Showing papers on "Leverage (finance) published in 2014"
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TL;DR: This article presented a model with leverage and margin constraints that vary across investors and time, and found evidence consistent with each of the model's five central predictions: constrained investors bid up high-beta assets, high beta is associated with low alpha, as they find empirically for US equities, 20 international equity markets, Treasury bonds, corporate bonds, and futures.
1,138 citations
TL;DR: In this article, the authors use shocks to the leverage of securities broker-dealers to construct an intermediary stochastic discount factor (SDF), which is used to price size, book-to-market, momentum, and bond portfolios with an R2 of 77% and an average annual pricing error of 1%
Abstract: Financial intermediaries trade frequently in many markets using sophisticated models. Their marginal value of wealth should therefore provide a more informative stochastic discount factor (SDF) than that of a representative consumer. Guided by theory, we use shocks to the leverage of securities broker-dealers to construct an intermediary SDF. Intuitively, deteriorating funding conditions are associated with deleveraging and high marginal value of wealth. Our single-factor model prices size, book-to-market, momentum, and bond portfolios with an R2 of 77% and an average annual pricing error of 1%�performing as well as standard multifactor benchmarks designed to price these assets.
446 citations
TL;DR: It is shown that, when banks can adjust their capital structures, reductions in real interest rates lead to greater leverage and higher risk for any downward sloping loan demand function, but if the capital structure is fixed, the effect depends on the degree of leverage.
321 citations
TL;DR: In this article, the authors developed a network approach to the amplification of financial contagion due to the combination of overlapping portfolios and leverage, and showed how it can be understood in terms of a generalized branching process.
Abstract: Common asset holdings are widely believed to have been the primary vector of contagion in the recent financial crisis. We develop a network approach to the amplification of financial contagion due to the combination of overlapping portfolios and leverage, and we show how it can be understood in terms of a generalized branching process. This can be used to compute the stability for any particular configuration of portfolios. By studying a stylized model we estimate the circumstances under which systemic instabilities are likely to occur as a function of parameters such as leverage, market crowding, diversification, and market impact. Although diversification may be good for individual institutions, it can create dangerous systemic effects, and as a result financial contagion gets worse with too much diversification. There is a critical threshold for leverage; below it financial networks are always stable, and above it the unstable region grows as leverage increases. Note that our model assumes passive portfolio management during a crisis; however, we show that dynamic deleveraging during a crisis can amplify instabilities. The financial system exhibits “robust yet fragile” behavior, with regions of the parameter space where contagion is rare but catastrophic whenever it occurs. Our model and methods of analysis can be calibrated to real data and provide simple yet powerful tools for macroprudential stress testing.
292 citations
TL;DR: This paper showed that the share of mortgages on banks' balance sheets doubled in the course of the twentieth century, driven by a sharp rise of mortgage lending to households, and that household debt to asset ratios have risen substantially in many countries.
Abstract: This paper unveils a new resource for macroeconomic research: a long-run dataset covering disaggregated bank credit for 17 advanced economies since 1870. The new data show that the share of mortgages on banks’ balance sheets doubled in the course of the twentieth century, driven by a sharp rise of mortgage lending to households. Household debt to asset ratios have risen substantially in many countries. Financial stability risks have been increasingly linked to real estate lending booms, which are typically followed by deeper recessions and slower recoveries. Housing finance has come to play a central role in the modern macroeconomy.
247 citations
TL;DR: The authors showed that the share of mortgages on banks' balance sheets doubled in the course of the 20th century, driven by a sharp rise of mortgage lending to households in many countries.
Abstract: This paper unveils a new resource for macroeconomic research: a long-run dataset covering disaggregated bank credit for 17 advanced economies since 1870. The new data show that the share of mortgages on banks’ balance sheets doubled in the course of the 20th century, driven by a sharp rise of mortgage lending to households. Household debt to asset ratios have risen substantially in many countries. Financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries. Housing finance has come to play a central role in the modern macroeconomy.
