Showing papers on "Leverage (finance) published in 2008"
TL;DR: This paper found that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: high (low) levered firms tend to remain as such for over two decades.
Abstract: We find that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: High (low) levered firms tend to remain as such for over two decades. This feature of leverage is largely unexplained by previously identified determinants, is robust to firm exit, and is present prior to the IPO, suggesting that variation in capital structures is primarily determined by factors that remain stable for long periods of time. We then show that these results have important implications for empirical analysis attempting to understand capital structure heterogeneity.
1,166 citations
TL;DR: In this paper, the authors present a theory of asset pricing that will shed light on the problems of emerging assets (like emerging markets) that are not yet mature enough to be attractive to the general public, and argue that the periodic problems faced by emerging asset classes are sometimes symptoms of what we call a global anxious economy rather than of their own fundamental weaknesses.
Abstract: ing opportunities for emerging economies. Their access to international markets has turned out to be very volatile, with frequent periods of market closures. Even worse, as we will show, emerging economies with sound fundamentals are the ones that issue less debt during these closures. The goal of this paper is to present a theory of asset pricing that will shed light on the problems of emerging assets (like emerging markets) that are not yet mature enough to be attractive to the general public. Their marginal buyers are liquidity constrained investors with small wealth relative to the whole economy, who are also marginal buyers of other risky assets. We will use our theory to argue that the periodic problems faced by emerging asset classes are sometimes symptoms of what we call a global anxious economy rather than of their own fundamental weaknesses.
606 citations
TL;DR: In this paper, the authors investigated how firms operating in capital market-oriented economies (the U.K. and the U.S.) and bank oriented economies (France, Germany, and Japan) determine their capital structure and found that the leverage ratio is positively affected by the tangibility of assets and the size of the firm.
Abstract: The paper investigates how firms operating in capital market-oriented economies (the U.K. and the U.S.) and bank-oriented economies (France, Germany, and Japan) determine their capital structure. Using panel data and a two-step system-GMM procedure, the paper finds that the leverage ratio is positively affected by the tangibility of assets and the size of the firm, but declines with an increase in firm profitability, growth opportunities, and share price performance in both types of economies. The leverage ratio is also affected by the market conditions in which the firm operates. The degree and effectiveness of these determinants are dependent on the country's legal and financial traditions. The results also confirm that firms have target leverage ratios with French firms being the fastest in adjusting their capital structure toward their target level and Japanese firms the slowest. Overall, the capital structure of a firm is heavily influenced by the economic environment and its institutions, corporate governance practices, tax systems, the borrower-lender relation, exposure to capital markets, and the level of investor protection in the country in which the firm operates.
562 citations
TL;DR: In this article, the authors compare firms' capital structure adjustments across countries and investigate whether institutional differences help explain the variance in estimated adjustment speeds, finding that legal and financial traditions significantly correlate with firm adjustment speeds.
Abstract: Many authors relate a firm’s performance to legal and political features and the regulatory environment in which it operates. This article compares firms’ capital structure adjustments across countries and investigates whether institutional differences help explain the variance in estimated adjustment speeds. We find that legal and financial traditions significantly correlate with firm adjustment speeds. More narrowly, institutional features also relate to adjustment speeds, consistent with the hypothesis that better institutions lower the transaction costs associated with adjusting a firm’s leverage. Such associations between institutional arrangements and leverage adjustment speeds are consistent with the dynamic trade off theory of capital structure choice.
428 citations
TL;DR: In this article, the authors examined the wealth effects of distress and bankruptcy filing for suppliers and customers of filing firms and found that on average, important wealth effects occur prior to and at bankruptcy filings and extend beyond industry competitors along the supply chain.
384 citations
TL;DR: The authors found that firms in bilateral relationships are likely to produce or procure unique products, especially when they are in durable goods industries, consistent with the arguments of Titman and Wessels.
Abstract: Firms in bilateral relationships are likely to produce or procure unique products—especially when they are in durable goods industries. Consistent with the arguments of Titman and Titman and Wessels, such firms are likely to maintain lower leverage. We compile a database of firms' principal customers (those that account for at least 10% of sales or are otherwise considered important for business) from the Business Information File of Compustat and find results consistent with the predictions of this theory.
337 citations
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TL;DR: In this paper, the authors examined how deviations from these targets affect how bidders choose to finance acquisitions and how they adjust their capital structure following the acquisitions, and they found that when a bidder's leverage is over its target level, it is less likely to finance the acquisition with debt and more likely to use equity.
