• Selected
• Entire List

Abstract:
We provide evidence on the covenant structure of corporate loan agreements. Building on the work of Jensen and Meckling (1976), Myers (1977) and Smith and Warner (1979), we summarize and test the implications for what we refer to as the Agency Theory of Covenants (ATC), using a large sample of privately placed corporate debt. Our results are consistent with many of the implications of the ATC, including a negative relation between the promised yield on corporate debt and the presence of covenants. We also find that borrower and lender characteristics, as well as macroeconomic factors, determine covenant structure. Loans are more likely to include protective covenants when the borrower is small, has high growth opportunities or is highly levered. Loans made to investment banks and syndicated loans are also more likely to include protective covenants, as are loans made during recessionary periods or when credit spreads are large. Finally, we show that consistent with the ATC, firms that elect to issue private rather than public debt are smaller, have greater growth opportunities, less long term debt, fewer tangible assets, more volatile cash flows and include more covenants in their debt agreements. An important byproduct of our analysis is to demonstrate empirically that covenant structure and the yield on corporate debt are determined simultaneously.

Abstract:
We provide evidence on the covenant structure of corporate loan agreements. Building on the work of Jensen and Meckling (1976), Myers (1977) and Smith and Warner (1979), we summarize and test the implications for what we refer to as the Agency Theory of Covenants (ATC), using a large sample of privately placed corporate debt. Our results are consistent with many of the implications of the ATC, including a negative relation between the promised yield on corporate debt and the presence of covenants. We also find that borrower and lender characteristics, as well as macroeconomic factors, determine covenant structure. Loans are more likely to include protective covenants when the borrower is small, has high growth opportunities or is highly levered. Loans made by investment banks and syndicated loans are also more likely to include protective covenants, as are loans made during recessionary periods or when credit spreads are large. Finally, we show that consistent with the ATC, firms that elect to issue private rather than public debt are smaller, have greater growth opportunities, less long term debt, fewer tangible assets, more volatile cash flows and include more covenants in their debt agreements. An important byproduct of our analysis is to demonstrate empirically that covenant structure and the yield on corporate debt are determined simultaneously.

Keywords: Bond Covenants, Costly Contracting hypothesis, Bank Loans, Corporate Debt, Agency Costs, Simultaneity

Abstract:
We quantify the empirical relevance of the pecking order hypothesis using a novel empirical model and testing strategy that addresses statistical power concerns with previous tests. While the classificatory ability of the pecking order varies significantly depending on whether one interprets the hypothesis in a strict or liberal (e.g., "modified" pecking order) manner, the pecking order is never able to accurately classify more than half of the observed financing decisions. However, when we expand the model to incorporate factors typically attributed to alternative theories, the predictive accuracy of the model increases dramatically --- accurately classifying over 80% of the observed debt and equity issuances. Finally, we show that what little pecking order behavior can be found in the data is driven more by incentive conflicts, as opposed to information asymmetry.

Capital Structure, Pecking Order, Information Asymmetry, Debt Capacity

Abstract:
We empirically examine whether firms engage in dynamic rebalancing of their capital structures, while allowing for costly adjustment. We begin by showing that the presence of adjustment costs has significant implications for the dynamic behavior of corporate financial policy and the interpretation of previous empirical results. Then, after confirming that financing behavior is consistent with the presence of adjustment costs, we use a dynamic duration model to show that firms behave as though adhering to a financial policy in which they actively rebalance their leverage to stay within an optimal range. We find that firms respond to changes in their equity value, due to price shocks or equity issuances, by adjusting their leverage over the two to four years following the change. The presence of adjustment costs, however, often prevents this response from occurring immediately, resulting in shocks to leverage that have a persistent effect. Our evidence suggests that this persistence is more likely a result of optimizing behavior in the presence of adjustment costs, as opposed to indifference towards capital structure.

Abstract:
We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate investment. Using a regression discontinuity design, we show that capital investment declines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in investment is concentrated in situations where agency and information problems are relatively more severe, highlighting how the state contingent allocation of control rights can help mitigate investment distortions arising from financing frictions.

Investment, Covenant, Debt, Contracts, Renegotiation, Default, Control Rights

Abstract:
We examine the evolution of corporate capital structures and find that little of the variation in leverage is captured by previously identified determinants, such as size, market-to-book, profitability, industry, etc. Instead, the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: High (low) levered firms tend to remain as such for over two decades. Additionally, this feature of leverage is robust to firm exit, is present prior to the IPO, and is largely unaffected by the process of going public, suggesting that variation in capital structures is primarily explained by factors that remain relatively stable for long periods of time.

