Showing papers on "Debt published in 1988"

The Determinants of Capital Structure Choice

Abstract: This paper analyzes the explanatory power of some of the recent theories of optimal capital structure. The study extends empirical work on capital structure theory in three ways. First, it examines a much broader set of capital structure theories, many of which have not previously been analyzed empirically. Second, since the theories have different empirical implications in regard to different types of debt instruments, the authors analyze measures of short-term, long-term, and convertible debt rather than an aggregate measure of total debt. Third, the study uses a factor-analytic technique that mitigates the measurement problems encountered when working with proxy variables.

Corporate Finance and Corporate Governance

Abstract: A combined treatment of corporate finance and corporate governance is herein proposed. Debt and equity are treated not mainly as alternative financial instruments, but rather as alternative governance structures. Debt governance works mainly out of rules, while equity governance allows much greater discretion. A project-financing approach is adopted. I argue that whether a project should be financed by debt or by equity depends principally on the characteristics of the assets. Transaction-cost reasoning supports the use of debt (rules) to finance redeployable assets, while non-redeployable assets are financed by equity (discretion). Experiences with leasing and leveraged buyouts are used to illustrate the argument. The article also compares and contrasts the transaction-cost approach with the agency approach to the study of economic organization.

Credit, Money, and Aggregate Demand

Abstract: Standard models of aggregate demand treat money and credit asymmetrically; money is given a special status, while loans, bonds, and other debt instruments are lumped together in a "bond market" and suppressed by Walras' Law. This makes bank liabilities central to the monetary transmission mechanism, while giving no role to bank assets. We show how to modify a textbook IS-UI model so as to permit a more balanced treatment. As in Tobin (1969) and Brunner-Meltzer (1972), the key assumption is that loans and bonds are imperfect substitutes. In the modified model, credit supply and demand shocks have independent effects on aggregate demand; the nature of the monetary transmission mechanism is also somewhat different. The main policy implication is that the relative value of money and credit as policy indicators depends on the variances of shocks to money and credit demand. We present some evidence that money-demand shocks have become more important relative to credit-demand shocks during the 1980s.(This abstract was borrowed from another version of this item.)

Do Taxes Affect Corporate Financing Decisions

Abstract: A new empirical method and data set are used to study the effects of tax policy on corporate financing choices Clear evidence emerges that non-debt tax shields "crowd out" interest deductibility, thus decreasing the desirability of debt issues at the margin Previous studies which failed to find tax effects examined debt-equity ratios rather than individual, well-specified financing choices This paper also demonstrates the importance of controlling for confounding effects which other papers ignored Results on other (asymmetric information) effects on financing decisions are also presented

Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation

Abstract: History suggests the following stylized facts about default on sovereign debt:(1) Defaults are associated with identifiably bad states of the world. (2) Defaults are usually partial, rather than complete.(3) Sovereign states usually are able to borrow again soon after a default. Motivated by these facts, this paper analyses a reputational equilibrium in a model that interprets sovereign debts as contingent claims that both finance investments and facilitate risk shifting. Loans are a useful device to facilitate risk shifting because they permit the prepayment of indemnities. Nevertheless, because the power to abrogate commitments without having to answer to a higher enforcement authority is an essential aspect of sovereignty, a decision by a sovereign to validate lender expectations about debt servicing depends on the sovereign's concern for its trust worthy reputation. A trustworthy reputationis valuable because it provides continued access to loans. A key aspect of the analysis is that lenders differentiate excusable default, which is associated with implicitly understood contingencies, from unjustifiable repudiation. In the reputational equilibrium, the short-run benefits from repudiation are smaller than the long-run costs from loss of a trustworthy reputation. Thus, although sovereigns sometimes excusably default, they never repudiate their debts. The reputational equilibrium can involve efficient risk shifting and efficient investment or it can involve a binding lending ceiling that limits risk shifting and can also restrict investment. The factors that tend to produce a binding lending ceiling include a high time discount rate for the sovereign, low-risk aversion forthe sovereign, and a low net return from the sovereign's investments.

