Corporate Debt Ratios Research Articles

An alternative test of the trade-off theory of capital structure

The purpose of this paper is to investigate the stochastic behavior of corporate debt ratios utilizing a balanced panel of 2,556 publicly traded U.S. firms during the period 1997-2010. We partition the panel into ten economic sectors and perform panel unit root tests on each sector employing book value and market value measures of debt ratio. First-generation panel unit root tests provide consistent evidence that debt ratios are mean reverting, which supports the trade-off theory. However, these tests rely on the assumption that the debt ratios are cross-sectionally independent, but tests of cross-sectional independence fail to uphold this assumption. Thus, utilizing a second-generation panel unit root test that controls for cross-sectional dependence, we uncover evidence showing that debt ratios are not mean reverting, which contradicts the trade-off hypothesis. We find that the recent macroeconomic developments triggered by the financial crisis and the Great Recession have considerable explanatory power over the dynamics of the debt ratios. In fact, when we exclude the years of the recent global financial crisis, the unit root hypothesis is rejected in one half of the sectors. We interpret these results as indicative that the recent global events may have produced in these sectors a structural change in the underlying data generation process (DGP). Overall, then, we find mixed evidence on the stationarity of debt ratios.

The Influence of a Firm's Ownership Structure and Chaebol Group Belongingness on its Debt Levels -Using Korean Firms-

In this paper, we investigate the influence of corporate ownership structure on debt ratio, by studying whether the importance of management's will and a firm's chaebol group affiliation affect its capital structure. As different regression models often indicate different results, they are in line with different firms' conditions, such as a corporate ownership structure or the previous year's debt levels, it might imply that it is too early to have a final conclusion about the relationship between a firm's debt level and corporate ownership structure. However, we confirm that firms debt ratios show statistically significant differences, based on firms' ownership structure and on chaebol group belongingness. In addition, corporate ownership structure and debt ratios present an inverted U-sharp(∩)relationship between them; and a negative association between them if firms are chaebol group affiliations, and a positive association otherwise. Finally, firms with a high level of ownership ratio or with chaebol group affiliations show high speed of capital structure adjustment compared with others, ceteris paribus. This implies that a strong ownership or an image of financial stability caused by chaebol group affiliation gives firms an opportunity for a fast capital structure adjustment. However, as our results also indicate, firms' debt ratios are more seriously influenced by their size, profits and tangible asset levels than their corporate ownership structure.

An Overview of the Corporate Capital Structure in the Industries at the Tokyo Stock Exchange

This paper presents an overview of the differentials in the capital structures in various industries in Japan. More specifically, we first examine how capital structures of the industries at the Tokyo Stock Exchange (TSE) First Section are different. After that, we investigate whether financial risks associated with corporate debt ratios are rewarded with higher returns within industries. Main findings from our investigations are as follows. First, we find that the capital structure of each industry at the TSE First Section is statistically significantly much different. Second, we also find that financial risks associated with corporate debt ratios are not rewarded with future positive stock returns when we exclude the effects of industrial differentials of corporate leverage.

Taxation and the Optimal Constraint on Corporate Debt Finance

The tax bias in favour of debt finance under the corporate income tax means that corporate debt ratios exceed the socially optimal level. This creates a rationale for thin-capitalization rules limiting the amount of debt that qualifies for interest deductibility. This paper sets up a model of corporate finance and investment in a small open economy to quantify the deadweight loss from the asymmetric tax treatment of debt and equity and to identify the second-best optimal debt-asset ratio in the corporate sector. For plausible parameter values derived from data for the Norwegian economy, the deadweight loss from the tax distortions to corporate financing decisions amounts to 2-3 percent of total corporate tax revenue, and the socially optimal debt-asset ratio is 4-5 percentage points below the debt level currently observed. Driving the actual debt ratio down to this level would generate a total welfare gain of about 3 percent of corporate tax revenue. The welfare gain would arise partly from a fall in the social risks associated with corporate investment, and partly from the cut in the corporate tax rate made possible by a broader corporate tax base.

