Showing papers on "Leverage (finance) published in 1993"

Asset specificity, firm heterogeneity and capital structure

Abstract: This paper presents an empirical investigation of the importance of specialized assets and other unique characteristics of a firm in explaining the variance in capital structure across firms. The results show that firm-specific effects contribute most to the variance in leverage, suggesting a strong link between strategy and capital structure.

Managerial Decision Making and Capital Structure

Abstract: This article investigates leverage influence on project selection. First, the authors examine 428 mergers (1962-82) and then 389 acquisitions of all types (1982-86). Announcement-period acquirer returns are greater the higher the leverage of the acquirer. A third data set contains 173 acquisitions undertaken during 1978-90 for firms that underwent major increases in leverage, often forced by hostile takeover. Acquisition performance increases after restructuring. The evidence is invariant with respect to methodology--beta-adjusted abnormal returns, numeraire portfolio approach, and three-factor regression model residuals produce identical results. Overall, the data support the hypothesis that debt improves managerial decision-making. Copyright 1993 by University of Chicago Press.

Capital structure as a bargaining tool : the role of leverage in contract renegotiation

Abstract: This paper presents a strategic model of temporarily high leverage. When the repayment of senior claims depends in part upon further investment, shareholders may be able to alter credibly their incentives to invest through an exchange of junior debt for equity and thereby force concessions from senior creditors. We focus on the conflict between shareholders and risk-averse workers and show that this strategic use of debt leads to an inefficient allocation of risk. We characterize conditions under which firms will undergo leveraged recapitalizations, their choice of debt instruments, and the dynamics of their capital structure.

Accounting measures of corporate liquidity, leverage, and costs of financial distress

Abstract: Liquid assets such as cash and marketable securities constitute a considerable portion of total assets, say 6.3% to 9.6%, of manufacturing firms. Financial managers pay a lot of attention to the measurement and management of corporate liquidity. It has also been recognized that a consequence of severe shortage of liquidity is financial distress. This study analyzes the relationship of the costs of financial distress to the level of corporate liquidity maintained and leverage.

Economic determinants of the relation between earnings changes and stock returns

Abstract: SYNOPSIS AND INTRODUCTION: In competitive product markets, product prices and thus firms' revenues incorporate the cost of equity capital. In a competitive capital market, the cost of equity capital (the expected return on equity) increases with the risk of firms' investments. Because accounting earnings are calculated without deducting the cost of equity capital, they are expected to be an increasing function of firms' investment risks. This simple competitive equilibrium analysis predicts a positive relation between changes in investment risk and expected earnings. The presence of corporate debt complicates the analysis because leverage effects seem likely to affect the relation between changes in investment risk and expected earnings. Using annual earnings and return data from 1950 to 1988, we document a statistically significant positive association between changes in equities' relative risks and in earnings. However, on average, only a small proportion of changes in earnings can be attributed to changes in risk. A much larger proportion is attributable to changes in economic rents (windfall gains and losses). The observed positive association between changes in earnings and changes in equities' risks suggests that leverage effects do not fully offset the effect of changes in investment risks. This

Managing Financial Distress and Valuing Distressed Securities: A Survey and a Research Agenda

Abstract: The role of high leverage in corporate restructuring, popularity of junk bonds (original-issue, high-yield bonds) and the savings & loan crisis have been important aspects of the finance scene in the 1980s A very active academic literature has developed in recent years on dealing with financial distress and the private and court-supervised mechanisms of resolving default The purpose of this article is to survey the empirical and theoretical research on (i) managing financial distress, and (ii) valuing corporate securities incorporating payouts in troubled reorganizations New research on both topics is contained in the nine papers presented in this Financial Distress Special Issue of Financial Management These papers are also surveyed in the context of related past research

Do Inside Ownership and Leverage Share Common Determinants

Abstract: Papers by Jensen and Meckling (1976), Jensen (1986), and Stulz (1988) suggest that a firm's leverage ratio and its level of inside ownership share common determinants. This paper examines whether inside equity and leverage are explained by a common set of variables that proxy for a firm's exposure to various market imperfections. These imperfections include the agency costs of equity, leverage-related costs, the tax advantage of debt, the costs of issuing securities, and the demand for risk-sharing by insiders. In contrast to Crutchley and Hansen (1989), but consistent with Jensen, Solberg, and Zorn (1992) and Holthausen and Larcker (1991), little evidence is found that leverage and inside equity are explained by the same variables. These results hold even after controlling for industry effects, an issue not examined by previous literature. In addition, leverage is related strongly and negatively to free cashflow, a result that is inconsistent with Jensen (1986), but consistent with the pecking order hypothesis of Myers (1984).

