How Entrenchment, Incentives and Governance Influence REIT Capital Structure

Although recent literature has confirmed the importance of viewing a firm??s capital structure choices of leverage and debt maturity as jointly determined, to date there has been little analysis of the importance of traditional governance variables on a firm??s capital structure decisions using a simultaneous equations approach. We examine the influence of managerial incentives, traditional managerial monitoring mechanisms and managerial entrenchment on the capital structure of Real Estate Investment Trusts (REITs). Using panel data, we estimate a system of simultaneous equations for leverage and maturity and find that firms with entrenched CEOs use less leverage and shorter maturity debt. This is consistent with the expectation that managers acting in their own self interest will choose lower leverage to reduce liquidity risk and use short maturity debt to preserve their ability to enhance their compensation and reputations by empire building. We also find evidence that traditional alignment mechanisms such as equity and option ownership have an offsetting effect; and that firms where the founder serves as CEO choose higher leverage and longer maturity debt. The results also provide evidence that leverage and maturity are substitutes, firms with high profitability and growth opportunities use less leverage and firms with liquid assets use more leverage and longer maturity debt.     

CEO's Inside Debt and Dynamics of Capital Structure

Debt‐type compensation (inside debt) exacerbates the divergence in risk preferences between the chief executive officer (CEO) and shareholders and, in turn, affects capital structure decisions. An excessively risk‐averse CEO tends to use less debt than the shareholders desire, reduce debt quickly when the firm is overlevered, but is reluctant to increase debt when the firm is underlevered. We find that higher CEO's inside debt ratio (i.e., inside debt as a percentage of total incentive compensation) is associated with lower firm leverage and faster (slower) leverage adjustments toward the shareholders’ desired level for overlevered (underlevered) firms. The CEO's inside debt ratio most conducive to capital structure rebalancing is around 10% of the firm's market debt ratio.     

Overconfidence and optimism: The effect of national culture on capital structure

This study assesses whether variations in capital structure across countries can be explained by cultural traits. We analyze capital structure choices of firms in 42 countries and provide evidence that these decisions are affected by the degree of individualism of the country where the firm is located. We assert that managers in countries with high level of individualism exhibit strong optimism and overconfidence which cause an upward bias in perception of supportable debt ratios. Our results are robust to controlling for other firm- and country specific determinants of capital structure choices and to using alternative model specifications and estimation techniques.     

Capital structure,equity ownership and firm performance

This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.     

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.     

Capital Structure and Political Risk in Asia-Pacific Real Estate Markets

This study investigates the determinants of capital structure decisions by real estate firms, with a specific focus on the impact of political risk on leverage. Using a sample of Asia-Pacific REITs and listed property trusts, we find those firms with properties located in countries characterized by relatively high degrees of political risk, such as political instability, and/or greater uncertainty in the ability to repatriate and monetize profits from international investment activities, employ less debt than their counterparts operating in more politically stable environments. This core finding remains robust to alternative sample selection criteria including the division of the sample into high versus low market-to-book value firms, and also holds within the subset of organizations that are active in raising additional capital in the secondary markets.     

Investment,leverage and political risk: Evidence from project-level FDI

Does capital structure influence firms' FDI capital expenditure decisions into countries with varying degrees of political risk? We explore this question using a novel dataset that matches 10,000 unique outward foreign direct investment (OFDI) projects with 1135 distinct U.S. firms over the period 2003–2014. We find that capital expenditures allocated to FDI projects are significantly lower for highly leveraged firms, in particular for firms with low growth opportunities. Firms also commit lower capital amounts to investments located in countries characterized by higher political risk. Furthermore, leverage and political risk interact with one another in determining the financial commitment of the FDI, with leverage exerting a significantly stronger negative effect on capital expenditures in countries where political risk is elevated. Our findings are consistent with the monitoring role of debt in curbing exposure to political risk in multinational firms' foreign operations, and corroborate the disciplinary role of leverage on firms' investment decisions.     

Investor sentiment and firm capital structure

We provide novel evidence of the role of investor sentiment in determining firms' capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms' debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is slower in low sentiment periods, indicating higher costs of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms' financing decisions and stock returns.     

