Firms' Histories and Their Capital Structures

This paper examines how cash flows, investment expenditures and stock price histories affect corporate 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 their effects are subsequently at least partially reversed. These results indicate that although a firm's history strongly influence their capital structures, that over time, financing choices tend to move firms towards target debt ratios that are consistent with the tradeoff theories of capital structure.

Are Corporate Default Probabilities Consistent with the Static Tradeoff Theory?

Default probability plays a central role in the static tradeoff theory of capital structure. We directly test this theory by regressing the probability of default on proxies for costs and benefits of debt. Contrary to predictions of the theory, firms with higher bankruptcy costs, i.e., smaller firms and firms with lower asset tangibility, choose capital structures with higher bankruptcy risk. Further analysis suggests that the capital structures of smaller firms with lower asset tangibility, which tend to have less access to capital markets, are more sensitive to negative profitability and equity value shocks, making them more susceptible to bankruptcy risk.

Managerial Discretion and the Capital Structure Dynamics

This paper examines the effect of managerial discretion on capital structure dynamics. Analyses of financing decisions indicate that managers with more discretion prefer issuing equity over debt. Examination of leverage changes suggests that increases in debt ratios due to positive and negative financial deficits are greater for managers with high discretion. Furthermore, when managers have high‐ discretion, debt changes seem to be more sensitive to issuance activities than to repurchase activities. For high‐discretion managers, market timing activities (equity issuance following increases in stock prices) and the passive response to stock price appreciations, result in greater declines in debt ratios. Finally, while firms tend to rebalance their capital structures over time regardless of the level of managerial discretion, the speed of target adjustment is much slower for high‐discretion managers

Two essays on capital structure

textThis dissertation consists of two essays on capital structure. Essay one, joint with Sheridan Titman, examines how cash flows, investment expenditures and stock price histories affect corporate 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 their effects are subsequently at least partially reversed. These results indicate that although a firm’s history strongly influence their capital structures, that over time, financing choices tend to move firms towards target debt ratios that are consistent with the tradeoff theories of capital structure. Essay two examines how managerial entrenchment, defined here as the extent to which managers can act in their self-interest, influences the levels of and changes in debt ratios. Consistent with prior research, I find that entrenched managers prefer lower leverage. Analyses of financing decisions indicate that they achieve lower debt ratios by issuing more equity and retaining more profits. Debt issuance, however, does not appear to be influenced by entrenchment. Examination of leverage changes suggests that increases in debt ratios in response to external financing needs are similar for all types of managers. Finally, building on the documented market timing effect on capital structure, I find that decreases in leverage due to equity issuance following increases in stock prices are greater when managers are entrenched.Financ

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