Carbon risk and corporate capital structure

This research exploits Australia's ratification of the Kyoto Protocol, which mandates the country to reduce carbon emissions, thereby exposing Australian firms to increased carbon risk, as a quasi-natural experiment to examine the causal effect of carbon risk on firm capital structure. We find that the Kyoto Protocol ratification leads to a decrease in financial leverage of heavy carbon emitting firms and such a decrease is more pronounced for financially constrained firms. Further analysis indicates that increased carbon risk leads to higher financial distress risk, which motivates firms to decrease financial leverage.     

CEO mobility and corporate policy risk

Career concerns can limit a manager's willingness to take risks, which can lead to excessive policy conservatism. An increase in a CEO's ability and willingness to change jobs (CEO mobility) can diversify her human capital and reduce her conservatism. We derive several CEO mobility measures and relate them to a policy riskiness index that captures the overall risk embedded in a firm's corporate policies. We find a strong positive relation between CEO mobility and the riskiness of corporate policies. We also link external regulatory shocks that constrain labor mobility to significant drops in corporate risk-taking.     

Geopolitical risk and corporate payout policy

In this study, we examine the effects of geopolitical risk on corporate payout policy. Exploiting a news-based index of geopolitical risk, we find that firms adopt a more conservative payout policy by reducing share repurchases in response to greater geopolitical risk, whereas the effects of geopolitical risk on cash dividends are insignificant. Further analysis suggests that cash flow uncertainty and financial distress risk are two potential channels through which geopolitical risk affects corporate payout policy. We also show that the effects of geopolitical risk on share repurchase are more pronounced for firms with greater exposure to product market competition and those facing higher threats of financial distress. Overall, our study emphasizes the implications of geopolitical risk for corporate payout choice.     

Optimal capital structure under corporate and personal taxation

In this paper, a model of corporate leverage choice is formulated in which corporate and differential personal taxes exist and supply side adjustments by firms enter into the determination of equilibrium relative prices of debt and equity. The presence of corporate tax shield substitutes for debt such as accounting depreciation, depletion allowances, and investment tax credits is shown to imply a market equilibrium in which each firm has a unique interior optimum leverage decision (with or without leverage-related costs). The optimal leverage model yields a number of interesting predictions regarding cross-sectional and time-series properties of firms' capital structures. Extant evidence bearing on these predictions is examined.     

A macroeconomic approach to corporate capital structure

The cross-sectional distribution of corporate capital structure and its macroeconomic implications are underexplored research areas. This paper embeds a dynamic trade-off theory of firm financing into a general equilibrium model with firm dynamics. I find that the stationary equilibrium replicates fairly well the distribution of leverage as well as the relationship between leverage, size and profitability. The counterfactual experiment points out relatively small effects of tax benefits on corporate capital structure. It also implies that the effects of the default cost on macroeconomic variables are almost negligible under endogenous capital structure choice.     

Managerial risk taking incentives and corporate pension policy

We examine whether the compensation incentives of top management affect the extent of risk shifting versus risk management behavior in pension plans. We find that risk shifting through pension underfunding (and, to a lesser extent, through pension asset allocation to risky securities) is stronger with compensation structures that create high wealth-risk sensitivity (vega) and weaker with high wealth-price sensitivity (delta). These findings are stronger for chief financial officers (CFOs) than for chief executive officers (CEOs), suggesting that pension policy falls within the CFO’s domain. Risk shifting through pension underfunding is also lower when the CFO’s personal stake in the pension plan is larger. Overall, these findings show that top managers’ compensation structure is an important driver of corporate pension policy. They also highlight firms within which the moral hazard concerns fueled by Pension Benefit Guaranty Corporation insurance are most relevant.     

Credit supply and corporate capital structure: Evidence from Japan

In this paper we examine how financial constraints, especially fluctuations in the supply of credit, affect the capital structure of 1537 publicly listed Japanese firms from 1980 to 2007, in a data set with 33,000 observations. It is one of the first studies to do so and is inspired by the recent studies of Leary (2009) and Faulkender and Petersen (2006). Japan was selected due to the extreme credit supply fluctuations observed during the last 30 years. It thus offers an ideal natural experiment to test the impact of credit supply on corporate capital structure. In particular, in our panel data study we investigated the impact of the asset bubble in the 1980s and the credit crunch of the late 1990s on corporate capital structure decisions. The results of this paper show, among other findings, that financial policy decisions are indeed influenced by monetary conditions and the supply of credit. In particular, smaller sized firms face financial constraints, especially during economic downturns.     

