Debt Covenants and Capital Structure: Evidence from an Exogenous Shock to Debt Capacity

2012 ◽  
Author(s):  
Moshe Cohen ◽  
Sharon P. Katz ◽  
Gil Sadka
Keyword(s):  
Capital Structure ◽  
Debt Covenants ◽  
Exogenous Shock ◽  
Debt Capacity

Debt Covenants and the Speed of Capital Structure Adjustment

2017 ◽  
Author(s):  
Erik Devos ◽  
Shofiqur Rahman ◽  
Desmond Tsang
Keyword(s):  
Capital Structure ◽  
Debt Covenants ◽  
Structure Adjustment

Bankruptcy Costs and the Firm's Optimal Debt Capacity: A Positive Theory of Capital Structure

1977 ◽  
Vol 43 (4) ◽  
pp. 1453 ◽  
Author(s):  
Wayne Y. Lee ◽  
Henry H. Barker
Keyword(s):  
Capital Structure ◽  
Positive Theory ◽  
Bankruptcy Costs ◽  
Debt Capacity

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.

Asset Volatility and Capital Structure: Evidence from Corporate Mergers

2020 ◽  
Author(s):  
Oliver Levine ◽  
Youchang Wu
Keyword(s):  
Capital Structure ◽  
Direct Evidence ◽  
Coefficient Estimates ◽  
Firm Risk ◽  
Cross Sectional ◽  
Corporate Acquisitions ◽  
Percentage Point Increase ◽  
Point Increase ◽  
Asset Volatility ◽  
Debt Capacity

We exploit cross-sectional variation in the predictable changes in asset volatility following corporate acquisitions to identify the effect of business risk on capital structure. We find that postmerger changes in leverage and cash holdings are strongly predicted by expected asset volatility changes estimated using premerger information. These capital structure adjustments are partly achieved through the choice of payment method. Our findings provide direct evidence for the coinsurance effect of mergers on debt capacity. More broadly, they suggest that firm risk is a first-order determinant of leverage, consistent with the tradeoff theory of capital structure. Our coefficient estimates imply that a one-standard deviation decline in a firm’s asset volatility corresponds to a 7.5-percentage point increase in leverage. This paper was accepted by Renee Adams, finance.

scholarly journals Pecking order, earnings management and capital structure

Accounting ◽  
2021 ◽  
Vol 7 (6) ◽  
pp. 1389-1394 ◽  
Author(s):  
Novi Swandari Budiarso ◽  
Winston Pontoh
Keyword(s):  
Capital Structure ◽  
Earnings Management ◽  
Stock Exchange ◽  
Agency Problem ◽  
Agency Problems ◽  
Order Theory ◽  
Pecking Order ◽  
Pecking Order Theory ◽  
Corporate Capital Structure ◽  
Debt Capacity

Most of studies imply that firms decrease or increase their debt capacity in context of pecking order theory or agency problems. On this point, the setting of this study is based on two main problems related to capital structure: the first is determining the source of funds for financing investments, and the second is solving the conflict between shareholders and managers, or the agency problem. The objective of this study is to provide evidence about how firms establish their capital structure in relation to pecking order theory and the agency problem by controlling earnings management in the context of Indonesian firms. This study conducts logistic regression on 28 firms in the consumer goods industry listed on the Indonesia Stock Exchange from 2010 to 2017.This study finds that pecking order theory determines the capital structure of most Indonesian firms with high debt. The results imply that agency problems are unable to explain corporate capital structure and earnings management is not effective for motivating Indonesian firms to establish corporate governance.

The Pecking Order Theory of Capital Structure

2020 ◽  
Author(s):  
Murray Z. Frank ◽  
Vidhan Goyal ◽  
Tao Shen
Keyword(s):  
Capital Structure ◽  
Adverse Selection ◽  
Small Firms ◽  
Order Theory ◽  
Selection Problem ◽  
Pecking Order ◽  
Pecking Order Theory ◽  
Internal Resources ◽  
Debt Capacity ◽  
Adverse Selection Problem

