What Determines the Speed of Adjustment to the Target Capital Structure?

We use a dynamic adjustment model and panel methodology to investigate the determinants of a time-varying optimal capital structure. Because firms may temporarily deviate from their optimal capital structure in the presence of adjustment costs, we also endogenize the adjustment process. In particular, we analyze the effects of firm-specific characteristics as well as macroeconomic factors on the speed of adjustment to the target leverage. Our sample comprises a panel of 90 Swiss firms over the years 1991 to 2001. We find that faster growing firms and those that are further away from their optimal capital structure adjust more readily. Our results also reveal interesting interrelations between the adjustment speed and popular business cycle variables. For example, the speed of adjustment is higher when the term spread is higher, i.e., when economic prospects are goodCapital structure; dynamic adjustment; business cycle; panel data

What Determines the Speed of Adjustment to the Target Capital Structure?

We use a dynamic adjustment model and panel methodology to investigate the determinants of a time- varying optimal capital structure. Because firms may temporarily deviate from their optimal capital structure in the presence of adjustment costs, we also endogenize the adjustment process. In partic ular, we analyze the effects of firm-specific characteristics as well as macroeconomic factors on the speed of adjustment to the target leverage. Our sample comprises a panel of 90 Swiss firms over the years 1991 to 2001. We find that faster growing firms and those that are further away from their optimal capital structure adjust more readily. Our results also reveal interesting interrelations between the adjustment speed and popular business cycle variables. For example, the speed of adjustment is higher when the term spread is higher, i.e., when economic prospects are good.Capital structure, dynamic adjustment, business cycle, panel data

Corporate governance and expected stock returns: evidence from Germany

Recent empirical work shows that a better legal environment leads to lower expected rates of return in an international cross-section of countries. This paper investigates whether differences in firm-specific corporate governance also help to explain expected returns in a cross-section of firms within a single jurisdiction. Constructing a corporate governance rating (CGR) for German firms, we document a positive relationship between the CGR and firm value. In addition, there is strong evidence that expected returns are negatively correlated with the CGR, if dividend yields and price-earnings ratios are used as proxies for the cost of capital. Most results are robust for endogeneity, with causation running from corporate governance practices to firm fundamentals. Finally, an investment strategy that bought high-CGR firms and shorted low-CGR firms would have earned abnormal returns of around 12 percent on an annual basis during the sample period. We rationalize the empirical evidence with lower agency costs and/or the removal of certain governance malfunctions for the high-CGR firms

Firm Characteristics, Economic Conditions and Capital Structure Adjustment

We use a dynamic framework and panel methodology to investigate the determinants of a firms’ time-varying capital structure. Our sample comprises 706 European firms from France, Germany, Italy and the U.K. over the period from 1983 to 2002. If capital structure adjustment is costly, firms may deviate temporarily from their target debt ratios. Therefore, we endogenize the adjustment process and analyze the impact of firm-specific characteristics as well as macroeconomic factors on the speed of adjustment towards target leverage. We find that larger and faster growing firms as well as firms that are further away from their targets adjust more readily. Additionally, we document interesting relations between well-known business cycle variables and the adjustment speed. In a nutshell, firms adjust faster in favorable macroeconomic conditions, e.g., if interest rates are low and the risk of disruptions in the global financial system are negligible. We also document that capital structure decision are largely determined by financial constraints. Finally, we shed new light on the interdependence between book value based and market value based measures of leverage as well as on capital structure rebalancing issues.Capital Structure, dynamic analysis, panel data

The Determinants of the German Corporate Governance Rating

This paper analyzes the determinants of the German corporate governance rating recently developed by Drobetz, Schillhofer, and Zimmermann (2004). We find a non- linear relationship between ownership concentration and the quality of firmlevel corporate governance as measured by the rating. Firms with larger boards of directors have lower governance ratings, but firms that apply US-GAAP or IAS rules and/or use an option-based remuneration plan have higher corporate governance ratings. Our results question the comply-or-explain principle embedded in recent corporate governance codes and call for a more rules-based approach in improving corporate governance in Europe.Corporate governance, endogeneity, ownership structure, board size, accounting principles, executive compensation.

