On the importance of systematic risk factors in explaining the cross-section of corporate bond yield spreads

In this paper we examine the importance of systematic equity market factors in explaining the cross-sectional variation in yield spreads on corporate debt. Based on a sample of 1771 corporate bonds over the period from January 1985 to March 1998, we find that once the default-related variables are controlled for, bond betas or sensitivities to aggregate equity market risks have very limited explanatory power. This is in contrast to [Elton, E.J., Gruber, M.J., 2001. Explaining the rate spread on corporate bonds. Journal of Finance 56, 247–277] who find that market factors tied to expected returns are predominantly important, but who do not control for these variables (i.e. the relevant variables from structural models), possibly biasing their estimates. On the other hand, our finding that the systematic factors exhibit some limited explanatory power suggests that the standard contingent claims approach may not fully apply. This finding is consistent with previous research that bond betas are not completely irrelevant once market frictions are introduced. Overall, the evidence provides empirical support for the proposition that structural models capture important elements of corporate bond yield spread determination and equity market systematic factors are by no means predominant.     

The Gilt-Equity Yield Ratio and the Predictability of UK and US Equity Returns

A number of financial variables have been shown to be effective in explaining the time-series of aggregate equity returns in both the UK and the US. These include, inter alia , the equity dividend yield, the spread between the yields on long and short government bonds, and the lagged equity return. Recently, however, the ratio between the long government bond yield and the equity dividend yield – the gilt-equity yield ratio – has emerged as a variable that has considerable explanatory power for UK equity returns. This paper compares the predictive ability of the gilt-equity yield ratio with these other variables for UK and US equity returns, providing evidence on both in-sample and out-of-sample performance. For UK monthly returns, it is shown that while the dividend yield has substantial in-sample explanatory power, this is not matched by out-of sample forecast accuracy. The gilt-equity yield ratio, in contrast, performs well both in-sample and out-of-sample. Although the predictability of US monthly equity returns is much lower than for the UK, a similar result emerges, with the gilt-equity yield ratio dominating the other variables in terms of both in-sample explanatory power and out-of-sample forecast performance. The gilt-equity yield ratio is also shown to have substantial predictive ability for long horizon returns.     

The Risk Microstructure of Corporate Bonds: A Case Study from the German Corporate Bond Market

This article presents joint econometric analysis of interest rate risk, issuer‐specific risk (credit risk) and bond‐specific risk (liquidity risk) in a reduced‐form framework. We estimate issuer‐specific and bond‐specific risk from corporate bond data in the German market. We find that bond‐specific risk plays a crucial role in the pricing of corporate bonds. We observe substantial differences between different bonds with respect to the relative influence of issuer‐specific vs. bond‐specific spread on the level and the volatility of the total spread. Issuer‐specific risk exhibits strong autocorrelation and a strong impact of weekday effects, the level of the risk‐free term structure and the debt to value ratio. Moreover, we can observe some impact of the stock market volatility, the respective stock's return and the distance to default. For the bond‐specific risk we find strong autocorrelation, some impact of the stock market index, the stock market volatility, weekday effects and monthly effects as well as a very weak impact of the risk‐free term structure and the specific stock's return. Altogether, the determinants of the spread components vary strongly between different bonds/issuers.     

The Gilt-Equity Yield Ratio and the Predictability of UK and US Equity Returns

A number of financial variables have been shown to be effective in explaining the time-series of aggregate equity returns in both the UK and the US. These include, inter alia , the equity dividend yield, the spread between the yields on long and short government bonds, and the lagged equity return. Recently, however, the ratio between the long government bond yield and the equity dividend yield – the gilt-equity yield ratio – has emerged as a variable that has considerable explanatory power for UK equity returns. This paper compares the predictive ability of the gilt-equity yield ratio with these other variables for UK and US equity returns, providing evidence on both in-sample and out-of-sample performance. For UK monthly returns, it is shown that while the dividend yield has substantial in-sample explanatory power, this is not matched by out-of sample forecast accuracy. The gilt-equity yield ratio, in contrast, performs well both in-sample and out-of-sample. Although the predictability of US monthly equity returns is much lower than for the UK, a similar result emerges, with the gilt-equity yield ratio dominating the other variables in terms of both in-sample explanatory power and out-of-sample forecast performance. The gilt-equity yield ratio is also shown to have substantial predictive ability for long horizon returns.     

