Showing papers on "Leverage (finance) published in 2002"

Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry

Abstract: Corporate governance theory predicts that leverage affects agency costs and thereby influences firm performance. We propose a new approach to test this theory using profit efficiency, or how close a firm’s profits are to the benchmark of a best-practice firm facing the same exogenous conditions. We are also the first to employ a simultaneous-equations model that accounts for reverse causality from performance to capital structure. We find that data on the US banking industry are consistent with the theory, and the results are statistically significant, economically significant, and robust.

The Financing of Research and Development

Abstract: Evidence on the "funding gap" for RD 2) evidence for high costs of RD 3) there are limits to venture capital as a solution to the funding gap, especially in countries where public equity markets are not highly developed; and 4) further study of governmental seed capital and subsidy programs using quasi-experimental methods is warranted.

Do Better Institutions Mitigate Agency Problems? Evidence from Corporate Finance Choices

Abstract: This paper examines how firm characteristics, legal rules and financial development affect corporate finance decisions. In contrast to the existing literature, I use data on unlisted companies to show that institutions play an important role in determining the extent of agency problems. In particular, I find that in countries with good creditor protection, it is easier for firms investing in intangible assets to obtain loans. The protection of creditor rights is also important for ensuring access to long-term debt for firms operating in sectors with highly volatile returns. Ceteris paribus, firms are more leveraged in countries where the stock market is less developed. Unlisted firms appear more indebted than listed companies even after controlling for firm characteristics such as profitability, size and the ability to provide collateral. Finally, institutions that favor creditor rights and ensure stricter enforcement are associated with higher leverage, but also with greater availability of long-term debt.

The Determinants of Capital Structure: Evidence from China

Abstract: This paper employs a new database, which contains the market and accounting data from more than 1000 Chinese listed companies up to the year 2000, to document the characteristics of these firms in terms of capital structure. As in other countries, leverage in Chinese firms increases with firm size, non-debt tax shields and fixed assets, and decreases with profitability and correlates with industries. We also find that ownership structure affects leverage. Different from those in other countries, leverage in Chinese firms increases with volatility and firms tend to have much lower long-term debt. The static tradeoff model rather than pecking order hypothesis seems better in explaining the features of capital structure for Chinese listed companies.

Optimal Lending Contracts and Firm Dynamics

Abstract: We develop a general model of lending in the presence of endogenous borrowing constraints. Borrowing constraints arise because borrowers face limited liability and debt repayment cannot be perfectly enforced. In the model, the dynamics of debt are closely linked with the dynamics of borrowing constraints. In fact, borrowing constraints must satisfy a dynamic consistency requirement: The value of outstanding debt restricts current access to short term capital, but is itself determined by future access to credit. This dynamic consistency is not guaranteed in models of exogenous borrowing constraints, where the ability to raise short term capital is limited by some prespecified function of debt. We characterize the optimal default-free contract - which minimizes borrowing constraints at all histories - and derive implications for firm growth, survival, leverage, and debt maturity. The model is qualitatively consistent with stylized facts on the growth and survival of firms. Comparative statics with respect to technology and default constraints are derived.

Corporate Diversification: What Gets Discounted?

Abstract: Prior literature finds that diversified firms sell at a discount relative to the sum of the imputed values of their business segments. We explore this documented discount and argue that it stems from risk-reducing effects of corporate diversification. Consistent with this risk-reduction hypothesis, we find that ~a! shareholder losses in diversification are a function of firm leverage, ~b! all equity firms do not exhibit a diversification discount, and ~c! using book values of debt to compute excess value creates a downward bias for diversified firms. Overall, the results indicate that diversification is insignificantly related to excess firm value. A STREAM OF LITERATURE SUGGESTS that corporate diversification is associated with a substantial reduction in firm value. An underlying theme of this literature is that conglomerates tend to misallocate their investment funds by cross subsidizing poorly performing divisions. Berger and Ofek ~1995! ,f or example, document that conglomerates are prone to cross-subsidize investments in divisions with poor growth opportunities. Consistent with this finding, Rajan, Servaes, and Zingales ~2000! model the presence of power struggles among the firm’s divisions and show that diversification causes resources to f low to inefficient investments. Similarly, Scharfstein and Stein ~2000! demonstrate how rent-seeking divisional managers can subvert the internal capital allocation decision. These studies depict conglomerates as organizations that divert funds from stronger divisions to weaker ones and thereby misallocate their investment capital.1

