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Unlike the extensive literature on the more general topic of capital structure, empirical research in the corporate debt maturity area is still scant. Related studies had formulated theoretical justifications for the observed cross-sectional multiplicity of debt maturities without a parallel concern in empirical research and to date, little empirical work has been conducted to test those formulations. In this context, this paper makes a major contribution in that it attempts to explain how corporate debt maturity choice is determined. At the core of this study is a general multiple choice model that makes it possible to examine how the different hypotheses on debt maturity advanced thusfar determine that choice. Using an ordered model as opposed to a simple model had the advantage of capturing the segmentation in the debt maturity market while allowing a gain in efficiency for the parameter estimates. The results from this model lend strong support to the hypothesis that, overall, when choosing the maturity of a new debt, corporate managers seek to minimize the agency costs of debt in general, especially those from the incentive for wealth expropriation by investing in riskier projects than originally anticipated. The evidence is also consistent with the assumption that managers do commit themselves not to transfer wealth from bondholders to stockholders by attaching protective covenants to the newly issued debt. Finally, the model's classificatory ability is tested for meaningfulness by comparing it to the proportional chance model.
This thesis aims to add empirical evidence to the corporate finance literature by looking at the financing decisions with a specific application to small companies in the context of the UK relatively highly regulated Main market, versus the lightly regulated Alternative Investment Market (AIM). I do this by gathering data on all quoted dead and alive companies in both markets from 1995 to 2008. I then split my sample firms in each market into different size groups and test my hypothesis within and across each group and each market. The thesis consists of six chapters. After an introductory chapter, I review the existing literature on capital structure and debt maturity controversies with an emphasis on recent empirical work. The next three chapters consist of three research papers. The first paper looks at the capital structure decisions of companies quoted in AIM and Main market across different size groups. In the second research paper, the maturity structure of debt is investigated in both markets. The third research paper tests the determinants of the delisting decision, particularly the effect of leverage using a sample of AIM companies. In the last chapter, I provide a summary of the main conclusions of the study and highlight some promising ideas for future research. The first empirical chapter analyses the drivers of leverage across firms' sizes and market of quotation. I find that companies that are listed on the Main market have higher leverage than those listed on AIM. My results show that AIM companies are subject to higher business risk and tend to have lower profitability and tangible assets. In addition, in both markets, small companies are different from large firms in their level of leverage, tangibility of assets, and profitability, suggesting that the drivers of the financing choice are size dependent. Interestingly, the impact of taxation is limited to only large companies in both markets. Similarly, the impact of the agency conflict is also limited to large companies, as for small firms I find a positive relationship between leverage and growth opportunities, in contrast to the predictions of the agency theory. These results suggest that size rather than market of quotation is more likely to explain firms' leverage. However, I find that the market of quotation affects their speed of adjustment toward target leverage ratios. Using the dynamic model of capital structure, I find that in the Main market, small companies adjust more rapidly than large firms, suggesting that they rely more on bank debt and thus result in lower costs of adjustment. In contrast, large firms on the AIM adjust more rapidly than small companies, suggesting that small AIM companies are subject to the highest costs of adjustment as they have the highest business risk and the lowest profitability. The second empirical paper investigates the determinants of the structure of debt maturity across firms' size groups in both markets. I find that firms quoted in the Main market use longer maturity of debt in contrast to their AIM counterparts. However, the structure of debt maturity is different between small and large companies, as small companies use shorter debt maturity. Moreover, I find that the determinants of debt maturity are relatively different across the two sets of markets, suggesting that the market of quotation, are likely to affect the structure of debt maturity. Particularly, the effect of leverage is mixed in those markets. In the Main market, companies with higher leverage use more long-term debt in contrast to those quoted in the AIM. In line with my results in the previous chapter, I find that the speed of adjustment depends on the market of quotation. Using a dynamic framework, I find that companies have a target debt maturity, but, while in the AIM large companies adjust more rapidly than small companies, I find the opposite in the Main market. I also contribute to the literature by assessing the impact of firm's life cycle on its choice of debt maturity. I use a sample of newly listed firms and assess the evolution of the maturity structure of their debt four years after their IPO. I find strong differences across the two markets. In