Leverage Adjustment Research Articles

Liquidity and speed of leverage adjustment

This article investigates the effect of liquidity on the speed of adjustment (SOA) of corporate leverage at the individual company level. Using panel analysis of data from 35 countries between 1996 and 2016, we find that high-liquidity firms have a significantly faster SOA than less liquid firms. This result survives a series of robustness checks and holds after addressing the endogeneity concern using exogenous shocks and additional control variables. We find that the positive effect of liquidity on the SOA exists only for over-levered firms, and this impact is moderated in countries with bankruptcy codes. We further find that the positive liquidity-SOA relationship is less (more) pronounced for firms in strong (weak) institutional environments. The results provide new insights into the role of liquidity in firms’ capital structure decisions and the determinants of capital structure dynamics. JEL Classification: G12, G32

Application of Bootstrap Simulation and Asymmetric Causal Approach to Fiscal Deficit-Inflation Nexus

This paper investigates the symmetric and asymmetric relationship between fiscal deficits and inflation in Nigeria within the context of bootstrap simulations with leverage adjustments using the quarterly frequency data from 1981Q1 to 2016Q4. The findings reveal that there is neither symmetric nor asymmetric causality between fiscal deficits and inflation in Nigeria. This implies that the fiscal deficits in Nigeria are not inflationary; and also, that persistent double-digit inflation rates are not the causal agents spurring perennial increase in fiscal deficits in Nigeria. This study, therefore, concludes that fiscal deficits could be used to stimulate output level in Nigeria without fueling inflationary spiral in the economy. JEL Classification: C32, E17

Leverage Dynamics Under Segmented Equity and Debt Markets

We study a continuous-time dynamic capital structure model in which a firm can continuously adjust its capital structure. Unlike previous models, we assume heterogeneous equity and debt holders and segmented equity and debt markets. We show that the expected future equity and debt market returns, but not realized market returns, affect the firm's debt issuance policy and speed of leverage adjustment. The effect is stronger for firms with larger asset beta. We empirically test and confirm our model predictions.

Does Growth Affect Firms’ Leverage Adjustment Speed? A Study of Indian Firms

The significance of firms’ growth opportunities as one of the determinants of leverage is documented in many prior studies. But, there are not enough studies which examine the impact of growth on leverage adjustment speed. In this backdrop, the present study investigates the relationship between growth and leverage adjustment speed. Second, the study also examines the moderating role of two dimensions of target deviation, that is, nature and level of deviation in the relationship between growth and leverage adjustment speed. Using partial adjustment model on a dataset of 28,532 firm-year observations comprising 2,718 listed Indian firms with 4–12 years data for each firm, the study observes faster leverage adjustment speed for high-growth firms (36%) than low-growth firms (24%). The results also confirm the moderating effect of target deviation in the relationship between growth and adjustment speed. Overall, the study concludes that firms’ growth opportunities cause asymmetries in target adjustment speed by altering the costs and benefits of adjustment, and nature and level of target deviation moderates the relationship between growth and adjustment speed. These findings are expected to have substantial practical implications for financial managers in their capital structure decisions.

Bank leverage and capital bias adjustment through the macroeconomic cycle

We assess the quantitative effects of the recent proposal for more robust bank capital adequacy. Our theoretical proof and evidence accord with the core thesis that banks become more stable by increasing their equity capital cushion to absorb extreme losses in times of severe financial stress. This analysis contributes to the ongoing policy debate on total capital adequacy. Our Monte Carlo simulation helps develop an analytical solution for the default probability adjustment through the macroeconomic cycle. This study poses a conceptual challenge to the normative view that banks should maintain high leverage over time.

Managerial Macro-Cognition and the Speed of Leverage Adjustment

This study takes advantage of the concept of “Managerial Macro-Cognition” (MMC) to explore how does the different macro cognition of executives will affect their capital structure decision. Drawing on a sample of Chinese listed firms from 2002 to 2018, I find that under the same conditions, the enterprise has executives with higher macro cognition can adjust its capital structure faster, the promote effect on the speed of the leverage adjustment caused by the macro cognition of executive is more obvious when cognition is about future. Besides, when the company is faced with financing constraints, tight monetary policy and low equity concentration, the influence of executives’ macro cognition on the adjustment speed is more obvious.

