Showing papers on "Leverage (finance) published in 1995"

Why Do Companies Go Public? An Empirical Analysis

Abstract: This paper empirically analyzes the determinants of an initial public offering (IPO) and the consequences of this decision on a company's investment and financial policy. We compare both the ex ante and the ex post characteristics of IPOs with those of a large sample of privately held companies of similar size. We find that (i) the likelihood of an IPO is positively related to the market-to-book ratio prevailing in the relevant industrial sector and to a company's size, (ii) IPOs are followed by an abnormal reduction in profitability, (iii) the new equity capital raised upon listing is not used to finance subsequent investment and growth, but to reduce leverage, (iv) going public reduces the cost of bank credit; (v) it is often associated by equity sales by controlling shareholders, and is followed by a higher turnover of control than for other companies.

Managerial Entrenchment and Capital Structure Decisions

Abstract: We test the prediction that leverage is inversely associated with managerial entrenchment. We examine leverage levels and year-to-year changes for several hundred firms between 1984 and 1991. We find that leverage levels are positively related to CEO stock ownership and CEO stock option holdings, and negatively related to CEO tenure and board of directors size. While generally consistent with less entrenched CEOs pursuing more leverage, these results are subject to alternative interpretations. We therefore analyze year-to-year changes in leverage around exogenous shocks to corporate governance variables. We find that leverage increases after unsuccessful tender offers and â¬Sforcedâ¬? CEO replacements, and under certain conditions after the arrival of major stockholders. These relations have greater magnitude when the sample is restricted to low-leverage firms, even when 80% of firms are defined as low-leverage. The results are consistent with decreases in entrenchment leading to increases in leverage, and with the majority of firms having less debt than optimal.

Leverage, Investment, and Firm Growth

Abstract: We show that there is a negative relation between leverage and future growth at the firm level and, for diversified firms, at the segment level. Further, this negative relation between leverage and growth holds for firms with low Tobin's q, but not for high-q firms or firms in high-q industries. Therefore, leverage does not reduce growth for firms known to have good investment opportunities, but is negatively related to growth for firms whose growth opportunities are either not recognized by the capital markets or are not sufficiently valuable to overcome the effects of their debt overhang.

Dynamic Capital Structure Under Managerial Entrenchment

Abstract: This paper develops a model in which debt serves to constrain inefficient investments of empire-building managers due to the consequent control implications of bankruptcy. Capital structure is voluntarily chosen by management, as a credible constraint which ensures sufficient efficiency to prevent takeover challenges. In particular, dynamic capital structure is derived as the optimal response of partially entrenched managers trading off empire-building ambitions with the need to retain the empire to realize these ambitions. Such capital structure is dynamically consistent; in the model, manages are free to readjust leverage each period. A policy of dividend payments coordinated with capital structure decisions follows naturally, as does implicatons for the level, frequency, and maturity structure of debt as a function of outside investment opportunities. Additionally, the model yields new testable implications for security design and changes in debt and empire building over a manager's career.

The determinants of corporate leverage and dividend policies

Abstract: In this paper we analyze the leverage and dividend choices than 6,700 industrial corporations over a 30-year period. Our empirical analysis is designed to provide a basis for assessing the relative importance of the various factors - taxes, contracting costs (particularly, the financial distress costs and the "free cash flow" benefits of debt), and signaling effects - in explaining corporate financial behavior. Such findings can than be used to guide corporate managers in thinking about trade-offs among different leverage and dividend choices.

Voluntary Disclosure in the Annual Reports of New Zealand Companies

Abstract: New Zealand is currently experiencing a liberal and competitive economic environment which has led to a greater investment interest in corporate securities. Likewise, New Zealand firms are also developing strategies to attract investors, for example, through voluntary disclosure of information. Therefore, the level of information voluntarily disclosed by New Zealand companies is of interest to prospective investors. The purpose of this study is to examine empirically the relationship between five firm-specific characteristics and the general level of accounting information voluntarily disclosed by companies listed on New Zealand Stock Exchange (NZSE). In this study the a priori expectations are based on agency theory. The five firm-specific characteristics examined are: firm size, leverage, assets-in-place, type of auditor, and foreign listing status. The results obtained from cross-sectional regression show that firm size, foreign listing status and leverage are significantly related to the extent of voluntary disclosure. In contrast assets-in-place and type of auditor are not significant explanatory variables. A study of this type would be of particular relevance to accounting policy makers because, inter alia, it helps them in (a) understanding corporate disclosure behaviour, (b) explaining why firms adopt certain disclosure strategies, and (c) developing a coherent and acceptable set of mandatory disclosure requirements.

