‘Hot’ Debt Markets and Capital Structure

This paper examines the motives of debt issuance during hot‐debt market periods and its impact on capital structure over the period 1970–2006. We find that perceived capital market conditions as favourable, an indication of market timing, and adverse selection costs of equity (i.e., information asymmetry) are important frictions that lead certain firms to issue more debt in hot‐ than cold‐debt market periods. Using alternative hot‐debt market issuance measures and controlling for other effects, such as structural shifts in the debt market, industry, book‐to‐market, price‐to‐earnings, size, tax rates, debt market conditions and adjustment costs based on debt credit ratings, we find that firms with high adverse selection costs issue substantially more (less) debt when market conditions are perceived as hot (cold). Moreover, the results indicate that there is a persistent hot‐debt market effect on the capital structure of debt issuers; hot‐debt market issuing firms do not actively rebalance their leverage to stay within an optimal capital structure range.     

Financial integration and emerging markets capital structure

This paper investigates the impact of country-level financial integration on corporate financing choices in emerging economies. Examining 4477 public firms from 24 countries, we find that corporate leverage is positively related to credit market integration and negatively related to equity market integration. As integration proceeds to higher levels, high-growth firms seem to obtain more debt than low-growth firms; large firms seem to obtain more debt - especially long-term debt - and issue more equity than small firms. Also, there is evidence that firms are able to borrow more funds in countries with more efficient legal systems during integration process.     

DOES FINANCIAL FLEXIBILITY REDUCE INVESTMENT DISTORTIONS?

The average U.S. firm has less leverage than one would expect based on the trade‐off between tax shields and bankruptcy costs. We focus on firms’ financial flexibility and examine whether firms preserve debt capacity to reduce investment distortions in the future. We find that firms with high unused debt capacity invest more in future years than do firms with low unused debt capacity. Furthermore, firms that are reluctant to borrow in unconstrained periods are more likely to issue debt in periods in which access to capital markets is more constrained.     

Sources of Financing,Profitability and Productivity: First Evidence from Matched Firms

This paper contributes to the literature on capital structure and firm performance. Using firm‐level data covering over 11,000 firms from 47 countries over a recent period of 1997‐2007, we address the effect of different sources of financing on corporate performance, employing a matching process, which allows an adequate `like‐for‐like’ comparison between high and low level of financing by firms. Robust to different matching estimators, the main findings are consistent with the theories of capital structure, in that firms with high debt‐to‐equity ratio tend to have lower returns to shareholders (profitability) and lower internal efficiency (productivity). The results become more robust when we separate the firms into advanced and emerging country‐groups or countries with high/low levels of financial development. Given the lower level of leverage below 50% on average in emerging markets (or in countries with lower level of financial reforms), firms in these economies face lower risk of financial distress and thereby less adverse effect on firm profitability and productivity, relative to their counterparts in advanced economies. We also find that retained earnings and equity financing improve performance, while debt financing by firms particularly in the form of bank loans leads to lower performance, although not so in the case of debt raised through issuing bonds.     

Financing Decisions along a Firm’s Life‐cycle: Debt as a Commitment Device

We analyse the life‐cycle patterns of a firm’s financing decisions and their interaction with future growth and development decisions. We derive different financing sequences which we link to existing empirical research as well as derive new testable hypotheses regarding differences in firms’ financing decisions to project, firm, market and country characteristics. We provide a rationale for the importance of (external) start‐up debt financing as observed in recent empirical studies. Furthermore, we argue that equity financing at both development stages is more likely for closely‐held firms and in countries in which entrepreneurs face high stigmatisation costs.     

The Sarbanes‐Oxley Act and the Choice of Bond Market by Foreign Firms

This paper examines the economic impact of the Sarbanes‐Oxley Act (SOX) by studying foreign firms’ choice of whether to issue bonds in the U.S. public bond market or elsewhere before and after the law's enactment in 2002. After controlling for firm characteristics, bond features, home‐country attributes, and market conditions, I find that foreign firms rely less on the U.S. public bond market after SOX. Additionally, some determinants of choosing the U.S. public bond market have changed since the passage of SOX: firms listing equities on U.S. stock exchanges, adopting International Financial Reporting Standards (IFRS), and doing large bond issuances are more likely to choose this market in the post‐SOX period than in the pre‐SOX period. Overall, these results are consistent with a shift in the expected costs and benefits of choosing the U.S. public bond market following SOX. This paper provides the first evidence about how SOX influences debt financing decisions and alters capital flows across international bond markets.     