236 citations
TL;DR: In this paper, the authors show that high leverage is optimal for banks in a model that has just enough frictions for banks to have a meaningful role in liquid-claim production.
Abstract: Liquidity production is a central function of banks. High leverage is optimal for banks in a model that has just enough frictions for banks to have a meaningful role in liquid-claim production. The model has a market premium for (socially valuable) safe/liquid debt, but no taxes or other traditional motives to lever up. Because only safe debt commands a liquidity premium, banks with risky assets use risk management to maximize their capacity to include such debt in the capital structure. The model can explain why banks have higher leverage than most operating firms, why risk management is central to banks’ operating policies, why bank leverage increased over the last 150 years or so, and why leverage limits for regulated banks impede their ability to compete with unregulated shadow banks.
212 citations
TL;DR: In this article, the authors exploit inter-temporal variations in employment protection across countries and find that rigidities in labor markets are an important determinant of firms' capital structure decisions.
Abstract: This paper exploits inter-temporal variations in employment protection across countries and finds that rigidities in labor markets are an important determinant of firms' capital structure decisions. Over the 1985-2007 period, we find that reforms increasing employment protection are associated with a 187 basis point reduction in leverage. We interpret this finding to suggest that employment protection increases operating leverage, crowding out financial leverage. This result is robust across measures of employment protection and leverage, and does not appear to be due to pre treatment differences between treated and control firms, omitted variables, unobserved changes in regional economic conditions, and reverse causality. Heterogeneous treatment effects are consistent with our economic intuition: we find that the negative effect is more pronounced in firms that are subject to frequent hiring and firing.
207 citations
TL;DR: This paper found that firms affected more by conservatism issue less debt, have lower leverage, hold more cash, are less likely to obtain a debt rating, and experience lower growth than unaffected firms with the same rating.
Abstract: Rating agencies have become more conservative in assigning corporate credit ratings over the period 1985 to 2009; holding firm characteristics constant, average ratings have dropped by three notches. This change does not appear to be fully warranted because defaults have declined over this period. Firms affected more by conservatism issue less debt, have lower leverage, hold more cash, are less likely to obtain a debt rating, and experience lower growth. Their debt spreads are lower than those of unaffected firms with the same rating, which implies that the market partly undoes the impact of conservatism on debt prices. This evidence suggests that firms and capital markets do not perceive the increase in conservatism to be fully warranted.
198 citations
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 research and development (R&D) expenditures, less risky investments, but higher profitability. Using the 9/11 terrorist attacks and Sept. 2008 Lehman Brothers bankruptcy as natural experiments, we demonstrate that investment policies of Republican managers became more conservative following these exogenous uncertainty-increasing events. Furthermore, around chief executive officer (CEO) turnovers, including CEO deaths, firm leverage policy becomes more conservative when managerial conservatism increases.
193 citations
TL;DR: In this paper, the authors focus on market "tantrums" in which risk premiums inherent in market interest rates fluctuate widely, and find some support for the proposition that market tantrums can arise without any leverage or actions taken by leveraged intermediaries.