Abstract: In the context of large acquisitions, we provide evidence on whether firms have target capital structures. We examine how deviations from these targets affect how bidders choose to finance acquisitions and how they adjust their capital structure following the acquisitions. We show that when a bidder's leverage is over its target level, it is less likely to finance the acquisition with debt and more likely to finance the acquisition with equity. Also, we find a positive association between the merger-induced changes in target and actual leverage and document that bidders incorporate more than two-thirds of the change to the merged firm's new target leverage. Following debt-financed acquisitions, managers actively move the firm back to its target leverage, reversing more than 75% of the acquisition's leverage effect within 5 years. Overall, our results are consistent with a model of capital structure that includes a target level and adjustment costs.
294 citations
TL;DR: In this article, the authors employ U.S. data over a 30-year sample period to test the relationship between macroeconomic conditions and capital structure adjustment speed using both two-stage and integrated partial adjustment dynamic capital structure models.
Abstract: Studies show that capital structure choice varies over time and across firms and that macroeconomic conditions are important factors in analyzing firms' financing choices. However, studies have largely ignored the impact of macroeconomic conditions on the adjustment speed of capital structure toward targets. Hackbarth et al. (2006) develop a contingent model for analyzing the impact of macroeconomic conditions on dynamic capital structure choice. Allowing for dynamic capital structure adjustments, their model predicts that firms should adjust their capital structure faster in booms than in recessions. We employ U.S. data over a 30 year sample period to test the relationship between macroeconomic conditions and capital structure adjustment speed using both two-stage and integrated partial adjustment dynamic capital structure models. We find evidence supporting the prediction from Hackbarth et al's theoretical framework that firms adjust to target leverage faster in good states than in bad states, where states are defined by term spread, default spread, GDP growth rate, and market dividend yield. Our results also support the pecking order theory in that under-levered firms adjust faster than firms that are over-levered. We find evidence favoring the market timing theory implication that under-levered firms have less incentive to adjust toward target leverage when stock market performance is good, as measured by dividend yield on the market and price-output ratio. Robustness tests demonstrate that our speed of capital structure adjustment cannot be simply explained by firm size, the degree of deviation from target, or by the definition of debt ratio. Our results are also robust to potential boundary issues.
279 citations
TL;DR: Li et al. as discussed by the authors found that corporate financing choices are not only affected by firm and industry factors, but also by country institutional factors, focusing on the roles of public governance in firm financing patterns and identifying 23 corruption scandals involving highlevel government bureaucrats in China and a set of publicly traded companies whose senior managers bribed bureaucrats or were connected with bureaucrats through previous job affiliations.
Abstract: Cross-sectional research finds that corporate financing choices are not only affected by firm and industry factors, but also by country institutional factors. This study focuses on the roles of public governance in firm financing patterns. To conduct a natural experiment that avoids endogeneity, we identify 23 corruption scandals involving high-level government bureaucrats in China and a set of publicly traded companies whose senior managers bribed bureaucrats or were connected with bureaucrats through previous job affiliations. We report a significant decline in the leverage and debt maturity ratios of these firms relative to those of other unconnected firms after the arrest of the corrupt bureaucrat in question. These relations persist even if we only focus on the connected firms that were not directly involved in the corruption cases. The relative decline in firm leverage is associated with negative stock price effects. We also examine the possibility that rent seekers are efficient firms and that corruption does not thus result in capital misallocation, but fail to find evidence to substantiate this postulation.
262 citations
TL;DR: Li et al. as mentioned in this paper found that corporate financing choices are not only affected by firm and industry factors, but also by country institutional factors, focusing on the roles of public governance in firm financing patterns and identifying 23 corruption scandals involving highlevel government bureaucrats in China and a set of publicly traded companies whose senior managers bribed bureaucrats or were connected with bureaucrats through previous job affiliations.
254 citations
TL;DR: The authors developed a dynamic tradeoff model to examine the importance of manager-shareholder conflicts in capital structure choice and showed that while refinancing costs help explain the patterns observed in the data, their quantitative effects on debt choices are too small to explain financing decisions.
Abstract: We develop a dynamic tradeoff model to examine the importance of manager-shareholder conflicts in capital structure choice. Using panel data on leverage choices and the model's predictions for different statistical moments of leverage, we show that while refinancing costs help explain the patterns observed in the data, their quantitative effects on debt choices are too small to explain financing decisions. We also show that by adding agency conflicts in the model and giving the manager control over the leverage decision, one can obtain capital structure dynamics consistent with the data. In particular, we find that the model needs an average agency cost of 1.5% of equity value to resolve the low-leverage puzzle and to explain the time series of observed leverage ratios. Our estimates also reveal that the variation in agency costs across firms is sizeable and that the levels of agency conflicts inferred from the data correlate with commonly used proxies for corporate governance.