Do LBO Supermarkets Charge More? An Empirical Analysis of the Effects of LBOs on Supermarket Pricing

Abstract: This article examines changes in supermarket prices in local markets following supermarket leveraged buyouts (LBOs). I find that prices rise following LBOs in local markets in which the LBO firm's rivals are also highly leveraged and that LBO firms have higher prices than their less leveraged rivals, suggesting that LBOs create incentives to raise prices. However, I also find that prices fall following LBOs in local markets in which rival firms have low leverage and are concentrated. These price drops are associated with LBO firms exiting the local market, suggesting that rivals

Good News, Bad News, Volatility, and Betas

Abstract: We investigate the conditional covariances of stock returns using bivariate exponential ARCH (EGARCH) models. These models allow market volatility, portfoliospecific volatility, and beta to respond asymmetrically to positive and negative market and portfolio returns, i.e., "leverage" effects. Using monthly data, we find strong evidence of conditional heteroskedasticity in both market and non-market components of returns, and weaker evidence of time-varying conditional betas. Surprisingly while leverage effects appear strong in the market component of volatility, they are absent in conditional betas and weak and/or inconsistent in nonmarket sources of risk. MANY RESEARCHERS HAVE DOCUMENTED that stock return volatility tends to rise following good and bad news. This phenomenon, which we call predictive asymmetry of second moments, has been noted both for individual stocks and for market indices.1 Given this evidence, there is also good reason to expect such an effect to exist in conditional betas as well. We provide a method for estimating time-varying conditional betas based on a bivariate version of the exponential ARCH (EGARCH) model of Nelson (1991), allowing for the possibility that positive and negative returns affect betas differently. The literature has focused on two classes of explanations for predictive asymmetry of second moments: the first, and most obvious, highlights the role of financial and operating leverage-e.g., if the value of a leveraged firm drops, its equity will, in general, become more leveraged, causing the volatility on equity's rate of return to rise. As Black (1976), Christie (1982), and Schwert (1989) show, however, financial and operating leverage cannot fully account for predictive asymmetry of second moments. A second set of explanations focuses on the role of volatility in determining the market risk

The determinants of board composition: An agency theory perspective

Abstract: This study examines the interrelation between board composition and variables that capture various agency and financial dimensions of the firm. The agency literature suggests that outside directors on the board provide important monitoring functions in an attempt to resolve, or at least mitigate, agency conflicts between management and shareholders. The agency literature indicates that other mechanisms such as managerial equity ownership, dividend payments, and debt leverage also serve as important devices in reducing agency conflicts in firms. This study argues and documents that an inverse relationship exists between the proportion of external members on the board and managerial stock ownership, dividend payout, and debt leverage. This is consistent with the hypothesis that individual firms choose an optimal board composition depending upon alternative mechanisms employed by the firm to control agency conflicts. Board composition is also found to be systematically related to a number of other variables including institutional holdings, growth, volatility, and CEO tenure.

The eva® financial management system

Abstract: In this article, we argue that for many large companies the tops-down, earnings per share-based model of financial management that has long dominated corporate American is becoming obsolete. The most serious challenge to the long reign of EPS is coming from a measure of corporate performance called "economic value added," or EVA. EVA is by no means a new concept. Rather it is a practical, and highly flexible, refinement of economists' concept of "residual income"--the value that is left over after a company's stockholders (and all other important stakeholders) have been adequately compensated. For companies that aim to increase their competitiveness by decentralizing, EVA is likely to be the most sensible basis for evaluating and rewarding the periodic performance of empowered line people, especially those entrusted with major capital spending decisions. EVA, moreover, is not just a performance measure. When fully implemented, it is the centerpiece of an integrated financial management system that encompasses the full range of corporate financial decision-making--everything from capital budgeting, acquisition pricing, and the setting of corporate goals to shareholder communication and management incentive compensation. By putting all financial and operating functions on the same basis, an EVA system effectively provides a common language for employees across all corporate functions, linking strategic planning with the operating divisions, and the corporate treasury staff with investor relations and human resources. We begin by describing the shortcomings of the tops-down, EPS-based model of financial management. Next we explain the rise of hostile takeovers--as well as the phenomenal success of LBOs--in the 1980s as capital market responses to the deficiencies of the EPS model. The EVA financial management system, we go on to argue, borrows important aspects of the LBO movement--particularly, its focus on capital efficiency and ownership incentives--but without the high leverage and concentration of risk that limit LBOs to the mature sector of the U.S. economy. In the final section, we present the outlines of an EVA-based incentive compensation plan that is designated to simulate for managers and employees the rewards of ownership.

