International income risk-sharing and the global financial crisis of 2008–2009

We examine the impact of the global financial crisis on the degree of international income and consumption risk-sharing among industrial economies using returns on cross-border portfolio holdings (e.g., debt, equity, FDI). We split the returns from the net foreign holdings as receipts (inflows) and payments (outflows) to investigate which of the two sides exhibited the greater resilience for income risk-sharing during the recent crisis. First, we find that debt delivered better risk-sharing than equity, mainly reflecting the deficit deterioration in EMU countries during the post-crisis period. FDI, by contrast, did not correspond to noticeable risk diversification. Second, separating output shocks into positive and negative components reveals that debt holding receipts (equity liability payments) performed better under negative (positive) realizations of the shock variable. Third, the unwinding of capital flows resulted in a sharp fall in income dis-smoothing via the debt liability channel in the new EU countries.     

Yield spreads,agency costs and the corporate bond call feature

This paper theoretically compares yields and optimal default policies for callable and non-callable corporate debt. It shows that, contrary to the conventional wisdom, it is possible for the yield spread (callable minus non-callable) to be negative. It also identifies the key determinants of the yield spread. Next, it shows that the optimal default trigger for non-callable debt is higher than the trigger for callable debt, resulting in additional default-related costs. Thus, the use of non-callable debt gives rise to an indirect agency cost of early default, which is the difference in total firm value with callable and non-callable debt. This agency cost provides a rationale for the existence of callable debt. By examining the determinants of the magnitude of this agency cost, the conditions that make callable debt more attractive (to the issuing firm) relative to non-callable debt are identified. This allows certain predictions to be made regarding the likelihood of a call feature in a corporate bond. The model's implications are supported by existing empirical studies.     

Concentrated Ownership, No Dividend Payout Requirement and Capital Structure of REITs: Evidence from Turkey

This paper studies empirically the capital structure of Turkish REITs as they offer unique and so far untested angles. They do not have to pay out dividends, yet enjoy the exemption from paying corporate taxes since their legal foundation in 1998. Several financial meltdowns occurred in the last three decades, keeping investors with a doubt about Turkey??s financial and political stability. The last meltdown in 2001 is part of the sample period. Findings show that Turkish REITs employ little long-term debt in their capital structure. The legal requirement that a leader entrepreneur be present with a minimum equity position of 25% introduces the agency problem between the majority and minority owners. The leader entrepreneurs, as non-taxable institutional investors, appear to dictate Turkish REITs?? dividend and debt policies and deplete REITs?? dividends, causing them to go to the long-term debt market. The financial meltdown of 2001 exerts negative short-term and positive long-term influence on the debt ratios while inflation??s effect is negative. Firm size, REITs?? engagement in development and stock market development influence debt ratios positively; tangibility and a few firm, ownership, and country-specific determinants appear to have either mixed or no influence on Turkish REITs?? debt policies.     

Culture and capital structure: What else to the puzzle?

This paper investigates four of Hofstede's cultural dimensions –individualism, masculinity, uncertainty avoidance, and long-term orientation– influence on firms' choices of short-term and long-term capital structures. Cultures influence on corporate risk-taking may drive their debt-to-equity mix based on the higher of their equity book or market value. We empirically test culture influence with a sample of 5968 firms from five industry sectors, across 33 countries, over 2009–2017. We find firms national culture influencing their choices of short-term and long-term debt to book and market value of equity. The influence is more significant on the short-term than the long-term capital structures. Furthermore, it is more significant on the short-term debt to market value of equity and on the long-term debt to book value of equity. Our robustness checks at the firm-level, country-level and sample-level confirm and reinforce our main results. These findings would provide financial analysts, investors, and creditors an in-depth understanding when comparing international firms' capital structures.     

Debt,hedging and human capital

This paper provides a theory of debt and hedging based on human capital. We distinguish human capital from physical capital in two ways: (1) human capital is inalienable and can exercise a one-sided option to leave the firm and (2) human capital is not perfectly replaceable. We show that a firm may reach the first best solution while issuing debt or equity to outsiders provided that either the insiders receive a senior claim or that the firm hedges. We then show that given asymmetric information concerning costs the only viable solution has the firm issuing debt to outsiders and hedging.     

Callable or convertible debt? The role of debt overhang and covenants

We analyze what role debt overhang and covenants have in a manager’s choice between issuing callable or convertible debt when a firm needs to issue a substantial amount of debt. Callable bonds provide a higher coupon in exchange for a repurchase option. Convertible bonds offer bondholders the option to exchange debt to equity. Using a dynamic capital structure model with investment choice, we find that callable debt implies a larger debt overhang friction, and for highly leveraged firms convertible debt is preferred. Moreover, if outstanding bonds have net-worth covenants attached, callable bonds are more likely to be issued. Our empirical findings support the theory.     