TL;DR: In this article, the importance of country-specific and firm-specific factors in the leverage choice of firms from 42 countries around the world was analyzed, and it was shown that there is an indirect impact from countryspecific factors on the capital structure of firms.
Abstract: We analyze the importance of firm-specific and country-specific factors in the leverage choice of firms from 42 countries around the world. Our analysis yields two new results. First, we find that firm-specific determinants of leverage differ across countries, while prior studies implicitly assume equal impact of these determinants. Second, although we concur with the conventional direct impact of country-specific factors on the capital structure of firms, we show that there is an indirect impact because country-specific factors also influence the roles of firm-specific determinants of leverage.
TL;DR: In this article, the impact of time-varying macroeconomic conditions on optimal dynamic capital structure and the aggregate dynamics of firms in a cross-section is studied. And the authors find that capital structure is procyclical at refinancing dates when firms relever, but counter-cyclical in aggregate dynamics, consistent with empirical evidence.
Abstract: We study the impact of time-varying macroeconomic conditions on optimal dynamic capital structure and the aggregate dynamics of firms in a cross-section. Our structural-equilibrium framework embeds a contingent-claim corporate financing model within a standard consumption-based asset-pricing model. This enables us to investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies as well as study the impact of preferences on capital structure. We find that capital structure is pro-cyclical at refinancing dates when firms relever, but counter-cyclical in aggregate dynamics, consistent with empirical evidence. Financially constrained firms follow more pro-cyclical policies. Capital structure is path-dependent. Leverage accounts for most of the macroeconomic risk relevant for predicting defaults. The paper also develops a number of novel empirically testable conjectures on capital structure in a dynamic economy.
TL;DR: In this article, the authors extend the current theoretical models of corporate risk management in the presence of financial distress costs and test the model's predictions using a comprehensive data set, showing that the shareholders optimally engage in ex-post risk management activities even without a pre-commitment to do so.
TL;DR: Li et al. as discussed by the authors examined the relation between leverage and investment in China's listed firms, where corporate debt is principally provided by state-owned banks and obtained three major findings.
Abstract: This study examines the relations between leverage and investment in China's listed firms, where corporate debt is principally provided by state-owned banks. We obtain three major findings. First, there is a negative relation between leverage and investment. Second, the negative relation between leverage and investment is weaker in firms with low growth opportunities and poor operating performance than in firms with high growth opportunities and good operating performance. Third, the negative relation between leverage and investment is weaker in firms with a higher level of state shareholding than in firms with a lower level of state shareholding. Overall, our results are consistent with the hypothesis that the state-owned banks in China impose fewer restrictions on the capital expenditures of low growth and poorly performing firms and also firms with greater state ownership. This creates an over-investment bias in these firms.
TL;DR: This article analyzed a sample of large privately and publicly held businesses that filed Chapter 11 bankruptcy petitions during 2001 and found pervasive creditor control, including senior lenders who exercise significant control through stringent covenants contained in DIP loans, such as line-item budgets.
Abstract: We analyze a sample of large privately and publicly held businesses that filed Chapter 11 bankruptcy petitions during 2001. We find pervasive creditor control. In contrast to traditional views of Chapter 11, equityholders and managers exercise little or no leverage during the reorganization process: Seventy percent of CEOs are replaced in the two years before a bankruptcy filing; very few reorganization plans (at most eight percent) deviate from the absolute priority rule in order to distribute value to equityholders. Senior lenders exercise significant control through stringent covenants contained in DIP loans, such as line-item budgets. Unsecured creditors gain leverage through objections and other court motions. We also find that bargaining between secured and unsecured creditors can distort the reorganization process. A Chapter 11 case is significantly more likely to result in a sale if secured lenders are oversecured, consistent with a secured creditor-driven fire-sale bias. It is much less likely when these lenders are undersecured or when the firm has no secured debt at all. Our results suggest that the advent of creditor control has not eliminated the fundamental inefficiency of the bankruptcy process: resource allocation questions (whether to sell or reorganize a firm) are ultimately confounded with distributional questions (how much each creditor will receive), due to conflict among creditor classes.
TL;DR: In this article, the authors examine the value of disclosure through the controversial SEC requirement, since overturned, which required major hedge funds to register as investment advisors and file Form ADV disclosures, and suggest that regulators should account for the endogenous production of information and the marginal benefit of disclosure to different investment clienteles.