Multinationality and capital structure dynamics: A corporate governance explanation

This paper examines the impact of corporate governance on capital structure dynamics. Using ordinary least squares regressions on 17,496 firm-year observations for 2,294 US multinational companies (MNCs) over the period 1990–2018, we find that MNCs with strong corporate governance use more debt than those with weak governance. Furthermore, strong corporate governance is associated with a faster speed of adjustment to capital structure. This relationship is more pronounced for MNCs than domestic companies, particularly for overlevered firms. We also use the two-part zero-inflated fractional regression model, instrumental variable, and structural equation model estimations to deal with any endogeneity concerns associated with the explanatory variables. Overall, our findings, which withstand a battery of robustness checks, suggest that improvements in corporate governance reduce the costs of monitoring for bondholders, resulting in increased debt financing.     

An option pricing approach to corporate dividends and the capital investment financing decision

In light of a growing trend toward viewing dividends as an investable asset class, this article opens up a new perspective on their valuation. We show that dividends can be viewed as options on the cash flow of the firm. That is, a firm either pays zero dividends, in which case the option expires out‐of‐the‐money, or it pays a positive dividend, the value of which corresponds to the option's moneyness. The exercise price is determined by the capital budget, the flexibility of the company to use external financing, and whether it has minimum and maximum dividends. The model is also capable of accommodating a stochastic capital budget, which allows for uncertain growth opportunities and their correlation with the firm's cash flows. We also present an application of the model using actual data for a large multinational company.     

Optimization of corporate capital structure A probabilistic Bayesian approach

This article develops a probabilistic approach to the problem of optimization of corporate capital structure. The approach enables quantitative assessment of optimal Debt to Equity ratio and includes calculation of probability of corporate bankruptcy in the future as a function of the time interval remaining until the bankruptcy. The probability is then used in a modified formula of discount share valuation to calculate the (share) value of a corporation that can become bankrupt at some future moment. Assessing the corporate (share) value in dependence on Debt/Equity ratio (which affects both corporate returns and probabilities of bankruptcy), one can find optimal value of the ratio which maximizes the share value. The optimal Debt/Equity ratio appears to be dependent on current corporate profitability, liquidity, and other fundamental factors. Factors of macroeconomic environment also appear to be relevant.     

The interaction between corporate tax structure and disclosure policy

When socially desirable behaviors are deemed difficult to legislate, tax code is often called upon to indirectly achieve the desired ends. Adjustments to tax policy have been employed to spark investment, encourage charitable donations, and discourage tobacco consumption, to name a few examples. This paper demonstrates that tax policy may also be an effective means of encouraging welfare enhancing disclosures by firms. Further, by inducing disclosures of the right types of information while discouraging revelation of other types, tax policy proves to be a more versatile instrument than direct regulatory attempts which can mandate (but not prohibit) disclosures. The intuition behind our results is that when firms make decisions to disclose (or withhold) pieces of private information, such a decision is often made with an eye on the potential for a large payoff. In such cases, progressive taxes can dampen the appeal of big payoffs and better align the incentives of firms with those of consumers. In short, while progressive taxes may be criticized for curbing aggressiveness, it is precisely such a decrease in aggressiveness that can prompt efficient sharing of information.     

Long-term persistence in corporate capital structure: Evidence from India

This study examines the stability of corporate capital structure in a sample of listed Indian firms for the period 1988–2015. In general, the firms do not maintain a stable level of leverage over long durations. The firm specific temporal variations in leverage are large and significant. We find that capital structure models that incorporate time varying firm effects perform better in explaining the variation in leverage than those that employ time invariant firm effects. The cross-sectional distribution of leverage also exhibits considerable variations over time. The quartile decompositions of leverage cross-sections reveal that migrations across leverage quartiles are pervasive. Only the firms with low leverage ratios ratio exhibit some persistence in their leverage ratios. High leverage ratios are not rare but are invariably transient.     

Organization capital and corporate cash holdings

This paper investigates the relationship between organization capital and corporate cash holdings. We develop two competing hypotheses in relating organization capital with cash holding. Our analysis reveals that organization capital is related to high levels of cash holdings. Moreover, we find that the effect of organization capital on corporate cash holdings is stronger for firms experiencing high levels of financing constraint and cash flow risk. Our results remain robust to alternative measures of organization capital and corporate cash holdings, and are not driven by omitted variable bias or endogeneity issues. We also find that the positive relation between organization capital and cash holdings is not confounded by sample period or industry group. Overall, we provide robust evidence that supports the precautionary motive for corporate cash holding.     

