Showing papers on "Leverage (finance) published in 2013"
TL;DR: In this article, the authors introduce a macro model to study the transmission of monetary policy and its interplay with bank capital regulation when banks are risky, and find that risk-based capital requirements amplify the cycle and are welfare detrimental.
424 citations
TL;DR: In this article, the authors analyze how changes in balance sheets of some 2800 banks in 48 countries over 2000-2010 respond to specific macro-prudential policies, and find that measures aimed at borrowers such as caps on debt to income and loan-to-value ratios, and limits on credit growth and foreign currency lending are effective in reducing leverage, asset and noncore to core liabilities growth during boom times.
404 citations
TL;DR: In this paper, a dynamic model of investment, capital structure, leasing, and risk management based on firms' need to collateralize promises to pay with tangible assets is developed. But the model is not suitable for large firms.
Abstract: We develop a dynamic model of investment, capital structure, leasing, and risk management based on firms' need to collateralize promises to pay with tangible assets. Both financing and risk management involve promises to pay subject to collateral constraints. Leasing is strongly collateralized costly financing and permits greater leverage. More constrained firms hedge less and lease more, both cross-sectionally and dynamically. Mature firms suffering adverse cash flow shocks may cut risk management and sell and lease back assets. Persistence of productivity reduces the benefits to hedging low cash flows and can lead firms not to hedge at all.
311 citations
Posted Content•
TL;DR: In this paper, the authors explore a contracting model that captures the observed features and find that intermediary leverage is negatively aligned with the banks' Value-at-Risk (VaR).
Abstract: The availability of credit varies over the business cycle through shifts in the leverage of financial intermediaries. Empirically, we find that intermediary leverage is negatively aligned with the banks' Value-at-Risk (VaR). Motivated by the evidence, we explore a contracting model that captures the observed features. Under general conditions on the outcome distribution given by Extreme Value Theory (EVT), intermediaries maintain a constant probability of default to shifts in the outcome distribution, implying substantial deleveraging during downturns. For some parameter values, we can solve the model explicitly, thereby endogenizing the VaR threshold probability from the contracting problem.
299 citations
TL;DR: In this paper, the authors present the puzzling evidence that, from 1962 to 2009, an average 10.2% of large public non-financial US firms have zero debt and almost 22% have less than 5% book leverage ratio.
284 citations
Posted Content•
TL;DR: In this article, the authors exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells and find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms.
Abstract: This paper presents evidence that firms choose conservative financial policies partly to mitigate workers' exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.
267 citations
TL;DR: In this article, the authors examined the impact of labor unemployment risk on corporate financing decisions and found that increased legally mandated unemployment benefits lead to increases in corporate leverage, especially for firms with greater layoff separation rates, labor intensity, and financing constraints.
266 citations
TL;DR: This article showed that optimism concerning the probability of downside states has no or little effect on asset prices because these types of optimism are disciplined by this constraint, while optimism regarding the relative probability of upside states could have significant effects on asset price.
Abstract: Belief disagreements have been suggested as a major contributing factor to the recent subprime mortgage crisis. This paper theoretically evaluates this hypothesis. I assume that optimists have limited wealth and take on leverage so as to take positions in line with their beliefs. To have a significant effect on asset prices, they need to borrow from traders with pessimistic beliefs using loans collateralized by the asset itself. Since pessimists do not value the collateral as much as optimists do, they are reluctant to lend, which provides an endogenous constraint on optimists' ability to borrow and to influence asset prices. I demonstrate that the tightness of this constraint depends on the nature of belief disagreements. Optimism concerning the probability of downside states has no or little effect on asset prices because these types of optimism are disciplined by this constraint. Instead, optimism concerning the relative probability of upside states could have significant effects on asset prices. This asymmetric disciplining effect is robust to allowing for short selling because pessimists that borrow the asset face a similar endogenous constraint. These results emphasize that what investors disagree about matters for asset prices, to a greater extent than the level of disagreements. When richer contracts are available, relatively complex contracts that resemble some of the recent financial innovations in the mortgage market endogenously emerge to facilitate betting.
264 citations
TL;DR: In this article, the authors used deal-level data from transactions initiated by large private equity houses and found that the abnormal performance of deals is positive on average, after controlling for leverage and sector returns.