On the relation between ownership structure and capital structure

Abstract: The agency relationship between managers and shareholders has the potential to influence decision-making in the firm which in turn potentially impacts on firm characteristics such as value and leverage. Prior evidence has demonstrated an association between ownership structure and firm value. This paper extends the literature by examining a further link between ownership structure and capital structure. Using an agency framework, it is argued that the distribution of equity ownership among corporate managers and external blockholders may have a significant relation with leverage. The empirical results provide support for a positive relation between external blockholders and leverage, and non-linear relation between the level of managerial share ownership and leverage. The results also suggest that the relation between external block ownership and leverage varies across the level of managerial share ownership. These results are consistent with active monitoring by blockholders, and the effects of convergence-of-interests and management entrenchment.

HOW DO CFOs MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS

Abstract: This paper summarizes the findings of the authors' recent survey of 392 CFOs about the current practice of corporate finance, with main focus on the areas of capital budgeting and capital structure. The findings of the survey are predictable in some respects but surprising in others. For example, although the discounted cash flow method taught in our business schools is much more widely used as a project evaluation method than it was ten or 20 years ago, the popularity of the payback method continues despite shortcomings that have been pointed out for years. In setting capital structure policy, CFOs appear to place less emphasis on formal leverage targets that reflect the trade-off between the costs and benefits of debt than on “informal” criteria such as credit ratings and financial flexibility. And despite the efforts of academics to demonstrate that EPS dilution per se should be irrelevant to stock valuation, avoiding dilution of EPS was the most cited reason for companies reluctance to issue equity. But despite such apparent contradictions between theory and practice, finance theory does seem to be gaining ground. For example, large companies were much more likely than their smaller counterparts to use DCF and NPV techniques, while small firms still tended to rely heavily on the payback criterion. And a majority of the CFOs of the large companies said they had “strict” or “somewhat strict” target debt ratios, whereas only a third of small firms claimed to have such targets. What does the future hold? On the one hand, the authors suggest that we are likely to see greater corporate acceptance of certain aspects of financial theory, including the use of real options techniques for evaluating corporate investments. But we are also likely to see further modifications and refinements of the theory, particularly with respect to smaller companies that have limited access to capital markets.

Earnings Quality in U.K. Private Firms

Abstract: UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private-company financial reporting nevertheless is lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, industry membership and auditor size, or by allowing endogenous listing choice. The result enhances understanding of private companies, which are predominant in the economy. It also provides insight into the economics of accounting standards.

Gains in Bank Mergers: Evidence from the Bond Markets

Abstract: This paper presents evidence that merging banks' bond adjusted returns are positive and significant in premerger and announcement months. Also, the acquiring banks' credit spreads on new debt issues are lower after the merger. Diversification and incremental size attained in the merger are significant determinants of the bond returns and the decline in credit spreads, after controlling for leverage and asset quality changes. Size effects are only significant for medium-size banks.

On The Determinants of Derivative Usage by Australian Companies

Abstract: This paper provides an examination of the determinants of derivative use by Australian corporations. We analysed the characteristics of a sample of 469 firm/year observations drawn from the largest Australian publicly listed companies in 1999 and 2000 to address two issues: the decision to use financial derivatives and the extent to which they are used. Logit analysis suggests that a firm's leverage (distress proxy), size (financial distress and setup costs) and liquidity (financial constraints proxy) are important factors associated with the decision to use derivatives. These findings support the financial distress hypothesis while the evidence on the underinvestment hypothesis is mixed. Additionally, setup costs appear to be important, as larger firms are more likely to use derivatives. Tobit results, on the other hand, show that once the decision to use derivatives has been made, a firm uses more derivatives as its leverage increases and as it pays out more dividends (hedging substitute proxy). The overall results indicate that Australian companies use derivatives with a view to enhancing the firms' value rather than to maximizing managerial wealth. In particular, corporations' derivative policies are mostly concerned with reducing the expected cost of financial distress and managing cash flows. Our inability to identify managerial influences behind the derivative decision suggests a competitive Australian managerial labor market.