Capital Structure, Financing Decisions, Tradeoff, Pecking Order

Abstract:
We show that incentive conflicts between firms and their creditors have a large impact on corporate debt policy. Net debt issuing activity experiences a sharp and persistent decline following debt covenant violations, when creditors use their acceleration and termination rights to increase interest rates and reduce the availability of credit. The effect of creditor actions on debt policy is strongest when the borrower's alternative sources of finance are costly. In addition, despite the less favorable terms offered by existing creditors, borrowers rarely switch lenders following a violation.

Capital Structure, Financial Policy, Debt, Control Rights, Optimal Contracting

Abstract:
This paper examines the dynamic properties of capital structure in a state-space framework. A system of stochastic differential equations is used to specify the dynamics for a firm's debt-to-equity ratio and the determinants of capital structure. The framework addresses statistical issues such as measurement error, missing data and endogeneity. There are several important results. First, firms gradually adjust their capital structure to a firm-specific, time-varying target, as opposed to a fixed level or industry average. Second, the rate at which they revert back to the target depends on several factors: the current position of their leverage relative to the target, their industry, and their financial health. Finally, the statistical issues have a significant impact on the results and subsequent conclusions. The primary economic conclusion is that observed financing behavior may be driven by concerns over credit-worthiness and access to external funds.

Capital Structure, Leverage, Dynamics, Kalman Filter

Abstract:
Using a large sample of private credit agreements between US publicly traded firms and financial institutions, we show that over 90% of long-term debt contracts are renegotiated prior to their stated maturity. Renegotiations result in large changes to the amount, maturity, and pricing of the contract, occur relatively early in the life of the contract, and are rarely a consequence of distress or default. Our analysis of the determinants of renegotiation reveal that the accrual of new information concerning the credit quality, investment opportunities, and collateral of the borrower, as well as macroeconomic fluctuations in credit and equity market conditions, are the primary determinants of renegotiation and its outcomes. The terms of the initial contract (e.g., contingencies) also play an important role in renegotiations; by altering the structure of the contract in a state contingent manner, renegotiation is partially controlled by the contractual assignment of bargaining power.

Renegotiation, Bargaining, Incomplete Contracts, Security Design, Bank Loans

Abstract:
We compare the dividend policies of publicly- and privately-held firms in order to identify the forces shaping corporate dividends. Our findings show that private firms smooth dividends significantly less than their public counterparts, suggesting that the scrutiny of public capital markets plays a central role in the propensity of firms to smooth dividends over time. Consistent with agency theory, we also find that public firms - with greater investor protection than private firms - pay relatively higher dividends and follow a dividend policy that is more sensitive to changes in investment opportunities. Finally, signaling-based theories are largely unsupported by the data, while tax considerations and financing constraints play a secondary role in explaining the observed differences in dividend policies between public and private firms.

Dividends, Payout Policy, Smoothing, Information Asymmetry, Agency Theory, Governance

Abstract:
We examine how shocks to the supply of credit impact corporate financing and investment using the collapse of Drexel Burnham Lambert, Inc., the passage of the Financial Institutions Reform, Recovery, and Enforcement Act, and regulatory changes in the insurance industry as an exogenous contraction in the supply of below-investment-grade credit after 1989. A difference-in-differences empirical strategy coupled with a variety of treatment-control comparisons reveals that substitution to bank debt and alternative sources of capital (e.g., equity, cash balances, trade credit) was extremely limited. Consequently, net investment decreased almost one-for-one with the contraction in net issuing activity. Further, the impact of the credit contraction on financing and investment varied cross-sectionally as a function of geographic heterogeneity in the cost of bank capital and the credit risk of borrowers. Despite this sharp change in behavior, corporate leverage ratios remained relatively stable, a result of the contemporaneous decline in debt issuances and investment. Overall, our findings highlight how even large firms with access to public credit markets are susceptible to fluctuations in the supply of capital.

Investment, Financing, Capital Structure, Supply of Credit, Bank Lending Channel, Market Segmenetation

Abstract:
We review recent evidence and future directions for empirical research on financial contracting in the context of corporate finance. Specifically, we survey evidence pertaining to incentive conflicts, control rights, collateral, renegotiation, and interactions between financial contracts and other governance mechanisms. We also discuss directions for future research, concluding that the financial contracting approach offers a potentially fruitful perspective for empirical researchers seeking to better understand a variety of issues in corporate finance including capital structure, investment policy, payout policy, and corporate governance.