THE DETERMINANTS OF CORPORATE DEBT RATIOS IN CHOSEN EUROPEAN COUNTRIES

The capital structure theories assume that level of debt is determined by company’s value, expected cash sources and profitability. The goal of this paper is to analyze determinants of corporate debt ratios. The main focus was put on analyzing whether the differences of willingness to use debt by companies result from profitability and/or collateral value of assets and/or company’s size. The analysis of public companies from France, Germany, United Kingdom and the Netherlands, from non-financial sectors, in years 2003-2010 was carried out. No evidence for positive connection association between debt level and profitability was found. We observed reverse relationship, however we cannot treat this as a general rule. We also cannot claim there is any particular corporate debt level specific because of country or sector, however the company’s size seems to be important determinant of debt usage.DOI: http://dx.doi.org/10.5755/j01.em.17.1.2252

Is the Partial Adjustment Model a Useful Tool for Capital Structure Research?*

Recent research has focused on the estimates of the speed of adjustment to target leverage as the indicators of the importance of dynamic trade-off behavior. We show that the observed corporate financing behavior and the resulting dynamics of corporate debt ratios are such that the speed of adjustment is not an economically meaningful measure of the importance of target debt ratios. We conclude that partial adjustment regressions that rely on the existence of a well-defined target debt ratio are ill-suited for quantifying the importance of dynamic trade-off behavior vis-a-vis alternative theories.

Culture, agency costs, and dividends

This paper presents a culturally rooted agency explanation for differences in dividend payout policies around the world. We conjecture that the social normative nature of culture influences the character of agency relations and determines the acceptance and legitimacy of different dividend payout strategies across different countries. By linking dividends to cultural differences across 5797 firms in 41 countries, our analysis shows that high individualism, low power distance, and low uncertainty avoidance are significantly associated with higher dividend payouts. A comprehensive set of robustness tests in which we control for legal institutions, share repurchases, corporate debt ratios, and ownership structures confirms that culture is a relevant factor when analyzing dividend distributions. Our results further show that legal institutions and culture as a social institution have complementary effects on dividend payouts. Overall, our finding that culture matters suggests important implications for a wide range of agency-based economic and capital market phenomena.

The effects of profitability and market performance on corporate financing behavior: a quantile regression approach

Profitability and market performance have been widely perceived in the literature as the decisive determinants of corporate financing behavior, yet the evidence in support of the hypothesis of capital structure theory is inconclusive. To reexamine the state of affairs, this paper employs the novel concept of “dual issues” rather than one issue either by debt or by equity in corporate financing behavior, and then applies the quantile regression analysis to avoid possible inaccuracies arising from the ordinary least squares. The findings show that the quantile regression approach offers a comprehensive explanation for the marginal effect of profitability and market performance on corporate debt ratio at a certain quantile.

ARTICLES

Some argue that corporate finance and governance practices were among the root causes of the Asian crisis. It is alleged that high and increasing corporate debt ratios were partly to blame. This claim is overstated: only South Korea and arguably Thailand had leverage ratios significantly above the G7 range, and only South Korea had an income-gearing ratio higher than the G7. Although the reliance on short-term debt was high, there was no drastic change in the maturity structure of debt before the crash. However, conventional factors are relatively more successful in explaining leverage for firms that were less closely connected to the relationship-based financing system. Our paper links to ongoing research on investor protection, cronyism, connections between business and government, and business groups. It ends by commenting on the 2008 financial crisis, currently engulfing the world, and highlights some similarities and paradoxes. Journal of International Business Studies (2009) 40, 990–1004. doi:10.1057/jibs.2009.13

A Research on Pecking Order Theory of Financing: The Case of Korean Manufacturing Firms

This paper empirically tests pecking order theory. Korean listed firms are used as the samples. On the whole we find supportive results for pecking order theory. The fixed effect model on the whole period shows that as pecking order theory suggests that debt ratio decreases as cash flow. ROA, physical assets, and firm size increase. Again, it is shown that corporate debt ratio significantly decreases as cash flow or ROA increases in every sub-sample, which coincides with the prediction of pecking order theory. Corporate debt ratio significantly decreases as physical assets or jinn size increases in case of the whole sample, pre-financial crisis period, and the sub-samples by q-ratio, which also supports the prediction of pecking order theory. Statistical significance of the coefficients of physical assets or firm size completely disappears after Korean financial crisis. Perhaps it is because the role of physical assets or firm size as a mitigator of information asymmetry significantly weakens after the financial crisis as Korean financial market becomes more transparent. For small firms only size variable is negatively and significantly related with debt to assets. It seems that size is an important factor for smaller firms in making financing decision.