Measuring Investment Distortions when Risk-Averse Managers Decide Whether to Undertake Risky Projects

Abstract: This paper examines distortions in corporate investment decisions when a new project changes firm risk It presents a dynamic model in which a self-interested, risk-averse manager makes investment decisions at a levered firm The model, calibrated using data from public firms, is used to estimate the magnitude of distortions in investment decisions Despite potential wealth transfers from debtholders, managers compensated with equity prefer safe projects to risky ones Important factors in this decision are the expected changes in the values of future tax shields and bankruptcy costs when firm risk changes We also evaluate the extent to which this effect varies with firm leverage, managerial risk aversion, managerial non-firm wealth, project size, debt duration, and the structure of management compensation packages

Capital structure, firm liquidity and growth

Abstract: This paper is an exploration of the relationships among the firm's financial structure, its choice of liquid asset holdings, and growth. We present a theoretical model of the firm where external finance is costly and where retaining earnings as liquid assets serves a precautionary motive. One of the predictions of this model is that a long-term reliance on high levels of debt finance tends to be associated with high levels of liquid asset holding. We test this empirically by estimating the determinants of liquid asset holdings using panel data sets of Belgian and UK firms. We find evidence of a positive relation between leverage and liquid asset holding. This result leads us to identify a possible linkage from high debt to high liquidity to slow growth. In light of this we discuss the possible implications of the development of stock markets, private equity, and venture capital markets.

A New Test of Capital Structure

Abstract: We report results of a new test of the financing of large and indivisible projects - arguably the focus of most capital structure theory. We develop a filter that identifies investment spikes in a large population of firms. Consistent with the pecking-order theory we find that projects are predominantly financed with debt, particularly in large and profitable firms. However, we reject the hypothesis that internal finance plays a major role in funding investment. Consistent with the trade-off theory, firms show a strong tendency to revert back to their initial leverage. This pattern of "pecking order in the short run, trade-off in the long run" is consistent with equity adjustment being postponed until certain thresholds are reached. However, we do not find evidence that equity issues are lumpy or infrequent.

Consumption, Dividends, and the Cross-Section of Equity Returns

Abstract: A central economic idea is that an asset's risk premium is determined by its ability to insure against fluctuations in consumption (i.e., by the consumption beta). Cross-sectional differences in consumption betas mirror differences in the exposure of the asset's dividends to aggregate consumption, an implication of many general equilibrium models. Hence, cross-sectional differences in the exposure of dividends to consumption may provide valuable information regarding the cross-sectional dispersion in risk premia. We measure the exposure of dividends to consumption (labeled as consumption leverage) by the covariance of ex-post dividend growth rates with the expected consumption growth rate, and alternatively by relying on stochastic cointegration between dividends and consumption. Cross-sectional differences in this consumption leverage parameter can explain about 50% of the variation in risk premia across 30 portfolios - which include 10 momentum, 10 size, and 10 book-to-market sorted portfolios. The consumption leverage model can justify much of the observed value, momentum, and size risk premium spreads. For this asset menu, alternative models proposed in the literature (including time varying beta models) have considerable difficulty in justifying the cross-sectional dispersion in the risk premia. Our measures of consumption leverage are driven by the exposure of dividend growth rates to low frequency movements in consumption growth. We document that it is this exposure that contains valuable information regarding the cross-sectional differences in risk premia across assets.

Capital Structure in Corporate Spin-offs

Abstract: This paper investigates how firms determine the capital structure of a subsidiary that is divested in a spin-off. In a spin-off, the parent divides the assets of the firm and chooses the capital structure for the new, stand-alone entity. Unlike the firms in other capital structure studies, the subsidiary's leverage ratio is its initial capital structure. Thus, the typical explanations for why firms' leverage ratios may deviate from their target ratios do not apply. I therefore use this sample to investigate how firms determine their capital structure. I find that the subsidiary has a leverage ratio lower than the parent but similar to a comparable non-spin-off firm. Also, similar to other firms, the subsidiary's leverage is negatively related to growth and positively related to its collateral value. However, unlike other firms, leverage is not inversely related to profitability. Further, the difference between the subsidiaries' and comparable firms' leverage ratios is positively related to profitability. These results support the predictions of the trade off theory of capital structure and provide insight into why previous studies find a negative relation between leverage and profitability.

