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.     

Equity market timing and capital structure: International evidence

We investigate the equity market timing hypothesis of capital structure in major industrialized (G-7) countries. As claimed by its proponents, we find that leverage of firms is negatively related to the historical market-to-book ratio in all G-7 countries. However, this negative relationship cannot be attributed to equity market timing. We find no association between equity issues and market-to-book ratios at the time of equity financing decisions by Japanese firms. Firms in all G-7 countries, except Japan, undo the effect of equity issuance and the impact of equity market timing attempts on leverage is short lived. This is inconsistent with the prediction of the equity market timing hypothesis and more in line with dynamic trade-off model.     

Capital structure around the world: The roles of firm- and country-specific determinants

We analyze the importance of firm-specific and country-specific factors in the leverage choice of firms from 42 countries around the world. Our analysis yields two new results. First, we find that firm-specific determinants of leverage differ across countries, while prior studies implicitly assume equal impact of these determinants. Second, although we concur with the conventional direct impact of country-specific factors on the capital structure of firms, we show that there is an indirect impact because country-specific factors also influence the roles of firm-specific determinants of leverage.     

Gross capital flows: Dynamics and crises

This paper analyzes the behavior of international capital flows by foreign and domestic agents, dubbed gross capital flows, over the business cycle and during financial crises. We show that gross capital flows are very large and volatile, especially relative to net capital flows. When foreigners invest in a country, domestic agents invest abroad, and vice versa. Gross capital flows are also pro-cyclical. During expansions, foreigners invest more domestically and domestic agents invest more abroad. During crises, total gross flows collapse and there is a retrenchment in both inflows by foreigners and outflows by domestic agents. These patterns hold for different types of capital flows and crises. This evidence sheds light on the sources of fluctuations driving capital flows and helps discriminate among existing theories. Our findings seem consistent with crises affecting domestic and foreign agents asymmetrically, as would be the case under the presence of sovereign risk or asymmetric information.     

Profitability and capital structure: Evidence from import penetration

Firms experiencing increases in import competition significantly reduce their leverage ratios by issuing equity and selling assets to repay debt. Using import tariffs and foreign exchange rates as instrumental variables for import penetration, I show that these results are not manifestations of endogenous relations between import competition and leverage. The results are consistent with traditional trade-off models of capital structure that predict a positive relation between book leverage and expected future profitability. Further evidence suggests that import competition affects leverage through changes in the trade-off between the tax benefits of debt and the costs of financial distress.     

Capital structure choice and company taxation: A meta-study

This paper provides a quantitative review of the empirical literature on the tax impact on corporate debt financing. Synthesizing the evidence from 48 previous studies, we find that this impact is substantial. In particular, the tax rate proxy determines the outcome of primary analyses. Measures like the simulated marginal tax rate (Graham, 1996) avoid a downward bias in estimates for the debt response to tax. Moreover, econometric specifications and the set of control-variables affect tax effects. Accounting for misspecification biases by means of meta-regressions, we predict a marginal tax effect on the debt ratio of about 0.27.     

Effect of diversification on capital structure

Previous empirical financial studies have paid little attention to the role of diversification strategy on financial choices. This study analyses the financing strategies of multibusiness firms, suggesting the relevance of sorting the diversification phenomena into its related and unrelated components. The implications of our findings are important because they explain earlier contradictory results on capital‐structure determinants and offer an explanation of how the degree of product specialization/diversification and the direction of diversification (related or unrelated) translate into different corporate financial behaviours.     

Human capital,capital structure,and employee pay: An empirical analysis

We test the predictions of Titman (1984) and Berk, Stanton, and Zechner (2010) by examining the effect of leverage on labor costs. Leverage has a significantly positive impact on cash, equity-based, and total compensation of chief executive officers (CEOs). Compensation of new CEOs hired from outside the firm is positively related to prior-year firm leverage. In addition, leverage has a positive and significant impact on average employee pay. The incremental total labor expenses associated with an increase in leverage are large enough to offset the incremental tax benefits of debt. The empirical evidence supports the theoretical prediction that labor costs limit the use of debt.     

Deviation from the target capital structure and acquisition choices

This study finds that managers take deviations from their target capital structures into account when planning and structuring acquisitions. Specifically, firms that are overleveraged relative to their target debt ratios are less likely to make acquisitions and are less likely to use cash in their offers. Furthermore, they acquire smaller targets and pay lower premiums. Managers of overleveraged firms also actively rebalance their capital structures when they anticipate a high likelihood of making an acquisition. Finally, they pursue the most value-enhancing acquisitions. Collectively, these findings improve understanding of how firms choose their capital structures and shed light on the interdependence of capital structure and investment decisions in the presence of financial frictions.     