Corporate Capital Structure Decisions: Evidence from Leveraged Buyouts

Abstract: We analyze the composition of the financing packages used in a large sample of leveraged buyout transactions in order to test a set of hypotheses developed in the prior literature about the determinants of corporate capital structure decisions. We focus in particular on the role of agency costs, bankruptcy risks, and tax considerations. We find evidence that all three have an impact, both on the degree of leverage employed in the transactions and on the attributes of the borrowings undertaken. The impacts are manifest in systematic relationships between the proportion and type of debt in the buyout financing package and the target firm's earnings rate, earnings variability, growth prospects, and its tax and liquidity position. 0 The logic and consequences of leveraged buyouts (LBOs), both for the participants involved and for the economy as a whole, have been widely debated in the academic literature and the popular business press. In a leveraged buyout, a group of investors acquires the public interest in a firm's common equity, primarily with borrowed funds, and takes the firm private. We offer here some further evidence on the nature of these transactions, with particular emphasis on the composition of the LBO financing package. Our objective is to attempt to explain why the observed financing choices were made by individual firms-by identifying the relationships between the characteristics of the target firms and the types of financings that were employed in their acquisition. We detect some clear patterns in the data, many of which we believe have broader implications for the design of corporate capital structures. In particular, we find evidence that LBO financing decisions appear systematically to be affected by the target firm's growth prospects, the level and variability of its return on assets, its pre-buyout liquidity position, and by tax considerations and post-buyout restructuring plans. We find similar evidence of systematic influences on the

Agency costs, taxes and debt: The UK evidence

Abstract: This paper provides an empirical examination of the impact of the corporation tax and agency costs on firms' capital structure decisions. Our evidence suggests that the agency costs are the main determinants of corporate borrowing. Consistent with the agency theory, we find that firms that have fewer growth options have more debt in their capital structure. Moreover, our results show that debt mitigates the free cash flow problem and that firms that are more likely to be diversified and less prone to bankruptcy are highly geared. the negative effect of insider shareholding on leverage disappears, however; when all the agency mechanisms are accounted for. In addition, we find that, in the long run, companies that are tax exhausted exhibit significantly lower debt ratios than tax-paying firms. However, in the short run, firms' capital structure decisions are not affected by taxation.

The resolution of technical default

Abstract: Costs of default underpin the debt covenant hypothesis-- which predicts that managers have incentives to avoid defaulting on notes and loans--yet prior research yields only limited confirmation of their existence. We provide evidence on the nature and magnitude of default costs, and show that announcements of technical default are associated with significant stock price declines for 87 firms defaulting on bank loans between 1983 and 1987. Combining post-default changes in terms of debt contracts with stock returns, we find that consequences arising from renegotiation of lending agreements are priced in the market, and estimate that higher costs of borrowing and new restrictions on firms' opportunities impose wealth losses of 1.4% on shareholders. Leverage measures, frequently used in accounting research as proxies for economic effects of debt contracts, are found to be poor surrogates for default or renegotiation costs.

Professional Football Sponsorship—Profitable or Profligate?

Abstract: The results of this empirical study of the English Premier League and First Division indicate that the vast majority of companies express a very positive view of their experience with professional football sponsorship However, there is evidence of a failure to employ a number of the techniques advocated in the literature This suggests that for some companies opportunities exist for sponsorship to make an even greater contribution to their communication objectives Key areas which need to be addressed are objective setting, evaluation, leverage and integration with other elements of the communication mix

Capital Structure Choice when Managers are in Control: Entrenchment versus Efficiency

Abstract: Recent capital structure theories have emphasized the role of debt in minimizing the agency costs that arise from the separation between ownership and control. In this paper we argue that capital structure choices themselves are affected by the same agency problem. We show that, in general, the shareholders' and the manager's capital structure choices differ not only in their levels, but also in their sensitivities to the cost of financial distress and taxes. We argue that only the managerial perspective can explain why firms are generally reluctant to issue equity, why they issue it only following a stock price run-up, and why Corporate America recently deleveraged under the same tax system that supposedly generated the increase in leverage in the 1980s.

