Leverage Costs Research Articles

Workplace Automation and Corporate Liquidity Policy

Using an occupational probability of computerization, we measure a firm’s ability to replace labor with automated capital. Our evidence suggests that the potential to automate a workforce enhances operating flexibility, allowing firms to hold less precautionary cash. To provide evidence for this mechanism, we exploit the 2011–2012 Thailand hard drive crisis as an exogenous shock to the cost of automation. In addition, the negative relation between prospective automation and cash holdings is greater for firms with a lower expected cost of worker displacement and greater labor-induced operating leverage. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.03902 .

Inequality-constrained monetary policy in a financialized economy

We study how income inequality affects monetary policy through the inequality-household debt channel. We design a minimal macro Agent-Based model that replicates several stylized facts, including two novel ones: falling aggregate saving rate and decreasing bankruptcies during the household's debt boom phase. When inequality meets financial liberalization, a leaning against-the-wind strategy can preserve financial stability at the cost of high unemployment, whereas an accommodative strategy, i.e. lowering the policy rate, can dampen the fall of aggregate demand at the cost of larger leverage. We conclude that inequality may constrain the central bank, even when it is not explicitly targeted.

Product competition, political connections, and the costs of high leverage

This paper explores whether the political connections of listed firms in China affect the costs of high leverage on a firm's product competition. We collect a sample of 1341 non-state-owned firms (i.e., private firms) with political connections listed in the Chinese stock market from 2009 to 2019. Using the sensitivity of sales growth to high leverage to proxy for the costs of high leverage, we find that the negative effect of high leverage on sales growth is significantly lower for companies with political ties. Our results are robust to a series of endogeneity corrections and robustness checks. We also find that political connections benefit highly leveraged firms by reducing the adverse behavior of customers and competitors. However, the effect of political connections on the unfavorable actions of employees and suppliers is not statistically significant. In addition, the mitigating effect of political connections on high leverage costs is more pronounced in firms with low profitability, headquartered in low-trust provinces, and experiencing high economic policy uncertainty. Finally, we find that political connections can also mitigate the negative effect of high leverage on firms’ investment and profit. Overall, our findings suggest that political connections reduce the cost of high leverage.

Ownership Concentration, Capital Structure and Stock Returns of Firms Listed at the Nairobi Securities Exchange

Ownership concentration enables majority shareholders to influence the capital structure; a key financing decision that is independently linked to firm performance. Ideally, firm managers should strive to maximize stock returns by selecting an appropriate optimal capital composition that maximizes the trade-off between the cost of leverage and gains. However, the performance benefits are not always realized because the controlling shareholders may adversely affect stock returns by extracting private benefits at the expense of the minority shareholders, leading potential investors to consider the firm as a risky and unattractive investment, hence lowering stock demand and price. This research sought to determine the intervening effect of capital structure on the ownership concentration and stock returns relationship. A census survey was done on sixty-seven firms listed at NSE from 2006 to 2019 and data was obtained from sixty firms that had been listed for at least two years. A fixed effects model was then utilized to conduct data analysis. The four-step mediation process showed that capital structure mediated the connection between ownership concentration and stock returns. The results contribute to the empirical literature by reducing the conflicting positions on the link between ownership concentration and stock returns by introducing capital structure into the relationship and confirming the role of capital structure in performance management. The study recommends that agents be given incentives through monitoring and regulation to ensure that management interests and those of their principals are aligned when important financing decisions are being made to serve the interests of both majority and minority shareholder. This will promote and enhance corporate performance and increase stock returns.

Temperature shocks and stock returns: evidence from major markets

ABSTRACT Global temperatures have increased at a historically unprecedented pace. The paper finds the negative impact of high temperatures on global stock prices and offers evidence on three channels that justify this impact, i.e. the effect on firms’ assets, on investments, and on leverage costs. The results encourage market stakeholders to consider the role of temperature shocks in their market involvement.

Workplace Automation and Corporate Liquidity Policy

Using an occupational probability of computerization, we measure a firm’s ability to replace labor with automated capital. Our evidence suggests that the potential to automate a workforce enhances operating flexibility, allowing firms to hold less precautionary cash. To provide evidence for this mechanism, we exploit the 2011–2012 Thailand hard drive crisis as an exogenous shock to the cost of automation. In addition, the negative relation between prospective automation and cash holdings is greater for firms with a lower expected cost of worker displacement and greater labor-induced operating leverage.