Optimality of Spin-Offs and Allocation of Debt

Abstract: Recent empirical studies have indicated that spin-offs are value enhancing, yet the theoretical aspects of spin-off gains have not been as well explored. This paper presents a theoretical analysis of spin-offs. In the model of the firm presented, outstanding risky debt gives rise to agency costs of underinvestment, which are offset by the benefit of debt-related tax shields. The trade-off specifies the optimal leverage for a firm. Within this framework, the paper considers whether and under what circumstances firm value could be enhanced by a spin-off. It is shown that a spin-off in which parent company debt is optimally allocated between the post-spin-off firms increases value by reducing agency costs and increasing the value of tax shields when the component firm cash flows are positively correlated. The optimal allocation is characterized in terms of the parameters of the technologies of the component firms. When the component cash flows are negatively correlated, under the sufficient conditions developed, a combined firm operation dominates spin-offs. Here, the coinsurance effect on investment incentives dominates the effect of a flexible allocation of

The Determinants of Corporate Leverage: A Panel Data Analysis

Abstract: Widespread increases in corporate leverage occurred over the 1980s in Australia. There was also considerable variation in leverage across firms. This paper uses a sample of 209 firms, observed annually between 1973 and 1991, to explore both cross-sectional and time variation in financial structure. The paper begins with a survey of the literature on corporate financial structure. This leads to a model that incorporates the major determinants of leverage. The empirical model takes into account the influence of both firm-specific and time-specific effects. The dynamics of leverage are also tentatively explored. The results suggest that a number of firm-related factors influence the relative costs of debt, the level of demand for and the availability of funds. Most important among these are firm size, growth, collateral and cash flow. A number of macro-economic variables are also found to influence leverage. Most important among these are real asset prices which play a significant role in the post-financial deregulation period.

Stock returns and classification pattern of firm‐specific financial variables: empirical evidence with finnish data

Abstract: This paper incorporates the findings of empirical classification patterns of financial ratios to studies investigating the relation between stock returns and financial factors of a firm. The empirical results indicate that the relevant information of the investigated financial characteristics of a firm can be presented in one factor, with respect to which single financial ratios seem not to have incremental information content in the Finnish stock market. In crossindustry sample this factor is reported to be leverage. However, when studying purely industrial firms, the most important factor consists of ratios representing several a priori characteristics of a firm.

Are Long-Short Equity Strategies Superior?

Abstract: Equity analysts and asset managers often focus on which stocks to buy rather than which stocks to sell. Consequently "sells," or overvalued stocks, may be perceived as relatively less efficiently priced. A market-neutral long-short equity strategy may be able to leverage "sell" information more efficiently than a traditional long-only strategy. Claims of the superiority of a long-short investment strategy are often based, however, on misunderstandings of modern investment theory. Increases in active return associated with the strategy are typically accompanied by increases in active risk.Given the level of information in most institutional stock forecasts, the implied level of portfolio risk, additional costs and available alternatives, many long-term institutional investors may prefer traditional long-only strategies. Long-short investing may be most appropriate as a special-situation strategy.

On flexibility, capital structure and investment decisions for the insured bank☆

Abstract: Most models of deposit insurance assume that the volatility of a bank's assets is exogenously provided. Although this framework allows the impact of volatility on bankruptcy costs and deposit insurance subsidies to be explored, it is static and does not incorporate the fact that equityholders can respond to market events by adjusting previous investment and leverage decisions. This paper presents a dynamic model of a bank that allows for such behavior. The flexibility of being able to respond dynamically to market information has value to equity-holders. The impact and value of this flexibility option are explored under a regime in which flat-rate deposit insurance is provided.

Extent of diversification and company performance: The New Zealand evidence

Abstract: This paper confirms the relative superiority of related-diversification in terms of the financial performance of New Zealand companies, companies which are much smaller and less diverse than those which normally feature in this literature. To facilitate comparisons with other studies, financial performance is measured in three ways: return on equity; return on assets; and sales growth. Other independent variables controlled for are company size; risk; leverage; technological opportunity; and industry concentration. The effective rates of protection afforded manufacturing industries (export subsidies and import tariffs) are also confirmed as having had some positive bearing on company performance.

