies is presented. But the model is not suitable for the analysis of credit spreads.
Abstract: I build a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the credit spread puzzle and the under-leverage puzzle in a unified framework. The model generates interesting dynamics for financing and defaults, including market timing in debt issuance and credit contagion. It also provides a novel procedure to estimate state-dependent default losses.
425 citations
TL;DR: This article examined the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure and found that if external funds are required, debt appears to be preferred to equity.
Abstract: We examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt capacity largely explain the use of new external equity financing by publicly traded firms. Finally, we present evidence that reconciles the frequent equity issues by small, high-growth firms with the pecking order. After accounting for debt capacity, the pecking order theory appears to give a good description of financing behavior for a large sample of firms examined over an extended time period.
414 citations
TL;DR: In this paper, the authors show that mispriced deposit insurance and capital regulation were of second-order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004.
Abstract: The paper shows that mispriced deposit insurance and capital regulation were of second-order importance in determining the capital structure of large U.S. and European banks during 1991 to 2004. Instead, standard cross-sectional determinants of non-financial firms' leverage carry over to banks, except for banks whose capital ratio is close to the regulatory minimum. Consistent with a reduced role of deposit insurance, we document a shift in banks' liability structure away from deposits towards non-deposit liabilities. We find that unobserved time-invariant bank fixed-effects are ultimately the most important determinant of banks' capital structures and that banks' leverage converges to bank specific, time-invariant targets. Copyright 2010, Oxford University Press.
TL;DR: In this paper, the authors quantify the empirical relevance of the pecking order hypothesis using a novel empirical model and testing strategy that addresses statistical power concerns with previous tests, and show that what little pecking-order behavior can be found in the data is driven more by incentive conflicts, as opposed to information asymmetry.
TL;DR: In this article, the authors analyze the strategic use of debt financing to improve a firm's bargaining position with an important supplier, and show that strategic incentives from union bargaining appear to have a substantial impact on corporate financing decisions.
Abstract: I analyze the strategic use of debt financing to improve a firm's bargaining position with an important supplier?organized labor. Because maintaining high levels of cor porate liquidity can encourage workers to raise their wage demands, a firm with external finance constraints has an incentive to use the cash flow demands of debt service to improve its bargaining position with workers. Using both firm-level collec tive bargaining coverage and state changes in labor laws to identify changes in union bargaining power, I show that strategic incentives from union bargaining appear to have a substantial impact on corporate financing decisions.
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TL;DR: In this paper, the authors investigate the stakeholder theory of capital structure from the perspective of a firm's relationships with its employees and find that firms that treat their employees fairly (as measured by high employee-friendly ratings) maintain low debt ratios.
Abstract: We investigate the stakeholder theory of capital structure from the perspective of a firm’s relationships with its employees. We find that firms that treat their employees fairly (as measured by high employee-friendly ratings) maintain low debt ratios. This result is robust to a variety of model specifications and endogeneity issues. The negative relation between leverage and a firm’s ability to treat employees fairly is also evident when we measure its ability by whether it is included in the list of Fortune Magazine’s “100 Best Companies to Work For.” These results suggest that a firm’s incentive/ability to offer fair employee treatment is an important determinant of its financing policy.
TL;DR: The authors showed that low-quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants.
Abstract: Using a novel dataset that records individual debt issues on the balance sheets of public firms, we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation. Relative to high-credit-quality firms, lowcredit-quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants. We discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts. (JEL G32)
TL;DR: In this article, an empirical examination of determinants of the capital structure of a sample of 299 Irish small and medium-sized enterprises (SMEs) is presented, and the influence of age, size, ownership structure and provision of collateral is found to be similar across industry sectors, indicating the universal effect of information asymmetries.
Abstract: This paper presents an empirical examination of determinants of the capital structure of a sample of 299 Irish small and medium-sized enterprises (SMEs). Results suggest that age, size, level of intangible activity, ownership structure and the provision of collateral are important determinants of the capital structure in SMEs. A generalisation of Zellner’s (Journal of the American Statistical Association57, 348–368, 1962) seemingly unrelated regression (SUR) approach is used to examine industry effects and to test the stability of parameter estimates across sectors. We find that the influence of age, size, ownership structure and provision of collateral is similar across industry sectors, indicating the universal effect of information asymmetries. Firms overcome the lack of adequate collateralisable firm assets in two ways: by providing personal assets as collateral for business debt, and by employing additional external equity to finance research and development projects.
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TL;DR: In this article, the authors examine the pervasive view that "equity is expensive" and conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities.
Abstract: We examine the pervasive view that “equity is expensive,” which leads to claims that high capital requirements are costly and would affect credit markets adversely. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. Any desirable public subsidies to banks’ activities should be given directly and not in ways that encourage leverage. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support. We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal, and, viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.
TL;DR: In this article, the authors used two dynamic partial adjustment capital structure models to estimate the impact of several macroeconomic factors on the speed of capital structure adjustment toward target leverage, and they found evidence that firms adjust their leverage toward target faster in good macroeconomic states relative to bad states.