Abstract: Using deal-level data from transactions initiated by large private equity houses, we find that the abnormal performance of deals is positive on average, after controlling for leverage and sector returns. Higher abnormal performance is related to improvement in sales and operating margin during the private phase, relative to that for quoted peers. General partners who are ex-consultants or ex-industry managers are associated with outperforming deals focused on internal value-creation programs, and ex-bankers or ex-accountants with outperforming deals involving significant mergers and acquisitions. The findings suggest the presence, on average, of positive but heterogeneous skills at the deal-partner level in large private equity transactions.
234 citations
TL;DR: In this article, a dynamic model of investment, capital structure, leasing, and risk management based on firms' need to collateralize promises to pay with tangible assets is developed. But the model is not suitable for large firms.
230 citations
TL;DR: The authors analyzes whether Taylor rules augmented with asset prices and credit can improve upon a standard rule in terms of macroeconomic stabilization in a DSGE with both a firms' balance-sheet channel and a bank-lending channel and in which the spread between lending and policy rates endogenously depends on banks' leverage.
Abstract: The global financial crisis has reaffirmed the importance of financial factors for macroeconomic fluctuations. Recent work has shown how the conventional pre-crisis prescription that monetary policy should pay no attention to financial variables over and above their effects on inflation may no longer be valid in models that consider frictions in financial intermediation (Curdia and Woodford, 2009). This paper analyzes whether Taylor rules augmented with asset prices and credit can improve upon a standard rule in terms of macroeconomic stabilization in a DSGE with both a firms' balance-sheet channel and a bank-lending channel and in which the spread between lending and policy rates endogenously depends on banks' leverage. The main result is that, even in a model in which financial stability does not represent a distinctive policy objective, leaning-against-the-wind policies are desirable in the case of supply-side shocks whenever the central bank is concerned with output stabilization, while both strict inflation targeting and a standard rule are less effective. The gains are amplified if the economy is characterized by high private sector indebtedness.
TL;DR: This paper examined the relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms' business risks and found that managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.
Abstract: This paper examines the two-way relationship between managerial compensation and corporate risk by exploiting an unanticipated change in firms’ business risks. The natural experiment provides an opportunity to examine two classic questions related to incentives and risk — how boards adjust incentives in response to firms’ risk and how these incentives affect managers’ risk-taking. We find that, after left-tail risk increases, boards reduce managers’ exposure to stock price movements and that less convexity from options-based pay leads to greater risk-reducing activities. Specifically, managers with less convex payoffs tend to cut leverage and R&D, stockpile cash, and engage in more diversifying acquisitions.
TL;DR: In this article, the authors demonstrate that personal political preferences of corporate managers influence corporate policies, and that managers who are likely to have conservative personal ideologies adopt and maintain more conservative corporate policies.
Abstract: We demonstrate that personal political preferences of corporate managers influence corporate policies. Specifically, Republican managers who are likely to have conservative personal ideologies adopt and maintain more conservative corporate policies. Those firms have lower levels of corporate debt, lower capital and R&D expenditures, less risky investments, but higher profitability. Using the 9/11 terrorist attacks and September 2008 Lehman Brothers bankruptcy as natural experiments, we demonstrate that investment policies of Republican managers became more conservative following these exogenous uncertainty increasing events. Further, around CEO turnovers, including CEO death, firm leverage policy becomes more conservative when managerial conservatism increases.
TL;DR: In this article, the authors investigated the relationship between capital structure and firm performance, paying particular attention to the degree of industry competition, and found that financial leverage has a positive and significant effect on firm performance.
TL;DR: The authors examined the international determinants of capital structure using a large sample of firms drawn from 37 counties and found that the reliable determinants for leverage are firm size, tangibility, industry leverage, profits, and inflation.
Abstract: This article examines the international determinants of capital structure using a large sample of firms drawn from 37 counties. The reliable determinants for leverage are firm size, tangibility, industry leverage, profits, and inflation. The quality of the countries’ institutions affects leverage and the speed of adjustment toward target leverage in significant ways. High-quality institutions lead to faster leverage adjustments, while laws and traditions that safeguard debt holders relative to stockholders (e.g., more effective bankruptcy procedures and stronger creditor protection) lead to higher leverage.