Abstract: Assessments of the risks to financial stability often focus on the degree of leverage in the system. In this report, however, we question whether subdued leverage of financial intermediaries is sufficient grounds to rule out stability concerns. In particular, we highlight unlevered investors as the locus of potential financial instability and consider the monetary policy implications. Our focus is on market “tantrums” (such as that seen during the summer of 2013) in which risk premiums inherent in market interest rates fluctuate widely. Large jumps in risk premiums may arise if non-bank market participants are motivated, in part, by their relative performance ranking. Redemptions by ultimate investors strengthen such a channel. We sketch an example and examine three empirical implications. First, as a product of the performance race, flows into an investment opportunity drive up asset prices so that there is momentum in returns. Second, the model predicts that return chasing can reverse sharply. And third, changes in the stance of monetary policy can trigger heavy fund inflows and outflows.Using inflows and outflows for different types of open-end mutual funds, we find some support for the proposition that market tantrums can arise without any leverage or actions taken by leveraged intermediaries. We also uncover connections between the destabilizing flows and shocks to monetary policy. We draw five principal conclusions from our analysis. First, in contrast with the common presumption, the absence of leverage may not be sufficient to ensure that monetary policy can disregard concerns for financial stability. Second, the usual macroprudential toolkit does not address instability driven by non-leveraged investors. Third, forward guidance encourages risk taking that can lead to risk reversals. In fact, our example suggests that when investors infer that monetary policy will tighten, the instability seen in summer of 2013 is likely to reappear. Fourth, financial instability need not be associated with the insolvency of financial institutions. Fifth, the tradeoffs for monetary policy are more difficult than is sometimes portrayed. The tradeoff is not the contemporaneous one between more versus less policy stimulus today, but is better understood as an intertemporal tradeoff between more stimulus today at the expense of a more challenging and disruptive policy exit in the future.Of course, our analysis neither invalidates nor validates the policy course the Federal Reserve has actually taken. Any such conclusion depends on an assessment of the balance of risks given the particular circumstances, which lies beyond the scope of our paper. Instead, our paper is intended as a contribution to developing the analytical framework for making policy judgments. But our analysis does suggest that unconventional monetary policies (including QE and forward guidance) can build future hazards by encouraging certain types of risk-taking that are not easily reversed in a controlled manner.
TL;DR: In this paper, the authors study business groups' internal capital markets using a unique data set on intra-group lending in Chile and find that firms that borrow internally have higher investment, leverage, and return on equity (ROE) than other firms.
TL;DR: In this paper, the authors work closely with academia and governmental organizations in the UK and abroad to develop new, innovative schemes for social impact investing, including considerations for public-private collaborations, legislative actions, and especially in this case, for the leveraged use of public and philanthropic funds in Crowdfunding.
Abstract: The authors work closely with academia and governmental organizations in the UK and abroad to develop new, innovative schemes for social impact investing. Such schemes include considerations for public–private collaborations, legislative actions, and especially in this case, for the leveraged use of public and philanthropic funds in Crowdfunding (CF). The relatively new phenomenon of CF can not only provide necessary funds for the social enterprises, it may also lead to a higher legitimacy of these through early societal interaction and participation. This legitimacy can be understood as a strong positive signal for further investors. Governmental tax-reliefs and guarantees from venture-philanthropic funds provide additional incentives for investment and endorse future scaling by leveraging additional debt-finance from specialized social banks. This case study identifies idiosyncratic hurdles to why an efficient social finance market has yet to be created and examines a schema as a case of how individual ...
TL;DR: In this article, the most important determinants of capital structure of 870 listed Indian firms comprising both private sector companies and government companies for the period 2001-2010 were identified using regression analysis, and it was concluded that factors such as profitability, growth, asset tangibility, size, cost of debt, tax rate, and debt serving capacity have significant impact on the leverage structure chosen by firms in the Indian context.
Abstract: The paper identifies the most important determinants of capital structure of 870 listed Indian firms comprising both private sector companies and government companies for the period 2001–2010. Ten independent variables and three dependent variables have been tested using regression analysis. It has been concluded that factors such as profitability, growth, asset tangibility, size, cost of debt, tax rate, and debt serving capacity have significant impact on the leverage structure chosen by firms in the Indian context.
TL;DR: In this article, the impact of capital structure choice on firm performance in India as one of the emerging economies is investigated based on the agency theory, which is in contrast with the assumptions of agency theory as commonly received and accepted in other developed as well as emerging economies.
Abstract: Purpose – Based on the agency theory, the purpose of this paper is to empirically investigate the impact of capital structure choice on firm performance in India as one of the emerging economies. Design/methodology/approach – Fixed effect panel regression model is used to analyse ten years of data (2003-2012) on the sample units, to find the relation between leverage and firm performance after controlling for factors such as size, age, tangibility, growth, liquidity and advertising. Findings – Empirical results suggest that leverage has a negative influence on financial performance of Indian firms, which is in contrast with the assumptions of agency theory as commonly received and accepted in other developed as well as emerging economies. Consequently, postulates of agency theory have to be seen with different perspective in India given the underdeveloped nature of bond markets and dominance of state-owned banks in lending to corporate sector. Practical implications – The findings of the paper will enable...