An Empirical Investigation of Factors Influencing Voluntary Disclosure of Financial Information on the Internet in the GCC Countries

Abstract: This paper examines the extent of financial information disclosed on the Internet by the Gulf Co-operation Council (GCC) countries. We collected data from listed companies in stock market of a representative group of GCC countries, to test research hypotheses related to the association between company characteristics and the voluntary dissemination of financial information on the Internet based on industry type and country. A cross-section of all 128 companies currently listed on the stock exchange of the selected GCC countries were determined. A hierarchical forward stepwise in logistic regression was undertaken to assess whether voluntary dissemination of financial information on the Internet was related to firm size, leverage, and profitability. Our results revealed that the probability of a firm to publish financial information on the Internet does not only depend on individual characteristic, but on a combination of interaction effects among firm characteristics (size, leverage, and profitability), industry type, and country.

The paradox of asset pricing

Abstract: Asset pricing theory abounds with elegant mathematical models The logic is so compelling that the models are widely used in policy, from banking, investments, and corporate finance to government To what extent, however, can these models predict what actually happens in financial markets? In The Paradox of Asset Pricing, a leading financial researcher argues forcefully that the empirical record is weak at best Peter Bossaerts undertakes the most thorough, technically sound investigation in many years into the scientific character of the pricing of financial assets He probes this conundrum by modeling a decidedly volatile phenomenon that, he says, the world of finance has forgotten in its enthusiasm for the efficient markets hypothesis--speculation Bossaerts writes that the existing empirical evidence may be tainted by the assumptions needed to make sense of historical field data or by reanalysis of the same data To address the first problem, he demonstrates that one central assumption--that markets are efficient processors of information, that risk is a knowable quantity, and so on--can be relaxed substantially while retaining core elements of the existing methodology The new approach brings novel insights to old data As for the second problem, he proposes that asset pricing theory be studied through experiments in which subjects trade purposely designed assets for real money This book will be welcomed by finance scholars and all those math--and statistics-minded readers interested in knowing whether there is science beyond the mathematics of finance This book provided the foundation for subsequent journal articles that won two prestigious awards: the 2003 Journal of Financial Markets Best Paper Award and the 2004 Goldman Sachs Asset Management Best Research Paper for the Review of Finance

The Dynamics of Capital Structure: An Empirical Analysis of a Partially Observable System

Abstract: This paper examines the dynamic properties of capital structure in a state-space framework. A system of stochastic differential equations is used to specify the dynamics for a firm's debt-to-equity ratio and the determinants of capital structure. The framework addresses statistical issues such as measurement error, missing data and endogeneity. There are several important results. First, firms gradually adjust their capital structure to a firm-specific, time-varying target, as opposed to a fixed level or industry average. Second, the rate at which they revert back to the target depends on several factors: the current position of their leverage relative to the target, their industry, and their financial health. Finally, the statistical issues have a significant impact on the results and subsequent conclusions. The primary economic conclusion is that observed financing behavior may be driven by concerns over credit-worthiness and access to external funds.

Expectations and Expatriations: Tracing the Causes and Consequences of Corporate Inversions

Abstract: This paper investigates the determinants of corporate expatriations. American corporations that seek to avoid U.S. taxes on their foreign incomes can do so by becoming foreign corporations, typically by 'inverting' the corporate structure, so that the foreign subsidiary becomes the parent company and U.S. parent company becomes a subsidiary. Three types of evidence are considered in order to understand this rapidly growing practice. First, an analysis of the market reaction to Stanley Works's expatriation decision implies that market participants expect its foreign inversion to be accompanied by a reduction in tax liabilities on U.S. source income, since savings associated with the taxation of foreign income alone cannot account for the changed valuations. Second, statistical evidence indicates that large firms, those with extensive foreign assets, and those with considerable debt are the most likely to expatriate - suggesting that U.S. taxation of foreign income, including the interest expense allocation rules, significantly affect inversions. Third, share prices rise by an average of 1.7 percent in response to expatriation announcements. Ten percent higher leverage ratios are associated with 0.7 percent greater market reactions to expatriations, reflecting the benefit of avoiding the U.S. rules concerning interest expense allocation. Shares of inverting companies typically stand at only 88 percent of their average values of the previous year, and every ten percent of prior share price appreciation is associated with 1.1 percent greater market reaction to an inversion announcement. Taken together, these patterns suggest that managers maximize shareholder wealth rather than share prices, avoiding expatriations unless future tax savings - including reduced costs of repatriation taxes and expense allocation, and the benefits of enhanced worldwide tax planning opportunities - more than compensate for current capital gains tax liabilities.

