FINANCIAL LITERACY AND PENSION INVESTMENT DECISIONS

The call for enhanced financial literacy amongst consumers is a global phenomenon, driven by the growing complexity of financial markets and products, and government concerns about the affordability of supporting an ageing population. Worldwide, defined benefit pensions are giving way to the risk and uncertainty of defined contribution superannuation/pension funds where fund members now make choices and decisions that were once made on their behalf. An important prerequisite for informed financial decision‐making is adequate financial knowledge and skills to make competent investment decisions. This paper reports the findings of an online survey of the members of a large Australian public sector‐based superannuation fund and shows that although respondents generally understand basic financial matters, on average, their understanding of investments concepts, such as the relationship between risk and returns, is inadequate. These results highlight the need for education programs focusing specifically on developing fund members’ investment knowledge and skills to facilitate informed retirement savings decisions.     

PRODUCTION TECHNOLOGY,NONDEBT TAX SHIELDS,AND FINANCIAL LEVERAGE

In the literature a negative relationship between debt and nondebt tax shields is predicted only for firms that have the same production technology (i.e., firms with perfectly correlated pretax output). In this paper we examine the relationship between production technology and differences in firms' financial leverage ratios, and find that firms in the same industry with highly (lowly) correlated output make similar (dissimilar) leverage decisions. Thus, the correlation of output across states of nature helps explain leverage differences that are not explained by industry differences. Contrary to previous predictions, however, leverage differences for firms with highly correlated pretax output suggest a positive relationship between debt and nondebt tax shields.     

INFORMATION CONTENT OF FINANCIAL LEVERAGE: A COMMENT

Kim, Chen and Nance in a previous article in this journal (January 1992) classified sample firms into two groups based on the relationship between change in stock prices and financial leverage to test the existence of optimal financial leverage. The inherent weakness of this methodology is that interpretation of test results on the existence of optimal financial leverage can be misleading in the case of serious confounding events.     

OPERATING LEVERAGE AND UNDERINVESTMENT

Using a contingent claims model, we examine the impacts of both operating leverage and financial leverage on a firm's investment decisions in the context of capacity expansion. Our model shows that quasi‐fixed operating costs could significantly mitigate the underinvestment problem for debt‐financed firms. The existing debt induces equity holders to delay equity‐financed expansion because the expanded earnings base will also benefit the debt holders by lowering the bankruptcy risk. The operating costs decrease this type of wealth transfer from equity holders to debt holders by magnifying the bankruptcy risk of the existing debt upon investment. By applying the Cox proportional hazard model on a large sample of publicly traded U.S. firms over 1966–2016, we offer empirical support for the theoretical predictions. The results are robust to various measures of operating leverage.