the Main market, my empirical evidence shows that in contrast with small companies, large companies change the structure of their debt maturity significantly as they are more likely to use longer maturity of debt in the post-IPO period. While in the AIM, the structure of debt maturity is not affected by size as neither large companies nor small companies change their debt maturity significantly. In the last empirical chapter, I study the impact of leverage on the delisting decision. I address the following questions: Do firms delist from the stock market because they are unable to raise equity capital and redress their balance sheet? Previous studies state that raising equity capital is one of the main benefits of stock market quotation. I expect firms that are not likely to take advantage of this benefit to have higher listing costs and more likely to delist. I use leverage as a proxy variable and a sample of voluntary delisting from AIM. I find that delisted companies have higher leverage as they did not raise equity capital over their public life. My results suggest that companies with higher leverage are more likely to delist voluntarily. These results hold even after controlling for agency conflicts, liquidity, and asymmetric information. I also investigate how the market reacts to the delisting announcement. I find that on the announcement date, stock prices decrease significantly. However, this reaction is not consistent with previous studies that report positive excess returns for companies that go private through different forms of buyouts. The voluntary delisting does not deliver good news to the market and hence voluntary delisting leads to a decrease in stock prices. I also find that firms that increased their leverage in the year prior to the delisting decision generate significantly lower excess returns than other firms. I compare my results to firms that delisted from the AIM but moved to the Main market. I find that that these firms generate statistically higher and positive returns than the remaining firms that delisted voluntarily. My results highlight the negative impact of leverage and a lack of equity financing on firms' market valuation. My results contribute to the literature and to policy making in several ways. First, I test various controversial and new hypotheses by focussing on differences in institutional settings between the AIM and the Main market. The former is less regulated and it is more likely to attract younger, high growth, and riskier companies. These differences allow me to test various hypotheses developed in previous literature relating to the financing choices of firms. In addition, I provide a deeper analysis of the impact of size on the firms' financing choices. I focus on the differences in leverages across the two, markets, changes in maturity from the IPQ dates, and the drivers of the decision and timing from the IPQ date of companies in the UK. Unlike previous studies, I show that the theoretical determinants of leverage, such as taxation and agency costs, across firms' size groups are not homogeneous, independently of the market quotation. However, I find significant differences across the two markets in terms of dynamic changes in leverage. In addition, my results highlight the impact of leverage on the decision to delist, and imply that policy makers need to facilitate the financing of companies when they list on the market, so that the benefits of listings outweigh the costs, and firms will not rush to voluntary delisting.
Empirical Capital Structure reviews the empirical capital structure literature from both the cross-sectional determinants of capital structure as well as time-series changes.
Abstract This paper focuses on the dynamic capital structure of firms: Why firms choose very different capital structure in different stages of their life-cycles? In a model of optimal financial contracting, we investigate whether subsequent financing decisions of firms are affected by the outcome of previous financing decisions. We find that the initial and subsequent financing decisions of the same firm may lead to different security choices. The firms' financing decisions will differ in two respect. First, there will be equilibrium contracts that investors would reject for some small firm, but accept them for an otherwise identical large firm (i.e. when the two firms have identical projects). Secondly, even the set of the equilibrium financial contracts differs in different stages of the firm's lifecycle: some contracts which are never sustainable as an initial contract for a small firm become sustainable for large firms. The reason is the stage-dependency of the control rights of subsequent claimholders: in addition to their own rights, holders of subsequent security issues may also rely on the firm's existing investors to enforce their claims. Whether or not they can do so, depends on the priority structure of the claims.Consistent with empirical evidence, our theory implies a life-cycle pattern of financing: firms will issue outside equity, short-term debt or convertible debt first, then use their retained earnings, issue longer-term debt, or outside equity to satisfy sub-sequent financing needs. A novel result of our analysis is that, despite the presence of severe market imperfections, the Modigliani-Miller indifference result between debt and equity does hold for large firms in our model, but at the same time, it fails to hold for small firms. The intuition is again the interaction between the control rights of subsequent claimholders. Since the control rights of previous securityholders represent an externality for subsequent claimholders, the marginal decision of which security to issue next becomes irrelevant once a firm has sufficient contractual complexity in place.