TL;DR: In this article, the authors evaluate whether Taylor rules augmented with asset prices, credit or bank leverage, 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.
TL;DR: In this paper, the authors examined the effect of access to debt markets on investment decisions by using debt ratings to indicate bond market access and found that rated firms are more likely to undertake acquisitions than non-rated firms.
TL;DR: The authors examined the impact of financial flexibility on the investment and performance of East Asian firms over the period 1994-2009 and found that firms that are financially flexible prior to this crisis have a greater ability to take investment opportunities, rely much less on the availability of internal funds to invest, and perform better than less flexible firms during the crisis.
Abstract: This study examines the impact of financial flexibility on the investment and performance of East Asian firms over the period 1994–2009. We employ a sample of 1,068 firms and place particular emphasis on the periods of the Asian crisis (1997–1998) and the recent credit crisis (2007–2009). The results show that firms can attain financial flexibility, primarily through conservative leverage policies and less commonly by holding large cash balances. Financial flexibility appears to be an important determinant of investment and performance, mainly during the Asian 1997–1998 crisis. In particular, firms that are financially flexible prior to this crisis (1) have a greater ability to take investment opportunities, (2) rely much less on the availability of internal funds to invest, and (3) perform better than less flexible firms during the crisis. Our analysis covering the credit crisis period of 2007–2009 suggests that some of the advantages of flexible firms towards investing persist but are significantly less pronounced over that period. We also find that the value of financial flexibility is region/country specific, which may be explained by the fact that different regions/countries often adopt different macroeconomic policies and operate in diverse economic/legal environments.
TL;DR: This article analyzed the relation between CEO personal risk taking, managerial risk-taking and total firm risk and found evidence that CEOs who possess private pilot's licenses are associated with riskier firms.
Abstract: This study analyzes the relation between CEO personal risk-taking, managerial risk-taking and total firm risk. We find evidence that CEOs who possess private pilot’s licenses, our proxy for personal risk-taking, are associated with riskier firms. Firms led by CEO pilots have higher equity return volatility, even beyond the amount explained by a wealth effect related to compensation structure. We trace the source of the elevated firm risk to specific corporate policies including leverage and acquisition activity. Our results suggest that non-pecuniary risk preferences revealed outside the scope of the firm have implications for project selection and various corporate policies.
TL;DR: Li et al. as mentioned in this paper identified profitability, industry leverage, asset growth, tangibility, firm size, state control, and the largest shareholding as reliable core factors explaining book leverage.
Abstract: Existing studies disagree over the basic determinants of capital structure in Chinese firms. We identify profitability, industry leverage, asset growth, tangibility, firm size, state control, and the largest shareholding as reliable core factors explaining book leverage. Compared with evidence from the United States and other countries, we identify three new core factors, and observe that the relative importance of four common core factors for Chinese firms is diverse. In particular, the state-control dummy is negatively associated with book leverage, contrary to findings in certain previous studies. Additional tests indicate that such a negative effect of state-control derives primarily from easier access to equity financing.
TL;DR: In this article, the authors revisited the well-established puzzle that leverage is negatively correlated with measures of profitability and found that at times when firms are at or close to their optimal level of leverage, the cross-sectional correlation between profitability and leverage is positive.
Abstract: We revisit the well-established puzzle that leverage is negatively correlated with measures of profitability. In contrast, we find that at times when firms are at or close to their optimal level of leverage, the cross-sectional correlation between profitability and leverage is positive. At other times, it is negative. These results are consistent with dynamic trade-off models in which infrequent capital structure rebalancing is optimal. The time series of market leverage and profitability in the quarters prior to rebalancing events match the patterns predicted by these models. Our results are not driven by investment layouts, market timing, payout, or mechanical mean reversion of leverage.
