High Levels Of Leverage Research Articles

Do high technology acquirers become more innovative?

Drawing on organizational, managerial and financial theories, we explore whether acquirers become more innovative and the factors that can enhance their absorptive and financial capacity to benefit from acquisition. Over a 3-year post-acquisition window, our sample of 2624 high technology US acquisitions records early reverses followed by positive R&D-intensity changes and insignificant R&D productivity changes. Controlling for acquisition endogeneity and deal-specific effects, significant acquirer characteristic effects emerge. In related acquisitions, a large knowledge base tends to increase R&D productivity, consistent with an enhanced capacity to select and absorb targets. In unrelated acquisitions, however, this relationship becomes increasingly negative as knowledge base concentration increases, consistent with arguments for an impaired peripheral vision and core rigidities. High leverage levels raise R&D productivity gains, consistent with enhanced monitoring induced efficiency. However, high leverage growth reduces R&D-intensity, consistent with increased financial constraints and short-termism.

Dividend and debt policies of family controlled firms

PurposeThis paper's aim is to examine whether board independence influences debt and dividend policies of family controlled firms.Design/methodology/approachThe paper examines panel data on a sample of Australian publicly‐listed firms over the period 2000‐2005 using panel (random effects) regression.FindingsEmpirical test demonstrates that family controlled firms appear to have higher levels of leverage and dividend payout ratios than their non‐family counterparts. More importantly, the result indicates that the positive impact of family control on dividend policy is due to the higher proportion of independent directors on family boards. This underlines the significant role that independent directors play in influencing firm's dividend policies, especially for family controlled firms. The result also supports the notion that independent directors and dividends are complementary government mechanisms. This paper, however, finds little evidence that board independence moderates the relationship between family control and debt.Research limitations/implicationsWhile not all family firms are the same, this research treats them as a homogeneous grouping (i.e. firms are delineated into family versus non‐family). The fact that family firms are difficult to identify and define (reflected in the diversity of definitions in the literature) may also affect the validity of studies of family business. For policy makers, the finding could serve to justify initiatives to encourage more independent directors on boards, especially in family controlled firms.Originality/valueThis paper provides evidence about the relationship between board independence, dividends and debt from a country with higher levels of private benefits of control, strong legal shareholder protection but less significant role of external governance mechanisms compared to the USA.

Pyramidal structure, firm capital structure exploitation and ultimate owners' dominance

In this paper we investigate how pyramid structure, separating cash flow rights and control rights, allows ultimate owners to control the company's resources for the creation of private benefits and to avoid punishment for such conduct. Empirical tests are conducted using three-stage least squares regression. The estimated results provide support for the hypotheses proposed that the separation of cash flow rights and control rights have led to the use of excess leverage among pyramidal companies to preserve ultimate owners' control. High levels of leverage, affect the firm's valuation negatively because of the potential for financial distress. Thus, our findings may provide one additional explanation for the severity of the decrease in corporate value among the pyramidal companies in Malaysia as pointed out in the studies of Claessens et al. (2002), Lins (2003), and Lemmon and Lins (2003). Secondly, the empirical evidence from this study provides insight into the forces that influence corporate valuation of firms in developed countries particularly those that have pyramidal structure.

Caught between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting

Banks face two moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects or simply being lazy and uninnovative). The privately-optimal level of bank leverage is neither too low nor too high: It balances effi ciently the market discipline imposed by owners of risky debt on managerial rent-seeking against the asset-substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this generates an equilibrium featuring systemic risk in which all banks choose inefficiently high leverage to fund correlated assets. A minimum equity capital requirement can rule out asset substitution but also compromises market discipline by making bank debt too safe. The optimal capital regulation requires that a part of bank capital be unavailable to creditors upon failure, and be available to shareholders only contingent on good performance.