Abstract: Mandatory disclosure is a regulatory tool intended to allow market participants to assess operational risk. We examine the value of disclosure through the controversial SEC requirement, since overturned, which required major hedge funds to register as investment advisors and file Form ADV disclosures. Leverage and ownership structures suggest that lenders and equity investors were already aware of operational risk. However, operational risk does not mediate flow‐performance relationships. Investors either lack this information or regard it as immaterial. These findings suggest that regulators should account for the endogenous production of information and the marginal benefit of disclosure to different investment clienteles.
TL;DR: In this paper, the authors empirically investigated the effects of competitive intensity and business strategy on the relationship between financial leverage and the performance of firms, and found that competitive intensity has a negative effect on the leverage-performance relationship, suggesting that competition acts as a substitute for debt in limiting manager's opportunistic behavior.
Abstract: This study empirically investigates the effects of competitive intensity and business strategy on the relationship between financial leverage and the performance of firms. Based on a sample of US manufacturing firms, this study confirms the hypothesis that the cost of debt is higher for product differentiation firms than cost leadership firms. Furthermore, the results indicate that competitive intensity has a negative effect on the leverage-performance relationship, suggesting that competition acts as a substitute for debt in limiting manager's opportunistic behavior. These findings reinforce the need to consider moderating factors such as strategic choice and the environment in which a firm operates when investigating the effects of leverage on performance.
TL;DR: In this article, the authors investigate the capital structure determinants of small and medium sized enterprises (SMEs) using a sample of Greek and French firms, and assess the extent to which the debt to assets ratio of firms depends upon their asset structure, size, profitability and growth rate.
Abstract: We investigate the capital structure determinants of small and medium sized enterprises (SMEs) using a sample of Greek and French firms We address the following questions: Are the capital structure determinants of SMEs in the two countries driven by similar factors? Are potential differences driven by country-specific or firm-specific factors? Are the size and structure of their financial markets important factors to explain any cross-country differences on SME capital structure? To answer these questions we apply panel data methods to the sample of firms for the period 1998 to 2002 We assess the extent to which the debt to assets ratio of firms depends upon their asset structure, size, profitability and growth rate The results show that the SMEs in both countries exhibit similarities in their capital structure choices Asset structure and profitability have a negative relationship with leverage, whereas firm size is positively related to their debt to assets ratio Growth is statistically significant only for France and is positively related to debt We attribute these similarities to their institutional characteristics and in particular the commonality of their civil law systems We find differences in the intensity of the capital structure relationship between the two countries We provide evidence that these differences are due to firm-specific rather than country factors
TL;DR: In this paper, a panel of 61,496 UK firms over the period 1997-2002 was used to study the effects of financial variables on firms' failure probabilities, differentiating firms into globally engaged and purely domestic.
Abstract: Financial constraints have been found to play an important role on various aspects of firm behavior. Yet, their effects on firm survival have been largely neglected. We use a panel of 61,496 UK firms over the period 1997–2002 to study the effects of financial variables on firms' failure probabilities, differentiating firms into globally engaged and purely domestic. Estimating a wide range of specifications, we find that lower collateral and higher leverage result in higher failure probabilities for purely domestic than for globally engaged firms. This can be seen as evidence that global engagement shields firms from financial constraints.
TL;DR: In this article, the authors examine the power and limits of the EU's leverage on domestic governance in candidate countries from Eastern Europe through the cases of Bulgaria and Romania, and argue that...
Abstract: The article examines the power as well as the limits of the EU's leverage on domestic governance in candidate countries from Eastern Europe through the cases of Bulgaria and Romania. It argues that...
TL;DR: In this paper, the authors investigate the impact of bankruptcy codes on firms' capital-structure choices and develop a theoretical model to identify how firm characteristics may interact with the bankruptcy code in determining optimal capital structures.
Abstract: We investigate the impact of bankruptcy codes on firms' capital-structure choices. We develop a theoretical model to identify how firm characteristics may interact with the bankruptcy code in determining optimal capital structures. A novel and sharp empirical implication emerges from this model: that the difference in leverage choices under a relatively equity-friendly bankruptcy code (such as the US's) and one that is relatively more debt-friendly (such as the UK's) should be a decreasing function of the anticipated liquidation value of the firm's assets.Using a large database of firms from the US and the UK over the period 1990 to 2002, we subject this prediction to extensive empirical testing, both parametric and non-parametric, using different proxies for liquidation values and different measures of leverage. We find strong support for the theory; that is, we find that our proxies for liquidation value are both statistically and economically significant in explaining leverage differences across the two countries. On the other hand, many of the other factors that are known to affect within-country leverage (e.g., size) cannot explain across-countries differences in leverage.