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TL;DR: The authors examined the impact of thin capitalization rules that limit the tax deductibility of interest on the capital structure of the foreign affiliates of US multinationals and found that thin capitalisation rules affect multinational firm capital structure in a significant way.
Abstract: This paper examines the impact of thin capitalization rules that limit the tax deductibility of interest on the capital structure of the foreign affiliates of US multinationals. We construct a new data set on thin capitalization rules in 54 countries for the period 1982-2004. Using confidential data on the internal and total leverage of foreign affiliates of US multinationals, we find that thin capitalization rules affect multinational firm capital structure in a significant way. Specifically, restrictions on an affiliate’s debt-to-assets ratio reduce this ratio on average by 1.9%, while restrictions on an affiliate’s borrowing from the parent-to-equity ratio reduce this ratio by 6.3%. Also, restrictions on borrowing from the parent reduce the affiliate’s debt to assets ratio by 0.8%, which shows that rules targeting internal leverage have an indirect effect on the overall indebtedness of affiliate firms. The impact of capitalization rules on affiliate leverage is higher if their application is automatic rather than discretionary. Furthermore, we show that thin capitalization regimes have aggregate firm effects: they reduce the firm’s aggregate interest expense bill but lower firm valuation. Overall, our results show than thin capitalization rules, which thus far have been understudied, have a substantial effect on the capital structure within multinational firms, with implications for the firm’s market valuation.
TL;DR: This article examined the role of private equity firms in the resolution of financial distress using a sample of 2,151 firms that borrow in the leveraged loan market between 1997 and 2010 and found that PE-backed firms are no more likely to default than other leveraged loans borrowers.
Abstract: We examine the role private equity (PE) firms play in the resolution of financial distress using a sample of 2,151 firms that borrow in the leveraged loan market between 1997 and 2010. Controlling for leverage, PE-backed firms are no more likely to default than other leveraged loan borrowers. When firms do default, PE-backed firms restructure more often out of court, restructure faster, and are more likely to remain an independent going concern following the restructuring. PE owners are also more likely to retain control of the firm following the restructuring. The propensity for PE owners to infuse capital as firms approach distress is positively related to measures of the success of the restructuring. Overall, our results show that PE sponsors resolve distress in portfolio firms relatively efficiently.
TL;DR: In this paper, the authors consider two effects of debt originating from agency theory, namely the takeover defense and the disciplinary effect of debt, on the speed of adjustment to the optimal capital structure and find that both overlevered and underlevered firms with weak governance adjust slowly toward their target debt levels.
Abstract: The effects of corporate governance on optimal capital structure choices have been well documented, though without offering empirical evidence about the impact of corporate governance quality on the adjustment speed toward an optimal capital structure. This study simultaneously considers two effects of debt originating from agency theory—the takeover defense and the disciplinary effects of debt—on the speed of adjustment to the optimal capital structure. Corporate governance has a distinct effect on the speed of capital structure adjustment: weak governance firms that are underlevered tend to adjust slowly to the optimal capital structure, because the costs of the disciplinary role of debt outweigh the benefits of using debt as a takeover defense tool. Although overlevered weak governance firms also adjust slowly, they do so because they are reluctant to decrease their leverage toward the target level to deter potential raiders, especially if they face a serious takeover threat. Therefore, this study finds that both overlevered and underlevered firms with weak governance adjust slowly toward their target debt levels, though with different motivations.
TL;DR: In this paper, the authors develop a dynamic asset pricing model in which monetary policy affects the risk premium component of the cost of capital, and analyze forward guidance, a "Greenspan put", and the yield curve.
Abstract: We develop a dynamic asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk-tolerant agents (banks) borrow from risk-averse agents (i.e., take deposits) to fund levered investments. Leverage exposes banks to funding risk, which they insure by holding liquidity buffers. By changing the nominal rate the central bank influences the liquidity premium, and hence the cost of taking leverage. Lower nominal rates make liquidity cheaper and raise leverage, resulting in lower risk premia and higher asset prices, volatility, investment, and growth. We analyze forward guidance, a “Greenspan put,” and the yield curve.