TL;DR: In this paper, two alternative methods of estimation, namely, fully modified OLS (FMOLS) and generalized method of moments (GMM), were applied to analyse the determinants of the capital structure of Indian firms using a panel of 1169 non-financial firms listed in either the Bombay Stock Exchange or the National Stock Exchange.
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TL;DR: In this paper, the authors use tax benefit functions to estimate firm-specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book-to-market.
Abstract: We use exogenous variation in tax benefit functions to estimate firm-specific cost of debt functions that are conditional on company characteristics such as collateral, size, and book-to-market. By integrating the area between the benefit and cost functions, we estimate that the equilibrium net benefit of debt is 3.5% of asset value, resulting from an estimated gross benefit (cost) of debt equal to 10.4% (6.9%) of asset value. We find that the cost of being overlevered is asymmetrically higher than the cost of being underlevered and that expected default costs constitute only half of the total ex ante costs of debt. HUNDREDS OF PAPERS investigate corporate financial decisions and the factors that influence capital structure. Much theoretical work characterizes the choice between debt and equity in a trade-off context in which firms choose their optimal debt ratio by balancing the benefits and costs. Traditionally, tax savings due to the deductibility of interest have been modeled as a primary benefit of debt (Kraus and Litzenberger (1973)). Other benefits include committing managers to operate efficiently (Jensen (1986)) and engaging lenders to monitor the firm (Jensen and Meckling (1976)). The costs of debt include financial distress (Scott (1976)), personal taxes (Miller (1977)), debt overhang (Myers (1977)), and agency conflicts between managers and investors or among different groups of investors. For the most part, these theoretical predictions have been tested using reduced form regressions that attempt to explain variation in capital structure policies based on estimated slope coefficients for factors such as firm size, tax status, asset tangibility, profitability, and growth options (Rajan and Zingales (1995), Frank and Goyal (2009), Graham, Lemmon, and Schallheim (1998)).
TL;DR: In this article, the authors point out two common problems in capital structure research: the common financial-debt-to-asset ratio (FD/AT) measure of leverage commits exactly this mistake, and research that explains increases in FD/AT explains decreases in non-financial liabilities.
Abstract: This paper points out two common problems in capital structure research. First, although it is not clear whether they should be considered debt, non-financial liabilities should never be considered as equity. Yet, the common financial-debt-to-asset ratio (FD/AT) measure of leverage commits exactly this mistake. Thus, research that explains increases in FD/AT explains, at least in parts, decreases in non-financial liabilities. Future research should avoid FD/AT altogether. Second, equity issuing activity should not be viewed as equivalent to capital structure changes. Empirically, the correlation between the two is weak. The capital structure and capital issuing literature are distinct.
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TL;DR: The authors analyzes corporate responses to the liability risk arising from its workers' exposure to newly identified carcinogens and finds that firms, especially those with weak balance sheets, tend to respond to such risks by acquiring large, unrelated businesses with relatively high operating cash flows.
Abstract: This paper analyzes corporate responses to the liability risk arising from its workers’ exposure to newly identified carcinogens. We find that firms, especially those with weak balance sheets, tend to respond to such risks by acquiring large, unrelated businesses with relatively high operating cash flows. The diversifying growth appears to be primarily motivated by managers’ personal exposure to their firms’ risk in that the growth has negative announcement returns and is related to firms’ external governance, managerial stockholdings, and institutional ownership. The results suggest corporate governance is particularly important when firms are exposed to the risk of large, adverse shocks.
TL;DR: This paper examined whether firms take these costs into account when deciding on the optimal amount of leverage and found that firms with leading track records in employee well-being significantly reduce the probability of bankruptcy by operating with lower debt ratios.
Abstract: Employees of liquidating firms are likely to lose income and non-pecuniary benefits of working for the firm, which makes bankruptcy costly for employees. This paper examines whether firms take these costs into account when deciding on the optimal amount of leverage. We find that firms with leading track records in employee well-being significantly reduce the probability of bankruptcy by operating with lower debt ratios. Moreover, we observe that firms with better employee track records have better credit ratings, even when we control for differences in firm leverage.
TL;DR: The authors embeds a structural model of credit risk inside a dynamic continuous-time consumption-based asset pricing model, which allows them to price equity and corporate debt in a unified framework, and generate a realistic average term structure and time series of actual default probabilities and credit spreads, together with a reasonable levered equity risk premium, which varies with macroeconomic conditions.
Abstract: We embed a structural model of credit risk inside a dynamic continuous-time consumption-based asset pricing model, which allows us to price equity and corporate debt in a unified framework. Our key economic assumptions are that the first and second moments of earnings and consumption growth depend on the state of the economy, which switches randomly, creating intertemporal risk, which agents prefer to resolve sooner rather than later, because they have Epstein-Zin-Weil preferences. Agents optimally choose dynamic capital structure and default times. For a dynamic cross-section of firms, our model endogenously generates a realistic average term structure and time series of actual default probabilities and credit spreads, together with a reasonable levered equity risk premium, which varies with macroeconomic conditions. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
TL;DR: In this article, the authors evaluate the capital-structure determinants of Latin American firms using a comprehensive sample covering seven countries and find a positive relation between leverage and ownership concentration, when losing control becomes an issue.