An empirical study of the value-relevance of using proportionate consolidation accounting for investments in joint ventures

This research examines bond risk premiums to determine whether creditors of companies with investments in joint ventures reflect legal or implicit measures of the debts of joint ventures. The legal view suggests that the amount of potential loss from an investment in a joint venture is limited to the investment. The implicit view suggests that the operations of the joint venture and the venturer are interdependent. Equity method accounting reflects the legal view and proportionate consolidation reflects the implicit view.The study examines whether bond risk premiums are more highly associated with accounting numbers from proportionate consolidation than equity method accounting. The study uses data from 10Ks, the Wall Street Journal, and Moody's Bond Record from May 1, 1995 through April 30, 1998. These 4 years are used because US interest rates were fairly stable during this period, which is an important factor when examining bond risk premiums. Additionally, the companies in the study needed to remain stable across the window of study – no mergers, acquisitions, buy-outs, or liquidations – in order to maintain a comparative sample over the entire time period. The risk premium model uses measures of default that change between equity method accounting and proportionate consolidation. Differences in the explanatory power of the model determine how creditors view the joint venture debts.The study shows that approximately half of equity investments represent investments in joint ventures. Furthermore, the average joint venture uses debt to finance about two-thirds of the assets. The results show that proportionate consolidation fails to improve the explanatory power of the model when examining the entire set of companies that invest in joint ventures. However, the data reject the null hypothesis of no improvement with proportionate consolidation when examining companies who guarantee the debt of their joint venture. The policy implication of this study indicates that a change to proportionate consolidation would provide more value-relevant information to creditors when companies guarantee the debt of the joint venture.     

Do Taxes Affect Corporate Financing Decisions?

This paper provides clear evidence of substantial tax effects on the choice between issuing debt or equity; most studies fail to find significant effects. The relationship between tax shields and debt policy is clarified. Other papers miss the fact that most tax shields have a negligible effect on the marginal tax rate for most firms. New predictions are strongly supported by an empirical analysis; the method is to study incremental financing decisions using discrete choice analysis. Previous researchers examined debt/equity ratios, but tests based on incremental decisions should have greater power.     

Does competition from new equity mitigate bank rent extraction? Insights from Japanese data

Previous research shows that bank information production mitigates asymmetric information problems. However, this literature has ignored the concern that firms with better growth prospects are more vulnerable to bank rent extraction. This paper points out that funding competition from new equity as an effective natural mechanism solves this important concern. Using Japanese data from 1983 to 1997, we show that the relationship between loan-to-debt ratio and growth, while starting significantly negative (consistent with holdup theory), turns significantly positive towards the high end of the growth spectrum. We confirm that high-growth firms raise more new equity than do low growth firms and use more equity relative to bonds in external finance. This is consistent with a generalized Myers–Majluf framework. These results suggest that for high growth firms, when competition from public debt lessens due to increased growth-based valuations, competition from new equity steps in to restrain bank rent extraction.     

Impact of interest rate surprises on Islamic and conventional stocks and bonds

This paper studies the impact of interest rate news surprises on Islamic and conventional stock and bond indices, using a dataset which covers interest rate announcements and forecasts, as well as stock and bond indices in three Islamic and eight non-Islamic countris. We find that interest rate surprises tend to have a smaller impact on the returns and volatility of Islamic than conventional bonds because Islamic bonds are structured to avoid explicit interest rates. However, interest rate surprises have about the same or bigger impact on the returns and volatility of Islamic relative to conventional stocks, despite the low amounts of cash and debt holdings of firms comprising Islamic stock indices.     

