Capital Structure Dynamics With Interrelated Adjustment

Despite ample research on corporate financing decisions, there is a growing interest in deepening our understanding of how firms structure their financing needs. In this dissertation, we build upon previous work on capital structure by examining the impact of firm-specific and macroeconomic risks on the capital structure of UK manufacturing firms. In particular, the dissertation consists of three separate, yet related essays. Each essay intends to serve a specific objective. The essays, in the order in which they appear, are entitled as follows: Essay I: The Response of Firms' Leverage to Risks: Evidence from UK Public versus Non-Public Firms Essay II: Capital Structure Adjustments: Do Macroeconomic and Business Risks Matter? Essay III: Macroeconomic Dynamics, Idiosyncratic Risk, and Firms' Security Issuance Decisions: An Empirical Investigation of UK Manufacturing Firms In the first essay, we empirically investigate whether the sensitivity of leverage to firm-specific (idiosyncratic) and macroeconomic risk differs across publicly listed and privately owned firms. We also study the implications of cash reserves-risk interactions for firms' leverage decisions. Using data from the Financial Analysis Made Easy (FAME) database, the analysis is carried out for a large panel of UK manufacturing firms over the period 1999-2008. The results provide significant evidence that UK manufacturing firms use less short-term debt in their capital structure during periods of high risk. This finding holds for both types of risk. The results on the differential effects of risk across public and non-public firms indicate that while the leverage of non-public firms is more sensitive to firm-specific risk in comparison to their public counterparts, the effects of macroeconomic risk on leverage are similar for both types of firms. The results of the indirect effects of risk show that firms with high levels of cash holdings are more (less) likely to reduce their leverage in periods when firm-specific (macroeconomic) is risk. On the whole, the results that we document in this essay provide strong evidence of the heterogenous sensitivities of leverage to risk across both types of firms and across different levels of firms' cash holdings. Essay II examines how risk affects firms' leverage adjustment decisions. Specifically, in this essay, we study the impact of risk about firms' own business activity and macroeconomic conditions on the speed with which firms adjust their capital structure toward their specific leverage targets. In doing this, we use an annual panel data obtained from the WorldScope file via DataStream for a fairly large sample of quoted UK manufacturing, covering the period 1981-2009. The results suggest that the adjustment is asymmetric and it depends on the magnitude of risk, the type of risk, and whether firms' actual leverage is above or below the target. Further, we find that firms with financial surpluses and above-target leverage adjust their leverage faster when firm-specific risk is low and when macroeconomic risk is high. In contrast, firms with financial deficits and below-target leverage are more likely to align their leverage toward their target in periods when both types of risk are low. Taken as a whole, our results suggest that firms adjust their leverage toward the target very asymmetrically across different levels and types of risk. This finding holds true even when we take into account several firm characteristics known to affect firms' adjustment speeds. The third essay analyzes how risk about firms' own business activity and macroeconomic conditions influences the security issuance decisions of listed UK manufacturing firms appeared on the WorldScope database during the period from 1981-2009. Estimating dynamic panel models using the system GMM estimator, we show that the issuance of new debt is significantly negatively related to idiosyncratic risk while both the issuance of new equity and the use of internally generated funds (retained earnings) are positively related to the risk. In contrast, we find that all these three sources of financing are significantly negatively associated with macroeconomic risk. Nevertheless, our results suggest that the aggregate dynamics of firms' target leverage are significantly negatively linked with these two types of risk. The results, from the debt-equity choice regression, indicate that the effect of both firm-specific and macroeconomic risk is significant and negative, implying that firms are likely to have low debt-equity ratio in periods when either type of risk is high.

This paper uses a dynamic unrestricted capital structure model to examine the determinants of the private companies' target financial leverage and the speed of adjustment to it in two transition economies, the Czech Republic and Bulgaria. We explicitly model the adjustment of companies' leverage to a target leverage, and this target leverage is itself explained by a set of factors. The panel data methodology combines cross-section and time-series information. The results indicate that the Bulgarian corporate credit markets were less supply-constrained than those of the Czech Republic during the period under investigation. Bulgarian companies adjusted much faster to the target leverage than Czech firms. The speed of adjustment related positively to the distance between target and observed ratio for Bulgarian companies while the relationship was neutral for Czech companies. The conservative policies of Czech banks and the exposure control were likely responsible for the slower adjustment among the larger companies while the opposite were true for Bulgarian banks and companies.

Despite significant theoretical and empirical developments in the capital structure literature, the trade-off theory and the related question of the optimality of the gearing ratio remain the subject of intense debate. The pecking order theory emerged to directly contrast with the implications of the trade-off theory. This paper investigates whether industry-optimal gearing ratio targeting behavior arises in the long run while a hierarchy of financing (or pecking order) arises in the short run. The relationship between components of common corporate gearing ratios is investigated using a Johansen co-integration methodology. Evidence of target adjustment is found, though only with respect to certain gearing ratios. Further, adjustment speed coefficients of the error correction representation imply that UK firms close the majority of any deviation from the target with retained earnings rather than external financing. However, while firms in mature industries appear to close the second largest part of any deviation with debt, firms in younger industries appear to close the second largest part of any deviation with equity. A general version of the pecking order theory can reconcile these results.