TL;DR: In this article, the authors exploit the introduction of weather derivatives as an exogenous shock to firms' ability to hedge weather risks and show that active risk management policies lead to an increase in firm value.
Abstract: This paper shows that active risk management policies lead to an increase in firm value. To identify the effect of hedging and to overcome endogeneity concerns, we exploit the introduction of weather derivatives as an exogenous shock to firms’ ability to hedge weather risks. This innovation disproportionately benefits weather-sensitive firms, irrespective of their future investment opportunities. Using this natural experiment and data from energy firms, we find that derivatives lead to higher valuations, investments, and leverage. Overall, our results demonstrate that risk management has real consequences on firm outcomes.
TL;DR: In this paper, the authors carried out a panel data analysis of 3175 SMEs from seven CEE countries during the period 2001-2005, modeling the leverage ratio as a function of firm specific characteristics hypothesized by capital structure theory.
TL;DR: The authors found that firms with traded CDS contracts on their debt are able to maintain higher leverage ratios and longer debt maturities during periods in which credit constraints become binding, as would be expected if the ability to hedge helps alleviate frictions on the supply side of credit markets.
Abstract: Does the ability of suppliers of corporate debt capital to hedge risk through credit default swap (CDS) contracts impact firms' capital structures? We find that firms with traded CDS contracts on their debt are able to maintain higher leverage ratios and longer debt maturities. This is especially true during periods in which credit constraints become binding, as would be expected if the ability to hedge helps alleviate frictions on the supply side of credit markets. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
TL;DR: In this paper, the authors consider an economy populated by institutional investors alongside standard retail investors and find that institutions optimally tilt their portfolios towards stocks that comprise their benchmark index, while leaving non-index stocks unaffected.
Abstract: Empirical evidence indicates that trades by institutional investors have sizable effects on asset prices, generating phenomena such as index effects, asset-class effects and others. It is difficult to explain such phenomena within standard representative-agent asset pricing models. In this paper, we consider an economy populated by institutional investors alongside standard retail investors. Institutions care about their performance relative to a certain index. Our framework is tractable, admitting exact closed-form expressions, and produces the following analytical results. We find that institutions optimally tilt their portfolios towards stocks that comprise their benchmark index. The resulting price pressure boosts index stocks, while leaving nonindex stocks unaffected. By demanding a higher fraction of risky stocks than retail investors, institutions amplify the index stock volatilities and aggregate stock market volatility, and give rise to countercyclical Sharpe ratios. Trades by institutions induce excess correlations among stocks that belong to their benchmark index, generating an asset-class effect. Institutions finance their additional purchases of index stocks by taking on leverage. A policy prescription that calls for a reduction in leverage, while reducing the riskiness of institutional portfolios, would also reduce the ability of institutions to tilt their portfolios towards index stocks, depressing the index level.
TL;DR: The authors found that common stock investors are around 50 percent more likely to subsequently start up a firm and that firms started up by stock market investors have about 25 percent lower sales and 15 percent lower return on assets.
Abstract: A tradition from Knight (1921) argues that more risk tolerant individuals are more likely to become entrepreneurs, but perform worse. We test these predictions with two risk tolerance proxies: stock market participation and personal leverage. Using investment data for 400,000 individuals, we find that common stock investors are around 50 percent more likely to subsequently start up a firm. Firms started up by stock market investors have about 25 percent lower sales and 15 percent lower return on assets. The results are similar using personal leverage as risk tolerance proxy. We consider alternative explanations including unobserved wealth and behavioral effects.
TL;DR: In this article, the authors explored the significance of firm-specific, institutional, and macroeconomic factors in explaining variation in leverage using a sample of firms from nine Eastern European countries.
Journal Article•
TL;DR: In this article, the impact of financial statement indicators to tax avoidance was studied using purposive sampling criteria and double linear regression analysis test and the results showed that ROA, leverage, corporate governance, company's size, and fiscal lost compensation had a simultanous significant impact on tax avoidance.
