Local social environment and the speed of leverage adjustment

This study examines the impact of social capital on firms’ leverage adjustment speed. Using a comprehensive dataset of 83,374 firm-year observations for 744 US counties for 1990–2016, we find that both underleveraged and overleveraged firms located in US counties with higher levels of social capital incur slower leverage adjustment towards their optimal target capital structure. This finding is robust to alternative measures of leverage and social capital, different model specifications, controlling for county- and firm-level characteristics, and endogeneity. We further identify two mechanisms through which social capital affects leverage adjustments: monitoring (channel for underleveraged firms) and disciplinary (channel for overleveraged firms) mechanisms.     

Internal capital markets and the partial adjustment of leverage

Prior literature provides support both for the existence of target capital structures and internal capital markets (ICM). The issue of whether firms use internal capital markets to reduce deviations from target capital structures, however, has yet to be examined. We provide the first empirical evidence of a link between deviations from target leverage and ICM activity. Based on data that allow us to trace intra-group capital market transactions for property–casualty insurers, our findings provide the first joint evidence that affiliated insurance companies have target leverage ratios and that ICM activity is used to manage deviations from target leverage.     

Employment protection and leverage adjustment speed: Evidence from China

Stricter employment protection may affect capital structure adjustment speed in two ways. First, it may increase the cost of capital and decrease the leverage adjustment speed. Second, it increases financing needs and capital adjustment speed. Using China's 2008 Labor Contract Law as a natural experiment and the PSM-DID methodology, we find that the latter effect dominates the former. Specifically, stricter employment protection increases leverage adjustment speed, and this effect is more pronounced for non-state-owned firms and firms with larger leverage deviations. Furthermore, transmission channel tests show that employment protection increases firms’ substitution of labor with capital, driving up investment and financing needs. Finally, the increased leverage adjustment speed induced by enhanced employment protection is beneficial to firm performance.     

Foreign institutional ownership and the speed of leverage adjustment: International evidence

Employing a large sample of 7246 firms across 38 economies from 2000 to 2013, we show a positive relation between foreign institutional ownership (FIO) and firms' speed of leverage adjustment. This positive relation is concentrated for over-leveraged firms that need to decrease financial leverage to rebalance their capital structures. We validate our findings using a 2SLS regression and a DiD estimation to exploit the exogenous variations in FIO generated by the inclusion of MSCI membership and the passage of the JGTRRA. These results suggest that foreign institutional investors play an important monitoring role in mitigating agency conflicts between shareholders and managers. Overall, this paper lends support to the dynamic trade-off theory.     

What explains the value premium? The case of adjustment costs,operating leverage and financial leverage

This paper empirically examines and compares the different theoretical predictions on how adjustment costs, operating and financial leverage influence the value premium. Consistent with Ozdagli (2012), financial leverage plays a dominant role, supported by adjustment costs (which represent the degree of investment irreversibility). Specifically, the observed value premium is driven by the financial leverage differences between value and growth firms, partially neutralized by investment irreversibility. The relation between the value premium and investment irreversibility is contrary to the intuition in Zhang (2005) and Cooper (2006). Operating leverage does not significantly influence the value premium.     

State ownership and adjustment speed toward target leverage: Evidence from a transitional economy

Using a quantile regression approach and 5,374 Vietnamese firm-year observations from 2000 to 2016, this paper examines the effect of state ownership on the speed of adjustment SOA toward target leverage across various levels of capital structure. The findings consistently show that these effects on SOA vary depending on the leverage level. The relationship is negative for low-leveraged firms, positive for high-leveraged firms, but insignificant in the central area of leverage distribution. Moreover, the negative effects are greater than the positive effects.     

Choice over asset economies: Default risk and corporate leverage

This paper attempts to clarify the apparent conflict between the recent contribution of Stiglitz and Smith (S-S) and the established Modigliani-Miller (M-M) leverage theorem. The two approaches differ in their treatment of asset creation. Whereas M-M restrict their discussion to a given set of competitive asset markets, S-S consider the addition of an extra asset to the original systems.     