Corporate Financing in East Asia Before the 1997 Crash

Some argue that corporate finance and governance practices were among the root causes of the Asian crisis. It is alleged that high and increasing corporate debt ratios were partly to blame. This claim is overstated: Only South Korea and arguably Thailand had leverage ratios significantly above the G7 range and only South Korea had an income-gearing ratio higher than the G7. Although the reliance on short-term debt was high, there was no drastic change in the maturity structure of debt before the crash. However, conventional factors are relatively more successful in explaining leverage for firms that were less closely connected to the relationship-based financing system. Our paper links to ongoing research on investor protection, cronyism, connections between business and government, and business groups. It ends by commenting on the 2008 financial crisis, currently engulfing the world, and highlights some similarities and paradoxes.

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.

The Determination of Capital Structure: Is National Culture a Missing Piece to the Puzzle?

Why does knowing the nationality of the company help predict its financial leverage? Differences in institutional backgrounds provide only a partial answer to this question. This study suggests that national culture affects corporate capital structures. Empirical hypotheses, drawn from financial models and cross-cultural psychology, are tested against a sample of 5591 firms across 22 countries. Results show that countries with high scores on the cultural dimensions of “conservatism” and “mastery” tend to have lower corporate debt ratios. The effects are strong and remain significant even after accounting for differences in economic performance, legal systems, financial institutions, and some other well-known determinants of debt ratios.

Is There a Size Gap in Corporate Leverage?. A European Comparison / Gibt es eine Kluft im Leverage europäischer Unternehmen?. Ein europäischer Vergleich

Summary The main purpose of this paper is to evaluate corporate debt ratios by size classes in Continental Europe. Evidence is given on a sample of firms in manufacturing industry for ten European countries, all of them being in Euroland apart from Denmark (Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Portugal and Spain). The descriptive analysis shows a 15 % point size gap in corporate leverage between small and large companies on average. Even after adjusting for structural factors, the size gap remains at 10 %. Yet, an overall assessment should not lead us to overlook national features when comparing small and large companies. In particular, three main groups emerge: in Germanic countries (Austria and Germany), the gap is the largest, mainly because of regulatory specificities. In a second cluster, companies from Denmark, France and Portugal exhibit significant differences in averages across sizes but at a lower extent than in the first group. As regards the other countries, even though the size gap is still the dominant pattern, the situation is less definite and deserves case by case analysis.

The Capital Structure Puzzle Revisited

Corporate finance researchers have long been puzzled by low corporate debt ratios given debt's corporate tax advantage. This article recognizes that firm value typically reflects a growing stream of earnings, while current debt reflects a nongrowing stream of interest payments. Debt to value is therefore a distorted measure of corporate tax shielding. Even with very small debt- related costs, this may explain the observed magnitude and cross- sectional variation of debt ratios. Since this variation may be independent of tax shielding, debt ratios provide an inappropriate framework for empirically examining the trade-off theory of capital structure. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

How Big is the Tax Advantage to Debt?

This paper uses an option valuation model of the firm to answer the question, What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios? We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to junip discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt-to-firm value ratios.

How Big is the Tax Advantage to Debt?

ABSTRACTThis paper uses an option valuation model of the firm to answer the question, “What magnitude tax advantage to debt is consistent with the range of observed corporate debt ratios?” We incorporate into the model differential personal tax rates on capital gains and ordinary income. We conclude that variations in the magnitude of bankruptcy costs across firms can not by itself account for the simultaneous existence of levered and unlevered firms. When it is possible for the value of the underlying assets to jump discretely to zero, differences across firms in the probability of this jump can account for the simultaneous existence of levered and unlevered firms. Moreover, if the tax advantage to debt is small, the annual rate of return advantage offered by optimal leverage may be so small as to make the firm indifferent about debt policy over a wide range of debt‐to‐firm value ratios.

