Shareholder litigation rights and capital structure decisions

We exploit the staggered adoption of the universal demand (UD) laws across U.S. states, which impedes shareholder rights to initiate derivative lawsuits, as a quasi-natural experiment to examine the relation between shareholder litigation rights and firm capital structures. We find that weaker shareholder litigation rights due to the UD laws adoption lead to higher financial leverage, which enhances firm value. Furthermore, the positive relation between the UD laws adoption and financial leverage is more pronounced for firms exposed to higher shareholder litigation risk ex ante or financially constrained firms. Our evidence is consistent with lower shareholder litigation threats motivating firms to increase financial leverage.     

Right‐to‐Work Laws and Financial Leverage

High leverage can be used to improve a firm's bargaining position with unions. I find that this use of leverage in the United States is concentrated in states without right‐to‐work (RTW) laws. The use of high leverage by unionized firms in these states is associated with high market‐to‐book ratios and is more likely when shareholder and manager interests are aligned through compensation contracts. I confirm these findings by examining the adoption of RTW laws in Oklahoma, as well as presidential and congressional elections. Moreover, I confirm the importance of RTW laws using cash balances instead of leverage.     

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.     

Zero leverage puzzle: Do labour laws matter?

Exploiting the staggered passage of labour protection laws in the United States, we find that higher labour adjustment costs increased the likelihood of observing zero leverage firms by 22%. This effect is significantly larger in states with stronger unionization, in industries with higher volatility and concentration, and in firms with higher labour intensity. Both within-firm changes in debt policies and higher propensity of newer firms to be debt-free are important in explaining these patterns. Overall, our work contributes to the literature on the relation between financial and labour markets by highlighting the role of labour laws in explaining the zero-leverage puzzle.     

Employee firing costs and accounting conservatism: Evidence from wrongful discharge laws

This paper identifies the causal effect of a firm's employee firing costs on its conditional conservatism, using the staggered adoption of US state wrongful discharge laws (WDLs) that increase a firm's cost of firing employees. We find that the adoption of WDLs leads to a significant increase in conditional conservatism. This result is greater for firms that are more labor-intensive, have higher propensities to fire employees, make more firm-specific investments and have greater risk. Overall, our findings support the view that higher firing costs lead to greater demand for conditional conservatism to decrease investment inefficiencies because higher firing costs make inefficient investments (including overinvestment in negative-net present value (NPV) projects and delays in disinvesting poorly performing projects) costlier for the firm.     

LABOR LAWS AND CORPORATE INVESTMENT

In the United States, the costs of unionized labor are higher in states without right‐to‐work (RTW) laws. I show that unionized firms located in these states invest less. These firms have about 4 percentage point lower capital expenditures (normalized by net property, plant, and equipment) than other firms. I confirm these findings by examining a natural experiment created by the adoption of RTW laws in Oklahoma and examining union certification elections using regression discontinuity design.     

The capital structure of domestic and foreign denominated debt: Firm-level evidence from South Korea

This study uses a two-part model with firm-level fixed effects to examine the decisions of Korean firms to issue domestic and foreign denominated debt (extensive margin), and among those firms using external finance, their level of leverage (intensive margin) in each denomination. We find that less profitable and fast-growing firms adopt a pecking order in their leverage decisions, which is evident in their preference for domestic, relative to foreign denominated debt. Interestingly, this relation is shown to be stronger following the 2007 financial crisis and suggests demand side factors are important to leverage decisions. Our results also indicate the fixed costs of issuing debt are important to debt use along the extensive margin and vary in strength by denomination. The use of foreign debt, with its higher fixed costs, is shown to be largely determined by factors associated with these costs.     

Employment protection and share repurchases: Evidence from wrongful discharge laws

We use the staggered adoption of Wrongful Discharge Laws (WDLs) by U.S. state courts as a quasi-natural experiment to examine the causal impact of firing costs and employment protection on corporate payouts. We find that the greater employment protection imposed by WDLs leads to higher share repurchases, and that this finding is more pronounced among firms with greater financial resources and better governance. Our results support the argument that as higher firing costs enhance employee entrenchment and encourage rent extraction behavior, firms have an incentive to increase share buybacks to mitigate a wealth transfer from shareholders to employees.     

Labor unemployment risk and corporate financing decisions

This paper presents evidence that firms choose conservative financial policies partly to mitigate workers' exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.     

Debt,Diversification, and Valuation

The separate associations between financial leverage and valuation and between diversification and valuation have been widely researched. The joint function of leverage, diversification, and valuation, however, has received much less attention. Previous research shows that compared to specialized firms, diversified firms tend to have higher free cash flows and fewer high net present value investment opportunities. Consequently, the agency costs associated with potential overinvestment are greater for diversified firms. The literature also proposes that financial leverage should reduce agency costs. Consequently, we expect that the values of diversified firms increase with leverage. Our tests provide strong support for the hypothesis that the values of diversified firms increase with leverage. This tendency is not observed for specialized firms.JEL Classification:     

Managerial discretion and efficiency of internal capital markets

I use the staggered adoption of state-level antitakeover laws to provide causal evidence that managerial agency problems reduce the allocative efficiency of conglomerate firms. I find that increases in control slack following the passage of antitakeover laws reduces q-sensitivity of investment by 64%. The adverse impact of the laws appears mostly at conglomerate firms that benefited from disciplinary takeover threats prior to the passage of the laws, lacked alternative sources of pressure on management, or had the structural makings to fuel wasteful influence activities and power struggles among managers. These findings suggest that takeover threats impact the efficiency of resource allocation.     