Disproportional Control and Insider Entrenchment: Evidence from Capital Structure Choices and Institutional Investment

A dual-class ownership structure, accompanied by disproportional control rights, is traditionally considered to be an inferior form of governance. We examine how the capital structure choices made by dual-class firms (i.e., by their controlling shareholders or insiders), as well as the investment choices made by the non-controlling institutional investors in these firms, vary with the presence of dual-class ownership and the degree of disproportional control it entails. We consider two sources of disproportional control: the difference between voting rights and cash flow rights and the difference between board election rights and cash flow rights. We find that dual-class firms, as well as firms with higher levels of disproportional control, have higher levels of leverage, a greater likelihood of issuing private debt, a higher fraction of long-term debt, and greater reliance on financial covenants. We also find that dual-class firms have significantly higher levels of institutional ownership, including ownership by institutions that are activist types, face stricter prudence laws, and have longer horizons. Overall, our evidence is not consistent with dual-class ownership promoting rent-seeking behavior. On the contrary, our evidence supports the view that insiders choose other mechanisms, debt in particular, to commit to not expropriate non-controlling shareholders.

The GARCH Structural Credit Risk Model: Simulation Analysis and Application to the Bank CDS Market During the 2007-2008 Crisis

We develop a structural credit risk model in which the unobserved asset volatility of the firm follows a GARCH process, as in Heston and Nandi (2000). We estimate our model using an Expectation Maximization algorithm, and benchmark it using simulated data against the Merton (1974) model, both when the latter is calibrated, and when its parameters are estimated using maximum likelihood techniques as in Duan (1994). The Duan method slightly outperforms GARCH when asset volatility is constant, and GARCH significantly outperforms both the Merton and Duan models when the asset follows a GARCH process. An application of the three models studied to the CDS market for the debt of US banks and financial corporations during the period 2007-2008 indicates high levels of asset volatility and financial leverage for many major banks during this period, although only moderate evidence of stochastic volatility. The GARCH model outperforms both the Duan and Merton models in out-of-sample CDS spread prediction. We document a wide incidence of inversion of the spread term structure in the CDS market, both in 2007 and 2008, and all three models exhibit an inverted spread term structure for all banks studied. The group of banks in which the models are able to generate nontrivial spreads is characterized by significantly higher equity time series volatility, higher average CDS spreads across all maturities, and a higher incidence of spread term structure inversion.

Asset sales and firm strategy: an analysis of divestitures by UK companies

This paper examines the financial causes and consequences of the decision to sell-off non-financial assets as part of a new or ongoing restructuring programme by UK non-financial companies between 1993 and 2000. We report that asset sales follow a period of declining operating returns and tend to occur in diversified companies with high levels of financial leverage. Stock prices respond positively to asset sale announcements. This arises due to improvements in operating returns and a decline in financial leverage and corporate diversification subsequent to the disposal. Our findings suggest that asset sales represent an effective operational response to a firm's poor financial condition. However, we also find that a manager's decision to sell assets is strongly influenced by the explicit threats to their control from lenders and competition from product, labour and takeover markets.

Is Corporate Securitization Set to Take Off?

Corporate securitization offers companies a financing solution that falls along the continuum between classical securitizations and unsecured straight corporate bonds, providing access to cheaper funding through structured credit. The notes issued by the borrower are funded by future cash flow generated by a business activity. In order to reach investment-grade credit quality, these hybrid vehicles use securitization-style financing structures and rely on a combination of restrictive covenants-both on the business financial profile and on its activity-and credit and liquidity enhancements to fund often-complex operating businesses at high levels of debt leverage. In addition to the infrastructure and healthcare sectors, various commercial endeavors have been the source of new issuance over the past decade, including football stadiums, public houses (pubs), Formula 1 racing licensing, champagne bottling, funeral homes, and forestry. While these sectors are disparate, it is clear that corporate securitizations are generally prevalent in industries that have utility or “utility like” strong, stable cash flows, as well as high barriers to entry and predictable operating expenditures and maintenance capital expenditures (capex). These industries also tend to have modest-growth capex requirements, and a mature, established track records. <b>TOPICS:</b>Fundamental equity analysis, accounting and ratio analysis, technical analysis

Corporate governance efficiency: an indexing approach using the stochastic frontier analysis