Growth through Acquisitions: A Fresh Look

Abstract: LBOs outbid corporate buyers and then produce extraordinary returns. How do they do it? A study of over 800 acquisitions shatters some myths about the value of timing and leverage Don't do the deal if you can't find the leader The conventional wisdom on successful corporate acquisitions is short and simple: Make them small and make them synergistic. Yet companies that rely solely on this view risk missing an entire world of valuable strategic opportunities. A year-long research program has shown that companies can pursue a nonsynergistic strategy profitably. In fact, research has uncovered a diverse group of organizations, including Thermo Electron Corporation, Sara Lee Corporation, and Clayton, Dubilier & Rice, that have grown dramatically and captured sustained returns of 18 to 35 percent per year by making nonsynergistic acquisitions. The successful acquirers fell into two groups: diversified public corporate acquirers and financial buyers such as leveraged buyout (LBO) firms. We chose to study LBO firms because, like the rest of the world, we were fascinated as we watched them outbid corporate buyers and then produce extraordinary returns without the benefit of synergies among their businesses. We compared the LBO firms' practices with those of successful diversified corporate acquirers and were surprised to find that their operating principles were remarkably similar. Yet many corporate strategists refuse to believe that they can be successful in pursuing nonsynergistic deals. In our view, their hesitancy results from two fundamental misconceptions about the way today's nonsynergistic acquirers operate. The first is that financial buyers rely on market timing to buy assets at a low price (and then turn around and sell them at a high price). In fact, we found that financial buyers actually pay substantial premiums above market price, just as other acquirers do. The second misconception is that high financial leverage is used to discipline managers. In fact, to avoid losing flexibility, the financial buyers in our study make a conscious effort to prevent high leverage from controlling managers' decision making about operations. Although many LBO firms start out with fairly high debt loads, they reduce their burden to relatively conventional levels (65 percent debt to total assets) within one to three years. Our findings are supported by the research of John Kitching, who studied 110 buyouts.(*) He found that by the second year after acquisition, debt repayment of the typical LBO exceeded repayment commitments by 600 percent. Without a doubt, the 21 companies in our sample were very successful. Altogether, they made 829 acquisitions. When asked whether they earned their cost of capital, 80 percent of the respondents (accounting for 611 acquisitions) said yes. Our sample of US corporate acquirers averaged more than 18 percent per year in total return to shareholders over a ten-year period, while the financial acquirers averaged 35 percent per year by their own estimates. Although the acquisitions of any given acquirer in our study were seemingly unrelated, successful acquirers picked a common theme and stuck to it. We noted, for example, that Clayton, Dubilier & Rice - a financial buyer - was skilled at turnarounds, often shrinking the acquired company before growing it.(**) Desai Capital Management, also an LBO firm, searched for growth opportunities in retail-related industries. Emerson Electric Company acquired companies with a core competence in component manufacturing, particularly those for which it could exploit cost-control capabilities. And Sara Lee, which has acquired more than 60 different consumer product companies - including Coach Leatherwear Company, Playtex Apparel, and Champion International Corporation - used branding and retailing as its common thread. Making acquisitions work But making this type of acquisition work is not easy. …

Corporate International Activity and Debt Financing

Abstract: The literature provides conflicting evidence on the relation between corporate international activity and the cost and level of debt financing. Based on this evidence, we explore the impact of firm internationalization on debt financing. Using a market based sample of U.S. firms, we find significant evidence of a non monotonic relation between firm international activity and both the cost and level of debt financing. Specifically, we find that, contrary to prior research, firm international activity is, on average, associated with a 13% reduction in the cost of debt financing and a 30% increase in firm leverage.

Twenty‐first century management rules: the management of relationships as intangible assets

Abstract: As much of the developed world faces a recessionary tide, age‐old questions on the nature of creating and sustaining lasting market value are once again being asked. In the past, questions of market value creation were answered by investing in tangible assets. Today, those same questions are being answered by investing in intangible assets. Intangible assets, such as knowledge, patents, organizational structure, copyrights, information technology, business processes and brand, among others, now constitute the majority of value created by firms today. However, ultimately, businesses are made up of a network of relationships: relationships with customers, employees, suppliers and partners. These “relationship assets” constitute a firm’s most valuable store of capital and their most important intangible assets. The ability to create and sustain maximum market value, therefore, requires a focused set of twenty‐first century management rules. Rules focused on intangible, relationship asset leverage.