Optimization of a firm's capital structure: A quantitative approach based on a probabilistic prognosis of risk and time of bankruptcy

This article develops a new probabilistic approach to the problem of optimization of a firm's capital structure. The main idea of the approach is straightforward. As a possible firm's bankruptcy is the principal factor restricting the amount of borrowed capital, we assess the probabilities of bankruptcy at various time horizons in the future dependent on the proportion of debt capital and other indices of a firm's current financial position and then calculate how these probabilities influence the firm's value.We identify a set of factors determining conditions of existence and the value of the optimal debt/equity ratio. These include the characteristics of a firm's debt (proportion of short-term component of the debt, cost of service, and maturity horizons of long-term component), characteristics of a firm's ability to pay the debt, and some macroeconomic factors.We represent dependencies of optimal debt/equity ratio and gains in a firm's value on the main influencing factors.The approach is based on real data of real firms and does not use superfluously formalized models. We believe it can be used in practical capital structure decisions although specific calculations must be fulfilled for each firm that needs such decision.     

The fluctuating maturities of convertible bonds

The maturities of newly issued convertible bonds vary substantially over time. Firm-specific determinants of maturity from the straight debt literature are relevant for convertible bonds. However, the growth of the convertible arbitrage industry and the role of convertible arbitrage hedge funds have changed the importance of firm characteristics in the convertible bond market. Recently issued convertible bonds come with particularly short maturities that serve as substitutes for call provisions. This substitution implies that backdoor-equity and sequential-financing rationales for issuing callable convertible bonds are also applicable for non-callable convertibles with shorter maturities.     

Financial factors and firm growth: evidence from financial data on Taiwanese firms

We investigate the possible predictability of firm growth in Taiwan using cross-sectional data of financial factors for the years 1997 and 2003 via principal component analysis. Our results reveal that the 18 financial variables (sales growth rate, total assets, total sales, return on assets, return on equity, gross margin, operating cost minus depreciation divided by sales plus other trading income, acid test ratio, debt–equity ratio, time interest earned, average receivables per average daily sales, inventory, average payables per average daily sales, working capital, working capital as a fraction of total assets, long-term liabilities as a fraction of total assets, and sales as a fraction of net worth of the firm) that we employ bunch together into five different financial ratios for the years 1997 and 2003 that are stable between these years. These financial factors are short-term liquidity, return on investment, long-term liquidity, firm size and capital turnover. Regressing these ratio groups (extracted principal components) on firm growth, we find return on investment in the year 1997 was positively and significantly related to firm growth, while long-term solvency was negatively related to firm growth. In addition, smaller firms tended to grow faster. By 2003, larger firms grew faster than smaller ones and short-term liquidity was positively and significantly related to firm growth, while return on investment was no longer a significant determining factor. Our findings suggest that firms that finance internally or do not rely too heavily on indebtedness may end up growing slower during boom periods but they are the ones that survive and outperform after the bust.     

The disciplinary role of debt and equity contracts: Theory and tests

We study how equity and debt contracts commit investors to discipline managers. Our model shows that the optimal allocation of debt, equity, and control rights depends on which disciplinary action is more efficient. When the efficient action is managerial replacement, then control rights should be allocated to equity holders, and capital structure should consist of equity and long-term debt. When the efficient action is liquidation, then control rights can be allocated to the manager, and capital structure should consist of equity and short-term debt. We find empirical support to the model's predictions in a sample of leveraged buyout transactions.     

To be or not to be all-equity for firms that eliminate long-term debt

Despite the advantages of debt, a significant number of firms that have an established leverage policy deliberately become all-equity. These firms eliminate a substantial amount of long-term debt as the average firm’s leverage ratio is approximately 30 percent at the year-end prior to debt elimination. Firm-level “shocks” such as CEO turnover and changes in credit ratings cannot explain the dramatic recapitalization decision. Consistent with the tradeoff theory, firms that eliminate debt have lower benefits (less tax shield benefits, agency costs) and higher costs (probability of financial distress, access to capital markets, etc.) of leverage in the three prior years compared to a matched sample. We also find that the factors influencing the decision to eliminate all debt is different from those to significantly reduce leverage or to have very low debt levels. Firms primarily finance the approximately $70 million of average long-term debt eliminated using proceeds from sales of relatively unproductive assets and from equity issues. Interestingly, over half of these firms issue significant amount of new debt within three years of becoming all-equity. Firms with lower liquidity and non-debt tax shields, higher potential overinvestment agency costs, and those that issue equity at the debt elimination year are more likely to relever quickly.     

On the suboptimality of single-factor exercise strategies for Bermudan swaptions

This paper examines the interaction between momentum in the returns of equities and corporate bonds. We find that investment grade corporate bonds do not exhibit momentum at the three- to 12-month horizons. Instead, the evidence suggests that they exhibit reversals. However, significant evidence exists of a momentum spillover from equities to investment grade corporate bonds of the same firm. Firms earning high (low) equity returns over the previous year earn high (low) bond returns the following year. The spillover results are stronger among firms with lower-grade debt and higher equity trading volume, seem robust to various risk and liquidity controls, and hold even after controlling for past earnings surprises. In examining the source of the spillover, we find that the bond ratings of firms with positive (negative) equity momentum continue to improve (deteriorate) in the future, suggesting underreaction to the information in past equity prices about changing default risk is a likely source of the spillover effect. Overall, our results suggest that both equity and debt underreact to firm fundamentals, but past equity returns is a better proxy of firm fundamentals than past bond returns.     