Lifetime Leverage Choice for Proprietary Farmers in a Dynamic Stochastic Environment

Abstract: This article reviews various models that may be used to explain optimal lever- age choice for the proprietary farmer in a stochastic dynamic environment and develops a new model that highlights the risk of failure rather than the usual concept of risk as the variability of wealth. The model suggests that in addition to the usual factors, farm financial leverage is affected by age, wealth, and the opportunity cost of farming. Farmers often make substantial changes in financial leverage over time. A frequently observed pattern is for a young farmer to start out heavily in debt, and pay down the debt over time, if the farm is successful. Young farmers who are unsuccessful seek alter- native employment in the agribusiness sector, or join the rural-to-urban migration move- ment. Given constant parameters for risk aversion and the underlying probability distri- bution, systematic planned changes in leverage over time are not consistent with existing static models of farm leverage choice (such as Barry, Baker, and Sanint 1980, 1981; and Collins). In addition, many existing models of dynamic leverage choice either fail to explain this behavior, or are based on unattractive assumptions. A popular explanation for these leverage changes is that young farmers are willing to take chances while older farmers are more conservative.' Even though changing risk aversion could explain changing lifetime leverage choices, there is little evidence that farmers become more risk averse with age. 2 An alternative explanation is that leverage choice is a dynamic process. This could mean that even if risk aversion or the parameters of the relevant density function did not change, a farmer could plan to change leverage over time. This article introduces a stochastic optimal control model of farm leverage choice that models failure risk rather than the typical concept of variability of wealth. An analytic solution is presented that gives qualitative results on how optimal leverage changes over time and in response to changing wealth and the changing opportunity cost of being a farmer. The first section discusses previous dynamic stochastic models of proprietary leverage. The second section develops an alternative model of farm leverage choice that considers the farmer's risk of bankruptcy. The text discusses the assumptions and impli- cations of the models, with most technical material left to appendices. The final section summarizes and states the primary testable implications of the model. The model suggests, in addition to the usual factors that affect the costs and benefits of leverage, that wealth, the opportunity cost of farming, and age also affect optimal leverage choice.

The financing and investment of a levered firm under asymmetric information

Abstract: This research extends the literature on financing and investment under asymmetric information by considering the effect of initial leverage. Because decisions affect the value of outstanding bonds, realistic behaviors arise that are absent in extant unlevered analyses. Leverage may induce social improvements in investment. Further, a stock offering may be a positive signal if lower-value firms face greater default risk and thus have lower debt values. Conditions that support positive reactions to equity funding appear to be present in the early 1990s.

Stock Market Behavior in a Small Capital Market: A Case of Nepal

Abstract: The purpose of this paper is to address the stock market behaviour in a small capital market in the context of Nepal. It attempts to examine relationship of market equity, market value to book value, price-earning, and dividends with liquidity, leverage, profitability, assets turnover, and interest coverages. The results indicate that larger stocks have larger price-earning ratios, larger ratio of market value to book value of equity, lower liquidity, lower profitability, and smaller dividends. Price-earning ratios and dividend ratios are more variable for smaller stocks whereas market value to book value of equity is more variable for larger stocks. Larger stocks also have higher leverage, lower assets turnover, and lower interest coverages but these are more variable for smaller stocks than for larger stocks. Stocks with larger market value to book value of equity have larger price-earning rations, and lower dividends. These stocks also have lower liquidity, higher leverage, lower earnings, lower turnover, and lower interest coverages.Stocks with higher price-earning ratios have lower liquidity, higher leverage, lower profitability, lower turnover, and lower interest coverages. However, these are all more variable for stocks with smaller price-earning ratios than for stocks with larger price-earning ratios.Stocks paying higher dividends have higher liquidity, lower leverage, higher earnings, higher turnover, and higher interest coverages. However, liquidity and leverage ratios are more variable for the stocks paying lower dividends while earnings, assets turnover, and interest coverages are more variable for the stocks paying higher dividends.

How well is debt managed by nonprofits

Abstract: Little is known about why nonprofits accrue debt, how much they owe, and whether the funds they borrow are used productively. This article distinguishes between productive, problematic, and deferred debt. Employing a data base representative of 114,726 tax-filing charitable nonprofits in the United States in 1986, it examines the pervasiveness of nonprofit debt and the relation between this debt and nonprofit financial health. The analysis finds that over 70 percent of the nonprofits hold debt, the distribution of this debt is highly concentrated, and the level of debt and leverage varies with asset size and type of activity. Nonprofits with higher leverage and absolute debt levels are financially healthier than those with lower levels. While the analysis does not determine whether financially stronger nonprofits are better able to borrow, the results support the view that borrowing in the nonprofit sector is economically efficient.