The Disciplining Role of Leverage in Dutch Firms

Abstract: In this study we investigate the role of leverage in disciplining overinvestment problems.We measure the relationships between leverage, Tobin s q and corporate governance characteristics for Dutch listed firms.Besides, our empirical analysis tests for determinants of leverage from tax and bankruptcy theories.Representing growth opportunities, q is expected to be an agency-based determinant of leverage.Simultaneously, q represents firm value, which is determined by leverage and governance structures.We test a structural equations model in which we deal with this simultaneous nature of the relation between leverage and q.Our results indicate that Dutch managers avoid the disciplining role of debt, when they are most likely to overinvest.Leverage is mainly determined by tax advantages and bankruptcy costs.In addition, we test the impact of leverage on excess investment.We do not find a difference in the influence of leverage on investment between potential overinvestors and other firms.This confirms that the disciplinary role of leverage in Dutch firms is absent.

Measures of Stock Market Value and Returns for the US Nonfinancial Corporate Sector, 1900-2000

Abstract: This paper describes a new dataset of annual time series relating to the US nonfinancial corporate sector: its market value, and the major underlying stocks and flows that are valued by financial markets. The data cover the entire twentieth century, and thus fill a significant gap in the documentation of financial and real economy linkages. Previously available data cover either shorter periods, or a more restricted sample of quoted companies. A range of series are constructed on a consistent basis: returns; dividend yields (both in standard form, and adjusting for net new issues/buybacks); earnings yields; and "q", on a range of definitions (one series runs from 1871-2001); as well as various corporate leverage measures. The main features of note are: the relative stability of both q and the adjusted (but not unadjusted) dividend yield; the systematic tendency for mean q to be less than unity; and the ambiguous picture presented by alternative measures of corporate leverage - most especially at the end of the sample.

Derivative financial instrument use in Australia

Abstract: This paper examines the relation between derivatives use and financial characteristics of Australian industrial and mining firms. The firm characteristics proxy for financial distress, tax losses, managerial ownership, growth opportunities, the ability to generate operating cash flows and liquidity. We also control for firm size, dividends and exposure to foreign exchange risk. The results show that firm size and leverage are the main explanatory variables for derivative use for both industrial and mining firms

Malaysia Privatization: A Comprehensive Study

Abstract: As the first comprehensive study on privatization in Malaysia, this paper compares financial and operating performance of a sample of 24 firms before and after privatization. The 24 firms were privatized via public listing on the Malaysian exchange -. Measures that improve following privatization include profitability, output level, and dividend payout; leverage declines. We also observe increased linkages between ownership and corporate governance with such performance changes. By and large, our results are similar to the results of the directly comparable multi-country studies of Megginson, Nash, and van Randenborgh (1994), Boubakri and Cosset (1998), and D’Souza and Megginson (1999).

Capital structures in emerging stock markets: the case of hungary

Abstract: This paper studies developments in the Hungarian capital markets during 1992‐95 and investigates the determinants of the capital structures of companies listed on the Budapest Stock Exchange. Hungarian companies had very low leverage ratios. Empirical findings indicate that the negative relationship between leverage and proportion of tangible assets was primarily caused by the lack of long-term debt financing. The relationship between leverage and the size of the company provides some indication of the importance of trade credits for the companies. The more profitable companies had less debt than less profitable ones. This is attributed to the firms’ financial incentives aggravated by the segmentation of Hungarian credit markets and credit rationing within the financial environment. Manufacturing firms and firms with the state among their major shareholders enjoyed higher levels of debt financing relative to other companies. HAT are the key financial and organizational factors determining the quality of restructuring and adjustment of privatized companies in transition economies? The importance of this question becomes clear once it is realized that macroeconomic stabilization cannot be achieved without the proper microeconomic environment. Capital markets, along with the rules and regulation governing these markets, are integral parts of this environment. Managers, owners, and other suppliers of finance who interact in these markets should be provided with the proper incentives and instruments to improve the economic efficiency of their firms. A large number of factors distort these incentives and reduce the set of available instruments even in the developed countries. The endogenous formation of new economic systems in transition economies makes it virtually impossible to mitigate all market imperfections at once.