A Theory of Capital Structure Relevance under Imperfect Information

Firms raise debt and equity capital to finance a positive net present value project in perfectly competitive capital markets; firm insiders know the function generating the random firm cash flow but potential capital suppliers do not. Taking into account the incentives of insiders to misrepresent their firm type, capital suppliers attempt to design financing mixes of debt and equity that eliminate the adverse incentives of insiders and correctly price securities. Necessary conditions for a costless separating equilibrium are developed to show that the amount of debt used by a firm is monotonically related to its unobservable true value.     

Corporate Debt Value,Bond Covenants,and Optimal Capital Structure

This article examines corporate debt values and capital structure in a unified analytical framework. It derives closed-form results for the value of long-term risky debt and yield spreads, and for optimal capital structure, when firm asset value follows a diffusion process with constant volatility. Debt values and optimal leverage are explicitly linked to firm risk, taxes, bankruptcy costs, risk-free interest rates, payout rates, and bond covenants. The results elucidate the different behavior of junk bonds versus investment-grade bonds, and aspects of asset substitution, debt repurchase, and debt renegotiation.     

Debt financing in private and public firms

Using administrative confidential data on the universe of Canadian corporate firms, we compare debt financing choices of private and public firms. Private firms have higher leverage ratios, which are entirely driven by private firms’ stronger reliance on short-term debt. Further, private firms rely more of leverage during economic expansions, while public firms rely on equity financing. Specifically, private firms manage to increase their long-term debt during expansions, while short-term debt is used during downturns. Our findings have implications for a better understanding of the role of asymmetric information in private firms’ capital structure decisions.     

Debt Management under Corporate and Personal Taxation

The presence of long-term debt in a corporation's capital structure is shown to give rise to a valuable tax-timing option that can be exercised by the firm on behalf of its shareholders. This option, which is not available if the firm is fully equity financed, implies that leverage will have a positive tax effect on total firm value even if there is no such effect associated with the tax deductibility of the coupon interest payments on debt. The more volatile interest rates and bond prices are, the more valuable the tax-timing option and the larger the favorable impact of debt on shareholder wealth.     

Optimal capital structures for private firms

This article shows how to construct an optimal capital structure for a private firm. Since the agents who supply the firm’s capital are risk averse, they diversify by holding both debt and equity. This can mitigate, or even eliminate, the classical risk shifting problem. There is a wealth effect since the optimal capital structure, which can involve multiple types of debt, depends on the amount of wealth that each agent contributes to the firm. However, it is shown that the agents’ equity holdings do not depend on the contributed amounts of wealth. Thus the model can produce a wedge between ownership rights and equity cashflow rights. These features are illustrated in a firm with three agents.     

SOME NEW EVIDENCE ON WHY COMPANIES USE CONVERTIBLE BONDS

The popular argument for convertibles holds that they provide issuers with "cheap" debt and allow them to sell equity at a premium over current value. Objecting to the "free lunch" implied by such an argument, financial economists have offered other explanations that show how the combination of debt and equity built into convertibles can serve to reduce information and agency costs faced by companies and their investors.
In this article, the authors use the results of their recent study to reconcile the two positions. Following Jeremy Stein's view of convertibles as "backdoor equity," the authors argue that convertible bond financing is an attractive alternative for companies that have large growth potential but find both conventional debt and equity financing very costly. Such companies are often deterred from funding their capital investments with straight public bonds by their high risk, relatively short track records, and high expected costs of financial distress. At the same time, the information "asymmetry" between management and outside investors can make equity very expensive in such cases. In layman's terms, management may feel that the company's share price does not accurately reflect its growth prospects, or be concerned that the mere announcement of a new equity offering will cause the share price to fall sharply.
To the extent the stock market is persuaded that management's choice of convertibles is based on this combination of promising growth prospects with limited financing options, it is likely to respond more favorably to the announcement of a new convertible offering. The authors furnish evidence in support of this argument by reporting that the market reacts less negatively to those convertible issuers with higher post-issue capital expenditures and higher market-to-book ratios, but with lower credit ratings and higher (post-offering) debt-equity ratios.     

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.     

The effects of tax provisions on long-run investment prospects

This paper examines the implications of the tax system on the long-run investment prospects for several classes of securities, including short-term debt, long-term debt, and equity. Combining apparently reasonable assumptions with tax provisions that are similar to those of the prevailing federal system, we indicate that equity may be the only investment medium that promises a positive real, after-tax return to a taxable investor.By modifying selected tax provisions that relate to investment activities, such that the recognition of unrealized appreciation is deferred and the investment itself leads to an immediate deduction, substantially different long-run implications are produced. In particular, under reasonable assumptions all classes of investments (with the possible exception of Treasury bills) appear to promise a positive real, after-tax return