Abstract: This research studied the impact of financial statement indicator to tax avoidance. ROA, leverage, corporate governance, company’s size, and fiscal lost compensation were used as an independent variable which were assumed have an impact to tax avoidance (dependent variable) proxied by Cash Effective Tax Rates (CETR). This research used purposive sampling criteria and double linear regression analysis test. The result was ROA, leverage; corporate governance, company’s size, and fiscal lost compensation had a simultanous significant impact to tax avoidance in manufactur companies listed in BEI 2007- 2010 period. ROA, company’s size, and fiscal lost compensation influence tax avoidance partially and significantly. Leverage and Corporate Governance had no partial significant influence to tax avoidance. This result was consistent to previous research of Sari and Martani (2010)
TL;DR: In this paper, the authors show that shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value, and instead choose to increase leverage even if the new debt is junior and would reduce firm value.
Abstract: Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if the new debt is junior and would reduce firm value. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history-dependent. If forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.
TL;DR: This article examined the capital-structure decisions of privately held US firms using data from four nationally representative surveys conducted from 1987 to 2003 and found that book-value firm leverage is negatively related to firm age and minority ownership; and is positively related to industry median leverage, the corporate legal form of organization, and the number of banking relationships.
Abstract: This study examines the capital-structure decisions of privately held US firms using data from four nationally representative surveys conducted from 1987 to 2003. Book-value firm leverage, as measured by either the ratio of total loans to total assets or the ratio of total liabilities to total assets, is negatively related to firm age and minority ownership; and is positively related to industry median leverage, the corporate legal form of organization, and to the number of banking relationships. In general, these results provide mixed support for both the Pecking-Order and Trade-Off theories of capital structure. What do we know about the capital structure of privately held US firms? The answer is “not much,” as almost all existing empirical studies of the capital structure of US firms have relied upon Compustat data for large corporations with publicly traded securities. 1 Although such large, publicly traded corporations hold the vast majority of business assets, they account for only a small fraction of the number of business entities. In the United States, for example, there are fewer than 10,000 firms that issue publicly traded securities, yet according to the US Internal Revenue Service, there were approximately 30 million small businesses as of
01 Jan 2013
TL;DR: In this paper, the determinants of corporate hedging based on samples taken from non-financial firms on the United Kingdom's Financial Times Stock Exchange FTSE 250 were examined, and the results suggest that firms that face higher probability of financial distress are using derivatives as risk management tool to stabilised firms' cash flows.
Abstract: This study examined the determinants of corporate hedging based on samples taken from non-financial firms on the United Kingdom’s Financial Times Stock Exchange FTSE 250. In this study, derivative usage is used as the proxy for risk management. The research model was estimated using the univariate binomial probit model and the Heckman two-stage regression model. The result indicates that executives with options on company’s shares prefer risk-taking and choose not to hedge. The study also found that corporate hedging is positively related to (1) level of firms’ leverage and (2) proportion of total turnover spent for interest payment. These results suggest that firms that face higher probability of financial distress are using derivatives as risk management tool to stabilised firms’ cash flows. Finally, this study also found that large firms are more likely to use derivatives due to the benefits of economies of scale.
Posted Content•
TL;DR: This paper found that strong creditor protection is associated with low long-term leverage across countries, and that strong protection discourages firms from making longterm cash flow commitments to service debt because managers and shareholders avoid the risk of losing control in the case of financial distress.
Abstract: For a large sample of 48 countries, we find robust evidence that strong creditor rights are associated with low long-term leverage across countries. We further find that strong creditor protection lowers long-term debt issuance, the extent to which investments are financed with long-term debt, and target leverage ratios. Finally, we find that firm and country characteristics influence the link between creditor protection and long-term leverage. Our results support the demand-side view that strong creditor protection discourages firms from making long-term cash flow commitments to service debt because managers and shareholders avoid the risk of losing control in the case of financial distress.
TL;DR: A hybrid neural network architecture of Particle Swarm Optimization and Adaptive Radial Basis Function (ARBF–PSO), a time varying leverage trading strategy based on Glosten, Jagannathan and Runkle volatility forecasts and a neural network fitness function for financial forecasting purposes are introduced.
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TL;DR: In this paper, the authors lay out a framework for the stress testing of banks: why is it useful and why has it become such a popular tool for the regulatory community in the course of the recent financial crisis; how is stress testing done -design and execution; and finally, with stress testing results in hand, how should one handle their disclosure, and should it be different in crisis vs. normal times.