Investor protection and convertible debt design

An important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio, maturity date and call period. Following Lewis et al. [Lewis, M., Rogalski, R., Seward, J., 2003. Industry conditions, growth opportunities and market reactions to convertible debt financing decisions. Journal of Banking and Finance 27, 153–181], we employ a single measure that simultaneously considers all of these features: the expected probability (measured at issue date) that the convertible will be converted to equity at maturity. We find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity. The positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs. Specifically, in countries with stronger shareholder rights, firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion. Furthermore, we find that large non-management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights. In contrast, firms in countries with stronger creditor rights issue convertibles with lower probability of conversion. We also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights.     

How Persistent Is the Impact of Market Timing on Capital Structure?

This paper examines the capital structure implications of market timing. I isolate timing attempts in a single major financing event, the initial public offering, by identifying market timers as firms that go public in hot issue markets. I find that hot‐market IPO firms issue substantially more equity, and lower their leverage ratios by more, than cold‐market firms do. However, immediately after going public, hot‐market firms increase their leverage ratios by issuing more debt and less equity relative to cold‐market firms. At the end of the second year following the IPO, the impact of market timing on leverage completely vanishes.     

Global equity offerings and access to domestic loan market: U.S. evidence

This study examines whether and to what extend global equity offerings at the IPO stage may affect issuing firms' ability to borrow in the domestic debt market. Tracking bank loans taken by U.S. IPO firms in the domestic syndicated loan market, we observe that global equity offering firms experience more favorable loan price than that offered to their domestic counterparts. This finding holds for a set of robustness tests of endogeneity issues. We also find that, compared with their domestic counterparts, global equity offering firms are less likely to have financial distress, engage more in international diversification, and are more likely to wait a longer time to apply for syndicated loans.     

The Risk‐Return Relation in International Stock Markets

We investigate the risk‐return relation in international stock markets using realized variance constructed from MSCI (Morgan Stanley Capital International) daily stock price indices. In contrast with the capital asset pricing model, realized variance by itself provides negligible information about future excess stock market returns; however, we uncover a positive and significant risk‐return tradeoff in many countries after controlling for the (U.S.) consumption‐wealth ratio. U.S. realized variance is also significantly related to future international stock market returns; more importantly, it always subsumes the information content of its local counterparts. Our results indicate that stock market variance is an important determinant of the equity premium.     

Do Emerging Market Firms Follow Different Dividend Policies From U.S. Firms?

We find that emerging market firms exhibit dividend behavior similar to U.S. firms, in the sense that dividends are explained by profitability, debt, and the market‐to‐book ratio. However, empirical dividend policy equations are structurally different, indicating different sensitivities to these variables. Additionally, emerging market firms seem to be more affected by asset mix, which seems to be due to their greater reliance on bank debt. Overall, country factors are as important in dividend policies as previous studies find them to be in capital structure decisions.     

Equity cross-listings in the U.S. and the price of debt

Using a large panel from 46 countries over 20 years, we find that non-U.S. firms issue corporate bonds more frequently and at lower offering yields following an equity cross-listing on a U.S. exchange. Firms issue more bonds through public offerings instead of private placements and in foreign markets rather than at home, in both cases at significantly lower yields. Moreover, the debt-related benefits are concentrated among firms domiciled in countries with less private benefits of control, efficient debt enforcement, and developed bond markets, suggesting that equity cross-listings cannot completely offset the impact of weak home country institutions. The results support the notion that the monitoring, transparency, and visibility benefits brought about by equity cross-listings on U.S. exchanges are valuable to bond investors.     

Analyst Coverage and Financing Decisions

We provide evidence that analyst coverage affects security issuance. First, firms covered by fewer analysts are less likely to issue equity as opposed to debt. They issue equity less frequently, but when they do so, it is in larger amounts. Moreover, these firms depend more on favorable market conditions for their equity issuance decisions. Finally, debt ratios of less covered firms are more affected by Baker and Wurgler's (2002) “external finance‐weighted” average market‐to‐book ratio. These results are consistent with market timing behavior associated with information asymmetry, as well as behavior implied by dynamic adverse selection models of equity issuance.     

Bond market access and investment

Prior research has shown that differential access to debt markets significantly affects capital structure. In this paper, we examine the effect of access to debt markets on investment decisions by using debt ratings to indicate bond market access. We find that rated firms are more likely to undertake acquisitions than nonrated firms. This finding remains even after accounting for firm characteristics, for the probability of being rated, and in matched sample analysis as well as in subsamples based on leverage, firm size, age and information opacity. Rated firms also pay higher premiums for their targets and receive less favorable market reaction to their acquisition announcements relative to non-rated firms. However, the average announcement returns to rated acquirers are non-negative. Collectively, these findings suggest that the lack of debt market access has a real effect on the ability to make investments as well as on the quality of these investments by creating underinvestment, instead of simply constraining overinvestment.     