Financial Contracting, Security Design, Control Rights, Renegotiation

Abstract:
By the end of January 2001, all NYSE stocks had converted their price quotations from 1/8ths and 1/16ths to decimals. This study examines the effect of this change in price quotations on ex-dividend day activity. We find that abnormal ex-dividend day returns increase in the 1/16th and decimal pricing eras, relative to the 1/8th era, which is inconsistent with microstructure explanations of the ex-day price movements. We also find that abnormal returns increase in conjunction with a May 1997 reduction in the capital gains tax rate, as they should if relative taxation of dividends and capital gains affects ex-day pricing.

Ex-dividend, transaction costs, taxes, decimalization

Abstract:
By the end of January 2001, all NYSE stocks had converted their price quotations from 1/8ths and 1/16ths to decimals. This study examines the effect of this change in price quotations on ex-dividend day activity. We find that abnormal ex-dividend day returns increase in the 1/16th and decimal pricing eras, relative to the 1/8thera, which is inconsistent with microstructure explanations of the ex-day price movements. We also find that abnormal returns increase in conjunction with a May 1997 reduction in the capital gains tax rate, as they should if relative taxation of dividends and capital gains affects ex-day pricing.

Ex-dividend, transaction costs, taxes, decimalization

Abstract:
Do the low long-run average returns of equity issuers reflect Do the low long-run average returns of equity issuers reflect underperformance due to mispricing or the risk characteristics of the issuing firms? We shed new light on this question by examining how institutional lenders price loans of equity-issuing firms. We find that equity-issuing firms' expected debt return is equivalent to the expected debt return of non-issuing firms with similar characteristics, implying that institutional lenders perceive equity issuers to be as risky as similar non-issuing firms. We also find that institutional lenders perceive small and high book-to-market borrowers as systematically riskier than larger borrowers with low book-to-market ratios, consistent with the asset pricing approach in Fama and French (1993). Finally, we find that firms' expected debt returns decline after equity offerings, consistent with recent theoretical arguments suggesting that firm risk should decline following an equity offering if equity is issued to exercise a real option. Overall, our analysis provides novel evidence consistent with risk-based explanations for the observed equity returns following IPOs and SEOs.

Equity Offering, Private Debt, Institutional Lenders

Abstract:
We investigate the empirical implications of using various measures of payout yield rather than dividend yield for asset pricing models. We find statistically and economically significant predictability in the time series when payout (dividends plus repurchases) and net payout (dividends plus repurchases minus issuances) yields are used instead of dividend yield. Similarly, we find that payout (net payout) yields contain information about the cross-section of expected stock returns exceeding that of dividend yield and that the high minus low payout yield portfolio is a priced factor.

Stock Returns, Predictability, Dividend Yield, Share Repurchases, Measurement Error

Abstract:
Previous research showed that the dividend price ratio process changed remarkably during the 1980`s and 1990`s, but that the total payout ratio (dividends plus repurchases over price) changed very little. We investigate implications of this difference for asset pricing models. In particular, the widely documented decline in the predictive power of dividends for excess stock returns in time series regressions in recent data is vastly overstated. Statistically and economically significant predictability is found at both short and long horizons when total payout yield is used instead of dividend yield. We also provide evidence that total payout yield has information in the cross-section for expected stock returns exceeding that of dividend yield and that the high minus low payout yield portfolio is a priced factor. The evidence throughout is shown to be robust to the method of measuring total payouts.

Abstract:
There is strong evidence in the literature that dividends and repurchases have been substitutes for each other throughout the 80's and 90's. Asset pricing models that try to relate cash flow distributions to asset prices need to take this into account. We find that while the dividend price ratio process has changed remarkably during the period, the total payout ratio (dividends plus repurchases normalized by price) has changed very little. More importantly, this difference has implications for asset pricing models. The widely documented decline in the predictive power of dividends for excess stock returns in recent periods is vastly overstated. Statistically and economically significant predictability is found at both short and long horizons when total payouts are used instead of dividends. In addition, we provide evidence that payouts have information in the cross-section for expected stock returns, which exceeds that of dividends.

Stock Returns, Predictability, Dividend Yield, Share Repurchases, Measurement Error

Abstract:
In this paper, we present an empirical analysis of deregulated electricity prices. We begin by examining the distributional and temporal properties of the price process in a non-parametric framework. This analysis is followed by comparing the forecasting ability of several different statistical models. The findings reveal several characteristics unique to electricity prices, including deterministic components of the series at different frequencies and a high degree of persistence in the price level. An "inverse leverage effect" is also found, where positive shocks to the price series result in larger increases in volatility than negative shocks. Results consistent with other asset prices, such as time-varying volatility are also uncovered. We find that existing financial models of asset prices fail to forecast the extremely erratic nature of electricity prices. Non-Markovian specifications, in conjunction with exogenous information (e.g. weather), are a necessary starting point for practical applications, such as security pricing.