The effect of interest rate volatility and equity volatility on corporate bond yield spreads: A comparison of noncallables and callables

This research investigates the impact of interest rate volatility upon corporate bond yield spreads. We first consider the impact of interest rate volatility upon noncallable bond spreads. Because greater interest rate volatility likely increases the volatility of the firm's debt, we hypothesize that the relation will be positive. Given that we do find a positive relation, we thus investigate whether the positive effect of interest rate volatility on yield spreads is stronger or weaker for callable bonds. We find that the effect is weaker for callable bonds. This result indicates that there is a negative relation between default spreads and call spreads, which is consistent with the theory of Acharya and Carpenter (2002), but in contrast to the theory of King (2002). Furthermore, our results for the relationship between equity volatility and yield spread tend to support Acharya and Carpenter (2002) more than King (2002).     

Why Do Firms Issue Equity?

We develop and test a new theory of security issuance that is consistent with the puzzling stylized fact that firms issue equity when their stock prices are high. The theory also generates new predictions. Our theory predicts that managers use equity to finance projects when they believe that investors' views about project payoffs are likely to be aligned with theirs, thus maximizing the likelihood of agreement with investors. Otherwise, they use debt. We find strong empirical support for our theory and document its incremental explanatory power over other security‐issuance theories such as market timing and time‐varying adverse selection.     

Leverage, options liabilities, and corporate bond pricing

The two major problems with typical structural models are the failure to attain a positive credit spread in the very short term, and overestimation of the overall level of the credit spread. We recognize the presence of option liabilities in a firm’s capital structure and the effect they have on the firm’s credit spread. Including option liabilities and employing a regime switching interest rate process to capture the business cycle resolves the above-mentioned drawbacks in explaining credit spreads. We find that the credit spread overestimation problem in one of the structural models, Collin-Dufresne and Goldstein (J Finan 56:1929–1957, 2001), can be resolved by combining option liabilities and the regime-switching interest rate process when dealing with an investment grade bond, whereas with junk bonds, only the regime-switching interest rate process is needed. We also examine vulnerable option values, debt values, and zero-coupon bond values with different model settings and leverage ratios.      

The value relevance of dirty surplus accounting flows in The Netherlands

Recently the Dutch financial reporting standard setters have taken steps to make dirty surplus accounting flows more visible to parties outside firms, either by eliminating their possibilities or by requiring comprehensive income-type statements. These steps are presumably based on the idea that dirty surplus accounting flows are relevant to investors and hence have to be visible to them.Whether dirty surplus accounting flows are indeed relevant in firm valuation is an empirical issue. This paper, therefore, explores both the incremental and relative value relevance of dirty surplus accounting flows for the Dutch listed firms in the period 1988–1997, when their existence was relatively unhindered.We find consistent evidence that both reported income and clean surplus income are relevant in explaining stock returns, though reported income seems a more relevant measure of returns in the period considered.The results suggest that aggregated dirty surplus flows are not associated with stock returns with accumulation intervals up to 10 years; however, asset revaluations and currency-translation differences are at times incrementally relevant to returns.     

电力行业上市公司的财务杠杆效应分析——基于2006-2009年的经验数据

我国上市公司的资本结构普遍不合理,并没有充分发挥债务融资的财务杠杆效应。本文以我国电力行业四家上市公司作为实证样本,基于其财务杠杆效应的利用现状,通过多元回归分析揭示了净资产收益率与负债权益比、债务利息率、息税前利润率等影响因素的相关性及显著性,从而为电力行业上市公司财务杠杆效应的有效利用提供理论指导与实务借鉴。     

Conditional conservatism and the yield spread of corporate bond issues

Building upon recent research which indicates that debt markets rather than equity markets shape financial reporting, this study examines how conditionally conservative financial reporting relates to the yield spread of corporate bond issues. Our findings suggest that the debt contract efficiency/information costs view of conditional conservatism, documented in private debt contracts, does not generalize to public debt contracts. Instead, a debt contract renegotiation costs perspective seems to better capture the dynamics of the public debt markets, with conditionally conservative reporting being associated with higher yield spread of corporate bond issues. Additional subsample test results indicate that the association between conditional conservatism and bond yield spreads is more pronounced in non-investment grade bonds, for bond issuers with more financial distress, and for bonds that are issued before the passage of the Sarbanes–Oxley Act. This study fills a gap in the conservatism literature, which focuses primarily on equity or private bank loan markets with traditional debt contract efficiency/information costs view.     