External Debt, Capital Flight and Political Risk

Abstract: This paper provides an explanation of the simultaneous occurrence in developing countries of a large accumulation of external debt, private capital outflows and relatively low domestic capital formation. We consider a general equilibrium model in which two types of government with conflicting distributional goals randomly alternate in office. Uncertainty over the fiscal policies of future governments generates private capital flight and reduced domestic investment. This political uncertainty also provides the incentives for the current government to over-accumulate external debt. The model also predicts that left-wing governments are more inclined to impose restrictions on capital outflows than right-wing governments. Finally, we examine how political uncertainty affects the risk premium charged by lenders and how debt repudiation may occur after a change of political regime.

Death, Birth, Productivity Growth and Debt Neutrality

Abstract: This paper reconsiders the necessary and sufficient conditions for debt neutrality. There is debt neutrality if, given a pro gram for public expenditure on current goods and services over time, the real equilibrium of the economy is not affected by a change in th e pattern of lump-sum taxes over time. If there is debt neutrality fo r instance, the substitution of borrowing today for lump-sum taxation today (followed by such further changes in the time path of future l ump-sum taxes as are required for maintaining government solvency) do es not affect the current and future behavior of private consumption and capital formation. Copyright 1988 by Royal Economic Society.

Debt versus Equity under Asymmetric Information

Abstract: In a world of asymmetric information in which only the insiders know the quality of the firm, it is claimed that debt, even if it is risky, is more advantageous than outside equity because issuance of debt is less attractive to inferior firms. The advantage to debt arises from the fact that it can keep unprofitable firms out of the market, thus improving the average quality of firms in the market. This advantage exists even if the firms cannot be perfectly sorted in the signaling equilibrium.

The Debt Crisis: Structural Explanations of Country Performance

Abstract: This paper develops a cross-country statistical model of debt rescheduling, and the secondary market valuation of LDC debt, which links these variables to key structural characteristics of developing countries, such as the trade regime, the degree of income inequality, and the share of agriculture in GNP Our most striking finding is that higher income inequality is a significant predictor of a-higher probability of debt rescheduling in a cross-section of middle-income countries. We attribute this correlation to various difficulties of political management in economies with extreme inequality. We also find that outward-orientation of the trade regime is a significant predictor of a reduced probability of debt rescheduling.

Capital structure and signaling game equilibria

Abstract: In this article we model the financing decisions of a firm as a sequential signaling game. We prove that, when insiders have perfect information regarding the firm's future case flows, the application of 'refinements' to the set of admissible equilibria leads to the dominance of debt over equity financing. However, we show that when insiders observe the firm's cash flows imperfectly, there may exist sequential equilibria in which this 'pecking order' breaks down and some firms strictly prefer equity to debt financing. We also prove that, despite the breakdown of the pecking order, the announcement effect of equity financing will be negative relative to debt financing.

The Buyback Boondoggle

Abstract: ACROSS Latin America today, countries are experimenting with marketbased debt reduction to ease their massive foreign debt burdens. Brazil expects to swap $8 billion of its debt for equity investments during 1988. During the first nine months of 1988, Chile swapped $1.42 billion of its bank debt for equity, and plans to repurchase more debt using reserves. Mexico, which converted roughly $2.5 billion worth of debt during 1986 and 1987, tried unsuccessfully to swap $10 billion in new senior bonds for $20 billion in bank debt in February 1988; a revised plan is said to be in the offing. Many smaller debtor countries are also attempting to restructure their foreign debts. Bolivia repurchased 46 percent of its bank debt last March, and there is now talk of Costa Rica engaging in a buyback.' The danger in the new trend is that when highly indebted countries retire their deeply discounted debt, either through buybacks or "debtequity" swaps, they may simply be using their scarce resources to subsidize their creditors. Such programs might be valuable as components of efficiency-enhancing larger deals between debtors and creditors. However, highly indebted countries do not benefit if they repurchase debt unilaterally, without receiving concessions. In some instances