Financial literacy,financial development,and leverage of small firms

This study examines the relationship between financial literacy and the leverage of small firms, specifically of the legal forms, sole proprietorships, and partnerships. Using a cross-section of 73,302 firms in 22 countries, we find that the leverage of small firms is negatively associated with financial literacy. Further, we explore the role of financial development, bankruptcy and transaction costs, and information asymmetry, in moderating the relationship. We find that the negative relationship is less pronounced in countries with lower financial development, high bankruptcy and transaction costs, and high information asymmetry environments, respectively. We contribute to the understanding of small firms' leverage and the literature on financial literacy, SMEs, finance, and entrepreneurship. This study offers policy implications for economies that promote SMEs for entrepreneurship training and development.     

Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms

This study provides evidence that transactions costs discourage debt reductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged and one-in-three subsequently experience financial distress. Transactions costs are significantly smaller, hence leverage falls by more and there is less recurrence of financial distress, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures.     

Financial distress and corporate risk management: Theory and evidence

This paper extends the current theoretical models of corporate risk-management in the presence of financial distress costs and tests the model's predictions using a comprehensive data set. I show that the shareholders optimally engage in ex-post (i.e., after the debt issuance) risk-management activities even without a pre-commitment to do so. The model predicts a positive (negative) relation between leverage and hedging for moderately (highly) leveraged firms. Consistent with the theory, empirically I find a non-monotonic relation between leverage and hedging. Further, the effect of leverage on hedging is higher for firms in highly concentrated industries.     

Heterogeneous effects of macroprudential policies on firm leverage and value

We empirically investigate the effect of financial institution-targeted macroprudential policies on firms using a comprehensive macroprudential policy dataset and corporate panel data across 35 countries. We find that tightening of macroprudential measures persistently curbs the leverage of firms, while loosening is related to the increase in leverage. We also find that this effect on leverage is heterogeneous across firms, as net macroprudential policy actions reduce the procyclicality of leverage more significantly for small firms and firms with high leverage. Also, we estimate the effect of macroprudential policies on firm value to evaluate potential policy trade-offs as the policies restrict the firms' access to credit during economic booms while protecting them from future financial crises. The effect of macroprudential policies on firm value is generally positive despite the policies' restrictive nature. Further, the effect on firm value is heterogeneous depending on firm characteristics: the positive effect becomes stronger as firms are less leveraged, but this positive effect is weaker for firms that grow faster, suggesting potential costs of macroprudential policies for these firms.     

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 Design of Financial Policies in Corporate Spin-offs

We examine differences in financial leverage between parentand spun-off firms that emerge from corporate spin-offs. Ourtests control for past financing choices and the costs of adjustingcapital structure, factors that can obscure cross-sectionalpatterns among firms' target leverage ratios. We find that firmsthat emerge from spin-offs with more financial leverage havea higher cash flow return on assets, lower variability of industryoperating income, and a greater proportion of fixed assets.The positive relation between profitability and the use of financialleverage, in a setting that is free of pecking order effects,is particularly important because it contrasts with existingevidence. Our results indicate that the ability to cover debtpayments and default-related costs are important determinantsof the use of financial leverage, as implied by the trade-offtheory of capital structure. We find no evidence that managerialincentives or governance characteristics affect the differencein leverage ratios in firms that emerge from spin-offs.     

How does uncertainty influence target capital structure?

This study investigates how uncertainty affects firms’ target capital structure using a panel data set of U.S. public manufacturers between 2003 and 2018 and finds that high-uncertainty firms have 10.1 (8.1) percentage points lower mean book (market) targets than low-uncertainty firms. This study also shows that the uncertainty effect on leverage targets is greater than the impact of firm size, market-to-book ratio, assets tangibility, R&D intensity, and industry median leverage, making uncertainty the most critical among all time-varying determinants of leverage targets. Further, this study finds that heightened uncertainty decreases debt tax shields, increases potential financial distress costs, and exacerbates debtholder–shareholder conflicts, thereby leading to a lower optimal or target leverage ratio.     

Voluntary IAS 1 accounting disclosures prior to official IAS adoption: An empirical investigation of UK firms

This paper focuses on firms’ voluntary compliance with the reporting requirements of the International Accounting Standard (IAS) 1 before the official adoption of IASs. The paper seeks to identify the motives for the voluntary adoption of IAS 1 and investigates the relation to the provision of voluntary accounting disclosures, the increase in equity capital, managers’ remuneration and firms’ stock returns. The study shows that the decision-making process of firms is significantly influenced by the intention to improve key financial measures, such as leverage, profitability and growth. Firms would tend to adopt an accounting policy or regulation when they feel that adoption would favourably impact on their financial situation. For example, the study indicates that firms voluntarily adopted IAS 1 before the official IAS adoption date in order to provide evidence of superior managerial ability and high quality reported accounting information. It is found that firms that perform well are more motivated to voluntarily abide by IAS 1. The study also reports that firms that provide voluntary accounting disclosures and perform increases in their equity capital appear to voluntarily adopt IAS 1. Similar findings are obtained for firms that display higher management remuneration and stock returns.     

Profitability and capital structure: Evidence from import penetration

Firms experiencing increases in import competition significantly reduce their leverage ratios by issuing equity and selling assets to repay debt. Using import tariffs and foreign exchange rates as instrumental variables for import penetration, I show that these results are not manifestations of endogenous relations between import competition and leverage. The results are consistent with traditional trade-off models of capital structure that predict a positive relation between book leverage and expected future profitability. Further evidence suggests that import competition affects leverage through changes in the trade-off between the tax benefits of debt and the costs of financial distress.