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.     

中国金融部门杠杆周期分析——基于1998-2018年的数据证明

结合中国经济金融体系发展实践,以银行部门（其他存款性公司）总资产/实收资本作为代理指标分析中国金融部门杠杆率的周期性特征,并对周期形成原因进行探究,对我国金融部门杠杆周期与金融周期的顺周期性进行检验。结果显示：在观测期内,中国金融部门杠杆经历了多个短周期,短周期长度在9～16个季度（约2～4年）不等,并经历了至少1次中周期,中周期时间约为35个季度（约9年）;我国金融部门杠杆周期与国家金融监管政策密切相关;我国金融部门的杠杆周期与金融周期并不必然表现为顺周期性。因此,我国应当更加注重金融监管政策和信贷政策的配合协同,科学反映金融部门杠杆情况,维护金融稳定,防止发生系统性金融风险。     

Financial leverage changes associated with corporate mergers

We empirically examine whether firms increase financial leverage following mergers. Firms could increase financial leverage either because of an increase in debt capacity or because of unused debt capacity from pre-merger years. We find that financial leverage of combined firms increases significantly following mergers. A cross-sectional analysis shows that the change in financial leverage around mergers is significantly positively correlated with the announcement period market-adjusted returns. Further tests indicate that the increase in financial leverage is an outcome of an increase in debt capacity, although there is weak evidence that some of the increase in financial leverage is a result of past unused debt capacity.     

The role of jumps and leverage in forecasting volatility in international equity markets

We analyze the importance of jumps and the leverage effect on forecasts of realized volatility in a large cross-section of 18 international equity markets, using daily realized measures data from the Oxford-Man Realized Library, and two widely employed empirical models for realized volatility that allow for jumps and leverage. Our out-of-sample forecast evaluation results show that the separation of realized volatility into a continuous and a discontinuous (jump) component is important for the S&P 500, but of rather limited value for the remaining 17 international equity markets that we analyze. Only for 6 equity markets are significant and sizable forecast improvements realized at the one-step-ahead horizon, which, nevertheless, deteriorate quickly and abruptly as the prediction horizon increases. The inclusion of the leverage effect, on the other hand, has a much larger impact on all 18 international equity markets. Forecast gains are not only highly significant, but also sizeable, with gains remaining significant for forecast horizons of up to one month ahead.     

The leverage effect and the basket-index put spread

Benchmark models that exogenously specify equity dynamics cannot explain the large spread in prices between put options written on individual banks and options written on the bank index during the financial crisis. However, theory requires that asset dynamics be specified exogenously and that endogenously determined equity dynamics exhibit a “leverage effect” that increases put prices by fattening the left tail of the distribution. The leverage effect is larger for puts on individual stocks than for puts on the index, thus increasing the basket-index spread. Time-series and cross-sectional variation in the leverage effect explains option prices well.     

The relationship between operating leverage and financial leverage

We model the relationship between operating and financial leverage. When operating leverage is exogenously specified, financial leverage is a monotonically decreasing function of operating leverage. When financial leverage is exogenously specified, operating leverage is initially increasing and subsequently decreasing in financial leverage. Finally, when both operating and financial leverage are chosen by the firm, they can be positively related, negatively related or unrelated, depending on which underlying parameter is driving the changes. Thus, operating leverage and financial leverage do not always behave as substitutes, as argued in the traditional literature. The relationship is complex, possibly non-monotonic and dependent on the circumstances; empirical tests need to take this reality into account.     

The relative influence of competitive intensity and business strategy on the relationship between financial leverage and performance

This study empirically investigates the effects of competitive intensity and business strategy on the relationship between financial leverage and the performance of firms. Based on a sample of US manufacturing firms, this study confirms the hypothesis that the cost of debt is higher for product differentiation firms than cost leadership firms. Furthermore, the results indicate that competitive intensity has a negative effect on the leverage-performance relationship, suggesting that competition acts as a substitute for debt in limiting manager's opportunistic behavior. These findings reinforce the need to consider moderating factors such as strategic choice and the environment in which a firm operates when investigating the effects of leverage on performance.     

Double leverage cycle,interest rate,and financial crisis

We view mortgage as a risky derivative of its underlying house collateral and combine no-arbitrage valuation with equilibrium valuation approaches to develop a dynamic model of leverage cycle and interest rate. This model provides a unified explanation to pro-cyclical optimism, asset prices, and leverage, and counter-cyclical volatility and interest rate. In addition, the model shows that tightening funding margin in the mortgage securities market dampens optimism, asset prices, and leverage, whereas it raises volatility and interest rate in the housing market. A double leverage cycle leads to more volatile markets and a severe leverage cycle, thus resulting in worse financial crises.     