This article is protected by copyright. All rights reserved
TL;DR: In this article, the determinants of the contribution of international banks to both global and local systemic risk during prominent financial crises were analyzed, and it was shown that global systemic risk in particular is predominantly driven by characteristics of the regulatory regime.
Abstract: We analyze the determinants of the contribution of international banks to both global and local systemic risk during prominent financial crises. We find no empirical evidence supporting the hypotheses that bank size, leverage, non-interest income or the quality of the bank’s credit portfolio are persistent determinants of systemic risk across financial crises. In contrast, our results show that global systemic risk in particular is predominantly driven by characteristics of the regulatory regime. We also confirm, for the subprime crisis, the hypothesis that the banks’ contribution to moderately bad tail events in the past predicts the financial sector’s crash risk.
TL;DR: In this paper, a comprehensive set of data of all registered firms in Thailand to examine whether firm size affects the relation between leverage and operating performance during the global financial crisis of 2007-2009.
Abstract: We draw on a comprehensive set of data of all registered firms in Thailand to examine whether firm size affects the relation between leverage and operating performance during the global financial crisis of 2007-2009. From a data set of 496,430 firm-year observations of a sample of 170,013 firms, we find that the magnitude of the effect of leverage on operating performance is non-monotonic and conditional on firm size. While our panel regression results indicate that leverage has a negative effect on performance across firm size subsamples, our year-by-year cross-sectional regression results show that the effect of leverage on performance is positive for small firms and is negative for large firms. Our findings show that about 75% of Thai firms in our sample appear to have managed to get through the global financial crisis on the basis that they do not have to simultaneously deleverage and liquidate their assets.
TL;DR: Both stock returns and performance improve after the takeover attempt and are consistent with the argument that the control threat has important spillover effects for the other firms in the industry.
Abstract: This paper studies how industry peers respond when another firm in the industry is the subject of a hostile takeover attempt. The industry peers cut their capital spending, free cash flows, and cash holdings, and increase their leverage and payouts to shareholders. They also adopt more takeover defenses. The stock price reaction upon announcement of the takeover is positive and larger for peer firms with higher capital spending and higher free cash flows. Before the takeover attempt, the peer firms borrow less and invest more than predicted. Both stock returns and performance improve after the takeover attempt. These results are consistent with the argument that the control threat has important spillover effects for the other firms in the industry.
This paper was accepted by Wei Xiong, finance.
TL;DR: In this paper, the effect of political patronage on firms' capital structure was investigated in Malaysia, a country characterised by relationship-capitalism, and covers 1988 to 2009, and showed a significant difference in the capital structure of patronised firms relative to non-connected firms.
TL;DR: In this article, the authors investigated the relative importance of five factors upon the capital structure decisions of Romanian firms listed at the Bucharest Stock Exchange and operating in the construction sector of the industry.
Abstract: This paperwork investigates the relative importance of five factors upon the capital structure decisions of Romanian firms listed at the Bucharest Stock Exchange and operating in the construction sector of the industry. The analysis is based on panel data estimations on a sample of 20 companies, observed during three years (2009-2011). Traditional explanatory variables are adopted in the study, including profitability, company size, tangibility of assets, liquidity and asset turnover. By employing the ordinary least squares method and the fixed effects model, simple and multiple linear regressions are obtained. These are further selected and interpreted in order to determine the influence of the independent variables upon the leverage of a company. The results show that profitability and liquidity ratios are negatively affecting the total debt ratio of Romanian companies. The tangibility of assets is also having a negative impact on leverage, strengthening the findings of previous empirical studies which claim that this indicator moves in opposite direction with the debt ratio of companies located in developing countries. On the other hand, the size of a company and its asset turnover have a positive correlation with leverage. The explanatory variable which has the highest impact on the capital structure choices is profitability.