Equity ownership structure, leverage, and productivity: Empirical evidence from Japan☆

Abstract: We focus here on the influence of equity ownership structure on leverage and also attempt to discriminate between competing hypotheses regarding the net influence of leverage on firm efficiency. In the case of Japan, institutional shareholders have been noted in particular for their active voice in firm affairs, and these major equity-holders are often also major debtholders. Such arrangements may serve to minimize both conflicts between managers and shareholders and between debtholders and shareholders. On the other hand, high levels of intercorporate ownership may insulate management and debtholders from shareholder influence and increase leverage. We observe a strong negative relationship between both institutional ownership and leverage and between leverage and productivity in Japan, and this seems to support the reputation of financial institutions in Japan for having a positive influence on the firms in which they own shares. We also find a strong positive influence of intercorporate shareholding on leverage, which may reflect the alignment of management and debtholders in the absence of an active equity influence. In all, it seems that ownership structure and agency costs are both important determinants of capital structure in Japan, and that an active equity influence is associated with both reduced leverage and positive productivity residuals. While we find no evidence that high leverage tends to increase efficiency, we do observe an important influence of equity ownership structure on leverage. These findings appear to support an agency theory of capital structure based on both conflicts between management and shareholders and between shareholders and debtholders.

Chapter 27 Financial structure and product market competition

Abstract: Publisher Summary This chapter focuses on four mechanisms that are identified in the literature as determining how financial structure affects value in product markets. These mechanisms are (1) the effect of investment choices of other firms in the industry on the interaction between the firm's financial structure and its investment incentives, (2) the effect of debt on a firm's ability to enter into advantageous implicit and explicit contracts with competitors or customers, (3) the effects of changes in leverage firms' incentives and on industry equilibrium in oligopolies,and (4) the exploitation by competitors of conflicts of interest caused by the firm's need to finance its investments externally. The industry equilibrium (IE) models are presented that directly extend the single firm paradigm by analyzing financial structure choice in the context of an industry equilibrium that takes into account the investment decisions of all firms in the industry. To discuss how financial structure affects the firm's ability to make credible implicit or explicit contracts with customers and rival firms, the chapter presents an analysis of two consequences of leverage. First, high debt levels increase the probability that the firm will become bankrupt and cannot be compelled to fulfil its obligations. Second, debt may decrease both the profits that the firm's equityholders receive from complying with the contract and the cost that they bear if they act opportunistically. Both these effects decrease the firm's ability to enter into credible contracts.

The information content of bankruptcy filing on securityholders of the bankrupt firm: An empirical investigation

Abstract: This paper captures the information content of bankruptcy announcements on stockholders and three different classes of debtholders using daily excess returns. Significant negative stock price reaction to the filing announcement is documented. More interestingly, the secured debtholders are unaffected by the announcement. However, the unsecured and the convertible debt classes exhibit significant adverse price reaction. During the event period, the secured debt group gains significantly while all other classes experience substantial losses. Cross-sectional analysis reveals that the complexity of the reorganization process, the security of the debt issue, and to some degree the anticipation of the bankruptcy filing are important determinants of bond excess returns. It is also found that leverage plays a significant role in preserving firm value by forcing the firm to confront reorganization sooner.

Gains From Diversifying Into Real Estate: Three Decades of Portfolio Returns Based on the Dynamic Investment Model

Abstract: This paper compares the investment policies and returns for portfolios of stocks and bonds with and without up to three categories of real estate. Both domestic and global settings are examined, with and without the possibility of leverage. The portfolios were generated via the dynamic investment model based on the empirical probability assessment approach applied to past (joint) realizations of returns, both with and without correction for “smoothing” in the real estate data series. Our principal findings are: (1) the gains from adding real estate, on a semi-passive (equal-weighted) basis, to portfolios of either U.S. or global financial assets were relatively modest; in contrast, (2) the gains from adding real estate to the universe of U.S. financial assets under an active strategy were rather large (in some cases highly statistically significant), especially for the very risk-averse strategies; (3) the gains from adding U.S. real estate to a universe of global financial assets under an active strategy were mixed, although generally favorable for the highly risk-averse strategies; (4) correcting for second-moment smoothing in the real estate returns series had a relatively small impact for the more risk-tolerant strategies; and (5) there was some evidence that desmoothing resulted in improved probability estimates.