Investigating the leverage effect in commodity markets with a recursive estimation approach

This paper investigates the presence of the leverage effect in commodities, in comparison with financial markets. The EGARCH model with a Mixture of Normals distribution (EGARCH-MN) is used to capture (i) heavy tails and skewness in the conditional returns, and (ii) leverage effects and time-varying long-term component in the volatility specification. Besides, the estimation strategy relies on an innovative recursive (REC) method, which allows disentangling the leverage effect from the unconditional skewness as an empirical result. When applied to a broadly diversified dataset of assets during 1995–2012, the EGARCH-MN models offers state-of-the-art specifications with leverage and fat-tailed skewed densities, that allow to contrast the specific characteristics of commodities with traditional assets (equities, bonds, FX).     

The effect of corporate sustainability performance on leverage adjustments

We examine the impact of corporate sustainability performance (CSP) on the speed at which firms adjust their leverage ratios to the target levels for a large sample of 31 countries from 2002 to 2018. Using two proxies of CSP, we find that firms with superior CSP tend to adjust faster toward their target leverage ratios. In exploring the potential underlying economic mechanisms through which CSP affects leverage adjustments, we find that better CSP helps firms to ease information asymmetry, enhance stakeholder engagement, push up stock prices in the stock market, and improve competitive advantage in the product market. In the cross section, the positive association between CSP and leverage adjustment speed is less pronounced in countries with high-quality institutions. The results remain unchanged in robustness tests. Overall, this paper highlights the important role of CSP in shaping corporate capital structure dynamics and suggests implications for corporate strategic planning on the privately optimal levels of CSP activities.     

Employee representation and financial leverage

We analyze how direct employee voice affects financial leverage. German law mandates that firms’ supervisory boards consist of an equal number of employees’ and owners’ representatives. This requirement, however, applies only to firms with more than two thousand domestic employees. We exploit this discontinuity and the law’s introduction in 1976 for identification and find that direct employee power increases financial leverage. This is explained by a supply side effect: as banks’ interests are similar to those of employees, higher employee power reduces agency conflicts with debt providers, leading to better financing conditions. These findings reveal a novel mechanism of direct employee influence.     

The role of on- and off-balance-sheet leverage of banks in the late 2000s crisis

Extensive regulatory changes and technological advances have transformed banking systems to a great extent. Banks have reacted to the challenges posed by the new operating environment by creating new products and expanding their activities to some uncharted business areas. In this paper, we study how modern banking which gave birth to the off-balance-sheet leverage activities affected the risk profile of U.S. banks as well as the level of systemic risk before and after the onset of the late 2000s financial crisis. Towards this, we separate on- from off-balance-sheet leverage and capture the latter with different, yet complementary, measures which do not exist in the current literature. Special attention is paid on the deleveraging process that occurred in the banking market after the crisis erupted, which is an additional innovative feature of this study. Our findings reveal that leverage, both explicit and hidden off-the-balance-sheet, increases the individual risk of banking firms making them vulnerable to financial shocks. Reverse leverage, on the other hand, is beneficial for individual banks’ health, but is found to be harmful for financial stability. We also demonstrate that the banks which concentrate on traditional lines of business typically carry less risk compared to those involved with modern financial instruments.     

A resolution of the distress risk and leverage puzzles in the cross section of stock returns

We revisit findings that returns are negatively related to financial distress intensity and leverage. These are puzzles under frictionless capital markets assumptions but are consistent with optimizing firms that differ in their exposure to financial distress costs. Firms with high costs choose low leverage to avoid distress, but they retain exposure to the systematic risk of bearing such costs in low states. Empirical results are consistent with this explanation. The return premiums to low leverage and low distress are significant in raw returns, and even stronger in risk-adjusted returns. When in distress, low-leverage firms suffer more than high-leverage firms as measured by a deterioration in accounting operating performance and heightened exposure to systematic risk. The connection between return premiums and distress costs is apparent in subperiod evidence. Both are small or insignificant prior to 1980 and larger and significant thereafter.     