Is Everything Neutral

Abstract: In his well-known analysis of the national debt, Robert Barro introduced the notion of a "dynastic family." This notion has since become a standard research tool, particularly in the areas of public finance and macroeconomics. In this paper, we critique the assumptions on which the dynastic model is predicated and argue that this framework is not a suitable abstraction in contexts in which the objective is to analyze the effects of public policies. We reach this conclusion by formally considering a world in which each generation consists of a large number of distinct individuals as opposed to one representative individual. We point out that family linkages form complex networks, in which each individual may belong to many dynastic groupings. The resulting proliferation of linkages between families gives rise to a host of neutrality results, including the irrelevance of all public redistributions, distortionary taxes, and prices. Since these results are not at all descriptive of the real world, we conclude...

Capital Structure Theory and REIT Security Offerings

Abstract: In this paper, we examine the stock price reactions to announcements of new security offerings by Real Estate Investment Trusts (REITs). REITs offer a unique setting in which to study these events because they do not pay taxes at the firm level. Theory suggests that the net tax gain to corporate borrowing is unambiguously negative for a REIT. Contrary to some recent studies, however, we find a positive stock price reaction to debt offerings, while the negative equity-issuance effect is preserved. Further empirical evidence lends support to signalling as the explanation for the positive significant debt-issuance effect.

Bankruptcy Costs and the Theory of Oligopoly

Abstract: This paper examines the relationship between financial decisions and output decisions in oligopolistic markets. Assuming a duopoly market structure in which financial decisions and output decisions follow in sequence, the authors analyze how bankrupt cy costs, which are incurred when the firm is unable to meet current debt obligations, affect the firm's behavior in output markets. With fixed bankruptcy costs, firms have an incentive to increase output le vels if they take on more debt. Proportional bankruptcy costs lead to a U-shaped relationship between output and debt. Foresighted owners of firms are led to take into account the strategic output effects of financial structure when considering an optimal financial structure for the firm.

Market-Based Debt-Reduction Schemes

Abstract: Recently much attention has been given to the idea of reducing the debt of developing countries through a "menu approach" of schemes that attempt to harness the discounts on debt in the secondary market. This paper, after reviewing the rationale for the orthodox strategy of concerted lending and the case for debt forgiveness, examines the logic behind several market-based debt reduction schemes. It shows that such schemes will ordinarily benefit both debtor and creditor only when the debtor is on the wrong side of the "debt relief Laffer curve" -- that is, where a reduction in nominal claims actually increases expected payment. This is, however, also the case in which unilateral debt forgiveness is in the interest of creditors in any case. The implication is that there is no magic in market-based debt reduction, as opposed to more straightforward approaches.

Conditionality, Debt Relief, and the Developing Country Debt Crisis

Abstract: This paper raises several cautionary notes regarding high-conditionality lending by the International Monetary Fund and the World Bank in the context of international debt crisis It is argued that the role for high-conditionality lending is more restricted than generally believed, because enforcement of conditionality is rather weak Moreover, the incentives for a country to abide by conditionality terms are also likely to be reduced by a large overhang of external indebtedness Given the limited ability to enforce conditionality agreements, modesty and realism should be a cornerstone of each program The experience with conditionality suggests two major lessons for the design of high-conditionality lending First, debt forgiveness rather than mere debt rescheduling may increase a debtor country's compliance with conditionality, and thereby increase the actual stream of repayments by the indebted countries Second, given the complexity of the needed adjustments, and the difficulty of enforcing conditionality agreements, programs are most likely to be successful when macroeconomic stabilization is given priority over large-scale liberalization

Rational Ponzi Games

Abstract: When can a government run a rational Ponzi game, i.e., issue debt and never pay back any interest or principal? The transversalit y condition of each individual implies that such schemes require an i nfinity of lenders. Given this, horizons are unimportant: Ponzi games cannot be ruled out by assuming that agents have infinite horizons. The authors point out both the basic similarity of, and some key diff erences between, rational Ponzi games and asset price bubbles or fiat money. Regarding international debt, the analysis implies that what matters for the feasibility of rational Ponzi games are conditions in the lenders', not the borrowers', economy. Copyright 1988 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

