Showing papers on "Capital structure published in 2011"

Presidential Address: Discount Rates

Abstract: Discount-rate variation is the central organizing question of current asset-pricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in price-dividend ratios due to variation in expected cashflows. Now it seems all price-dividend variation corresponds to discount-rate variation. We also thought that the cross-section of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discount-rate theories based on central ingredients and data sources. Incorporating discount-rate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics.

Determinants of capital structure

Abstract: Purpose – The aim of this empirical study is to explore the factors that affect the capital structure of manufacturing firms and to investigate whether the capital structure models derived from Western settings provide convincing explanations for capital structure decisions of the Pakistani firms.Design/methodology/approach – Different conditional theories of capital structure are reviewed (the trade‐off theory, pecking order theory, agency theory, and theory of free cash flow) in order to formulate testable propositions concerning the determinants of capital structure of the manufacturing firms. The investigation is performed using panel data procedures for a sample of 160 firms listed on the Karachi Stock Exchange during 2003‐2007.Findings – The results suggest that profitability, liquidity, earnings volatility, and tangibility (asset structure) are related negatively to the debt ratio, whereas firm size is positively linked to the debt ratio. Non‐debt tax shields and growth opportunities do not appear ...

Testing static trade-off against pecking order models of capital structure

Abstract: This paper tests traditional capital structure models against the alternative of a pecking order model of corporate financing. The basic pecking order model, which predicts external debt financing driven by the internal financial deficit, has much greater explanatory power than a static trade-off model which predicts that each firm adjusts toward an optimal debt ratio. We show that the power of some usual tests of the trade-off model is virtually nil. We question whether the available empirical evidence supports the notion of an optimal debt ratio.

Hierarchical determinants of capital structure.

Abstract: We analyze the influence of time-, firm-, industry- and country-level determinants of capital structure. First, we apply hierarchical linear modeling in order to assess the relative importance of those levels. We find that time and firm levels explain 78% of firm leverage. Second, we include random intercepts and random coefficients in order to analyze the direct and indirect influences of firm/industry/country characteristics on firm leverage. We document several important indirect influences of variables at industry and country-levels on firm determinants of leverage, as well as several structural differences in the financial behavior between firms of developed and emerging countries.

Private Equity and Long‐Run Investment: The Case of Innovation

Abstract: a long-standing controversy is whether leveraged buyouts (LBOs) relieve managers from short-term pressures from public shareholders, or whether LBO funds them? selves sacrifice long-term growth to boost short-term performance. We examine one form of long-run activity, namely, investments in innovation as measured by patent? ing activity. Based on 472 LBO transactions, we find no evidence that LBOs sacrifice long-term investments. LBO firm patents are more cited (a proxy for economic impor? tance), show no shifts in the fundamental nature of the research, and become more concentrated in important areas of companies' innovative portfolios. In his influential 1989 paper, "The Eclipse of the Public Corporation," Michael Jensen predicted that the leveraged buyout (LBO) would emerge as the dom? inant corporate organizational form. With its emphasis on corporate gover? nance, concentrated ownership, monitoring by active owners, strong manage? rial incentives, and efficient capital structure, he argued that the buyout is superior to the public corporation with its dispersed shareholders and weak governance. These features enable LBO managers to add value more effec? tively and make long-run investments without catering to the public market's demands for steadily growing quarterly profits, which Stein (1988) and others argue can lead firms to myopically sacrifice such expenditures.1 In this case, it

Overconfidence and Early-Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies

Abstract: We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity. Such overconfident managers use less external finance and, conditional on accessing external capital, issue less equity than their peers. Second, CEOs who grew up during the Great Depression are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.

Cash Flows and Leverage Adjustments

Abstract: Recent research has emphasized the impact of transaction costs on firm leverage adjustments. We recognize that cashflow realizations can provide opportunities to adjust leverage at relatively low marginal cost. We find that a firm's cashflow features affect not only the leverage target, but also the speed of adjustment toward that target. Heterogeneity in adjustment speeds is driven by an economically meaningful concept: adjustment costs. Accounting for this fact produces adjustment speeds that are significantly faster than previously estimated in the literature. We also analyze how both financial constraints and market timing variables affect adjustments toward a leverage target.