The pecking order theory of corporate capital structure developed by states that issuing securities is subject to an adverse selection problem. Managers endowed with private information have incentives to issue overpriced risky securities. But they also understand that issuing such securities will result in a negative price reaction because rational investors, who are at an information disadvantage, will discount the prices of any risky securities the firm issues. Consequently, firms follow a pecking order: use internal resources when possible; if internal funds are inadequate, obtain external debt; external equity is the last resort. Large firms rely significantly on internal finance to meet their needs. External net debt issues finance the minor deficits that remain. Equity is not a significant source of financing for large firms. By contrast, small firms lack sufficient internal resources and obtain external finance. Although much of it is equity, there are substantial issues of debt by small firms. Firms are sorted into three portfolios based on whether they have a surplus or a deficit. About 15% of firm-year observations are in the surplus group. Firms primarily use surpluses to pay down debt. About 56% of firm-year observations are in the balance group. These firms generate internal cash flows that are just about enough to meet their investment and dividend needs. They issue debt, which is just enough to meet their debt repayments. They are relatively inactive in equity markets. About 29% of firm-year observations are in the deficit group. Deficits arise because of a combination of negative profitability and significant investments in both real and financial assets. Some financing patterns in the data are consistent with a pecking order: firms with moderate deficits favor debt issues; firms with very high deficits rely much more on equity than debt. Others are not: many equity-issuing firms do not seem to have entirely used up the debt capacity; some with a surplus issue equity. The theory suggests a sharp discontinuity in financing methods between surplus firms and deficit firms, and another at debt capacity. The literature provides little support for the predicted threshold effects. The theoretical work has shown that adverse selection does not necessarily lead to pecking order behavior. The pecking order is obtained only under special conditions. With both risky debt and equity being issued, there is often scope for many equilibria, and there is no clear basis for selecting among them. A pecking order may or may not emerge from the theory. Several articles show that the adverse selection problem can be solved by certain financing strategies or properly designed managerial contracts and can even disappear in dynamic models. Although adverse selection can generate a pecking order, it can also be caused by agency considerations, transaction costs, tax consideration, or behavioral decision-making considerations. Under standard tests in the literature, these alternative underlying motivations are commonly observationally equivalent.

scholarly journals Debt Capacity and Tests of Capital Structure Theories

2010 ◽  
Vol 45 (5) ◽  
pp. 1161-1187 ◽  
Author(s):  
Michael L. Lemmon ◽  
Jaime F. Zender
Keyword(s):  
Capital Structure ◽  
Good Description ◽  
High Growth ◽  
Order Theory ◽  
Pecking Order ◽  
Pecking Order Theory ◽  
Growth Firms ◽  
Debt Capacity ◽  
Financing Behavior ◽  
The Impact

AbstractWe examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt capacity largely explain the use of new external equity financing by publicly traded firms. Finally, we present evidence that reconciles the frequent equity issues by small, high-growth firms with the pecking order. After accounting for debt capacity, the pecking order theory appears to give a good description of financing behavior for a large sample of firms examined over an extended time period.

scholarly journals Do local governments use municipal companies for off-balance-sheet financing?

2020 ◽  
Vol 7 (54) ◽  
pp. 242-257
Author(s):  
Weronika Stobieniecka ◽  
Anna Białek-Jaworska
Keyword(s):  
Capital Structure ◽  
Corporate Finance ◽  
Local Governments ◽  
Balance Sheet ◽  
Agency Problems ◽  
Ordinary Least Squares ◽  
Explanatory Variables ◽  
The Public ◽  
Debt Capacity

AbstractThis paper investigates whether municipalities in Poland use their municipal companies to increase debt capacity beyond the limitations imposed by the fiscal debt rules. The article presents corporate governance and agency problems on the example of relations between local government units and affiliated companies. We review and link literature on corporate finance, in particular capital structure, and public finance - debt liabilities of municipalities. We analyse a sample of 2,019 observations of municipalities and their municipal companies using the Ordinary Least Squares (OLS) method, where explanatory variables were taken from the public and corporate finance (leverage and its determinants). Results show that long-term debt of municipalities is positively associated with the leverage and size of municipal companies, but it is negatively related to their profitability.

scholarly journals O setor como determinante da estrutura de capital: evidências após as alterações das alíquotas do IPI no Brasil

2019 ◽  
Vol 17 (1) ◽  
pp. 1
Author(s):  
Rossimar Laura Oliveira ◽  
Eduardo Kazuo Kayo
Keyword(s):  
Treatment Group ◽  
Capital Structure ◽  
Direct Relationship ◽  
Empirical Investigation ◽  
Econometric Model ◽  
Exogenous Shock ◽  
Brazilian Government ◽  
The Mean ◽  
The Relationship

This paper is an empirical investigation that uses IPI benefits (tax benefit) offered by the Brazilian government as an exogenous shock in the relationship between firm and industry leverage. We used data from Brazilian companies between 2007 and 2015. The econometric model used was diff-in-diff-in-diff. The results show a direct relationship between the mean industry leverage and the firm’s leverage. The same remains for the treatment group after inclusion of exogenous shock of IPI reduction in the model. These results are aligned with studies that consider the industry as the principal influencing aspect of the firm's capital structure.

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