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  4. Preliminary Program
  5. Determinants of Corporate Leverage
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Determinants of Corporate Leverage

Paper Session

Monday, Jan. 4, 2021 12:15 PM - 2:15 PM (EST)

Hosted By: American Finance Association
  • Chair: Ozde Oztekin, Florida International University

Inflexibility and Leverage

Olivia Gu
,
University of Hong Kong
Dirk Hackbarth
,
Boston University
Tong Li
,
University of Hong Kong

Abstract

Firms' inflexibility to adjust their scale persistently explains capital structure variations in a comprehensive sample and randomly-selected subsamples. Higher inflexibility leads to lower financial leverage, potentially due to higher default risk and lower value of tax shields. Contraction inflexibility determines leverage more than expansion inflexibility. Moreover, inflexibility explains financial leverage on top of operating leverage variability and cash flow variability. Interestingly, the substitution effect between financial and operating leverage is much weaker among flexible firms. In addition, inflexible firms increase leverage more than flexible firms following a positive credit supply shock, which supports our main findings.

Index Creation, Information, and External Finance

Vidhan Goyal
,
Hong Kong University of Science and Technology
Daniel Urban
,
Erasmus University
Wenting Zhao
,
Technical University of Munich

Abstract

How do firms added to an equity index change their financing strategies? We use the formation of new equity indexes and changes to index methodology as a setting to examine how shocks to a firm's information environment affect the debt supply and financing of firms. Firms added to an index are covered by more equity analysts and have greater news coverage, resulting in higher information production. Consequently, bond liquidity improves and firms benefit from lower yield spreads on newly issued debt. Treatment firms increase their leverage by about two percentage points relative to control firms. The response is primarily in the more information-sensitive public debt market, with firms issuing more public debt.

Actively Keeping Secrets from Creditors: Evidence from The Uniform Trade Secrets Act

Scott B. Guernsey
,
University of Tennessee
Kose John
,
New York University
Lubomir Litov
,
University of Oklahoma

Abstract

We find that an increase in a firm’s incentives to use trade secrets to protect its intellectual property
results in a more actively managed capital structure. Exploiting U.S. states’ adoption of the Uniform
Trade Secrets Act as a positive “shock” in the protection afforded to trade secrets, we find that firms
covered by the Act reduce debt levels while increasing investments in intangibles. Additional tests
suggest that firms fund these financing and investment activities by issuing more equity. Consistent
with an increase in overall intangibility magnifying contracting problems with creditors, we find that
covered firms experience higher costs of debt.

It's Not So Bad: Director Bankruptcy Experience and Corporate Risk Taking

Radhakrishnan Gopalan
,
Washington University in St. Louis
Todd Gormley
,
Washington University in St. Louis
Ankit Kalda
,
Indiana University

Abstract

We show that firms take more (but not necessarily excessive) risks when one of their directors experiences a corporate bankruptcy at another firm where they concurrently serve as a director. This increase in risk-taking is concentrated among firms where the director experiences a shorter, less-costly bankruptcy and where the affected director likely exerts greater influence and serves in an advisory role. The findings show that individual directors, not just CEOs, can influence a wide range of corporate outcomes. The findings also suggest that individuals actively learn from their experiences and that directors tend to lower their estimate of distress costs after participating in a bankruptcy firsthand.
Discussant(s)
Aydogan Alti
,
University of Texas-Austin
Christian Leuz
,
University of Chicago
Mitchell Petersen
,
Northwestern University
Gennaro Bernile
,
University of Miami
JEL Classifications
  • G3 - Corporate Finance and Governance