Capital Structure, CEO Dominance, and Corporate Performance

We use agency theory to investigate the influence of CEO dominance on variation in capital structure. Due to agency conflicts, managers may not always adopt leverage choices that maximize shareholders’ value. Consistent with the prediction of agency theory, the evidence reveals that, when the CEO plays a more dominant role among top executives, the firm adopts significantly lower leverage, probably to evade the disciplinary mechanisms associated with debt financing. Our results are important as they demonstrate that CEO power matters to critical corporate outcomes such as capital structure decisions. In addition, we find that the impact of changes in capital structure on firm performance is more negative for firms with more powerful CEOs. Overall, the results are in agreement with prior literature, suggesting that strong CEO dominance appears to exacerbate agency costs and is thus detrimental to firm value.     

Shareholders' control rights,family ownership and the firm's leverage decisions

We investigate the association between controlling shareholders' ownership (CS_Own) and firms' leverage decisions in the Singaporean context. We examine whether the impact of ownership concentration on leverage differs across excess and lower control. We report that shareholders with excess control prefer leverage financing for an optimal capital structure and focus on value maximisation rather using leverage as a tool of minority shareholders' expropriation. Our analysis shows that firms capital structure significantly influences by the coalition of shareholders particularly decisions about leverage financing in addition to the firms' specific characteristics and institutional arrangements. Our empirical evidence shows that controlling shareholders with a lower fraction of equity are more concerned about limited holding thus prefer leverage over equity financing to inflate their equity stake to protect them from the potential takeovers and mergers. We report that capital structure decisions in Singapore are linked with the trade-off between the controlling shareholders' target of mitigating firm risk and their non-dilution entrenchment needs. Further, we found an inverted U-shaped association between control ownership and leverage financing. In terms of moderating effect of family-controlled ownership, our findings exhibit that leverage financing is less pronounced for family firms in Singapore due to the under-diversified investment portfolio.     

Does the Source of Capital Affect Capital Structure?

Prior work on leverage implicitly assumes capital availabilitydepends solely on firm characteristics. However, market frictionsthat make capital structure relevant may also be associatedwith a firm’s source of capital. Examining this intuition,we find firms that have access to the public bond markets, asmeasured by having a debt rating, have significantly more leverage.Although firms with a rating are fundamentally different, thesedifferences do not explain our findings. Even after controllingfor firm characteristics that determine observed capital structure,and instrumenting for the possible endogeneity of having a rating,firms with access have 35% more debt.     

Agency costs,taxes and debt: The UK evidence

This paper provides an empirical examination of the impact of the corporation tax and agency costs on firms' capital structure decisions. Our evidence suggests that the agency costs are the main determinants of corporate borrowing. Consistent with the agency theory, we find that firms that have fewer growth options have more debt in their capital structure. Moreover, our results show that debt mitigates the free cash flow problem and that firms that are more likely to be diversified and less prone to bankruptcy are highly geared. the negative effect of insider shareholding on leverage disappears, however; when all the agency mechanisms are accounted for. In addition, we find that, in the long run, companies that are tax exhausted exhibit significantly lower debt ratios than tax-paying firms. However, in the short run, firms' capital structure decisions are not affected by taxation.     

Managerial entrenchment, equity payout and capital structure

I develop a contingent claims model to examine the impacts of managerial entrenchment on capital structure and security valuation. The analysis shows that managers’ self-interested leverage choices deviate significantly from the optimal leverages that maximize firm values, partially explaining the suboptimal leverage ratios observed empirically (Graham, 2000). Both the extent and sensitivity of the deviations are affected by firm characteristics, debt features and default solutions. The shareholder-manager conflicts over risk level and cash payout vary dynamically with a firm’s financial health. Managerial entrenchment does not mitigate the agency problems of debt since managers’ discretionary decisions on milking properties or asset substitution could be driven by incentives to increase their own utility.     

Group Affiliation and Ownership Concentration as Determinants of Capital Structure Decisions: Contextualizing the Facts for an Emerging Economy

This study considers the firm’s affiliation with business groups and the ownership structure as determinants of leverage decisions in Chilean firms. The major findings show that group-affiliated firms take advantage of internal capital markets and transactions with related parties (e.g., low transference price or loans at competitive interest rates) that reduces the demand for external debt. Majority shareholders in affiliated firms behave as controllers of managers, on the one hand, and avoid the supervisory role of debt, on the other hand. In stand-alone firms, supervision led by majority shareholders is complemented by the monitoring role of debt through higher levels of leverage. We conclude that further developments in capital structure theories adjusted to the particularities of the different institutional contexts are needed.     