Firm growth type and capital structure persistence

We find that growth type (identified by a two-way sort on firm initial market-to-book ratio and asset tangibility) can parsimoniously predict significantly dispersed and persistently distinct future leverage ratios. Growth type is persistent; growth-type-sorted cross-sections of corporate fundamental variables (such as tangible versus intangible investment style) are also meaningfully persistent. As economic and market conditions improve, low growth type firms are keener to issue new debt than equity, whereas high growth type firms are least likely to issue debt and keenest to issue equity. These findings demonstrate that firms rationally invest and seek financing in a manner compatible with their growth types. Consistent with a generalized Myers–Majluf framework, growth type compatibility enables distinct growth types and hence specifications of market imperfection or informational environments to persist. Growth type is apparently a fundamental factor for capital structure persistence.     

Short‐Term Performance of U.S.‐Bound Chinese IPOs

Firms from emerging markets, including China, increasingly seek to raise capital outside of their home markets. We examine the short‐term performance of U.S.‐bound Chinese initial public offerings (IPOs) and find that these IPOs have significantly lower underpricing than a matched sample of U.S. counterparts. We also find that the magnitude of IPO underpricing for U.S.‐bound Chinese firms is positively related to revisions in offer price.     

Market Segmentation Effects in Corporate Credit Rating Changes: The Case of Emerging Markets

We examine stock market reactions to corporate credit rating changes in 26 emerging market countries included in the Morgan Stanley Capital International (MSCI) Emerging Market Index. We hypothesize and test the notion that emerging market firms in the American Depository Receipts (ADRs) markets are more likely to purchase ratings from the Big Two (Moody’s and S&P), and that they react more strongly to the announcements of corporate rating changes by Moody’s or S&P than to those of raters in local markets. We compare the effect of credit rating changes of the Big Two in two emerging stock markets: local markets (local currencies) and ADR markets (U.S. dollars). We find significant price reactions in the ADR markets, and insignificant reactions in local markets, and conclude that there is capital market segmentation in ADR markets for credit rating changes of emerging market firms. We find evidence that investors react more strongly in the ADR markets than local markets because they require higher costs of capital for firms cross-listed both in the ADR markets and local markets due to greater expected bankruptcy costs and foreign exchange risks of those firms. We also report that stock markets react significantly, not only to rating downgrades, but also to upgrades in the ADR markets.

Equity and debt issuance by firms violating GAAP

We examine security issuance in restated periods by firms that misreport financial statements and find that only a small per cent of such firms issues securities in the restated period. Investors are misled by mistakes made by firms issuing equity more so than other restating firms at the initial announcement of misreported earnings, but are not misled by mistakes made by debt‐issuing firms. Equity‐issuing firms that manage earnings to beat analyst expectations experience abnormally high returns in the restated period prior to security issuance. Firms that restated more reports and have higher pre‐mistake returns are more likely to issue equity. High leverage, firm size and number of restated periods are positively associated with the likelihood of debt issuance by restating firms.     

Cross-listing effect on information environment of foreign firms: ADR type and country characteristics

We examine sources of improvement in the information environment of foreign firms that cross-listed in the United States as American Depositary Receipts (ADRs) between 1995 and 2005. We analyze changes in the number and dispersion of analyst recommendations on foreign firms following their cross-listing. We find increases in analyst coverage intensity across all four types of ADR programs, especially among firms that were listed on organized exchanges (the listing effect), and those that adopted capital raising ADR programs (the financing effect). Our results suggest that the listing effect is more persistent than the financing effect. On the other hand, reductions in recommendation dispersion are observed mainly for firms that choose non-capital raising ADRs and those from emerging markets. Overall, improvements in information environment are more profound among foreign firms originating from countries with greater information asymmetry, namely, countries with weaker legal tradition and rule of law, and countries that are less familiar to U.S. investors.     

Political rights and the cost of debt

We examine the impact of country-level political rights on the cost of debt for corporate bonds issued by firms incorporated in 39 countries. Similar to, but separate from, the relation for creditor rights, greater political rights are associated with lower yield spreads. A one standard deviation increase in political rights is associated with an 18.6% decline in bond spreads. We find evidence that political and legal institutions are substitutes; marginal improvements in political rights produce greater reductions in the cost of debt for firms from countries with weaker creditor rights. We examine potential factors through which political rights may affect the cost of debt and find that greater freedom of the press provides an important channel for reducing bond risks. Moreover, debt of firms with cross-listed equity trades at a premium in U.S. markets, but this relation appears to be more consistent with improved visibility than with bonding effects.