Determinants of the floating-to-fixed rate debt structure of firms

We analyze the effects of managerial incentive, firm characteristics and market timing on floating-to-fixed rate debt structure of firms. We find that chief financial officer's (CFO's), not chief executive officer's (CEO's), incentive has a strong influence on firm's debt structure. When CFOs have incentives to increase (decrease) firm risk, firms obtain volatility-increasing (-decreasing) debt structure. These effects are present only for CFOs who are not subject to high monitoring by board members, CEOs, or corporate control market. Our findings suggest that agency problems at the level of non-CEO executives could be an important driver of various corporate decisions.     

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.     

Ownership structure and tax-friendly dividends

The paper examines the existence of tax-based dividend clienteles using the novel environment of Australia, which has operated a full dividend imputation system since 1987. The analysis jointly focuses on the tax-based preferences of five categories of shareholders, including both domestic and foreign-domiciled shareholder classes. Incorporating the dividend franking percentage as a direct measure of the degree of tax benefit associated with dividends, strong evidence supporting the existence of tax-based dividend clienteles is present for both domestic and foreign shareholder categories. This includes domestic corporate blockholders and company directors, and local institutional investors following tax reforms in 2000, and foreign institutional shareholders which, alternatively, demand lower dividends and dividend franking. These findings persist after considering the effect of share repurchases, and under various model specifications controlling for unobserved firm heterogeneity and potential endogeneity between ownership structure and dividend payout policy.     

Long term changes in voting power and control structure following the unification of dual class shares

We study the effects of a regulatory change that induced the unification of most dual class shares in Israel in the 1990s. Specifically, we follow the evolution of ownership structure in a sample of 80 companies that unified their dual-class shares, and compare it with a control sample of firms that maintained their dual share structure at least until 2000. Our main findings are as follows. First, controlling shareholders offset the dilution of voting rights they incurred upon unification by: 1) increasing their holdings prior to the unification (ex-ante preparation), and 2) by buying shares afterwards; by the end of the sample period their voting power was only marginally lower than in the control sample. This offsetting result suggests that marginal voting rights may be important to controlling shareholders even beyond the 50% threshold. Second, share unifications were not associated with much change in the identity of controlling shareholders. Third, the proportion of firms affiliated with pyramidal business groups in the sample of unifying firms was lower than in the population of listed firms as a whole and not different from that in the control sample, suggesting that pyramidal ownership structures did not replace dual class shares. Finally, unifying firms did not exhibit a substantial improvement in their performance and valuation in comparison with the control sample.     

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.     

Why does capital structure choice vary with macroeconomic conditions?

We develop a computable general equilibrium model explaining financing over the business cycle. To avert agency conflicts, managers must hold a high percentage of their firm's equity. During contractions, firms substitute debt for equity in order to maintain managerial equity shares. During expansions, risk-sharing improves, with increases in managerial wealth facilitating substitution of equity for debt. In calibrated simulations, (counter) cyclical variation in leverage is only exhibited by less constrained firms. All firms exhibit financial accelerator effects. However, the effect is decreasing in financial flexibility. The model's predictions regarding financing and investment are consistent with empirical evidence.     

The effect of state laws on capital structure

US manufacturing firms incorporated in states with stronger payout restrictions use less debt, while antitakeover statutes do not significantly reduce long-run leverage. Correcting for the endogenously determined choice of where to incorporate, we find that firms sort themselves according to state laws and capital structure needs. After accounting for self-selection, state antitakeover laws are positively associated with debt as a fraction of market value, possibly due to lower market values for these firms. Payout restrictions appear to reduce leverage for firms that have not reincorporated outside their home states. These constraints explain part of the negative relation between profitability and leverage.     

Collateral and capital structure

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.     

A revisit to the dependence structure between the stock and foreign exchange markets: A dependence-switching copula approach

This paper develops a dependence-switching copula model to examine dependence and tail dependence for four different market statuses, namely, rising-stocks/appreciating-currency, falling-stocks/depreciating-currency, rising-stocks/depreciating-currency, and falling-stocks/appreciating-currency. The model is then applied to daily stock returns and exchange rate changes for six major industrial countries over the 1990–2010 period. The dependence and tail dependence among the above four market statuses are asymmetric for most countries in the negative correlation regime, but symmetric in the positive correlation regime. These results enrich the findings in the existing literature and suggest that analyzing cross-market linkages within a time-invariant copula framework may not be appropriate.     

Cross-border trading as a mechanism for implicit capital flight: ADRs and the Argentine crisis

Cross-listed shares may confound government efforts to control capital outflows by providing a legal means through which investors can transfer their wealth outside the country. We study the recent experience of investors who while subject to capital controls, were able to purchase cross-listed shares using local currency, convert them into dollar-denominated shares, re-sell them abroad, and deposit the dollar proceeds in foreign bank accounts. Capital controls drive a wedge between the price of local shares and their corresponding cross-listed shares. This wedge provides an implicit devaluation forecast and the market's valuation of capital control circumvention.