TL;DR: In this paper, a maximum likelihood procedure is used to estimate a stochastic cost frontier and the parameters of an equation relating cost inefficiency to leverage simultaneously, which tends to support the influence of institutional factors on this link.
Abstract: This paper aims to provide new empirical evidence on a major corporate governance issue: the relationship between leverage and corporate performance. We propose two major findings to this literature by applying frontier efficiency techniques to measure performance of medium-sized firms from seven European countries. A maximum likelihood procedure is used to estimate a stochastic cost frontier and the parameters of an equation relating cost inefficiency to leverage simultaneously. We find that the relationship between leverage and corporate performance varies across countries, which tends to support the influence of institutional factors on this link. We then suggest the influence of the efficiency of the legal system and in a lesser degree of the access to bank credit on the relationship between leverage and corporate performance.
TL;DR: In this article, the effect of bank market concentration and institutions on capital structure in 39 countries was analyzed for 12,049 firms over 1995-2004 and showed that firm leverage increases with greater bank concentration and stronger protection of creditor rights.
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TL;DR: In this article, the authors study a model in which future financing constraints lead firms to have a preference for investments with shorter payback periods, investments with less risk, and investments that utilize more pledgeable assets.
Abstract: We study a model in which future financing constraints lead firms to have a preference for investments with shorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.
TL;DR: In this article, the authors study a model in which future financing constraints leas firms to have a preference for investments with sorter payback periods, investments with less risk, and investments that utilize more pledgeable assets.
Abstract: We study a model in which future financing constraints leas firms to have a preference for investments with sorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.
TL;DR: In this paper, the authors examined the association between corporate governance structures and incidences of listing suspension from the JSE Securities Exchange of South Africa and found that the likelihood of suspension is higher in firms with a smaller proportion of non-executive directors, without an audit committee, and with greater block-share ownership and higher gearing.
TL;DR: In this paper, the authors examined the determinants of corporate leverage in Egypt according to the assumptions of three theories of capital structure: tradeoff, pecking order, and free cash flow.
Abstract: Purpose – This research paper aims at examining the determinants of corporate leverage in Egypt according to the assumptions of three theories of capital structure: tradeoff, pecking order, and free cash flow.Design/methodology/approach – The methodology utilizes the benefits of the partial adjustment autoregressive model to measure the speed of adjusting long‐term and short‐term debts to a target level.Findings – The results indicate that companies use both long‐term and short‐term debt to adjust the leverage with a relative dependence on long‐term debt; the tradeoff‐related determinants of capital structure are taxes, debt/equity ratio and bankruptcy risk; the pecking order‐related determinants of capital structure are growth and profitability; borrowing decisions are not affected by the assumptions of free cash flow. Overall, the explanatory powers of the three regression equations are high and significant which indicate that the model construction is quite indicative.Originality/value – The paper cont...
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TL;DR: In this paper, a contracting model for the determination of leverage and balance sheet size for financial intermediaries that fund their activities through collateralized borrowing is proposed. But the model is limited to U.S. investment banks, and leverage is procyclical in the sense that leverage is high when the balance sheet is large.
Abstract: We study a contracting model for the determination of leverage and balance sheet size for financial intermediaries that fund their activities through collateralized borrowing. The model gives rise to two features: First, leverage is procyclical in the sense that leverage is high when the balance sheet is large. Second, leverage and balance sheet size are both determined by the riskiness of assets. For U.S. investment banks, we find empirical support for both features of our model, that is, leverage is procyclical, and both leverage and balance sheet size are determined by measured risks. In a system context, increased risk reduces the debt capacity of the financial system as a whole, giving rise to amplified de-leveraging by institutions by way of the chain of repo transactions in the financial system.
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TL;DR: This article found that short-term interest rates are determinants of the cost of leverage and are important in influencing the size of financial intermediary balance sheets, except for periods of crisis, higher balance-sheet growth tends to be followed by lower interest rates, and slower balance sheet growth is followed by higher interest rates.
Abstract: In a market-based financial system, banking and capital market developments are inseparable. We document evidence that balance sheets of market-based financial intermediaries provide a window on the transmission of monetary policy through capital market conditions. Short-term interest rates are determinants of the cost of leverage and are found to be important in influencing the size of financial intermediary balance sheets. However, except for periods of crises, higher balance-sheet growth tends to be followed by lower interest rates, and slower balance-sheet growth is followed by higher interest rates. This suggests that consideration might be given to a monetary policy that anticipates the potential disorderly unwinding of leverage. In this sense, monetary policy and financial stability policies are closely linked.