Capital Structure

Paper Session

Sunday, Jan. 8, 2017 10:15 AM – 12:15 PM

Sheraton Grand Chicago, Sheraton Ballroom III
Hosted By: American Finance Association
  • Chair: Mark Leary, Washington University-St. Louis

The Misallocation of Finance

Toni Whited
University of Michigan
Jake Zhao
Stony Brook University


We ask whether financial assets are well-allocated in the cross-section of firms. Extending the framework of Hsieh and Klenow (2009) to the liabilities side of the balance sheet, we estimate the real losses that accrue from the cross-sectional misallocation of financial liabilities across firms. Using U.S. and Chinese data on manufacturing firms, we find significant misallocation of debt and equity. Although financial liabilities appear well-allocated in the United States, they are not in China. If China's debt and equity markets were as developed as those in the United States, China would realize gains of approximately 80% in terms of firm value added. We also back out the cost of debt and equity for each firm with our model, taking into account allocation distortions. We find that larger firms and firms located in more developed cities face markedly lower costs.

Corporate Capital Structure Actions

Murray Frank
University of Minnesota and SAIF
Tao Shen
Tsinghua University


Existing empirical models of corporate leverage do a good job of predicting the cross section pattern of debt and equity repurchases. However, they do a poor job predicting debt and equity issuing. To improve the performance we use a large number of macroeconomic variables in reduced rank regression to estimate leverage targets based on firm-specific sensitivities to four common factors. This model gets the correct cross section patterns of issuing and repurchasing. The four factors load heavily on asset tangibility, taxation, corporate overhead, and volatility. The model performs particularly well for larger, profitable, and dividend paying firms. Smaller, high growth, and technology firms are
not as well predicted by the model.

Financing Intangible Capital

Qi Sun
Shanghai University of Finance and Economics
Mindy X. Zhang
University of Texas-Austin


Firms finance intangible investment through employee compensation contracts. In a dynamic model in which intangible capital is embodied in a firm's employees, we analyze the firm's optimal decisions of intangible capital investment, employee compensation contracts, and financial leverage. Employee financing is achieved by delaying wage payments in the form of future claims. We document that intangible capital investment is highly correlated with employee financing, but not with debt issuance or regular equity refinancing. In the quantitative analysis, we show that this new channel of employee financing explains the cross-industry differences in leverage and financing patterns.

Understanding Precautionary Cash at Home and Abroad

Michael Faulkender
University of Maryland
Kristine Hankins
University of Kentucky
Mitchell Petersen
Northwestern University


In the presence of market frictions, it is optimal for firms to stockpile cash to fund investment projects which may arise in the future. Prior work has documented that firm’s precautionary savings motives predict variation in the size of firm’s cash stockpile. The dramatic run up in cash stockpiles raises the question of why these precautionary motives have increased. In the presence of repatriation taxes, foreign and domestic cash are imperfect substitutes. We show that although precautionary motives explain variation in the level of cash held domestically, they provide little explanatory power for the level of foreign cash. Multinational firm’s foreign cash balances are instead explained by low foreign tax rates and the ability to transfer profits within the firm through related party sales. The firms with the greatest incentive and ability to transfer income to low tax jurisdictions do, and this results in stockpiles of cash trapped in their foreign subsidiaries.
Arthur Korteweg
University of Southern California
Armen Hovakimian
Baruch College
Ilona Babenko
Arizona State University
Rohan Williamson
Georgetown University
JEL Classifications
  • G3 - Corporate Finance and Governance