Trade credit and the speed of leverage adjustment

PurposeThe purpose of this paper is to examine the impact of trade credit on the speed of adjustment (SOA) of short-term leverage. Bankruptcy cost is higher for over-levered firms, generating a good incentive to use trade credit as a lower cost substitute; hence, firms adjust capital more quickly.Design/methodology/approachFirm-level data are used from five countries, in two different economic orientations, during the period 2000–2017: bank-oriented economies include France, Germany and Japan, and market-oriented economies include the UK and the USA. First, using the two-step GMM the study estimates the target short-term leverage ratio. Then, it examines the impact of trade credit on the SOA of the actual leverage towards the target leverage ratio.FindingsIt finds a positive impact of a low amount of trade credit (high capacity) on the SOA for over-levered firms. This is in line with the substitution effect, where the bankruptcy cost is higher for over-levered firms, which leads them to substitute bank loans with trade credit.Research limitations/implicationsThe study uses data from publicly traded firms; data from non-listed and small firms may be considered as a good opportunity for future research.Practical implicationsThe policy implication that can be derived from the empirical results is that firms’ management should recognise the relationship between trade credit and deviation from target short-term leverage. During periods of high short-term leverage firms should use trade credit as a source of finance when adjusting the short-term leverage towards the target ratio.Originality/valueThis study is the first to examine the influence of trade credit on the SOA.

Bank loan supply shocks and leverage adjustment

We investigate the effect of bank loan supply shocks on firms’ leverage adjustment. We show that the impact of bank shocks is larger for firms with greater dependence on financially troubled banks. We measure firms’ pre-crisis loan dependence on troubled banks by using matched firm–bank loan data. Using the boom-bust cycle from 1987 to 2014 in Japan as a quasi-experiment, we find that financially constrained firms adjust their leverage slower during credit-crunch periods than during other periods. During credit-crunch periods following banking crisis, firms associated with failing banks or with banks that have a limited capacity to supply loans show a slower adjustment than other firms. Bank shocks have significant effects on small firms’ adjustment but not on that of large firms. These results are robust when we consider demand-side effects and perform other robustness tests. Our results imply that bank shocks have a persistent effect on borrowers’ leverage.

Do cash flow imbalances facilitate leverage adjustments of Chinese listed firms? Evidence from a dynamic panel threshold model

This paper investigates the asymmetric impact of cash flow on firms’ leverage adjustments. We use a dynamic panel threshold model and estimate it with a newly-developed first-difference GMM approach, which allows endogeneity in both threshold variable and regressors. Employing data of 1054 Chinese listed firms during 2004–2016, we show that Chinese listed firms have leverage targets, towards which they adjust at an average speed of 25.9%. Moreover, firms with larger absolute cash flow adjust towards their leverage targets significantly faster than those with smaller absolute cash flow. This finding is robust to a post-financial crisis sample period, alternative measures of leverage and cash flow, and the incorporation of an additional control variable. We find evidence that cash flow imbalances facilitate leverage adjustments by reducing adjustment costs, and Chinese listed firms rely more on debt issues. These findings provide new insights on firms’ leverage adjustment and cash flow management.

Foreign ownership and capital structure dynamics

This study explores the relationship between foreign investors and the dynamics of capital structure. Using a sample of listed firms in Taiwan during the period from 1997 to 2016, our results reveal that firms with higher foreign ownership are less likely to issue debt, indicating that foreign investors serve as a direct substitute for debt by enhancing corporate governance. Moreover, foreign investors help reduce leverage adjustment costs, which in turn increases the speed of adjustment toward target leverage. Overall, this study highlights the important role played by foreign investors in shaping firms’ optimal capital structure decisions and shareholder wealth maximization, and thus provides evidence in supporting a positive view of foreign ownership in emerging markets.

Can Machines Learn Capital Structure?

Yes, they can! Machine learning models predict leverage better than linear models and identify a broader set of leverage determinants. They boost the out-of-sample R-squared from 36% to 56% over OLS and LASSO. The best performing model (random forests) selects market-to-book, industry median leverage, cash and equivalents, Z-Score, profitability, stock returns, and firm size as reliable predictors of market leverage. More precise target estimation yields a 10%-33% faster speed of adjustment and improves prediction of financing actions relative to linear models. Machine learning identifies uncertainty, cash flow, and macroeconomic considerations among primary drivers of leverage adjustments.

News media coverage and corporate leverage adjustments

We examine the impact of the media on firms’ leverage adjustments. Using a comprehensive sample of global news across 33 countries, we find that greater news coverage and more positive news sentiment are associated with greater leverage adjustment speeds. This finding is consistent with the argument that media coverage and content help lower the cost of firms’ adjustment toward target leverage. We further find evidence supporting two mechanisms through which the news media affects leverage adjustments: information dissemination and monitoring. Overall, our results are consistent with the dynamic trade-off theory of capital structure.