Abstract: How much capital and liquidity does a bank need – to support its risk taking activities? During the recent (and still ongoing) financial crisis, answers to this question using standard approaches, e.g. regulatory capital ratios, were no longer credible, and thus broad-based supervisory stress testing became the new tool. Bank balance sheets are notoriously opaque and are susceptible to asset substitution (easy swapping of high risk for low risk assets), so stress tests, tailored to the situation at hand, can provide clarity by openly disclosing details of the results and approaches taken, allowing trust to be regained. With that trust re-established, the cost-benefit of stress testing disclosures may tip away from bank-specific towards more aggregated information. This paper lays out a framework for the stress testing of banks: why is it useful and why has it become such a popular tool for the regulatory community in the course of the recent financial crisis; how is stress testing done – design and execution; and finally, with stress testing results in hand, how should one handle their disclosure, and should it be different in crisis vs. “normal” times.
Journal Article•
TL;DR: In this paper, the authors used Pearson correlation to ascertain the interrelationship between the variables, whereas multiple-regression was used to assess the extent of the effect of the independent variables on the dependent variable.
Abstract: With the increasing trend of sudden corporate failure in both global and local context, shareholders and other stakeholders are increasingly becoming more concerned of the financial performance of their firms. The study therefore aimed to find out the factors affecting the financial performance of listed companies at Nairobi Securities Exchange in Kenya. It was informed by trade off and the agency theories. The study adopted an explanatory research design and 29 listed firms (excluding listed banks and insurance companies) which have consistently been operating at the Nairobi securities exchange during the period 2006-2012 were sampled. Purposive sampling technique was used. The analysis of the data collected from financial statement followed a number of basic statistical techniques. Descriptive statistics (mean and standard deviation) and inferential statistics (Pearson correlation and multiple-regression) were used to analyze data. Pearson correlation was used to ascertain the interrelationship between the variables, whereas multiple-regression was used to assess the extent of the effect of the independent variables on the dependent variable. Study findings showed that leverage had a significant negative effect on financial performance (? 1 = -0.289, ?<0.05). Findings also showed that liquidity had a significant positive effect on financial performance (? 2 = 0.296, ?<0.05). Company size had a significant positive effect on financial performance (? 3 = 0.480, ?<0.05). The study also revealed that company age had a significant positive effect on financial performance (? 4 = 0.168, ?<0.05). The study provides some precursory evidence that leverage, liquidity, company size and company age play an important role in improving company’s financial performance. The study suggests that there is need to determine an optimal debt level that balances the benefits of debt against the costs of debt and developing sound techniques of managing current assets to ensure that neither insufficient nor unnecessary funds are invested in current assets as maintaining a balance between short-term assets and short-term liabilities is critical. The study also suggest that firms should expand in a controlled way with the aim of achieving an optimum size so as to enjoy economies of scale which can ultimately result in higher level of financial performance. Keywords: Financial Performance, Liquidity, Leverage, Company Size and Age
TL;DR: In this paper, the authors investigated the impact of firm level characteristics (size, leverage, tangibility, loss ratio (risk), growth in writing premium, liquidity, leverage and loss ratio) on performance of insurance companies in Ethiopia.
Abstract: The performance of any business firm not only plays the role to improve the market value of that specific firm but also leads towards the growth of the whole sector which ultimately leads towards the overall prosperity of the economy Assessing the determinants of the performance of organizations has gained importance in the corporate finance literature; however, in the context of insurance sector, it has received little attention particularly in Ethiopia Accordingly, this study investigated the impact of firm level characteristics (size, leverage, tangibility, Loss ratio (risk), growth in writing premium, liquidity and age) on performance of insurance companies in Ethiopia Return on total assets (ROA) - a key indicator of insurance company's performance- is used as dependent variable while age of company, size of the company, growth in writing premium, liquidity, leverage and loss ratio are independent variables The sample includes 9 insurance companies over the period 2005-2010 The audited annual reports (Balance sheet and Profit/Loss account) of insurance companies were obtained from National Bank of Ethiopia (NBE) and insurance companies’ annual publication reports The results of regression analysis reveal that insurers’ size, tangibility and leverage are statistically significant and positively related with return on total asset; however, loss ratio (risk) is statistically significant and negatively related with ROA Thus, insurers’ size, Loss ratio (risk), tangibility and leverage are important determinants of performance of insurance companies in Ethiopia But, growth in writing premium, insurers’ age and liquidity have statistically insignificant relationship with ROA