Company Cost of Capital and Leverage: A Simplified Textbook Relationship Revisited

In this paper, we revisit a frequently employed simplification within the WACC approach that company cost of capital k_{V} is supposed to be invariant to the debt ratio and therefore equal to the unlevered cost k_{U}. Even though we know from Miles and Ezzell (1980) that k_{V} formally differs from k_{U}, treating both costs as equal strongly facilitates the practical firm valuation e.g. when companies strategically change their target debt ratios to a significantly different magnitude after a transaction. We provide both a theoretical model and an empirical analysis using 29 firms of the German stock market to quantify the economic significance between the company cost of a levered and an otherwise identical but unlevered firm. In particular, we can numerically support the usual simplification in the absence of default risk. In case that firms are default-risky, however, empirical findings indicate a clear difference between these costs equal to 1.88 percentage points on average even for moderate assumed bankruptcy costs which translates to a company mispricing of nearly 100%. As a result, the company cost of capital does practically not depend on the debt ratio if the firm is not subject to default risk or if bankruptcy costs are negligible. Otherwise, it does and a negligence of this relationship can cause significant mispricings.

Is sustainable investing good for the environment

Purpose- The primary objective of this research initiative is to gain insight to the conceptual layers of sustainable investing and to shade light on the ESG impact, ESG rating diversities and on the counterproductivity issues with respect to sustainable investment strategies. Conceptually, the Sustainable Investing are numerous and evolving. The old definition of “An investment is sustainable if the investment is fortified with “financial returns only” is transformed into an ESG-investing mode. Within this transformatory process a new and rapidly evolving type of investment called ‘Impact Investment” has heated the debate. The strategic focus might be on the “Impact First Investors” or on the “Financial First Investors” on many sectors and themes (Jaquier, 2011:25). A more recent definition “Fiduciary Investing” defines an Investment as sustainable, if the investor seeks to minimize the negative impact or the losses from ESG related investments. Major impact areas are financial services, agriculture, energy, environment, community housing, water, education and health. Given the broad range of definitions and areas, the global sustainable fund assets under management rose by 8% over the last quarter to USD 3 trillion at the end of December 2023 (Morningstar Manager Research, Jan. 25, 2024). Within the impact capacity of the Sustainable Investments, investor impact happens through three different impact mechanisms called Shareholder Engagement, Capital Allocation and the Indirect impacts (Kölbel, J.F. et all, 2020). Hartzmark, S. M., and Shue, K., aims to reveal emprically the granularity of the “impact elasticity” and hence the emission levels and ratios for green and brown firms based on the changes of their implied cost of capital, financial performance, interim returns, financial distress, leverage, productivity shocks and portfolio holdings of sustainable funds. Investors can screen out investments further based on the ESG ratings criteria. In this respect, Sustainable Investors representing over USD 100 trln in combined asstes are heavily usind the ESG ratings of different rating agencies (Berg, F., et all, 2022). However, ESG ratings which increasingly influence Sustainable Investment decisions, are very much diversified by different rating companies. The divergence of ESG ratings introduces uncertainity and performance evaluation difficulties for the decision makers (Berg, F., Kölbel J.F., Rigobon, R., 2022:1316). Methodology- The ESG Divergence research is based on the critical evaluation of the data stemming from six different ESG rating providers such as KLD, Sustainalytics, Moody’s ESG, Refinitiv, MSCI and S&P Global. A new taxanomy is developed for the divergence of ratings are evaluated on the basis of scope, measurement and weightings diversities of the models. The counterproductivity analysis for Sustainable Investing strategies is based on the definition of “impact elasticity”. The impact elasticity is measured as the level change in a firm’s emissions intensity for a unit change of its cost of capital. Findings- Sustainable Investing differs from conventional investments considerably. According to Kölbel, J.F. et all, Sustainable Investors, whose decisions are based primarily on the layer of social impact, mechanisms, should pursue shareholder engagement throughout their portfolio, allocate capital to sustainable companies whose growth is limited by external financing conditions, and screen out companies based on the absence of specific environmental, social, and governance practices that can be adopted at reasonable costs. Conclusion- A very important conclusion stemms from the fact that, in the absence of green substitutes for entire brown industries, the diminishing sustainable investments could contribute to more emission levels. Accordingly, the greening of a sector should come from the internal and revolutionary Dynamics withing the brown industries. Keywords: Sustainable investing, ESG ratings, corporate social responsibility, ethical investing. JEL Codes: G4, O44, Q56, D81

Does Climate Change Exposure Matter to Stakeholders? Evidence from the Costs of High Leverage

Does Climate Change Exposure Matter to Stakeholders? Evidence from the Costs of High Leverage

Do adjustment costs influence firms’ target adjustment speeds? International evidence from share repurchase legalization

Do firms change their capital structure adjustment speed towards a target when adjustment costs change? Under a unified capital structure approach that combines the static trade-off and pecking order theories, firms minimize adjustment costs in setting their target adjustment speed. For below-target firms, the availability of share repurchases lowers the expected cost of increasing leverage towards the target. Extending the adjustment cost-based unified framework to the availability of share repurchases, which exogenously lowers the expected cost of leverage increases for below-target firms, I show the availability of share repurchases to result in these firms increasing their leverage adjustment speed towards a target. As predicted, this effect does not hold for the above-target firms.