Predictability in the cross-section of European bank stock returns

This paper investigates the impact of individual bank fundamental variables on stock market returns using data from a panel of 235 European banks from 1991 to 2005. The sample period marks a significant transition in the European banking sector, characterized by higher competition, lower profit margins in the traditional interest-related business and increasing non-interest income in terms of fees and commissions. In panel regressions, we relate bank stock returns to fundamental accounting information and use several corrections for the standard errors to control for heteroscedasticity, autocorrelation and spatial correlation. Our results indicate that several bank-specific variables exhibit a robust explanatory power across different model specifications. Most important, there is a positive impact of the ratio of loans to total assets, the ratio of non-interest income to total income, and the ratio of off-balance sheet items to total assets on subsequent bank stock returns. In contrast, the ratio of loan-loss-provisions to net interest revenue and the ratio of book value of equity to total assets load negatively on subsequent bank stock returns. Overall, the valuation of bank stocks incorporates both the traditional loan-related side of the banking business and the growing off-balance activities.Asset pricing, bank stock returns, bank-specific accounting ratios.

Conditional Performance Evaluation for German Mutual Equity Funds

We investigate the performance of a sample of German mutual equity funds over NEWLINE the period from 1994 to 2003. Our general finding is that mutual funds, on average, NEWLINE hardly produce excess returns relative to their benchmark that are large enough to NEWLINE cover their expenses. This conclusion is drawn from a variety of model specifications NEWLINE and is robust to many different benchmarks. Compared to unconditional NEWLINE measures, fund performance substantially deteriorates when we measure conditional NEWLINE alphas both in single-index and multi-factor models. We also measure fund NEWLINE performance in the Euler-equation framework and test several specifications of the NEWLINE stochastic discount factor using GMM. The result that funds underperform even before NEWLINE costs is even more pronounced. Overall, given the fact that stock returns are to NEWLINE some extent predictable by using publicly available information, conditional analysis NEWLINE raises the hurdle for active managers seeking abnormal positive performance, NEWLINE because it gives them no credit for exploiting readily available information

Estimating the Cost of Executive Stock Options: Evidence from Switzerland

It is often argued that Black-Scholes (1973) values overstate the subjective value of stock options granted to risk-averse and under-diversified executives. We construct a “representative” Swiss executive and extend the certainty- equivalence approach presented by Hall and Murphy (2002) to assess the value-cost wedge of executive stock options. Even with low coefficients of relative risk aversion, the discount can be above 50% compared to the Black-Scholes values. Regression analysis reveals that the equilibrium level of executive compensation is explained by economic determinant variables such as firm size and growth opportunities, whereas the managers’ pay-forperformance sensitivity remains largely unexplained. Firms with larger boards of directors pay higher wages, indicating potentially unresolved agency conflicts. We reject the hypothesis that cross-sectional differences in the amount of executive pay vanish when risk-adjusted values are used as the dependent variable.Managerial compensation, incentives, executive stock options, option valuation, risk aversion

The Determinants of the German Corporate Governance Rating

This paper analyzes the determinants of the German corporate governance rating NEWLINE recently developed by Drobetz, Schillhofer, and Zimmermann (2004). We find a NEWLINE non- linear relationship between ownership concentration and the quality of firmlevel NEWLINE corporate governance as measured by the rating. Firms with larger boards of NEWLINE directors have lower governance ratings, but firms that apply US-GAAP or IAS NEWLINE rules and/or use an option-based remuneration plan have higher corporate governance NEWLINE ratings. Our results question the comply-or-explain principle embedded in NEWLINE recent corporate governance codes and call for a more rules-based approach in NEWLINE improving corporate governance in Europe