Capital structure theory is one of the most dynamic areas of finance and forms the basis for modern thinking on the capital structure of firms. Much controversy has resulted from comparisons of the theory of capital structure originally developed by Franco Modigliani and Merton Miller to real-world situations. Two competing theories have emerged over the years, the optimal capital structure theory and the pecking order theory.Arvin Ghosh begins with an overview of the controversies regarding capital structure theories, and then statistically tests both the optimal capital structure and pecking order theories. Using the binomial approach he analyzes the determinants of capital structure while discussing the role of market power in determining capital structure decisions. Ghosh probes the questions of new stock offerings and stockholders' returns, and analyzes capital structure and executive compensation. He then looks into debt financing ownership structure, and the controversal relationship between capital structure and firm profitability. Finally, he discusses the latest developments in the field of capital structure.A concise overview of a major issue in business economics and finance, this volume provides a fuller understanding of capital structure influence on the financial performance of firms, and will certainly stimulate further debate. While hundreds of scholarly articles have been written on the subject this is the first book to test competing theories against measurements of firms' performance and their underlying capital structure.

Recent research has examined asymmetries in firms' adjustments toward target leverage. Assuming firms mainly adjust their debt levels, Byoun (Journal of Finance, 2008) finds that firms adjusting most quickly possess two important characteristics: above-target debt and a financing surplus. Using alternative models allowing for adjustments in both debt and total assets, we still find evidence of asymmetries in leverage adjustments, but that firms adjusting fastest have above-target leverage and a financing deficit. Our paper shows how alternative assumptions about leverage dynamics may lead to different conclusions about target adjustment behavior.

Originally published in 1986. This book is concerned with how regional economies adapt and respond to changing circumstances, and especially with the spatial system and processes of restructuring. Throughout the book there is a methodological commitment to adjustment theory - a unique analytical framework for the study of the dynamics of advanced capitalist economies. Instead of homogenising space in the manner of neoclassical economic theory, the authors focus on adjustment processes that produce and reproduce spatial differentiation. The most important facets of regional economic structure are covered – employment, wages, prices, migration, and capital investment – in terms of their own dimensions and their connections with the larger theoretical framework. Each part of the book develops one particular dimension of regional adjustment, and each has an overview and summary. Within each part, there is a sequence of related studies focussing on the empirical aspects, theoretical logic, and distributive consequences of regional adjustment.

This thesis is an empirical investigation of three related capital structure dynamics of US-based multinationals and their domestic counterparts. Specifically, the thesis examined whether there are differences in capital structure adjustment speed between US-based Multinationals (hereafter, MNCs) and Domestic Corporations (hereafter, DCs), and if so, what theoretical factors contribute to the differences. At an industry level, the thesis examine whether or not industries of US-based Multinationals (MNCs) and their domestic counterparts (DCs) have different speed of capital structure adjustment toward the target level, particularly the manufacturing industry. And at the macro level, the thesis estimates the effect of macroeconomic factors (commercial paper spread, growth in aggregate capital expenditure of nonfinancial firms, and consumer price index (CPI)), and macroeconomic conditions defined by GDP, default spread, unemployment and price-output ratio on capital structure dynamics of US-based MNCs relative to DCs. Various econometric techniques were employed in the thesis to test the hypothesis that capital structure dynamics of US-based MNCs differ from DCs. Using fixed effect instrumental variables (FEIV), the empirical results shows that on average, DCs adjust to target leverage faster than MNCs. Similarly, the results support existences of capital structure differences among industries for MNCs and DCs.

Quantitative finance is a combination of economics, accounting, statistics, econometrics, mathematics, stochastic process, and computer science and technology. Increasingly, the tools of financial analysis are being applied to assess, monitor, and mitigate risk, especially in the context of globalization, market volatility, and economic crisis. This two-volume handbook, comprised of over 100 chapters, is the most comprehensive resource in the field to date, integrating the most current theory, methodology, policy, and practical applications. Showcasing contributions from an international array of experts, the Handbook of Quantitative Finance and Risk Management is unparalleled in the breadth and depth of its coverage. Volume 1 presents an overview of quantitative finance and risk management research, covering the essential theories, policies, and empirical methodologies used in the field. Chapters provide in-depth discussion of portfolio theory and investment analysis. Volume 2 covers options and option pricing theory and risk management. Volume 3 presents a wide variety of models and analytical tools. Throughout, the handbook offers illustrative case examples, worked equations, and extensive references; additional features include chapter abstracts, keywords, and author and subject indices. From "arbitrage" to "yield spreads," the Handbook of Quantitative Finance and Risk Management will serve as an essential resource for academics, educators, students, policymakers, and practitioners.