International integration of financial markets and the cost of capital

Abstract: Despite the increased capital mobility that has accompanied the trend towards liberalisation and international integration of financial markets, differences remain in financing costs and, in particular, the cost of capital, that similar businesses face in different countries. These differences have attracted considerable attention as important factors influencing international investment and productivity growth. A number of reviewed empirical studies suggest that Japan and Germany enjoyed a considerable advantage with regard to the cost of equity and, more broadly, the cost of capital compared to the United States and the United Kingdom in the 1980s. This was due to higher leverage, a much lower cost of equity in Japan and a lower cost of German firms' debt to banks. Many studies have argued that closer bank-customer relationships, and more stable prices and growth rates in Japan and Germany have tended to lower their cost of capital. More recent studies which cover the period ...

An Empirical examination of corporate capital structure in Australia and the USA

Abstract: The aim of this thesis is to expand our understanding of the corporate capital structure puzzle by conducting a more complete empirical investigation of the financing decision. This thesis extends our knowledge of the capital structure decision in at least four major ways. First, it considers the capital structure decision from a broader perspective than is normally taken. Both the total level of debt and the maturity of that debt is taken into consideration when measuring capital structure. Indeed, this study represents the first major attempt to explain cross-sectional variations in debt maturity. The empirical investigation of corporate debt maturities uncovered a number of regularities. The empirical evidence strongly supports the traditional notion that firms match the maturity of liabilities with the maturity of assets. In addition, debt ratios and firm size were found to be positively correlated with debt maturity. These findings support the notion that debt maturity affects agency/information asymmetry costs, bankruptcy costs and transaction costs.Second, both pecking order theory and static tradeoff variables are considered in attempting to explain cross-sectional variations in debt levels. In the past, many studies have ignored the effects of transaction costs on the ability of firms to change their capital structures. By allowing for the impediments that transaction costs place on the ability of firms to move to their static tradeoff optimal capital structures, a fuller, more complete picture of the "capital structure puzzle" has been gained. The findings presented here suggest that cross-sectional variations in capital structure are much better explained when both historical circumstances and static tradeoff variables are considered. Debt ratios were found to be positively related to firm size and assets in place/investment and negatively related to profitability. These findings support the view that bankruptcy and agency costs and transaction costs/pecking order theory affect debt ratios. Only limited support was found for the tax based theory of capital structure.Third, this study has used a number of different methods to define both debt levels and debt maturity. This is in contrast to previous capital structure studies where researchers have concentrated on one or two measures of capital structure. The large number of different leverage measures used in this study overcomes these cautions and criticisms allowing greater validity to be placed on the empirical results. The results found here suggest that while there was a relatively high degree of correlation between different measures of capital structure, there were a number of occasions where the choice of the leverage dependent variable affected the sign and significance of the resultant regression co-efficient. This suggests that caution must be placed on analyses which solely base their claims on the results of one dependent measure of leverage.Finally, this study represents the first major empirical analysis of capital structure in Australia. Analysis of capital structure is important as the capital structure decision is one of the three major financial decisions that a firm makes. In addition, the analysis of both an Australian sample and a US sample allows greater generalization of results compared with studies based solely on US data, and also provides the chance to compare Australian corporate capital structures with US corporate capital structures. The most notable difference between the US and Australian samples was the relatively large amounts of short term debt used by Australian firms. This suggests that short term debt cannot be ignored when one is investigating empirical capital structure regularities of Australian firms.

A Note on Taxes and the Capital Structure of Partnerships, REITs, and Related Entities

Abstract: Jaffe (1991) shows that the value of partnerships and REITs is generally invariant to leverage, although certain tax law provisions can result in an inverse relationship between value and leverage....

Leverage, resource allocation and growth

Abstract: The effects of resource allocation on firms comprising the competitive economy are examined within the structure of a simple general equilibrium model. The study shows that capital structure of a firm is independent of its value, — a result that can be characterized as the mirror-image of the celebrated Modigliani-Miller proposition. The structure of present analysis highlights how costs of capital assets change, what affects the prices of the firms, and how these changes are reflected in the operations of the firms in an overall economic set up. The paper then establishes that if debt is increased, and the (relatively) levered firm expands, its stock price goes up and the (relatively) less levered firm shrinks and moves in the opposite direction in all respects. The appropriate conditions for profitable leveraged buyout are spelled out, and other conditions are also specified as to when merger is unprofitable. Finally, the paper is concluded with some thoughts on possible future research along the lines outlined in this work.