International equity valuation: the relative importance of country and industry factors versus company‐specific financial reporting information

The relative importance of country‐ and industry‐specified factors vis‐à‐vis company‐specific financial statement–based information in explaining equity valuation multiples in an international setting is examined. Both country‐specific effects via previously identified variables and an indicator variable approach are analysed. While company‐specific factors are predominant in explaining cross‐sectional differences in valuation, country and industry factors have sizable incremental explanatory power over them; the latter are not independent, so their relative importance is influenced by how we adjust for this commonality. Using country indicators provides larger incremental explanatory power than using country‐specific factors, suggesting that previously identified factors may be measured with sizeable error or omitted factors are important.     

The Characteristics and Valuation of Loss Reserves of Property Casualty Insurers

This study examines characteristics and valuation of claim loss reserves of property casualty insurers. Using SEC disclosures of revisions (development) in loss reserve estimates, we document substantial serial correlation in loss reserve development, indicating that reported loss reserves do not fully reflect available information, consistent with management exercising discretion over reported loss reserves. We find that loss reserve development reported one year after the balance sheet date has significant explanatory power for firm value incremental to book value of equity and earnings, suggesting investors at least partially identify management's influence on reported loss reserves, and adjust firm values accordingly.     

EVIDENCE ON THE ROLE OF TAXES ON FINANCING CHOICE: CONSIDERATION OF MANDATORILY REDEEMABLE PREFERRED STOCK

In this study we examine the effect of firms' marginal tax rates on incremental and overall reliance on mandatorily redeemable preferred stock (MRPS). Similarities in the cash flows associated with debt and MRPS, as well as similarities in the claims of holders of debt and MRPS on the assets of issuing firms, suggest that MRPS may be viewed as a substitute for debt. However, important differences in the tax treatment of MRPS and debt suggest that firms that cannot make full use of interest tax shields may be able to finance more efficiently using MRPS instead of debt. The results indicate that, both incrementally and overall, firms with low marginal tax rates rely more heavily on MRPS than debt relative to firms with high tax rates. This finding is consistent with the proposition that firms that cannot make full use of interest tax shields finance incrementally using equity rather than debt.     

Why electric utility stocks are sensitive to interest rates

The determinants of electric utility stock interest rate sensitivity are examined. The bond rating of a utility's debt has a strong influence on its equity sensitivity to interest rates. The common stock of highly rated utilities is more interest rate sensitive than that of lower rated utilities. This finding is consistent with investors valuing utility stocks as predominantly income-oriented securities. Once the rating of the debt is controlled for, the debt-level of the utility is positively correlated with interest rate sensitivity. Additionally, larger utilities are found to be more interest rate sensitive than smaller utilities. Evidence is also presented that a utility's proportion of maturing long-term debt influences interest rate sensitivity. A measure for regulatory lag is developed but appears to have no effect on interest rate sensitivity.     

Required return on equity when capital structure is dynamic

We link the firm's required return on equity to its target debt ratio. We find that a firm's expected return on equity is increasing in the product of the distance between its debt ratio and its target debt ratio, its speed of adjustment, and the spread of the tax benefits of its debt over its bankruptcy costs of debt. Our empirical tests validate the testable implications of our model.     

Reformulating Tax Shield Valuation: A Note

Standard financial theory (in the absence of agency costs and personal taxes) implies that each dollar of debt contributes to the value of the firm in proportion to the firm's tax rate. To derive this result, incremental debt is assumed permanent. This paper shows that when the firm acts to maintain a constant market value leverage ratio, the marginal value of debt financing is much lower than the corporate tax rate. Since Hamada's 2 unlevering procedure for observed equity betas was derived under the assumption of permanent debt, we derive an unlevering procedure consistent with the assumption of a constant leverage ratio.