In April 1991, regulators seized the major subsidiaries of First Executive Corporation (FE), an insurer that invested heavily in junk bonds. During the junk bond market turmoil of 1989–1990, adverse publicity fueled a bank run at FE, forcing a $4 billion portfolio liquidation before the market rose 50–60% in 1991–1992. More traditional insurers did not receive commensurate press coverage, despite their substantial exposure to real estate declines, which were roughly 2.5 times the junk bond decline. Seizure of FE's subsidiaries was defensible, although FE would have become solvent within a year, given average junk bond market appreciation.

This paper studies accounting choice in 76 NYSE firms with persistent losses and dividend reductions (40% forced by binding covenants). We find that managers' accounting choices primarily reflect their firms' financial difficulties, rather than attempts to inflate income. Firms with and without binding covenants exhibit minor accrual differences in the ten years before the dividend reduction. In the dividend reduction and following three years, the full sample exhibits large negative accruals that likely reflect the fact that 87% of sample firms engage in contractual renegotiations -with lenders, unions, government, and/or management-that provide incentives to reduce earnings.

Liquidity production is a central function of banks. High leverage is optimal for banks in a model that has just enough frictions for banks to have a meaningful role in liquid-claim production. The model has a market premium for (socially valuable) safe/liquid debt, but no taxes or other traditional motives to lever up. Because only safe debt commands a liquidity premium, banks with risky assets use risk management to maximize their capacity to include such debt in the capital structure. The model can explain why banks have higher leverage than most operating firms, why risk management is central to banks׳ operating policies, why bank leverage increased over the last 150 years or so, and why leverage limits for regulated banks impede their ability to compete with unregulated shadow banks.

In this paper, a model of corporate leverage choice is formulated in which corporate and differential personal taxes exist and supply side adjustments by firms enter into the determination of equilibrium relative prices of debt and equity. The presence of corporate tax shield substitutes for debt such as accounting depreciation, depletion allowances, and investment tax credits is shown to imply a market equilibrium in which each firm has a unique interior optimum leverage decision (with or without leverage-related costs). The optimal leverage model yields a number of interesting predictions regarding cross-sectional and time-series properties of firms' capital structures. Extant evidence bearing on these predictions is examined.

Firms deliberately but temporarily deviate from permanent leverage targets by issuing transitory debt to fund investment. Leverage targets conservatively embed the option to issue transitory debt, with the evolution of leverage reflecting the sequence of investment outlays. We estimate a dynamic capital structure model with these features and find that it replicates industry leverage very well, explains debt issuances/repayments better than extant tradeoff models, and accounts for the leverage changes accompanying investment “spikes.” It generates leverage ratios with slow average speeds of adjustment to target, which are dampened by intentional temporary movements away from target, not debt issuance costs.

Both a firm's market-timing opportunities and its corporate lifecycle stage exert statistically and economically significant influences on the probability that it conducts a seasoned equity offering (SEO), with the lifecycle effect empirically stronger. Neither effect adequately explains SEO decisions because a near-majority of issuers are not growth firms and the vast majority of firms with high M/B ratios and high recent and poor future stock returns fail to issue stock. Since without the offer proceeds 62.6% of issuers would run out of cash (81.1% would have subnormal cash balances) the year after the SEO, a near-term cash need is the primary SEO motive, with market-timing opportunities and lifecycle stage exerting only ancillary influences.

Aggregate real dividends paid by industrial firms increased over the past two decades even though, as Fama and French (J. Financial Econ. 60, 3) (2001a) document, the number of dividend payers decreased by over 50%. The reason is that (i) the reduction in payers occurs almost entirely among firms that paid very small dividends, and (ii) increased real dividends from the top payers swamp the modest dividend reduction from the loss of many small payers. These trends reflect high and increasing concentration in the supply of dividends which, in turn, reflects high and increasing earnings concentration. For example, the 25 firms that paid the largest dividends in 2000 account for a majority of the aggregate dividends and earnings of industrial firms. Industrial firms exhibit a two-tier structure in which a small number of firms with very high earnings collectively generates the majority of earnings and dominates the dividend supply, while the vast majority of firms has at best a modest collective impact on aggregate earnings and dividends.

A hot growth stock in the 1980s, L.A. Gear's equity fell from $1 billion in market value in 1989 to zero in 1998. For over six years as revenues declined precipitously, management tried a series of radical strategy shifts while subsidizing the firm's large losses through working-capital liquidations. The L.A. Gear case illustrates that asset liquidity (broadly construed, not limited to excess cash) can give managers substantial operating discretion during financial distress. It also shows (1) that debt covenants can be stronger disciplinary mechanisms than requirements to meet cash interest payments, (2) why debt contracts typically constrain earnings instead of cash flow, (3) why cash balances are not equivalent to negative debt, and (4) why debt maturity matters. We find that many firms have highly liquid asset structures, thus their managers have the potential to subsidize losing operations should the need arise.

We study the signaling content of managers' dividend decisions for 145 NYSE firms whose annual earnings decline after nine or more consecutive years of growth. Using a variety of model specifications and definitions of favorable dividend signals, we find virtually no support for the notion that dividend decisions help identify firms with superior future earnings. Dividends tend not to be reliable signals because (i) a behavioral bias (overoptimism) leads managers to overestimate future earnings when growth prospects fade; and (ii) managers make only modest cash commitments when they increase dividends, undermining the reliability of such signals.

This article documents new and empirically important interactions between cash-balance and leverage dynamics. Cash ratios typically vary widely over extended horizons, with dynamics remarkably similar to (and complementary with) those of capital structure. Leverage and cash dynamics interact approximately as predicted by the internal-versus-external funding regimes in Myers and Majluf (1984, J. Finan. Econ., 13, 187–221.). Leverage is quite volatile when cash ratios are stable and vice-versa, while net-debt ratios are almost always volatile. Most firms increase leverage sharply as cash balances (internal funds) become scarce. Capital structure models that extend Hennessy and Whited (2005, J. Finan., 60, 1129–1165.) to include cash-balance dynamics explain some, but not all, aspects of the observed relation between cash squeezes and leverage increases.