Target Debt Levels Research Articles

Multiple Equilibria between Fertility Rates and Pension Levels Based on the Target Level of Government Debt

We show that when the government has a target debt level, multiple equilibria exist in the relationship between fertility rates and pension levels. One is associated with a high fertility rate and a high pension level. The other is associated with a low fertility rate and a low pension level. If the government fails to provide adequate security for individuals during their retirement years, it would result in a failure of coordination between the government and individuals.

Signaling Credit Risk in Agriculture: Implications for Capital Structure Analysis

Signaling is an important element in the lender-borrower relationship that influences the cost and availability of debt capital to agricultural borrowers. This paper analyzes the effects of signaling on farm capital structure in conjunction with the pecking order and trade-off theories. The aggregate estimation indicates that signaling does affect agricultural credit relationships through measures of past cash flow and profitability. High-quality borrowers achieve greater credit capacity by providing lenders with valid signals of their financial status, while adjusting toward target debt levels over time and following the pecking order relationship in the short run.

An Analysis of the Financing Decisions of REITs: The Role of Market Timing and Target Leverage

This paper examines the role of capital market conditions and target leverage on the marginal financing decisions of Real Estate Investment Trusts (REITs), which include both capital raising and capital reduction activities. We investigate the relevance of a hybrid hypothesis whereby REITs have target leverage, but they also choose and time their marginal financing decisions according to the capital market conditions. The empirical results suggest that target leverage behavior plays a secondary role to market timing behavior in the financing decisions of REITs. In particular, we find strong and consistent evidence that REITs exhibit market timing behavior in terms of when and what type of capital to issue or reduce. Such market timing practices, motivated by attempts to take advantage of capital market conditions, may shift the firms away from their target leverage. However, we observe that in the long run, most REITs do move their capital structure towards the target debt level.

Corporate Financing Decisions: UK Survey Evidence

Abstract: Despite theoretical developments in recent years, our understanding of corporate capital structure remains incomplete. Prior empirical research has been dominated by archival regression studies which are limited in their ability to fully reflect the diversity found in practice. The present paper reports on a comprehensive survey of corporate financing decision‐making in UK listed companies. A key finding is that firms are heterogeneous in their capital structure policies. About half of the firms seek to maintain a target debt level, consistent with trade‐off theory, but 60% claim to follow a financing hierarchy, consistent with pecking order theory. These two theories are not viewed by respondents as either mutually exclusive or exhaustive. Many of the theoretical determinants of debt levels are widely accepted by respondents, in particular the importance of interest tax shield, financial distress, agency costs and also, at least implicitly, information asymmetry. Results also indicate that cross‐country institutional differences have a significant impact on financial decisions.

How does Financial Distress Affect Small Firms’ Financial Structure?

This paper provides new evidence on the financial structure of small firms by emphasizing the role played by financial distress. We specify a model of debt adjustments that allows us to investigate the specific nature of the adjustment process towards target debt levels in small firms, which is then extended to account for the effect of financial distress on financial structure decisions. Our models were estimated by the Generalized Method of Moments on a data panel of small Portuguese firms during a period of recession, in which a substantial proportion of the companies analyzed faced a financial distress situation. We find that small firms do adjust their debt ratios towards target levels, the speed of adjustment being faster in the shorter term. Our results also indicate that there are major differences in the determinants of long-term and short-term debt, highlighting the role played by debt maturity in explaining a firm’s financial structure. Finally, random behavior is observed in financially distressed firms, who seem to be disoriented when making their financial structure decisions.

The valuation effects of long‐term changes in capital structure

PurposeThis paper aims to test the irrelevance proposition whereby changes in capital structure do not affect firm value.Design/methodology/approachThe long‐run effect of changes in capital structure on firm value is examined, using a sample of 243 French firms over the period 1987‐1996.FindingsThe null hypothesis cannot be rejected. No evidence is found to support a significant relationship between the changes in debt ratios and the changes in value. To assess the strength of this finding, control for reversion towards the target debt level induced by the static trade‐off theory is introduced. Similar results were obtained.Originality/valueThis paper is one of the first to analyze the long‐term relationship between financial structure changes and value, and to propose a direct test for the irrelevance proposition.