If Pecking Order behavior of financing choice is mitigated by debt capacity concerns, then Tradeoff and Pecking Order theories are difficult to distinguish empirically. In this paper, we extend the Myers and Majluf (1984) model to derive new testable implications of the interaction between adverse selection costs and debt capacity constraints. Our model predicts that the probability of debt issuance will be a non-monotonic function of the size of the financing deficit. The probability of debt issuance will initially increase in the size of the deficit as adverse selection costs of issuing equity outweigh the costs due to loss of debt capacity, then decrease as costs due to loss of debt capacity become more important, and finally increase again as the deficit becomes very large. Our empirical tests on a sample of firms from COMPUSTAT from 1971-1998 classified into five size groups demonstrate that, even after allowing for the possible endogeneity of the financing deficit, the predicted non-monotonicity prevails for all size group of firms. Even for those firms in the smallest size group for which debt capacity is not a dominant concern, the initial range over which the relationship between the deficit size and the probability of debt issue is significantly positive includes as much as 67% of all issues. Consistent with the predictions of the model, the intermediate range between the two turning points (over which the probability of debt issue decreases in the size of the deficit and debt capacity concerns dominate) is larger for smaller and younger firms. It is also larger for firms with lower past profitability, and firms with higher growth opportunities. We also find that the probability of debt issue is lower (higher) for firms that are above (below) an estimated target debt ratio, and higher for firms with higher past profitability, lower market-to-book, and poor recent stock price performance. Aside from demonstrating the relevance of both adverse selection costs and debt capacity constraints for firms' financing decisions, our results also show that firms exhibit target-reverting behavior and time the market.
Despite ample research on corporate financing decisions, there is a growing interest in deepening our understanding of how firms structure their financing needs. In this dissertation, we build upon previous work on capital structure by examining the impact of firm-specific and macroeconomic risks on the capital structure of UK manufacturing firms. In particular, the dissertation consists of three separate, yet related essays. Each essay intends to serve a specific objective. The essays, in the order in which they appear, are entitled as follows: Essay I: The Response of Firms' Leverage to Risks: Evidence from UK Public versus Non-Public Firms Essay II: Capital Structure Adjustments: Do Macroeconomic and Business Risks Matter? Essay III: Macroeconomic Dynamics, Idiosyncratic Risk, and Firms' Security Issuance Decisions: An Empirical Investigation of UK Manufacturing Firms In the first essay, we empirically investigate whether the sensitivity of leverage to firm-specific (idiosyncratic) and macroeconomic risk differs across publicly listed and privately owned firms. We also study the implications of cash reserves-risk interactions for firms' leverage decisions. Using data from the Financial Analysis Made Easy (FAME) database, the analysis is carried out for a large panel of UK manufacturing firms over the period 1999-2008. The results provide significant evidence that UK manufacturing firms use less short-term debt in their capital structure during periods of high risk. This finding holds for both types of risk. The results on the differential effects of risk across public and non-public firms indicate that while the leverage of non-public firms is more sensitive to firm-specific risk in comparison to their public counterparts, the effects of macroeconomic risk on leverage are similar for both types of firms. The results of the indirect effects of risk show that firms with high levels of cash holdings are more (less) likely to reduce their leverage in periods when firm-specific (macroeconomic) is risk. On the whole, the results that we document in this essay provide strong evidence of the heterogenous sensitivities of leverage to risk across both types of firms and across different levels of firms' cash holdings. Essay II examines how risk affects firms' leverage adjustment decisions. Specifically, in this essay, we study the impact of risk about firms' own business activity and macroeconomic conditions on the speed with which firms adjust their capital structure toward their specific leverage targets. In doing this, we use an annual panel data obtained from the WorldScope file via DataStream for a fairly large sample of quoted UK manufacturing, covering the period 1981-2009. The results suggest that the adjustment is asymmetric and it depends on the magnitude of risk, the type of risk, and whether firms' actual leverage is above or below the target. Further, we find that firms with financial surpluses and above-target leverage adjust their leverage faster when firm-specific risk is low and when macroeconomic risk is high. In contrast, firms with financial deficits and below-target leverage are more likely to align their leverage toward their target in periods when both types of risk are low. Taken as a whole, our results suggest that firms adjust their leverage toward the target very asymmetrically across different levels and types of risk. This finding holds true even when we take into account several firm characteristics known to affect firms' adjustment speeds. The third essay analyzes how risk about firms' own business activity and macroeconomic conditions influences the security issuance decisions of listed UK manufacturing firms appeared on the WorldScope database during the period from 1981-2009. Estimating dynamic panel models using the system GMM estimator, we show that the issuance of new debt is significantly negatively related to idiosyncratic risk while both the issuance of new equity and the use of internally generated funds (retained earnings) are positively related to the risk. In contrast, we find that all these three sources of financing are significantly negatively associated with macroeconomic risk. Nevertheless, our results suggest that the aggregate dynamics of firms' target leverage are significantly negatively linked with these two types of risk. The results, from the debt-equity choice regression, indicate that the effect of both firm-specific and macroeconomic risk is significant and negative, implying that firms are likely to have low debt-equity ratio in periods when either type of risk is high.