Capital Structure Choice When Managers are in Control: Entrenchment Versus Efficiency

Abstract: Recent capital structure theories have emphasized the role of debt in minimizing the agency costs that arise from the separation between ownership and control. In this paper we argue that capital structure choices themselves are affected by the same agency problem. We show that, in general, the shareholders' and the manager's capital structure choices differ not only in their levels, but also in their sensitivities to the cost of financial distress and taxes. We argue that only the managerial perspective can explain why firms are generally reluctant to issue equity, why they issue it only following a stock price run-up, and why Corporate America recently deleveraged under the same tax system that supposedly generated the increase in leverage in the 1980s.

A multivariate analysis of REIT performance by financial and real asset portfolio characteristics

Abstract: This paper examines the risk-adjusted performance of real estate investment trusts (REITs) from 1986 through 1990 in relation to financial and property characteristics of their portfolios. The Sharpe measure of risk-adjusted rate of return was regressed against financial ratios and property investment ratios for a sample of equity and mortgage REITs. The results show that, in general, financial ratios (gross cash flow, leverage, asset size), regional location of properties, and types of real estate investments determine the risk-adjusted performance. More specifically, location of properties in the western United States, ownership of health care properties, and investment in securitized mortgages positively affect the risk-adjusted return. The individual financial variables were not found to be statistically significant in influencing REIT returns.

Capital Structure and Ownership Distribution of Tender Offer Targets: An Empirical Study

Abstract: This study investigates the capital and ownership structure of firms receiving tender offers. Predictions of control-driven models developed by Haris and Raviv (1988) and Stulz (1988) and value-maximizing models developed by Israel (1991, 1992) are examined. The study reports results consistent with the predictions that: 1) target firms increase leverage during control contests, 2) leverage increases are higher when the tender offer is opposed, 3) leverage increases are higher when the tender offer is unsuccessful, and 4) ownership structure is important to explaining the success of tender offers. When tested jointly with other independent variables, only capital structure is statistically significant in explaining both management's opposition and the success of a tender offer.

Agency costs in the banking industry: An examination of ownership behavior, leverage and dividend policies

Abstract: This paper examines agency theory arguments in the banking industry by analyzing the effect of four variables that proxy for agency costs—earnings volatility, managers' portfolio diversification losses, bank size, and standard deviation of bank equity returns—on the three financial policy variables of managerial stock ownership, leverage, and dividend yield. It is one of the first studies that examines the determination of financial policy variables, in light of agency concerns, in the banking industry. The study examines the largest 104 U.S. banks during the period 1985–1989. Evidence suggests that bank size and a measure of the managers' portfolio diversification opportunity set affect the bank's level of managerial stock ownership, leverage and dividends.

Fundamentals and bubbles in asset prices: Evidence from U.S. and Japanese asset prices

Abstract: This paper investigates the existence and extent of non-fundamental bubbles in both U.S. and Japanese asset prices by employing a flexible empirical method which allows us to decompose asset prices into fundamental and non-fundamental bubble components. This study finds that a substantial fraction of U.S. and Japanese asset prices is accounted for by non-fundamental bubble components and that these asset prices overreact to non-fundamental bubble shocks. In addition, allowing for time-varying interest rates as another fundamental factor does not change any qualitative results about the role of non-fundamental bubble components. This suggests that the present value model fails to explain volatile asset price behavior even with time-varying interest rates.

In High Gear: A Case Study of the Hees-Edper Corporate Group

Abstract: This study compares firms in the Hees-Edper Group with a number of other independent firms of similar size and in the same industries over a four-year period from 1988 to 1992, just prior to the first release of news that the Hees-Edper group was in financial trouble. During that period, HeesEdper firms recorded profitability levels comparable to (or below) those of the matched firms. The Hees-Edper firms were also shown to have been much higher risk investments well before the group's financial position began to deteriorate. They were more highly levered, but even after risk levels are adjusted for this, the risk levels of Hees-Edper firms remain much higher.Our study shows that the extreme incentive-based compensation schemes used by Hees-Edper firms encouraged managers to adopt high-risk strategies, and that the intercorporate co-insurance (allowed by the interlocking ownership structure of the firms) made this possible by increasing the group's apparent debt capacity. Since this higher risk did not improve overall performance, it was arguably at an economically inefficient higher level. The higher leverage of Hees-Edper companies should have produced a sizable tax advantage because of the deductibility of interest at the corporate level. The mediocre performance of the companies thus raises the possibility that abnormally poor performance was masked by tax breaks.