Director capital and corporate disclosure quality

Conventional wisdom regarding board effectiveness emphasizes the role of board composition and incentives in alleviating conflicts of interest. We argue that board capital, however, may be a more important aspect of board efficacy since directors are the highest level agents of shareholders, meet infrequently, and shareholders have limited recourse for poor decision-making. In contrast, shareholders and the SEC can sue/prosecute directors for conflicts of interest or bias. One role of the board involves determining the depth and degree of the firm’s financial disclosures. To test the idea that high capital boards seek to provide greater disclosure quality to investors, we manually collect data on director attributes and apply factor analysis to measure the networking, educational, and experience capital of the board. The results indicate that board capital is positively related to disclosure quality, with differing key attributes for inside and outside directors. These results are robust to 2SLS and difference-in-difference approaches.     

Carbon risk and dividend policy: Evidence from China

Using a large sample of Chinese listed industrial firms from 2009 to 2019, this study investigates the effect of firm-level carbon risk on dividend policy. We find that carbon risk has a significant and negative impact on a firm's dividend payout level. We also find that when firms' capability in innovation is stronger, the degree of earnings uncertainty is higher, a firm belongs to high‑carbon industries, the negative relationship between carbon risk and dividend payout level is more significant. Furthermore, financial constraints and cash holdings are two underlying channels through which carbon risk affects cash dividend payouts. Our findings remain consistent across several robustness checks.     

Monetary policy and corporate default

When a corporation issues debt with a fixed nominal coupon, the real value of future payments decreases with the price level. Forward-looking corporate default decisions therefore depend on monetary policy through its impact on expected inflation. We build a general equilibrium economy with deadweight bankruptcy costs that demonstrates how nominal rigidities in corporate debt create an important role for monetary policy even in the absence of standard nominal frictions such as staggered price setting in the output market. Under a passive nominal interest rate peg, the direct effects of a negative productivity shock combine with deflation to produce strong incentives for corporate default. A debt-deflationary spiral results when there are real costs of financial distress. Inflation targeting eliminates this amplification mechanism but full inflation targeting requires permitting the nominal interest rate to depend explicitly on credit market conditions.     

Investment timing and optimal capital structure under liquidity risk

Deterioration in debt market liquidity reduces debt values and affects firms' decisions. Considering such risk, we develop an investment timing model and obtain analytic solutions. We carry out a comprehensive analysis in optimal financing, default, and investment strategies, and stockholder–bondholder conflicts. Our model explains stylized facts and replicates empirical findings in credit spreads. We obtain six new insights for decision makers. We propose a ‘new trade-off theory’ for optimal capital structure, a new tax effect, and new explanations of ‘debt conservatism puzzle’ and ‘zero-leverage puzzle’. Failure in recognizing liquidity risk results in substantially over-leveraging, early bankruptcy or investment, overpriced options, and undervalued coupons and credit spreads. In addition, agency costs are surprisingly small for a high liquidity risk or a low project risk. Interestingly, the risk shifting incentive and debt overhang problem decrease with liquidity risk under moderate tax rates while they increase under high tax rates.     

A jump-diffusion model for pricing corporate debt securities in a complex capital structure

This paper proposes a jump-diffusion model, in closed form, to price corporate debt securities, senior and junior, with the same maturity and violation of the absolute priority rule. We take the structural approach that the firm's asset value follows a jump-diffusion process in a stochastic interest rate economy. Default occurs only if the firm value at the maturity of the corporate debts is less than the sum of the prespecified face values. Unlike previous models in the structural approach, our model is consistent with the current term structures of credit spreads for both senior and junior debts. In particular, it captures realistic short maturity credit spreads observed in the market. The key idea is to allow the jump intensity to be a time-dependent function. As an application, valuation of credit spread options is presented.     

Board structure and corporate risk taking in the UK financial sector

This paper examines the relationship between board structure and corporate risk taking in the UK financial sector. We show how the board size, board independence and combining the role of CEO and chairperson in boards may affect corporate risk taking in financial firms. Our sample is based on a panel dataset of all publicly listed firms in the UK financial sector, which includes banks, insurance, real estate and financial services companies over a ten year period (2003 − 2012). After controlling for the effects of endogeneity through the application of the dynamic panel generalized method of moments estimator, the findings of this study suggest that the presence of non-executive directors and powerful CEOs in corporate boards reduces corporate risk taking practices in financial firms. The negative relationship can be explained within the agency theory context, where managers are regarded as more risk averse because of the reputational and employment risk. An increased power concentration is therefore expected to enhance the risk aversion behaviour of directors. The findings however, do not show any significant effect of board size on corporate risk taking in financial firms. As this study covers recommendations of the UK Corporate Governance Code on the role of corporate boards in managing firms' risk, the empirical evidence could be useful for corporate governance regulation and policy making.