Valuing the speed of adjustment of capital structure

AbstractI estimate the optimal speed of adjustment (SOA) policy for a large sample of US firms by examining the dynamics of the opportunity cost of leverage. Studying the dynamics of the opportunity cost of leverage as opposed to leverage ratios allows me to estimate the value of a given SOA policy and hence calibrate the optimal SOA policy in terms of firm value. Simulation results show that the optimal SOA is between 31% and 37% when adjustment costs are considered. The sensitivity of firm value to SOA is low for a wide range of SOAs around the optimal level. However, extremely high or low SOAs have substantial negative impacts on firm value.

Impact of Corporate Governance on Cost of Capital: Moderating Role of Foreign Ownership

Abstract. The purpose of this study is to examine the impact of corporate governance mechanism with moderating role of foreign ownership on the cost of capital. The 108 listed nonfinancial firm’s annual data, ranging from 2011 to 2017, is extracted from annual reports. The ordinary least square method has been used with different techniques such as common, fixed, and random effect models but most variables were significant in the common effect model. The statistical findings of the study indicate that there is a significant relationship between corporate governance mechanisms and the cost of capital in non-financial firms of Pakistan. To some extent foreign ownership moderates, the relationship between the audit committee, board of directors’ managerial ownership, and cost of capital and leverage (debt to asset ratio) plays a controlling role among these variables. All non-financial firms should increase the environment of foreign ownership in their firms for the profit maximization and development of the economy.

Asymmetric Information and Agency Cost of Financial Leverage and Corporate Investments: Evidence from Emerging South-East European Countries

In this paper, we investigated the impact of financial leverage on investment decisions on a sample of 811 firms from ten emerging South-Eastern European countries (Bosnia and Herzegovina, Bulgaria, Montenegro, Croatia, Greece, Romania, North Macedonia, Slovenia, Serbia and Turkey). We apply a panel regression model involving investment ratio as a dependent variable, leverage as independent variable, and control for several firm characteristics that closely determines the corporate investments. The results of the analysis show that leverage is negatively related to investment in the companies in SEE. But only long term debt has a stronger negative impact on investment for firms with low growth opportunities than for firms with high growth opportunities. These findings show supportive evidence of agency theories of corporate leverage, especially with the debt overhang theory, but did not give strong validation that leverage has a disciplining role for firms with low growth opportunities in SEE emerging markets. In addition to leverage, we found that corporate investments in the SEE countries decrease significantly with tangibility and the company size. Corporate investments in the SEE countries increase significantly with cash flow, sales, non-debt tax shield and profitability. Overall, the results slightly defer with those from the research on the case of developed markets.

Cost of high leverage in socially responsible firms in a linear dynamic panel model. Evidence from product market interactions

Corporate Social responsibility is the major challenge for senior management of firms and they devoted the significant resources for CSR initiatives. Despite of significant comprehension of CSR, an ongoing debate is still under consideration about its economic repercussions in terms of “do well by doing good”. Corporations are facing huge leverage cost with bad customer reputation in the product market. This study attempt to examine this phenomenon as the cost of high leverage in socially responsible firms and the product market interactions of those firms. The data is collected from 2009-2020 in linear dynamic setting for product market interaction, and two step system GMM estimation technique is applied for endogeneity concerns. The study identified that socially responsible firms are experiencing better growth in their sales in product market that maximize the financial benefits. However, the high leverage cost worsen their performance in product market because leverage is associated with some losses in market share due to unfavorable actions of competitors and customers. Socially responsible firms experience the low cost of high leverage which helps the firms to increase the performance in product market. Moreover, the corporate governance effectively devises the strategies to diminish the high leverage cost in the way towards better product market interactions. The results are conclusive across the financial crisis, firm’s classifications and different channels of firms. The study enables the holistic and broader understanding of CSR in the reduction of high leverage cost with an intention to increase the firm’s sustainability in product market. The study contributes with a view to ascertain the cost of high leverage in socially responsible firms for product market interactions of Pakistani firms in a linear dynamic panel.