Diversity and Determinants of Corporate Financing Decisions: Survey Evidence

Despite theoretical developments in recent years, our understanding of corporate capital structure remains incomplete. Prior empirical research has been dominated by archival regression studies which are limited in their ability to fully reflect the diversity found in practice. The present paper reports on a comprehensive survey of corporate financing decision-making in 192 UK listed companies. A key finding is that firms are heterogeneous in their capital structure policies. About half of the firms seek to maintain a target debt level, consistent with trade-off theory, but 60% claim to follow a financing hierarchy, consistent with pecking order theory. These two theories are not viewed by respondents as either mutually exclusive or exhaustive, since some firms adopt (at least partially) both strategies, while a significant number of firms do not appear to follow either of these strategies. Such observations raise concerns about the usefulness of large-scale regression modelling of capital structure determinants. In normal usage, these models can only describe whether a particular theory is consistent with the observed capital structure of the 'average firm' in the population. They are not typically used to model the diversity of capital structure practice. As found in many regression-based determinant studies, there is clear evidence here that company size affects corporate financing decisions. For example, large companies are more likely to adopt a target debt level and to maintain financial slack (though not more likely to follow a hierarchy of finance). Similarly, current high levels of gearing encourage a greater focus on particular issues, such as projected cash flows, loan covenants and non-interest tax shields. This contingency on debt levels suggests that empirical studies of capital structure dynamics may be particularly fruitful. Investigation of debt level determinants shows that many of the theoretical arguments are widely accepted by respondents, in particular the importance of interest tax shield, financial distress, agency costs and also, at least implicitly, information asymmetry.

Informative value of firm capital structure

In this paper, the informative value of firm capital structure is analyzed. In the first part, a theoretical background regarding capital structure theories is presented. In the second (empirical) part, the Ohlson (1995) valuation framework is used in order to analyze the informative value of firm capital structure on a sample of data for the Czech (non-financial) companies. A contextual approach is adopted and the value relevance of debt is analyzed considering the signalling and the optimal capital structure theories. According to the results and in accordance with the optimal capital structure theory, debt is more penalized in case of the companies that deviate from the target debt level. Moreover, debt proves to be a positive signal for the firms with a higher earnings growth potential. This, in turn, is consistent with the signalling theory.

The control hypothesis and recurring versus accumulated free cash flow

This paper offers and investigates the hypothesis that managers are motivated to control accumulated free cash flows, as well as to control the recurring component from operations as suggested in Jensen's (1986, 1988) theory on agency behavior and control. Such managers may be willing to sacrifice a portion of the recurring component of free cash flow in the form of additional interest expense, as well as to incur the additional monitoring by capital markets, in exchange for control over a greater level of accumulated free cash flow in the form of cash and equivalents. Partial support for this hypothesis is observed for a sample of acquisition targets possessing poison pill defenses, which enhances the likelihood of the required agency behavior. Target firms are observed to have above-average levels of capital expenditures, cash and equivalents, and debt. When regressed on premiums offered to target shareholders, however, only the target debt level is found to be significant.

The Choice Between Equity and Debt: An Empirical Study

This empirical study of security issues by UK companies between 1959 and 1974 focuses on how companies select between financing instruments at a given point in time. It throws light on a number of interesting questions. First, it demonstrates that companies are heavily influenced by market conditions and the past history of security prices in choosing between debt and equity. Second, it provides evidence that companies appear to make their choice of financing instrument as if they have target levels of debt in mind. Finally, the results are consistent with the notion that these target debt levels are themselves a function of company size, bankruptcy risk, and asset composition.

The Choice Between Equity and Debt: An Empirical Study

ABSTRACTThis empirical study of security issues by UK companies between 1959 and 1974 focuses on how companies select between financing instruments at a given point in time. It throws light on a number of interesting questions. First, it demonstrates that companies are heavily influenced by market conditions and the past history of security prices in choosing between debt and equity. Second, it provides evidence that companies appear to make their choice of financing instrument as if they have target levels of debt in mind. Finally, the results are consistent with the notion that these target debt levels are themselves a function of company size, bankruptcy risk, and asset composition.