The Early History of Price Index Research

Abstract: This paper examines the domestic and foreign fixed investment expenditures of a sample of U.S. multinational firms to explain empirically each type of investment and to determine whether there are significant interactions between them. Models exhibiting two types of interactions, one, financial and the other, production-based, are explored theoretically and empirically. The financial interaction is the result of a model which assumes a risk of bankruptcy and its associated costs; under these circumstances, the firm faces an increasing cost of capital as a function of its debt/equity ratio. Domestic and foreign investment are interdependent, since, in competing for finance, each affects the cost of capital in the other location. Production interactions can arise when, because of start-up costs or other factors that produce nonlinear cost functions, it may become profitable to shift production from the home to the foreign location. The hypotheses are tested on data covering the domestic and foreign operations of seven multinational firms for a period of 16 to 20 years. The firm level investment functions fit reasonably well for both domestic and foreign expenditures; an interdependence between domestic and foreign investment was confirmed frequently through the finance side, but only once via production.

Buybacks, Exit Bonds, and the Optimality of Debt and Liquidity Relief

Abstract: We compare various forms of market-based debt relief with coordinated debt forgiveness on the part of creditors. These schemes lead to different allocations of resources and levels of debtor and creditor welfare, but all attempt to stimulate debtor investment through reductions in the level of debt. If investment-incentive effects are present, then investment in liquidity-constrained debtors will respond by enough to make a reduction in debt profitable, but not by enough to make the reduction in debt optimal. For these countries the optimal debt-relief package (from the creditors perspective) will include an infusion of new lending.

Debt Relief and Adjustment Incentives

Abstract: The argument that debt relief would increase the incentive of a debtor country to make an adjustment effort (to invest) and that for this reason creditors may benefit by granting relief is analyzed in this paper. It is shown that there are actually opposing incentive effects of debt relief and that the argument could be valid in particular circumstances. A distinction is made between exogenous and endogenous relief, the latter compelled by low capacity to pay caused by low investment earlier.

Capital Structure, Ownership, and Capital Payment Policy: The Case of Hospitals

Abstract: This study examines effects of pertinent features of hospital capital payment policies on hospital capital structure decisions in a one-period stochastic, value-maximization model. Separate models are developed for for-profit and not-for-profit hospitals. Hospital debt-to-assets ratios are analyzed empirically using a cross-section of data from the American Hospital Association. Although the effect on capital structure of hospital reliance on cost-based reimbursement cannot be signed theoretically, in both for-profit and not-for-profit cases, a higher cost-based share leads to higher leverage. Factors associated with high bankruptcy risk (e.g., earnings volatility) cause hospitals to take on less debt. THE HOSPITAL INDUSTRY EXHIBITS two prominent characteristics that have unique implications for its capital structure. First, the majority of hospitals are organized as private not-for-profit (NFP) institutions. Since there is no applicable corporate income tax, any risk of bankruptcy might imply that the NFP hospital would select an all-equity hospital structure. Yet it is a stylized fact that almost all NFP hospitals have debt obligations. At the same time, there exists a sizeable minority of hospitals operated by government or as for-profit organizations. Forprofit hospitals are subject to all tax privileges and obligations applicable to forprofit enterprises in other sectors. Thus, the industry provides a laboratory for analysis of the effect of ownership on organizations' capital structures. A second unique feature of the industry is that almost all hospital revenue is derived from public and private insurers (Waldo et al. [21]). At least until very recently, insurers in this industry paid hospitals on either a retrospective-cost or

The Effects of Financial Disclosure Levels on Firms' Choices among Alternative Foreign Stock Exchange Listings