TL;DR: In this article, the authors show that corporate financial policies are highly interdependent; firms make financing decisions in large part by responding to the financing decisions of their peers, as opposed to changes in firm-specific characteristics.
Abstract: We show that corporate financial policies are highly interdependent; firms make financing decisions in large part by responding to the financing decisions of their peers, as opposed to changes in firm-specific characteristics. On average, a one standard deviation change in peer firms' leverage ratios is associated with an 11% change in own firm leverage ratios --- a marginal effect that is significantly larger than that of any other observable determinant and one that is driven by interdependencies among debt and equity issuance decisions. Consistent with information-based theories of learning and reputation, we find that smaller, more financially constrained firms with lower paid and less experienced CEOs are more likely to mimic their peers. Additionally, we quantify the externalities engendered by these peer effects, which can amplify the impact of changes in exogenous determinants on leverage by almost 70%.
TL;DR: In this paper, the authors investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies, and of preferences on capital structure, and find that financially constrained firms choose more procyclical policies and that leverage accounts for most of the macroeconomic risk relevant for predicting defaults, but is a poor measure of how preferences impact capital structure.
Abstract: We study the impact of time-varying macroeconomic conditions on optimal dynamic capital structure for a cross-section of firms. Our structural-equilibrium framework embeds a contingent-claim corporate financing model within a consumption-based asset-pricing model. We investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies, and of preferences on capital structure. While capital structure is pro-cyclical at dates when firms re-lever, it is counter-cyclical in aggregate dynamics, consistent with empirical evidence. We also find that financially constrained firms choose more pro-cyclical policies and that leverage accounts for most of the macroeconomic risk relevant for predicting defaults, but is a poor measure of how preferences impact capital structure. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
TL;DR: In this paper, the authors demonstrate that a conservative leverage policy directed at maintaining financial flexibility can enhance investment ability, and that financial flexibility in the form of untapped reserves of borrowing power is crucial missing link in capital structure theory.
Abstract: We demonstrate that a conservative leverage policy directed at maintaining financial flexibility can enhance investment ability. Our analysis reveals that following a period of low leverage, firms make larger capital expenditures and increase abnormal investment. We find that these new investments are financed through new issues of debt. The impact of financial flexibility is both statistically significant and economically sizeable. Further, long run performance tests reveal that financially flexible firms not only invest more, but also invest better. Our results are consistent with the view that financial flexibility in the form of untapped reserves of borrowing power is a crucial missing link in capital structure theory.
Abstract: We study the impact of banking system reforms during a crisis following a period of undisciplined lending. Regulatory changes aimed at strengthening the banks’ capital structure and risk management practices do not have a uniform impact on bank productivity, but rather favor financially sound or strategically privileged banks. We present evidence documenting the differential impact of regulatory reforms on Korean commercial bank productivity over the period 1995–2005. Average technical efficiency of banks decreased during the financial crisis of 1997–1998. It improved following the subsequent bank restructuring and continued to improve through 2005. The capital adequacy ratio is positively associated with banks’ technical efficiency. The non-performing loans ratio is negatively associated with technical efficiency. Both relationships are accentuated during the crisis but attenuated after the reforms.
TL;DR: In this article, the authors show that financial flexibility in the form of untapped reserves of borrowing power is a crucial missing link in capital structure theory and the impact of financial flexibility is both statistically significant and economically sizable.
Abstract: We document, for the first time, that a conservative leverage policy directed at maintaining financial flexibility can enhance investment ability. Our analysis reveals that following a period of low leverage, firms make larger capital expenditures and increase abnormal investment. We find that these new investments are financed through new issues of debt. The impact of financial flexibility is both statistically significant and economically sizable. Further, long-run performance tests reveal that financially flexible firms not only invest more but also invest better. Our results are consistent with the view that financial flexibility in the form of untapped reserves of borrowing power is a crucial missing link in capital structure theory. There is a puzzling empirical regularity in the capital structure literature. Many firms appear to borrow less than the dominant theories predict. In his influential paper, Graham (2000) finds, “Paradoxically, large, liquid, profitable firms with low expected distress costs use debt conservatively.” He also reports that this conservative behavior appears to be persistent. Similar issues are discussed, among others, by Minton and Wruck (2001) and Strebulaev and Yang (2008). Recent survey evidence has shed some light on this matter (Bancel and Mittoo, 2004; Brounen, De Jong, and Koedijk, 2004; Graham and Harvey, 2001; Pinegar and Wilbricht, 1989). These studies suggest that it is financial flexibility that primarily drives chief finance officers’ leverage choices. Respondents say that flexibility is very important in enabling their companies to undertake investment in the future, when asymmetric information and contracting problems might otherwise force them to forego profitable growth opportunities. In other words, companies may adopt a conservative leverage policy to maintain “substantial reserves of untapped borrowing