Applied corporate finance

Abstract: Preface Acknowledgements Chapter 1 The Foundations Chapter 2 The Objective in Decision Making Chapter 3 The Basics of Risk Chapter 4 Risk Measurement and Hurdle Rates in Practice Chapter 5 Measuring Return on Investments Chapter 6 Project Interactions, Side Costs, and Side Benefits Chapter 7 Capital Structure: Overview of the Financing Decision Chapter 8 Capital Structure: The Optimal Financial Mix Chapter 9 Capital Structure: The Financing Details Chapter 10 Dividend Policy Chapter 11 Analyzing Cash Returned to Stockholders Chapter 12 Valuation: Principles and Practice Appendix 1 Appendix 2 Appendix 3 Appendix 4

Capital structure and corporate performance of Malaysian construction sector

Abstract: This paper investigates the relationship of capital structure and corporate performance of firm before and during crisis (2007). This study focuses on construction com panies which are listed in Main Board of Bursa Malaysia from 2005 to 2008. All the 49 construction companies are divided into big, medium and small sizes,based on the paid - up capital. The result shows that there is relationship between capital structure a nd corporate performance and there is also evidence shows that no relationship between the variables investigated. For big companies, ROC with DEMV and EPS with LDC have a positive relationship whereas EPS with DC is negatively related. In the interim, only OM with LDCE has positive relationship in medium companies and EPS with DC has a negative relationship in small companies. In sum, the outcome reveals that the relationship exists between capital structure and corporate performance in selected proxies.

Capital Structure Decisions During a Firm's Life Cycle

Abstract: The study reported here examines the financing choices of small and medium-sized firms, i.e., those most vulnerable to information and incentive problems, through the lens of the business life cycle. We argue that the controversy in the empirical literature regarding the determinants of capital structure decisions is based on a failure to take into account the different degrees of information opacity, and, consequently, firms' characteristics and needs at specific stages of their life cycles. The results show that, in a bank-oriented country, firms tend to adopt specific financing strategies and a different hierarchy of financial decision-making as they progress through the phases of their business life cycle. Contrary to conventional wisdom, debt is shown to be fundamental to business activities in the early stages, representing the first choice. By contrast, in the maturity stage, firms re-balance their capital structure, gradually substituting debt for internal capital, and for firms that have consolidated their business, the pecking-order theory shows a high degree of application. This financial life-cycle pattern seems to be homogeneous for different industries and consistent over time.

The Effect of Capital Structure on Profitability: Evidence from the United States