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.     

Competition in the presence of individual demand uncertainty

This article offers a tractable model of (oligopolistic) competition in differentiated product markets characterized by individual demand uncertainty. The main result shows that, in equilibrium, firms offer advance purchase discounts and that these discounts are larger than in the monopolistic benchmark. Competition reduces welfare by increasing the fraction of consumers who purchase in advance, that is, without (full) knowledge of their preferences.     

Systematic risk,the tradeoff of leverage and IPO first-day returns

In this paper, we investigate IPO first-day returns in French market. Our focus is to assess the relationship between equity risk, corporate leverage and IPO initial returns. Based on data of 254 French IPOs, traded on Euronext/Alternext markets over the period 2006 and 2016, we find that estimated beta and idiosyncratic volatility are strongly and negatively related to book and market net gearing ratios. We also find that the interaction terms between equity risk measures and corporate leverage ratios are inversely related to IPO first-day returns. In addition, we highlight that industry and macroeconomic environment variables are significant predictors of equity initial returns. Robustness check of our findings indicates less relevant results for corporate leverage when it is estimated as independent variable.

     

Asymmetric adjustment toward optimal capital structure: Evidence from a crisis

We employ dynamic threshold partial adjustment models to study the asymmetries in firms' adjustments toward their target leverage. Using a sample of US firms over the period 2002–2012, we document a negative impact of the Global Financial Crisis on the speed of leverage adjustment. In our subperiod analysis, we find moderate evidence of cross-sectional heterogeneity in this speed, which seems more pronounced pre-crisis and provides little support for the financial constraint view. Over the pre-crisis period, more constrained firms, such as those with high growth, with large investment, of small size, and with volatile earnings, adjust their capital structures more quickly than their less constrained counterparts. These firms rely heavily on external funds to offset large financing deficits, suggesting that their higher adjustment speeds may be driven by lower adjustment costs that are shared with the transaction costs of accessing external capital markets. During the crisis, the speed of adjustment varies with the deviation from target leverage: only firms with sufficiently large deviations attempt to revert to the target, albeit slowly. Overall, our results provide new evidence of both cross-sectional and time-varying asymmetries in capital structure adjustments, which is consistent with the trade-off theory.     

No one left behind: how social distance affects life-saving decision making

Extant research on social distance and decision-making under risk has mostly focused on how people reach different decisions for themselves than others under the same circumstances. This research adds to this literature by studying how the social distance between the decision-maker and people in danger influences risk preference in life-saving domain. We found that decision-makers tend to be more risk-seeking when the lives of close others are at stake than distant others regardless of whether the situation is framed in terms of loss or gain. However, the effect of social distance on risk preference was eliminated when it was the responsibility of the decision-makers rather than the chance to pick the potential victims to save. By analyzing the shape of value function, we provided preliminary evidence for the hypothesis that decision-makers engage in feeling-based evaluation when close others’ lives are at stake but calculation-based evaluation when distant others’ lives are at stake, which could account for the effect of social distance on risk preference documented in this research. A final experiment yielded direct evidence that evaluation mode mediates the relationship between social distance and risk preference.     

Informational leverage: the problem of noise traders

The literature suggests that security design can be used to manipulate the information content of securities prices [what is referred to as the “informational leverage effect” in Boot and Thakor (J Finance 48, 1349–1378, 1993)]. The informational leverage effect arises in this literature in a market microstructure environment in which noise trade is exogenous, which is a fairly standard assumption dating back to the framework developed in Grossman and Stiglitz (Am Econ Rev 70, 393–408, 1980). This assumption is relaxed in our paper, and we show that the informational effects described in the related literature become less clear cut when noise trading activity is endogenous. We find that the intensity and direction of these effects depends crucially on the parameters describing the modeling environment. The elegant point of the informational leverage literature is that these effects arise largely independently of such parameters, but with endogenous noise trading that is no longer true. This literature may, therefore, lead to too strong conclusions being drawn about the relationship between information revelation and security design. We are very grateful for the helpful comments made by an anonymous referee.     