Abstract: Firms are increasingly adopting a global perspective. Nowhere is this more evident than in the accelerating internationalization of the world's financial capital markets. In just five years the dollar volume of debt and equity securities placed annually by firms outside of their national borders has increased by 900%.' In the US, primary offerings of foreign debt and equity have averaged over $5 billion per year since 1975. Between 1974 and 1984, the dollar volume of foreign stocks traded in secondary markets in the US rose 839%. A recent survey lists 472 companies as having active international trading in their equity securities. Once a firm decides to list its equity securities on a foreign exchange, available evidence suggests that the choice of listing location(s) is not random. This study addresses this question by presenting empirical evidence on the cross-sectional association between the financial disclosure levels of nine major stock exchanges (in eight countries) and the observed exchange choices of a sample of 207 US and non-US firms whose equity securities are listed on at least one foreign exchange. We interpret "financial disclosure" broadly to include both mandated accounting, listing and regulatory requirements and voluntary disclosures dictated by the expectations of market participants. Examining large firms with at least one foreign listing allows us to more effectively control for factors motivating firms' decisions to list abroad and to concentrate on factors influencing choices among alternative foreign exchange listings. Results from univariate and multivariate tests are consistent with financial disclosure levels influencing foreign exchange listing decisions.

Credibility, Debt and Unemployment: Ireland's Failed Stabilization

Abstract: Can the credibility of a stabilization plan affect the output costs of disinflation? The new classical economics has asserted this possibility, but little evidence has been brought forward. This paper analyzes the stabilization program of Ireland in the l980s against the background of the new classical economics, The main questions are two: Did EMS membership yield a special credibility bonus? And is the stabilization program sustainable. The answer to both questions is negative. The idea of a credibility bonus Is an attractive potential policy implication of EMS membership: by joining the EMS, playing by the rules of fixed exchange rates and benefiting from the stabilizing influence of German inflation targets, a country's policy makers achieve a dramatic turn around in expectations, in inflation and in long-term interest rates. But the evidence on international disinflation in the 1980s shows that it was not limited to EMS members; all OECD countries experienced sharply reduced inflation and a large drop in long-term nominal interest rates, EMS membership did not contribute to reduce the sacrifice ratio of disinflation. In fact Germany, on whose anti-inflation credentials the credibility effects are supposedly based has one of the highest sacrifice ratios among DECD countries. Ireland did reduce inflation to the German level, but a serious public debt problem has emerged and the unemployment rate stands near 20 percent. This raises questions of the Sargent-Wallace kind about the sustainability of the program.

Do Taxes Affect Corporate Financing Decisions

Abstract: A new empirical method and data set are used to study the effects of tax policy on corporate financing choices. Clear evidence emerges that non-debt tax shields "crowd out" interest deductibility, thus decreasing the desirability of debt issues at the margin. Previous studies which failed to find tax effects examined debt-equity ratios rather than individual, well-specified financing choices. This paper also demonstrates the importance of controlling for confounding effects which other papers ignored. Results on other (asymmetric information) effects on financing decisions are also presented.

The Early History of Price Index Research

Abstract: This paper examines the domestic and foreign fixed investment expenditures of a sample of U.S. multinational firms to explain empirically each type of investment and to determine whether there are significant interactions between them. Models exhibiting two types of interactions, one, financial and the other, production-based, are explored theoretically and empirically. The financial interaction is the result of a model which assumes a risk of bankruptcy and its associated costs; under these circumstances, the firm faces an increasing cost of capital as a function of its debt/equity ratio. Domestic and foreign investment are interdependent, since, in competing for finance, each affects the cost of capital in the other location. Production interactions can arise when, because of start-up costs or other factors that produce nonlinear cost functions, it may become profitable to shift production from the home to the foreign location. The hypotheses are tested on data covering the domestic and foreign operations of seven multinational firms for a period of 16 to 20 years. The firm level investment functions fit reasonably well for both domestic and foreign expenditures; an interdependence between domestic and foreign investment was confirmed frequently through the finance side, but only once via production.