Abstract: The relationship between capital structure and profitability cannot be ignored because the improvement in the profitability is necessary for the long-term survivability of the firm. This paper seeks to extend Abor's (2005) findings regarding the effect of capital structure on profitability by examining the effect of capital structure on profitability of the American service and manufacturing firms. A sample of 272 American firms listed on New York Stock Exchange for a period of 3 years from 2005 - 2007 was selected. The correlations and regression analyses were used to estimate the functions relating to profitability (measured by return on equity) with measures of capital structure. Empirical results show a positive relationship between i) short-term debt to total assets and profitability and ii) total debt to total assets and profitability in the service industry. The findings of this paper show a positive relationship between i) short-term debt to total assets and profitability, ii) long-term debt to total assets and profitability, and iii) total debt to total assets and profitability in the manufacturing industry. This paper offers useful insights for the owners/operators, managers, and lending institutions based on empirical evidence. Introduction The capital structure decision is crucial for business organizations. The capital structure decision is important because of the need to maximize returns of the firms, and because of the impact, such a decision has on the firm's ability to deal with its competitive environment. The capital structure of a firm is a mixture of different securities. In general, firms can choose among many alternative capital structures. For example, firms can arrange lease financing, use warrants, issue convertible bonds, sign forward contracts or trade bond swaps. Firms can also issue dozens of distinct securities in countless combinations to maximize overall market value (Abor, 2005, p. 438). A number of theories have been advanced in explaining the capital structure of firms. Despite the theoretical appeal of capital structure, researchers in financial management have not been able to find a model for an optimal capital structure. The best that academics and practitioners have been able to achieve are prescriptions that satisfy short-term goals (Abor, 2005, p. 438). The lack of a consensus about what would qualify as optimal capital structure in the sendee and manufacturing industries has motivated us to conduct this research. Abetter understanding of the issues at hand requires a look at the concept of capital structure and its effect on the firm's profitability. Most other empirical studies on the capital structure of the firm and profitability have been conducted on industrial firms. There might be other factors that affect the profitability of service firms, which are not involved in manufacturing. In service industry, investment in machinery and equipment is very low. If service firms lease their facilities (buildings), then their total capital invested is mainly working capital (Gill, Biger, and Bhutani, 2009, p. 48). In order to examine whether these different investment patterns are also related to the capital structure of these firms, we chose to sample companies from both service industries and manufacturing. This study examines the relationship between capital structure and profitability of the American service and manufacturing firms. The literature cites a number of variables that are potentially associated with the profitability of firms. In this study, the selection of exploratory variables is based on the alternative capital structure, profitability theories and previous empirical work. The choice can be limited, however, due to data limitations. As a result, the set of proxy variables includes six factors: three ratios of short-term debt to total assets, long-term debt to total assets, total debt to total assets and, in addition, sales growth, firm size, and profitability (measured by return on equity). …

Family Control and Financing Decisions

Abstract: This study uses a comprehensive European dataset to investigate the role of family control in corporate financing decisions during the period 1998-2008. We find that family firms have a preference for debt financing, a non-control-diluting security, and are more reluctant than non-family firms to raise capital through equity offerings. We also find that credit markets are prone to provide long-term debt to family firms, indicating that they view their investment decisions as less risky. In fact, our empirical results demonstrate that family firms invest less than non-family firms in high-risk, research and development (R&D) projects, but not in low-risk, fixed-asset capital expenditure (CAPEX) projects, suggesting that fear of control loss in family firms deters risk-taking. Overall, our findings reveal that the external financing (and investment) decisions of family firms are in greater (lesser) conflict with the interests of minority shareholders (bondholders).

Cash conversion cycle and firm's performance of Japanese firms

Abstract: Purpose – The purpose of this paper is to investigate the relation between a firm's cash conversion cycle and its profitability.Design/methodology/approach – The relation between the firm's cash conversion cycle and its profitability is examined using dynamic panel data analysis for a sample of Japanese firms for the period from 1990 to 2004. The analysis is applied at the levels of the full sample and divisions of the sample by industry and by size.Findings – A strong negative relation between the length of the firm's cash conversion cycle and its profitability is found in all of the authors’ study samples except for consumer goods companies and services companies.Originality/value – Traditional focus in corporate finance was on the long‐term financial decisions, particularly capital structure, dividends, and company valuation decisions. However, the recent trend in corporate finance is the focus on working capital management. Most of working capital management literature is based on the US experience. T...

Two Common Problems in Capital Structure Research: The Financial- Debt-To-Asset Ratio and Issuing Activity Versus Leverage Changes

Abstract: This paper points out two common problems in capital structure research. First, although it is not clear whether non-financial liabilities should be considered debt, they should never be considered as equity. Yet, the common financial-debt-to-asset ratio (FD/AT) measure of leverage commits this mistake. Thus, research on increases in FD/AT explains, at least in part, decreases in non-financial liabilities. Future research should avoid FD/AT altogether. The paper also quantifies the components of the balance sheet of large publicly traded corporations and discusses the role of cash in measuring leverage ratios. 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.

