Do Firms Purposefully Change Capital Structure? Evidence from an Investment-Opportunity Shock to Drug Firms

2020 ◽  
pp. 1-30
Author(s):  
Erasmo Giambona ◽  
Joseph Golec ◽  
Florencio Lopez-de-Silanes
Keyword(s):  
Capital Structure ◽  
Price Competition ◽  
Debt Maturity ◽  
Investment Opportunity ◽  
Convertible Debt ◽  
Financial Flexibility ◽  
Structure Changes ◽  
Unsecured Debt ◽  
Investment Opportunities ◽  
Debt Capacity

We study the capital structure changes of drug firms after an investment-opportunity shock brought about by the Biologics Price Competition and Innovation Act. Using a difference-in-difference approach, we show that the shock led drug firms to make their capital structures less constraining by decreasing leverage, shortening debt maturity, increasing unsecured debt, and reducing convertible debt. New debt covenants became less restrictive and firms raised equity to preserve borrowing capacity. Our results support the view that firms actively manage their capital structures to bolster financial flexibility and increase debt capacity in response to new investment opportunities.

Valuing firm’s financial flexibility under default risk and bankruptcy costs: a WACC based approach

2019 ◽  
Vol 15 (5) ◽  
pp. 688-699
Author(s):  
Carlo Mari ◽  
Marcella Marra
Keyword(s):  
Capital Structure ◽  
Default Risk ◽  
Weighted Average ◽  
Debt Management ◽  
Costs And Benefits ◽  
Debt Structure ◽  
Financial Flexibility ◽  
Content Type ◽  
Bankruptcy Costs ◽  
Debt Capacity

PurposeThe purpose of this paper is to present a model to value leveraged firms in the presence of default risk and bankruptcy costs under a flexible firm’s debt structure.Design/methodology/approachThe authors assume that the total debt of the firm is a combination of two debt components. The first component is an active debt component which is assumed to be proportional to the firm’s value. The second one is a passive predetermined risk-free debt component. The combination of the two debt categories makes the firm’s capital structure more realistic and allows us to include flexibility into the firm’s debt structure management. The firm’s valuation is performed using the discounted cash flow technique based on the weighted average cost of capital (WACC) method.FindingsThe model can be used to define active debt management strategies that can induce the firm to deviate from its capital structure target in order to preserve debt capacity for future funding needs. The firm’s valuation is performed by using the WACC method and a closed form valuation formula is provided. Such a formula can be used to value costs and benefits of financial flexibility.Research limitations/implicationsThe proposed approach provides a good compromise between mathematical complexity and model capability of interpreting the various economic and financial aspects involved in the firm’s debt structure puzzle.Practical implicationsThis model offers a realistic approach to practical applications where real financing decisions are characterized by a simultaneous use of these two debt categories. By comparing costs and benefits deriving from using unused debt capacity for future funding needs, the model provides a quantitative support to investigate if financial flexibility can add value to firms.Originality/valueTo the authors knowledge, the approach the authors propose is the first attempt to build a valuation scheme that accounts for firm’s financial flexibility under default risky debt and bankruptcy costs. Including financial flexibility, this model fills an important gap in the literature on this topic.

The Effect of Financial Flexibility on Payout Policy

2018 ◽  
Vol 55 (1) ◽  
pp. 263-289
Author(s):  
Anil Kumar ◽  
Carles Vergara-Alert
Keyword(s):  
Causal Effect ◽  
Sharp Decrease ◽  
Payout Policy ◽  
Share Repurchases ◽  
Standard Deviation Increase ◽  
Financial Flexibility ◽  
Exogenous Shocks ◽  
Investment Opportunities ◽  
Debt Capacity ◽  
Real Estate Prices

We use variation in real estate prices as exogenous shocks to firms’ debt capacity to study the causal effect of financial flexibility on payout policy. We show that an increase in financial flexibility results in higher dividends, share repurchases, and payout flexibility. We find that a 1-standard-deviation increase in a firms’ collateral value results in 0.26- and 0.55-percentage-point increases in nondiscretionary and discretionary payouts, respectively. This effect is stronger for firms with few investment opportunities. Moreover, highly leveraged firms are more likely to cut dividends in response to a sharp decrease in their financial flexibility.

scholarly journals Financial Flexibility as an Investment Efficiency Factor in Asian Companies

2018 ◽  
Vol 20 (2) ◽  
pp. 137 ◽  
Author(s):  
Victoria Cherkasova ◽  
Evgeny Kuzmin
Keyword(s):  
Investment Efficiency ◽  
Small Companies ◽  
Investment Activity ◽  
Financial Flexibility ◽  
Investment Expenditure ◽  
Institutional Economic ◽  
The Difference ◽  
Debt Capacity ◽  
The Impact ◽  
Capacity Method

This study explores the impact of a company’s financial flexibility on the effectiveness of its investments.The number of companies that have financial flexibility was calculated with the application of thespare debt capacity method. The research identifies the impact of financial flexibility on investment activity and on the level of suboptimal investments. The data from 1,736 companies in theAsian region, during the 2005-2015time period, are presented. The Asian region has unique institutional, economic and commercial environments that present a great basis for this paper. The results of the research reveal that financially flexible companies spend more on their investment expenditure and conduct more effective investment policiesby reducing the level of over- and underinvestment. Financial flexibility helps companies to make effective investments during a crisis period, but the difference in the flexibility between developed and developing countries and between large and small companies was not observed.

Sign in / Sign up

Export Citation Format

Share Document