On the determinants of SME capital structure in Central and Eastern Europe: A dynamic panel analysis

The purpose of this paper is to test how firm characteristics affect SMEs’ capital structure using a unique dataset of micro, small, and medium-sized firms (SMEs) in Central and Eastern Europe (CEE). We carry 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. By using the cash flow as an explanatory variable, we test some of the predictions of the pecking order theory. According to this theory, firms with more available internal funds should use less external funding. We do find strong evidence in favor of the pecking order theory, given that there is a negative and significant correlation between profitability and leverage. When we control for other firm specific characteristics such as future growth opportunities, liquidity, sales growth, size and assets structure, the cash flow is found to be a strong determinant of firm leverage. We also argue that the determinants of firm leverage may be considerably different depending on firms’ size and age. The empirical results show that cash flow coefficient remains negative and statistically significant only for medium-sized firms, thus suggesting that larger firms with sufficient internal funds use less external funding than comparable smaller firms. We obtain similar results when we estimate the model by firm age; older firms demonstrate similar behavior as larger firms.     

Leverage,output effects,and the M-M theorems

This paper uses the Capital Asset Pricing Model to link the financial policy of the firm with the firm's real decisions including output, input mix, and investment. Whereas the M-M leverage theorems were derived for a given set of real decisions, this paper considers the impact of leverage on firm optimization when interest is tax-deductible. In general, leverage impacts upon factor proportions, capital stock, and output decisions. In the final proposition, the author demonstrates that the ‘cost of capital’ need not decline with leverage even in perfect capital markets and with default-free debt.     

Do Credit Spreads Reflect Stationary Leverage Ratios?

Most structural models of default preclude the firm from altering its capital structure. In practice, firms adjust outstanding debt levels in response to changes in firm value, thus generating mean-reverting leverage ratios. We propose a structural model of default with stochastic interest rates that captures this mean reversion. Our model generates credit spreads that are larger for low-leverage firms, and less sensitive to changes in firm value, both of which are more consistent with empirical findings than predictions of extant models. Further, the term structure of credit spreads can be upward sloping for speculative-grade debt, consistent with recent empirical findings.     

Overconfidence and Early‐Life Experiences: The Effect of Managerial Traits on Corporate Financial Policies

We show that measurable managerial characteristics have significant explanatory power for corporate financing decisions. First, managers who believe that their firm is undervalued view external financing as overpriced, especially equity financing. Such overconfident managers use less external finance and, conditional on accessing external capital, issue less equity than their peers. Second, CEOs who grew up during the Great Depression are averse to debt and lean excessively on internal finance. Third, CEOs with military experience pursue more aggressive policies, including heightened leverage. Complementary measures of CEO traits based on press portrayals confirm the results.     

Are the benefits of debt declining? The decreasing propensity of firms to be adequately levered

We observe a persistent increase in the percentage of firms with little or no debt in their capital structure over the last three decades. The fraction of firms with less than five percent debt in their capital structure increases from 14.01 percent in 1977 to 34.42 percent in 2010 while the percentage of all-equity firms increases 200 percent over the same period. We find that even after controlling for firm- and industry-specific variables that are relevant to capital structure policy, there is a deficiency in firms' propensity to be levered. Additionally, the deficiency is increasing over time and by 2010 the percent of firms that are nearly all-equity is twice the predicted level. Our findings are robust to different methodologies, specifications, and time periods. Overall, these results suggest that the well-documented benefits of leverage are less valuable over the sample period and that the determinants of firms' capital structure decisions have evolved since the 1970s.     

Debt enforcement,financial leverage,and product failures: Evidence from China and the United States

Building on capital structure and product market interactions, and the role of debt enforcement in leveraged firms' investments, we examine whether cross-country debt enforcement can produce different associations between financial leverage and product failures. Results show that different debt enforcement systems can generate opposite leverage effects. In countries with weak/nearly ineffective debt enforcement, financial leverage shows an incentive investment effect due to low default costs, and thus highly leveraged firms tend to invest more and are less likely to have product failures. Conversely, in countries with strict/effective debt enforcement, distressed companies tend to have an underinvestment effect and more product failures.