On the Firm's Production, Capital Structure and Demand for Debt

SOME economists have ignored corporate financing decisions on the assumption that they do not affect the investment and production decisions of firms. Yet even if this extreme position is accepted, firms must still make financing decisions which in turn have impacts on other sectors of the economy. Since interest payments on corporate debt are tax deductible, the reliance of firms on debt as opposed to equity financing directly affects the revenue the federal government collects through taxation of corporate profits. The corporate presence in bond markets and corporate borrowing from banks can be expected to affect both interest rates and the demand for money. Thus any large macro model must somehow account for the borrowing behavior of firms. Yet in assessing this portion of the 1965 Brookings Quarterly Econometric Model of the United States, de Leeuw (1965, p. 506) writes that the regressions for business borrowing are the least successful of the model. In this paper we derive an equation for the long-term debt ratio (capital structure) of a firm which can be estimated using available data. Unlike some recent qualitative studies' on the aggregate corporate debt ratio as related to inflation and taxation over time, our primary aim is to explain differences in the debt behavior among individual firms. Tobit estimation results, explicitly allowing for the fact that some firms have no long-term debt, are presented for both U.S. and Japanese firms. Our theoretical model implies that the long-term debt ratio which maximizes the present value of the existing stockholder's equity depends positively on the cost of equity and negatively on the cost of debt, capital productivity, and retained earnings. Our estimation results are generally in agreement with these expectations. In particular, we find that capital productivity, which has not been included as an explanatory variable in most previous studies,2 and the cost of equity capital are both important determinants of the firm's capital structure. Our empirical results also support the view put forward by Komiya3 that debt ratios for Japanese firms are higher than those for U.S. firms in part because the cost of equity has been historically higher in Japan than in the United States in relation to the cost of debt. Other important attempts to explain the debt ratio as a behavioral function of the price of debt and other variables include the studies of de Leeuw (1965) and Goldfeld (1969).4 Certain conceptual problems mar these studies, however. Short-term and long-term debt are not distinguished, despite the fact that long-term debt is usually used to finance capital spending while short-term debt is used to finance inventory and

A MEAN‐VARIANCE THEORY OF OPTIMAL CAPITAL STRUCTURE AND CORPORATE DEBT CAPACITY

AN ISSUE OF CONCERN to the theory of business finance over the past two decades has been the effect of financial structure on the valuation of firms. The traditional presumption is that a firm's value is a concave function of its financial leverage, and that an optimal financial leverage exists where the slope of the function is zero.' This argument is suspect to the extent that it attempts to value a firm's securities in isolation from the rest of the capital market. The pathbreaking works by Modigliani and Miller (MM) have provided the foundations for studying the effect of financial structure on the valuation of firms in equilibrium. MM (1958, 1969) establish that the total value of the firm, in the absence of taxes, remains constant across all degrees of financial leverage. Building on the foundations laid by MM, numerous authors2 have confirmed the MM no-tax thesis using a variety of equilibrium approaches. MM (1963) and some of these authors have shown further that a proportional corporate income tax provides sufficient economic incentive for firms to maximize their use of debt financing. However, in the five-year period from 1966 to 1970 the capital needs of nonfinancial corporations in the United States were financed approximately by two-thirds equity and one- third debt.3 Furthermore, the average corporate debt ratio (which reflects the valuation of equity at market value) is only approximately 20 percent.4 Even these highly aggregated figures suggest that an element of major importance to financial managers and the investing public is missing from the MM theory. Robicheck and Myers (1965, p. 20) and Hirshleifer (1970, p. 264) suggest that bankruptcy costs may represent the major missing element and that incorporating these costs within the foundations laid by MM may support the concept of an optimal capital structure. The importance of bankruptcy costs was particularly well demonstrated by Miller (1962) when he explicitly utilized bankruptcy costs to * Visiting Associate Professor of Finance, Purdue University, on leave from the Ohio State University. Acknowledgement. This paper is based on Chapter Five of my Ph.D. thesis (Kim (1974)) at State

A Comparative International Study of Growth, Profitability, and Risk as Determinants of Corporate Debt Ratios in the Manufacturing Sector

The purpose of this paper is to test the hypothesis that three financial performance variables, namely, growth, profitability, and risk, are determinants of corporate debt ratios in the manufacturing sector in industrialized countries. In particular, a linear model is hypothesized and Ordinary Least Squares is used to estimate the coefficients for the relationship. The sample used contains 816 firms in four selected industries in five industrialized countries during the period 1966–72.