Three Essays in Corporate Finance

Abstract

Three Essays in Corporate Finance Jeong Hwan Lee This dissertation consists of three essays on corporate nance. In the rst chapter, I investigate how a liquidity cost associated with debt‘debt servicing cost’a¤ects a rm’s capital structure policy. In contrast to the standard capital structure theory prediction that builds on a trade-o¤between interest tax shields and expected bankruptcy costs, public rms use debt quite conservatively. To address this well known debt conservatism puzzle (Graham 2000), I argue that servicing debt drains valuable liquidity for a nancially constrained rm and hence endogenously creates ‘debt servicing costs,’which have received little attention in the literature. To examine the in‡uence of debt servicing costs on capital structure choices, I develop and estimate a dynamic corporate nance model with interest tax shields, liquidity management, investment, external debt and equity nancing costs, and capital adjustment costs. By using the marginal value of liquidity as a natural measure of the debt servicing costs, I nd that (1) an increase in nancial leverage results in higher debt servicing costs, even with risk-free debt. (2) a smaller rm tends to experience greater debt servicing costs because of its endogenously large investment demands; and (3) in the majority of cases, equity proceeds are used for cash retention as well as capital expenditure, especially when a rm faces large current and future investment needs. In addition, I quantitatively show that large debt servicing costs are closely associated with low leverage and frequent equity nancing by analyzing the role of xed operating costs and convex capital adjustment costs. In the second chapter, I empirically support the theoretical debt servicing costs analysis of the previous chapter. I rstly examine the structural estimation method used for the calibration of my model in the rst chapter. The statistical property of the simulated method of moments estimator and detailed identi cation scheme for the calibration are investigated in the rst half of this chapter. Then I cross-sectionally con rm the validity of debt servicing costs predictions on capital structure choices. I study how each rm’s convex capital adjustment costs, operating leverage, pro t volatility, and future investment needs in‡uence capital structure policies. Consistent with the debt servicing costs predictions, rms with higher convex capital adjustment costs, higher operating leverage, higher pro t volatility and larger future investment demands show lower leverage ratios and more frequent equity nancing activities. These ndings shed new lights on pervasively conservative debt policy in U.S. public rms. A higher pro tability observed in large future investment demands rms also suggests the importance of debt servicing costs consideration in resolving the puzzling negative correlation between pro tability and leverage ratios. In the third chapter, I examine how macroeconomic conditions a¤ect the cyclical variations in capital structure policies. As in the nancial crisis of 2008, economic contractions a¤ect a rm’s pro tability, investments and external nancing conditions altogether. To address the e¤ects of these simultaneous changes on capital structure dynamics, I develop and estimate a dynamic trade-o¤ model with investment, payouts, and liquidity policies with macroeconomic pro tability and nancing shocks. Investment dynamics and a higher value of liquidity of economic downturn are pivotal in capital structure dynamics; the former drives the issuance of debt and equity, and the latter leads to active debt retirements and conservative debt issues in upturns. My model yields the following main results: (1) Equity issues are pro-cyclical, and concentrated for small, low pro t, and large investment demand rms in earlier stage of economic upturns. (2) Payouts peak in later stages of upturns and co-move positively with equity issues; (3) Debt policies move counter-cyclically, and leverage ratios after debt issuance and retirement are even higher during economic downturns. My comparative static analysis predicts pro-cyclical debt policy for nancially constrained rms, and pervasively conservative use of debt for rms expecting nancial market shutdowns.