Firms’ histories and their capital structures

This paper examines how cash flows, investment expenditures, and stock price histories affect debt ratios. Consistent with earlier work, we find that these variables have a substantial influence on changes in capital structure. Specifically, stock price changes and financial deficits (i.e., the amount of external capital raised) have strong influences on capital structure changes, but in contrast to previous conclusions, we find that over long horizons their effects are partially reversed. These results indicate that although firms’ histories strongly influence their capital structures, over time their capital structures tend to move towards target debt ratios that are consistent with the tradeoff theories of capital structure.     

Predicting systematic risk: Implications from growth options

In accordance with the well-known financial leverage effect, decreases in stock prices cause an increase in the levered equity beta for a given unlevered beta. However, as growth options are more volatile and have higher risk than assets in place, a price decrease may decrease the unlevered equity beta via an operating leverage effect. This is because price decreases are associated with a proportionately higher loss in growth options than in assets in place. Most of the existing literature focuses on the financial leverage effect: This paper examines both effects. We show, with a simple option pricing model, the opposing effects at work when the firm is a portfolio of assets in place and growth options. Our empirical results show that, contrary to common belief, the operating leverage effect largely dominates the financial leverage effect, even for initially highly levered firms with presumably few growth options. We then link variations in betas to measurable firm characteristics that proxy for the fraction of the firm invested in growth options. We show that these proxies jointly predict a large fraction of future cross-sectional differences in betas. These results have important implications on the predictability of equity betas, hence on empirical asset pricing and on portfolio optimization that controls for systematic risk.     

A Dynamic Model of Optimal Capital Structure

This paper presents a continuous time model of a firm that candynamically adjust both its capital structure and its investmentchoices. In the model we endogenize the investment choice aswell as firm value, which are both determined by an exogenousprice process that describes the firm's product market. Withinthe context of this model we explore cross-sectional as wellas time-series variation in debt ratios. We pay particular attentionto interactions between financial distress costs and debtholder/equityholderagency problems and examine how the ability to dynamically adjustthe debt ratio affects the deviation of actual debt ratios fromtheir targets. Regressions estimated on simulated data generatedby our model are roughly consistent with actual regressionsestimated in the empirical literature.     

Market Imperfections, Investment Flexibility, and Default Spreads

This paper develops a structural model that determines default spreads in a setting where the debt's collateral is endogenously determined by the borrower's investment choice, and a demand variable with permanent and temporary components. We also consider the possibility that the borrower cannot commit to taking the value‐maximizing investment choice, and may, in addition, be constrained in its ability to raise external capital. Based on a model calibrated to data on office buildings and commercial mortgages, we present numerical simulations that quantify the extent to which investment flexibility, incentive problems, and credit constraints affect default spreads.     

The determinants of office cap rates: The international evidence

We examine commercial office cap rates in 89 large cities in 33 developed and developing countries in the 2000–2019 period. We find that cap rates decline throughout the world over this period, reflecting a corresponding decline in the real rate of interest. In the cross-city analysis our most robust findings are that office cap rates are lower in wealthier cities, especially those that are either considered gateway cities or financial centers. In addition, cap rates tend to be higher in countries with lower credit ratings and higher inflation rates. We find that cap rates in suburban office markets are higher than in central business districts, and for a given metropolis, suburban cap rates are lower in suburbs with better public transport connections to the central business district. Finally, evidence from regressions with city fixed effects reveal that cap rates rise as the discount rate and vacancy rates increase and fall as cities get wealthier.     

Feedback from Stock Prices to Cash Flows

Feedback from financial market prices to cash flows arises when a firm's nonfinancial stakeholders, for example, its customers, employees, and suppliers, make decisions that are contingent on the information revealed by the price. Complementarities across stakeholders result in cascades, wherein relatively small stock price moves trigger substantial changes in asset values. This paper analyzes the relation between such feedback effects and parameters such as the information cost, the volatility of existing projects, the risk aversion of liquidity suppliers, and the precision of managerial information.