PurposeThe purpose of this paper is to identify efficient governance using a governance efficiency score based on recommendations provided by codes of best practices in order to determine “good governance”.Design/methodology/approachBased on a sample of 320 US listed firms from 1994‐2001, governance practices were synthesized by an index computed according to a parametric method, the stochastic frontier analysis, which allows taking into account the relation between inputs (governance axes) and outputs (performance).FindingsThe use of a latent classis in the specification of the model allowed detecting two groups of firms according to their specific characteristics. The results of affectation equation show that the probability of being in the highest performing group is more important when the firm size, the dividend yield and the return on equity (ROE) are high, while a high leverage level decreases the chance to be in the non‐performing group. Moreover, the model allows establishing a dualist description of the two groups which point out two opposite governance systems. The non‐performing system is characterized by a managerial discretion, an ownership concentration, a dominance of the board by the CEO and a manager entrenchment. However, the highest performing system is characterized by an inside control efficiency and an inside financial control efficiency.Research limitations/implicationsThe sample choice presents a selectivity bias. Firms of the sample present some particularities in relation to other US firms, which limits the study generalisation. This study can also be the object of replications in other contexts.Originality/valueThis work is a demarcation in relation to previous works studying corporate governance quality, and particularly the relation between governance and performance. It provides a new econometric approach to develop a synthetic index to evaluate corporate governance firms' practices, wedged on performance level achieved by different firms.

U-Shaped Cost of Equity Function? Digging Into Modigliani-Miller (1958) Mistake

Modigliani and Miller (1958, The cost of capital, corporation finance and the theory of investment, The American Economic Review, Vol. 48, No 3) assert that, beyond some high level of leverage, the cost of equity curve may be decreasing. Despite the lack of rigour of their argument, this proposition received a small amount of criticism. However, it is wrong: in an MM world, the cost of equity function must be increasing, because under the dynamics of MM Proposition II, the marginal cost of debt must be lower than the cost of equity. Should, by any chance, the marginal cost of debt be higher than the cost of equity, arbitrage opportunities, incompatible with market equilibrium, would emerge. In this way, the intuitive idea that the cost of equity may increase unboundedly is recovered. Nevertheless, the cost of equity function will tend to infinity only if the first derivative of the interest cost function also tends to infinity. Otherwise, in the limit, the cost of equity will tend to a finite number. These findings reinforce the theoretical validity of MM propositions.

International evidence on the non-linear impact of leverage on corporate cash holdings

This paper investigates cash holding behaviour of firms from France, Germany, Japan, the UK and the US using data for 4069 companies over the period 1996–2000. Our focus is particularly on the relation between cash holdings and leverage. We argue that the impact of leverage on cash balances of firms is likely to be non-monotonic. To the extent that leverage of firms acts as a proxy for their ability to issue debt one would expect a negative (substitution effect) relation between leverage and cash holdings. However, as leverage increases firms are likely to accumulate larger cash reserves to minimise the risk of financial distress and costly bankruptcy. Thus, one would expect a positive (precautionary effect) relationship between cash holdings and leverage at high levels of leverage. Our findings provide strong and robust support for a significant non-linear relation between cash holdings and leverage. Additionally, our results show that the impact of leverage on cash holdings partly depends on country-specific characteristics such as the degree of creditor protection, shareholder protection, and ownership concentration.

How Does the Down-Payment Constraint Affect the UK Housing Market?

A house purchase typically requires a deposit (or down-payment) and so a significant amount of cash. This paper considers the empirical implications of this borrowing constraint for the housing market. It shows that, at the aggregate level, models of the housing market that incorporate the constraint are consistent with the following stylised facts: i) a positive correlation between house price inflation and transactions; ii) greater volatility of former owner-occupiers' house price inflation than for first-time buyers; iii) the presence of first-time buyers in the market falls with the rate of change of house prices; and iv) house prices are more sensitive to the incomes of the young. The paper then exploits variation across local housing markets in the rate of change in house prices and considers how leverage affects the response of the rate of change of house prices to shocks. The evidence, based on data for 147 district-level housing markets for the period 1993-2002, suggests that a large incidence of households with high levels of leverage (loan to value ratios) raises the sensitivity of house prices to a shock. This is also consistent with the down-payment constraint model of the housing market.

Corporate Governance and Performance: An Indexing Approach Using the Stochastic Frontier Analysis

In this paper, we study the association between firms' specific characteristics and performance for a sample of 320 American firms using a governance efficiency index, calculated by the Stochastic Frontier Analysis. The use of a latent classes in the specification of the model, allowed to detect two groups of firms according to their specific characteristics as: the firm size, the leverage, the dividend yield and the return on equity (ROE). The results of affectation equation show that the probability to be in the second group (the most perform) is more important when the firm size, the dividend yield and the ROE are high, while a high leverage level decreases the chance to be in the first group (the less perform).