The effect of financial leverage on real and accrual-based earnings management

Past research has documented a substitution effect between real earnings management (RM) and accrual-based earnings management (AM), depending on relative costs. This study contributes to this research by examining whether levels of (and changes in) financial leverage have an impact on this empirically documented trade-off. We hypothesise that in the presence of high leverage, firms that engage in earnings manipulation tactics will exhibit a preference for RM due to a lower possibility – and subsequent costs – of getting caught. We show that leverage levels and increases positively and significantly affect upward RM, with no significant effect on income-increasing AM, while our findings point towards a complementarity effect between unexpected levels of RM and AM for firms with very high leverage levels and changes. This is interpreted as an indication that high leverage could attract heavy outsider scrutiny, making it necessary for firms to use both forms of earnings management in order to achieve earnings targets. Furthermore, we document that equity investors exhibit a significantly stronger penalising reaction to AM vs. RM, indicating that leverage-induced RM is not as easily detectable by market participants as debt-induced AM, despite the fact that the former could imply deviation from optimal business practices.     

An additional analysis of estimation techniques for the degree of financial leverage

This study compares three different empirical proxies for the financial leverage component of a systematic risk‐composition model employed in prior financial research. We consider one static accounting measure and two elasticity‐based measures. We find that the traditional static accounting measure of financial leverage provides statistically different estimates of financial leverage when compared to estimates from elasticity‐based measures of the degree of financial leverage. The findings are important because the elasticity‐based models for the degree of financial leverage have clear theoretical links to market‐based models of systematic risk, while the static accounting measure of financial leverage does not. Practitioners and researchers should carefully consider why they are estimating financial leverage and choose the appropriate method for doing so given the goals and potential consequences for biased estimation.     

A two-part fractional regression model for the financial leverage decisions of micro,small, medium and large firms

In this paper we examine the following two hypotheses, which traditional theories of capital structure are relatively silent about: (i) the determinants of financial leverage decisions are different for micro, small, medium and large firms; and (ii) the factors that determine whether or not a firm issues debt are different from those that determine how much debt it issues. Using a binary choice model to explain the probability of a firm raising debt and a fractional regression model to explain the relative amount of debt issued, we find strong support for both hypotheses. Confirming recent empirical evidence, we find also that, although larger firms are more likely to use debt, conditional on their having some debt, firm size is negatively related to the proportion of debt used by firms.     

金融危机背景下金融杠杆作用之审视

本文认为金融杠杆的存在有其必然性和合理性.在当前背景下,适当利用金融杠杆对走出金融危机阴影仍具有重要意义.就我国而言,金融杠杆的发展仍有不足,为扩大需求应考虑适度加大杠杆化力度.     

The macroeconomic determinants of technology stock price volatility

Stock prices reflect the value of anticipated future profits of companies. Since business cycle conditions impact the future profitability of firms, expectations about the business cycle will affect the current value of firms. This paper uses daily and monthly data from July 1986 to December 2000 to investigate the macroeconomic determinants of US technology stock price conditional volatility. Technology share prices are measured using the Pacific Stock Exchange Technology 100 Index. One of the novel features of this paper is to incorporate a link between technology stock price movements and oil price movements. The empirical results indicate that the conditional volatilities of oil prices, the term premium, and the consumer price index each have a significant impact on the conditional volatility of technology stock prices. Conditional volatilities calculated using daily stock return data display more persistence than conditional volatilities calculated using monthly data. These results further our understanding of the interaction between oil prices and technology share prices and should be of use to investors, hedgers, managers, and policymakers.     

Stock Prices and Inflation: New Evidence from the Pacific-Basin Countries

This paper investigates the statistical relationship between stock prices and inflation in nine countries in the Pacific-Basin. On balance, regression analysis on the nine markets shows negative relationships between stock returns in real terms and inflation in the short run, while co-integration tests on the same markets display a positive relationship between the same variables over the long run. The time path of the response of stock prices plotted against corresponding changes in consumer price indices validates this dichotomy in time-related response patterns of stock prices to inflation; namely, a blip of negative responses at the beginning changes to a positive response over a longer period of time. Stock prices in Asia, like those in the U.S. and Europe, appear to reflect a time-varying memory associated with inflation shocks that make stock portfolios a reasonably good hedge against inflation in the long run.     

On the volatility spillover between lslamic and conventional stock markets: A quantile regression analysis

This paper aims at analyzing the degree and structure of interdependencies in terms of volatility (transmission, contagion) between Islamic and conventional stock markets on calm periods and at times of financial fragility and crisis. We focused on the recent financial instability periods and used the Quantile Regression-based GARCH model. Main results lead to very interesting conclusions. First, it has been found that Islamic stock markets are not totally immune to the global financial crisis. Second, a very strong interdependence is sensed from the conventional to the Islamic stock markets, especially, from the conventional developed markets to the Islamic Emerging and Arab markets and to the Islamic developed markets. Finally, it has been proved that the interdependencies from conventional to Islamic markets are propagated between Islamic markets. Our findings suggest that the Islamic finance industry does not seem able to provide cushion against economic and financial shocks that affect conventional markets.