Anomalies,risk adjustment and seasonality: Australian evidence

On the basis of raw return analysis, economically significant anomalies appear to exist in relation to the size, momentum, book-to-market and profitability of Australian firms. However, characteristic-sorted portfolios are shown to load in very particular ways on multiple risk factors. After adjusting for exposure to risk, convincing evidence only remains for the size premium. An analysis of seasonality shows that, rather than being consistent throughout the year, anomaly returns are concentrated in a handful of months. We provide and test preliminary explanations of the observed seasonality in these well-known anomalies.     

Family control and adjustment to the optimal level of cash holding

Given the predominance of family control in most European corporations, understanding how this type of ownership affects firms’ cash holding policy is important. The literature has yet to address this subject satisfactorily; therefore, we outline a way to model how family firms define their cash policy, specifically, the way in which they adjust their cash holding to an optimal level. We base our analysis on trade-off theory and the precautionary motive for holding cash. Our empirical results show that family firms adjust their cash holding level more aggressively than non-family firms, and, therefore, family firms are capable of achieving optimal cash holding faster and more efficiently than non-family firms. Further, we find that family firms have a heterogeneous cash policy; in particular, young family firms, financially constrained family firms, and family firms that operate in countries with strong investor protection adjust their cash holding more aggressively.     

Collateral affects return risk: evidence from the euro bond market

Covered bonds and senior bonds are prominent securities in the euro bond market. Senior bonds are unsecured, while covered bonds are secured—backed by collateral. Our results show that the presence of collateral reduces the total risk in individual bonds by more than 70%. Compared to diversified portfolios of senior bonds, diversified portfolios of covered bonds have a significantly lower level of systematic risk. However, the fraction of systematic risk to total risk is higher for covered bonds. By decomposing the variance of bond returns, we find that around 33% of the risk in senior bonds is systematic, versus 53% in covered bonds. Both types of bonds contain instrument-specific risk.

     

The Bologna process: how student mobility affects multi-cultural skills and educational quality

We analyze the two goals behind the European Bologna process of increasing student mobility: enabling graduates to develop multi-cultural skills and increasing the quality of universities. We isolate three effects: (1) a competition effect that raises quality, (2) a free-rider effect that lowers quality, and (3) a composition effect that influences the relative strengths of the two previous effects. The effects lead to a trade-off between the two goals. Full mobility may be optimal only when externalities are high. In this case, student mobility yields inefficiently high educational quality. For moderate externalities, partial mobility is optimal and yields an inefficiently low quality of education.      

The differential impact of leverage on the default risk of small and large firms

We analyse a sample of 6 million firm-year observations of large corporations and small and medium sized enterprises (SMEs) spanning 6 European countries from 2005 to 2015, to determine the impact of leverage and different sources of funding on default risk. We find that financial leverage has a greater impact on the probability of default of SMEs than of large corporations. The difference in default probability between the top and bottom leverage quartiles is 1.24% for large firms and 2.87% for SMEs. This difference may be explained by the greater exposure of SMEs to short-term debt and their consequently higher refinancing risk. Indeed, we find that SMEs that recover from the state of insolvency may have similar leverage to defaulted SMEs; however their liability structure is significantly altered towards long-term debt and away from short-term debt. Our findings have important implications not only for bank regulators and policy-makers but also for credit risk modelling.     

Changes in risk and the demand for saving

How does risk affect saving? Empirical work typically examines the effects of detectible differences in risk within the data. How these differences affect saving in theoretical models depends on the metric one uses for risk. For labor-income risk, second-degree increases in risk require prudence to induce increased saving demand. However, prudence is not necessary for first-degree risk increases and not sufficient for higher-degree risk increases. For increases in interest-rate risk, a precautionary effect and a substitution effect need to be compared. This paper provides necessary and sufficient conditions on preferences for an Nth-degree change in risk to increase saving.