A resource dependence theory perspective on low savings, cost of capital, leverage and bank valuation in South Africa

ABSTRACT South Africa has one of the lowest savings rates of the emerging economies. However, the minimum capital and liquidity coverage prudential requirements are consistently exceeded by local banks. This paper investigates whether low savings have any impact on bank’s cost of capital, leverage and valuation through the lens of the resource dependence theory. The Autoregressive Distributed Lag Bounds Test estimates of panel data from 2008 to 2018 suggest that low savings have a long-run relationship with cost of equity, leverage and bank’s value. Furthermore, bank’s value and cost of equity are negatively affected in the short run but positively in the long run, implying that South African banks benefit from their interactions with contractual savings institutions in the long run and transfer cost increases to customers. As for leverage, the impact is positive in the short and not significant in the long run. The policy implications of these findings are, at the banks’ level, to act on the financial determinants of savings and household over-indebtedness. Banks should promote financial literacy and trust, avoid predatory lending and cut back bank charges in order to attract households informal savings (called stokvels in South Africa) by offering, for example, fixed floor rate on deposits when repo rate decreases and no ceiling when repo rate increases. At a national level, competitive exchange rate as well as the protection of property rights as per the literature would drive individual and national savings through investment.

Build New or Retrofit? Leverage Cost Benefits for Building Energy Efficiency

Build New or Retrofit? Leverage Cost Benefits for Building Energy Efficiency

Analysis of the mitigation effects of corporate social responsibility on the negative impact of high leverage in ASEAN-5

One of the ASEAN Economic Community's intentions is to direct firms in ASEAN to society-oriented development. We investigate the impact of corporate social responsibility that is moderated by high leverage to sales growth in the region of ASEAN-5. The research sample consisted of 87 firms that were listed in the stock exchange of ASEAN-5, including Indonesia, Malaysia, Singapore, Thailand, and the Philippines during the period of 2014–2018. This research found a significant positive impact of corporate social responsibility moderated by a high leverage to sales growth. This research contributes to previous research on high leverage costs literature through reviewing existing determinants of high leverage costs including additional variables such as country-level factors in the ASEAN-5 region.

To be or not to be all-equity for firms that eliminate long-term debt

Despite the advantages of debt, a significant number of firms that have an established leverage policy deliberately become all-equity. These firms eliminate a substantial amount of long-term debt as the average firm’s leverage ratio is approximately 30 percent at the year-end prior to debt elimination. Firm-level “shocks” such as CEO turnover and changes in credit ratings cannot explain the dramatic recapitalization decision. Consistent with the tradeoff theory, firms that eliminate debt have lower benefits (less tax shield benefits, agency costs) and higher costs (probability of financial distress, access to capital markets, etc.) of leverage in the three prior years compared to a matched sample. We also find that the factors influencing the decision to eliminate all debt is different from those to significantly reduce leverage or to have very low debt levels. Firms primarily finance the approximately $70 million of average long-term debt eliminated using proceeds from sales of relatively unproductive assets and from equity issues. Interestingly, over half of these firms issue significant amount of new debt within three years of becoming all-equity. Firms with lower liquidity and non-debt tax shields, higher potential overinvestment agency costs, and those that issue equity at the debt elimination year are more likely to relever quickly.

What Can Betting Markets Tell Us About Investor Preferences and Beliefs? Implications for Low Risk Anomalies

An empirical puzzle in financial markets, known as the low-risk anomaly, is that riskier assets earn lower risk-adjusted returns than less risky assets. Theories for this phenomenon focus either on market frictions, such as leverage costs, or non-traditional preferences for lottery-like payoffs. We relate the low risk anomaly to the Favorite-Longshot Bias in betting markets, where returns to betting on riskier longshots are lower than returns to betting on favorites, and provide novel evidence to both anomalies. Synthesizing the evidence, we study the joint implications from the two settings for a unifying explanation. Rational theories of risk-averse investors with homogeneous beliefs cannot explain the cross-sectional relationship between diversifiable risk and return in betting markets. Rather, we appeal to models of non-traditional preferences or heterogeneous beliefs. We find that a model with reference-dependent preferences, featuring probability weighting and diminishing sensitivity, two features of Cumulative Prospect Theory, best fits the data, and is able to capture the choice and the amount to bet. Calibrated parameter values for probability weighting and diminishing sensitivity that capture financial markets facts can simultaneously explain the betting market facts. However, explaining the choice to bet is at odds with loss-aversion, a feature of Cumulative Prospect Theory often used in financial markets applications.

The Leverage Effect of Bank Disclosures

The general view underlying bank regulation is that bank disclosures provide market discipline and reduce banks’ risk-taking incentives. We show that bank disclosures can increase bank leverage and bank risk. The reason stems from the interaction between insured and uninsured debt. Bank disclosures reduce the agency problem between uninsured debt and equity, thereby lowering the cost of leverage for banks. By issuing uninsured short-term debt that is repaid ahead of insured deposits when economic conditions deteriorate, banks dilute insured deposits. Higher levels of uninsured short-term debt increase the subsidy provided by deposit insurance, which increases banks’ risk-taking incentives. We identify conditions under which this negative leverage effect dominates the standard market discipline effect, so that providing market discipline through bank disclosures increases banks’ risk.