A Fast Literature Search Engine based on top-quality journals, by Dr. Mingze Gao.
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Results 6 resources
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Empirical research has struggled to show that variation in corporate capital structure arises from variation in estimated corporate income tax rates. We argue that, in previous studies, both the tax rates applied to multinational corporations and the taxable income earned have been mismeasured. Using the Bureau of Economic Analysis annual survey sample combined with each firm's income and country specific tax rate, we find that firms do have higher leverage ratios and lower interest coverage ratios when they operate in countries with higher tax rates, as theory would suggest. The trade-off theory of capital structure continues to have empirical support.
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We examine whether values of equity options traded on individual firms are sensitive to the firm’s capital structure. We estimate the compound option (CO) model, which views equity as an option on the firm. Compared with the Black-Scholes model, the CO model with a term structure of volatility (TSV) reduces pricing errors by 20% on average. The compound option effect is particularly strong for highly levered firms and long-term options, in which the pricing improvement is up to 70% of the Black-Scholes error. Without a TSV, the CO model reduces pricing errors of in-the-money options by 12.74% on average and for out-of-the-money by 9.22%. We show that the CO model implies a market value of firm leverage and allows imputation of the firm’s implied volatility, both of which have potential applications in corporate finance.
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The sample of observed defaults significantly understates the average firm׳s true expected cost of default due to a sample selection bias. I use a dynamic capital structure model to estimate firm-specific expected default costs and quantify the selection bias. The average firm expects to lose 45% of firm value in default, a cost higher than existing estimates. However, the average cost among defaulted firms in the estimated model is only 25%, a value consistent with existing empirical estimates from observed defaults. This substantial selection bias helps to reconcile the levels of leverage and default costs observed in the data.
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Surprisingly little is known about the business cycle dynamics of leverage. The existing evidence documents that target leverage evolves pro-cyclically either for all firms or financially constrained ones. In contrast, we show that, on average, target leverage ratios evolve counter-cyclically once cyclicality is measured comprehensively, accounting for variation in explanatory variables and model parameters. These counter-cyclical dynamics are robust to different subsamples of firms, data samples, empirical models of leverage, and definitions of leverage. There is a fraction of 10–25% of firms with pro-cyclical dynamics whose characteristics are consistent with counter-cyclical dynamics for loss-given-default and probability of default.
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We quantify the importance of collateral versus taxes for firms' capital structures. We estimate a dynamic model in which a taxable firm seeks financing for investment, and a dynamic contracting environment motivates endogenous collateral constraints. Optimal leverage stays a safe distance from the constraint, balancing the tax benefit of debt with the cost of lost financial flexibility. We estimate this flexibility cost to be 7.2% of firm assets, a percentage that is comparable to the tax benefit. Models with different tax rates fit the data equally well, and leverage responds to the tax rate only when taxes are low.
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We examine how production flexibility affects financial leverage. A worldwide sample of energy utilities allows us to apply direct measures for production flexibility based on their power plants. We find that production flexibility increases financial leverage. For identification, we exploit privatizations and deregulations of electricity markets, geographical variations in natural resources, the technological evolution of gas-fired power plants, and differences in electricity prices and recapitalization cost across regions. Production flexibility affects financial leverage via the channels of reduced expected cost of financial distress and higher present value of tax shields. The relative importance of these channels depends on firms' profitability.