Capital structure and financial performance: evidence from selected business companies in colombo stock exchange sri lanka

Abstract: Capital structure is most significant discipline of company’s operations. This researcher constitutes an attempt to identify the impact between Capital Structure and Companies Performance, taking into consideration the level of Companies Financial Performance. The analyze has been made the capital structure and its impact on Financial Performance capacity during 2005 to 2009 (05 years) financial year of Business companies in Sri Lanka. The results shown the relationship between the capital structure and financial performance is negative association at -0.114. Co-efficient of determination is 0.013. F and t values are 0.366, -0.605 respectively. It is reflect the insignificant level of the Business Companies in Sri Lanka. Hence Business companies mostly depend on the debt capital. Therefore, they have to pay interest expenses much.

Firm- and Country-Level Determinants of Corporate Leverage: Some New International Evidence

Abstract: This research analyzes the determinants of capital structure across 37 countries. Institutional arrangements matter for capital structure decisions; however, firm-level covariates drive two-thirds of the variation in capital structure across countries, while the country-level covariates explain the remaining one-third. The observed relationships between the country-level determinants and leverage provide strong support to the predictions of both the trade-off and the pecking-order theories. Country-level determinants serve as substitute mechanisms for the firm-level, industry-level, and macroeconomic determinants by moderating their marginal impact on leverage.

Monetary Policy, Leverage, and Bank Risk-Taking

Abstract: The recent global financial crisis has ignited a debate on whether easy monetary conditions can lead to greater bank risk-taking. We study this issue in a model of leveraged financial intermediaries that endogenously choose the riskiness of their portfolios. When banks can adjust their capital structures, monetary easing unequivocally leads to greater leverage and higher risk. However, if the capital structure is fixed, the effect depends on the degree of leverage: following a policy rate cut, well capitalized banks increase risk, while highly levered banks decrease it. Further, the capitalization cutoff depends on the degree of bank competition. It is therefore expected to vary across countries and over time.

Debt Financing and Financial Flexibility: Evidence from Pro-active Leverage Increases

Abstract: Firms that intentionally increase leverage through substantial debt issuances do so primarily as a response to operating needs rather than a desire to make a large equity payout Subsequent debt reductions are neither rapid, nor the result of pro-active attempts to rebalance the firm’s capital structure towards a long-run target Instead, the evolution of the firm’s leverage ratio depends primarily on whether or not the firm produces a financial surplus In fact, firms that generate subsequent deficits tend to cover these deficits predominantly with more debt even though they exhibit leverage ratios that are well above estimated target levels Our findings are broadly consistent with a capital structure theory in which financial flexibility, in the form of unused debt capacity, plays an important role in capital structure choices

An International Comparison of Capital Structure and Debt Maturity Choices

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.

Fiduciary Duties and Equity-Debtholder Conflicts

Abstract: We use an important legal event as a natural experiment to examine the effect of management fiduciary duties on equity-debt conflicts. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors' fiduciary duties in firms incorporated in that state. This change limited managers' incentives to take actions favoring equity over debt for firms in the vicinity of financial distress. We show that this ruling increased the likelihood of equity issues, increased investment, and reduced firm risk, consistent with a decrease in debt-equity conflicts of interest. The changes are isolated to firms relatively closer to default. The ruling was also followed by an increase in average leverage and a reduction in covenant use. Finally, we estimate the welfare implications of this change and find that firm values increased when the rules were introduced. We conclude that managerial fiduciary duties affect equity-bond holder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare.

Firms’ debt–equity decisions when the static tradeoff theory and the pecking order theory disagree

Abstract: This paper tests the static tradeoff theory against the pecking order theory. We focus on an important difference in prediction: the static tradeoff theory argues that a firm increases leverage until it reaches its target debt ratio, while the pecking order yields debt issuance until the debt capacity is reached. We find that for our sample of US firms the pecking order theory is a better descriptor of firms’ issue decisions than the static tradeoff theory. In contrast, when we focus on repurchase decisions we find that the static tradeoff theory is a stronger predictor of firms’ capital structure decisions.