Credit supply and capital structure adjustments

AbstractUsing the staggered deregulation of the U.S. banking industry as a series of exogenous shocks, I study the effect of the credit supply on the speed of capital structure adjustment. I find robust evidence that interstate and intrastate banking deregulation are positively associated with leverage adjustments. Specifically, the speeds of adjustment to target leverage are faster in the postderegulation periods. I also find that the positive effect is driven by firms that are financially constrained, are financially dependent on banks, and have less access to the public debt market and by deregulated banks’ ability to geographically diversify the credit risk.

Information Asymmetry and Leverage Adjustments: A Semiparametric Varying-coefficient Approach

Summary Information asymmetry reflects the risk and uncertainty faced by investors and is a measure of a firm's transparency. High information asymmetry could increase the cost of external financing, which in turn impedes a firm's leverage (debt–asset ratio) adjustment. The paper studies the adjustment speed towards the target leverage in the presence of information asymmetry by using microlevel data from China. In contrast with previous studies, we allow heterogeneity in the adjustment speed coefficient by modelling it as a non-parametric function of information asymmetry and other firm characteristics. This refinement not only allows for more flexibility in the model, but it also facilitates further exploration into the differences and determinants of firms’ financing behaviour. We uniquely build the firm level measure of information asymmetry into the traditional partial leverage adjustment framework. Based on our firm level measure of the adjustment speed, our paper explores why the leverage adjustment speed matters by examining its association with corporate performance indicators. We find that China's firms do have leverage targets and they slowly adjust towards these targets. We also find that the adjustment speed decreases with an increase in information asymmetry. Overall, firms which converge towards their targets faster perform better in value, profitability, investment and costs.

Are banks using leverage to target return on equity? Evidence from the US and the EU

Abstract We find evidence that banks actively use leverage to attain RoE targets and that leverage adjustments are primarily driven by capital distributions to shareholders. Using a large group of publicly-traded commercial banks from the US and the EU for the period 2001–2013, we demonstrate that this effect particularly holds for large banks before the crisis. Such behaviour may have led banks to enter the crisis with insufficient capital buffers to absorb losses, requiring unprecedented support by the public sector to maintain their solvency. Therefore, recent policies restricting the use of RoE as a metric in remuneration schemes and introducing constraints to capital distributions unless banks maintain certain buffers above the regulatory minimum, are in the right direction.

Rating and capital structure: How do the signs affect the speed of adjustment?

AbstractStandard and Poor's ratings can be modified by the addition of a plus (+) or minus (−) sign to show the relative standing within each major rating category. In this paper, we analyze the influence of these signs on the speed of leverage adjustment for listed European companies in the 2004–2014 period. Our results indicate that (a) when a qualification is accompanied by a minus sign, it adjusts more slowly than qualifications either with a plus sign or without a sign; (b) when a rating has a plus sign, the adjustment is slower than when it has no sign; and (c) when a qualification is BBB‐, the speed of its leverage adjustment is close to zero. These results suggest that companies with signs in their ratings decrease their speed of adjustment to the target leverage ratio. In addition, such companies are especially concerned about a credit rating downgrade when it implies a possible loss of the degree of investment (BBB‐).

Inter-firm relationships and leverage adjustment

This paper points out that inter-firm relationships influence the speed of adjustment of financial leverage, using business group–affiliation data of Japanese business groups (keiretsu) spanning about 30 years. It finds that the adjustment speed of firms within business groups is slower than that of independent firms. This finding remains robust given the use of several estimation methods. Overall, findings indicate the importance of considering the inter-firm relationship in capital structure study.

Target Leverage Adjustment and Growth in Shipping Companies

Target Leverage Adjustment and Growth in Shipping Companies

How Often Do Firms Rebalance Their Capital Structures? Evidence from Corporate Filings

We use new hand-collected data from corporate filings to study the drivers of corporate capital structure adjustment. Classifying firms by their adjustment frequencies, we reveal previously unknown patterns in their reasons for financing and financial instruments used. Some are consistent with existing theory, while others are understudied. Many leverage changes are outside of the firm's control (e.g., executive option exercise) or incur negligible adjustment costs (e.g., credit line usage). This implies a lower frequency of proactive leverage adjustments than indicated by prior research using accounting data, suggesting that costs of adjustment are higher, or the benefits lower, than previously thought.

Supply Chain, Product Pricing, and Capital Structure

This paper examines how firms’ reliance on the supply chain affects capital structure decision via suppliers’ product pricing. In the model firms’ reliance on a supply chain delivers either a hedge effect or a risk-amplification effect, depending on the direction and magnitude of product demand correlations between firms along the supply chain. The risk-amplification (hedge) effect makes firms lower (increase) their leverage, pay more (less) interest for debt use, and take a more conservative (active) leverage adjustment policy. Our model further captures several supply-chain-specific phenomena; e.g., the EBIT bullwhip, risk propagation, and the supplier-driven vertical spillover effect.