The Impact of Leverage on Hedge Fund Risk and Return

As in the case of traditional investments, hedge funds are often compared on a risk adjusted basis. Risk adjustment is of particular importance for hedge fund analysis since two funds may differ solely by leverage, such that they may differ on an absolute return basis, but be similar on a risk adjusted basis. While leverage should theoretically not affect the level of risk adjusted return within a strategy, it is possible that funds which use higher levels of leverage may in fact trade differently than funds using lower levels of leverage. In this article, the effect of leverage on hedge fund risk and return is analyzed. In brief, results are presented on the level of leverage used in various hedge fund strategies. Results are also provided on the degree to which leverage above or below the median fund leverage results in superior or inferior risk adjusted performance within a particular hedge fund strategy. Overall the results show that while different hedge fund strategies may use different amounts of leverage, within a particular hedge fund strategy, there is little evidence of a significant difference between risk adjusted performance of funds with above-median and below-median leverage.

Asset Sales, Operating Performance and Firm Strategy: An Empirical Analysis

This paper examines the operating performance of UK firms following a decision to sell off non-financial assets as part of a new or ongoing restructuring program. We report that asset sales normally follow a sustained period of poor operating performance, and tend to occur in well-diversified firms with high levels of financial leverage. In general, asset sales lead to a significant improvement in firm operating performance. Our findings suggest that, for the UK at least, managers sell assets in response to discipline from lender monitoring, product markets and markets for managerial labour.

Corporate Governance and Financing Policy: New Evidence

Prior research has often taken the view that entrenched managers tend to avoid debt. Contrary to this view, I find that firms with weak shareholder rights, as measured by the Gompers et al. (2003) governance index, actually use more debt finance and have higher leverage ratios. I provide an explanation by showing that entrenched managers choose conservative investment policies and thus trade-off expected bankruptcy costs with tax shields of debt at higher leverage levels. Consistent with this, I find evidence that firms with weak shareholder rights have lower bond yields when issuing debt, enjoy higher credit ratings, and have a higher propensity to engage in conglomerate mergers. To address the potential endogeneity of the governance index, I use the exogenous shock to corporate governance generated by the adoption of state antitakeover laws and find that managers increase leverage when they are less vulnerable to takeovers.

The Impact of Family Control of Firms on Leverage: Australian Evidence

This paper investigates whether leverage of family controlled firms differs from that of non-family controlled firms. Using data from publicly listed industrial firms in Australia traded over 1998 to 2002, family controlled firms appear to have higher levels of leverage than non-family counterparts. Results indicate that the families' incentive to use debt as a means of concentrating voting power outweighs the need to reduce debt in order to mitigate firm risk. Additional analyses show that the desire to use debt as a means for concentrating control is stronger for both smaller family firms and family firms operating in the mining sector. These results add new findings to the leverage literature.

Discretionary Accruals, Managers' Incentives, and Stock Prices

Recent accounting research finds that the discretionary accrual component of earnings communicates managers' private information to stock market participants. We show that effects related to managerial compensation contracts and corporate debt agreements influence how the stock market interprets the discretionary component. Managerial opportunism--signaled by bonus components highly sensitive to earnings, and pre-managed earnings at levels consistent with benefits from exploiting accruals--is associated with negative stock price effects when managers make income-increasing accruals. Opportunism that benefits stockholders relative to debtholders--signaled by firms with high leverage levels--is associated with positive stock price effects when managers make income-increasing accruals. The paper focuses on the incentives managers face in reporting earnings, and provides new evidence on how incentives can influence stock prices.

The Capital Structure of Listed Companies in Poland

This paper examines the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage. Polish firms had extremely low leverage levels, suggesting a growing stock market and a potential reluctance of banks to grant loans to old and risky firms. The empirical exercise finds that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage. Finally, shareholder concentration has a neutral or even a beneficial influence on firm leverage. The nature of ownership may be primarily responsible for this finding.

The Capital Structure of Listed Companies in Poland

This paper examines the capital structure of listed firms in Poland, using firm-level panel data to study the determinants of leverage. Polish firms had extremely low leverage levels, suggesting a growing stock market and a potential reluctance of banks to grant loans to old and risky firms. The empirical exercise finds that large, new, foreign-owned firms, and firms with strong cash positions have higher levels of leverage. Finally, shareholder concentration has a neutral or even a beneficial influence on firm leverage. The nature of ownership may be primarily responsible for this finding.