The Danger of Leverage and Volatility

Abstract: High expected returns are attractive but are associated with high risk. Ultimately, risk shows up as volatility. Volatility is a fundamental feature of a business but can be increased through firm or investor leverage. Volatility without leverage significantly reduces long term return. Leverage and volatility combined can turn moderately poor returns into disasters and reduce long term return far more than is generally appreciated. Many investments with high expected returns have disappointing long term returns or appreciable chances of disaster.

The contribution of management buy-ins to corporate restructuring : concepts, characteristics and performance

Abstract: From the mid-1980s many UK venture capitalists, as an extension to their involvement in management buy-outs, made investments in management buy-ins where they backed new managers to purchase equity stakes in an existing company This Thesis analyses the corporate restructuring and entrepreneurial influences behind buy-ins taking note of turnaround and venture capital influences It draws on general buy-in characteristics from a database of 750 management buy-ins and the results of a representative questionnaire survey of 59 management buy-ins (mailed in February 1990) and backed by individual case studies It is hypothesised that management buy-ins are a distinctive corporate restructuring form and have major differences with management buy-outs Buy-ins are shown to be significantly different from buy-outs in terms of source, activity and realisation; they are more likely to be bought from a private source and to end up in receivership Financing structures are more conservative but not on a statistically significant basis Buy-in teams are smaller than in buy-outs, frequently have initial skills gaps, and in a minority of cases are led by second time entrepreneurs The target company is normally identified through informal networks Buy-ins are followed by a significantly higher degree of action in financial, product and marketing areas than Buy-outs and other restructuring processes such as turnarounds Compared to US LBOs more attention is paid to working asset management with little unbundling of fixed assets and higher capital expenditure Team Leaders are shown to be mainly opportunist in terms of entrepreneurial typology with a minority craftsmen and, unexpectedly, a few mainly motivated by push factors This is in contrast to buy-outs where a typology is developed showing a preponderance of craftsmen Overall performance after buy-in was below original Business Plan but heavily influenced by adverse economic and financial conditions Different types of Team Leaders were not associated with significant differences in performance although opportunists were more likely to be acquisitive Contrary to the principles of corporate restructuring, discriminant analysis showed equity ratchets and higher rates of leverage being negative influences on profitability Case studies showed ineffective monitoring and control by some venture capitalists Buy-ins of privately owned companies where there are particular problems of information assymetery and those bought in the late 1980s where unrealistically high prices may have been paid for the target company were poor performers Among entrepreneur related variables, the team's knowledge of each other was an important positive influence but education was negative

Heterogeneous Beliefs and Learning about the Expected Return in a Market for a Short-Lived Asset

Abstract: This paper examines the properties of asset prices in an economy in which the true expected return on an asset is unknown and investors have heterogeneous assessments of the expected return. The principal innovation of the analysis is that the formation and evolution of investors' beliefs are modeled in a Bayesian framework. Among other things, this allows one to operationalize the notion of investor confidence. The dispersion of beliefs is, in contrast to the findings of many existing studies, not vacuous for asset prices and, in fact, can have virtually any qualitative effect on asset prices depending on the parameterization. The model has implications for the volatility of asset prices and shows that learning can give rise to some unconventional relationships, such as an inverse relationship between asset prices and risk.

Capital market imperfections before and after financial liberalization: a Euler Equation approach to panel data for Ecuadorian firms

Abstract: Using a large set of panel data for Ecuadorian firms, the authors analyze the role of capital market imperfections in investment decisions and investigate whether the financial reforms introduced in the 1980s in Ecuador succeeded in relaxing financial constraints. To facilitate capital accumulation and growth, the Ecuadorian government removed administrative controls on the interest rate and eliminated or scaled down directed credit programs. The model used here allows both for an increasing cost of borrowing, as the degree of leverage increases, and for a ceiling on leverage. The econometric results suggest that both types of capital market imperfections are important for small and young firms, but not for large and old firms. Moreover, the estimated equations do not provide evidence that financial reform in Ecuador has helped to relax these financial constraints.