This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

  1. Home
  2. ASSA Annual Meeting
  3. 2023
  4. Program
  5. Corporate Finance: Capital Structure
« Back to Results

Corporate Finance: Capital Structure

Paper Session

Sunday, Jan. 8, 2023 8:00 AM - 10:00 AM (CST)

Sheraton New Orleans, Rhythms II
Hosted By: American Finance Association
  • Chair: Diego Garcia, University of Colorado Boulder

Optimal Time-Consistent Debt Policies

Andrey Malenko
,
University of Michigan
Anton Tsoy
,
University of Toronto

Abstract

We study time-consistent debt policies in a trade-off model of debt in which the firm can freely issue new debt and repurchase existing debt. A debt policy is time-consistent if in any state equityholders prefer to follow it rather than to deviate from it but lose credibility in sustaining debt discipline in the future. In a class of policies, the optimal time-consistent debt policy consists of an interest coverage ratio (ICR) target and two regions for the ICR: the stable and the distress regions. In the stable region, the firm actively manages liabilities to the ICR target by issuing/repurchasing debt. A sufficiently large negative shock to cash flows pushes the firm into the distress region, where it abandons the target and waits until either cash flows recover or further negative shocks trigger bankruptcy. Credit spreads are sensitive to cash flow shocks in the distress region but not in the stable region. The optimal policy captures realistic features of debt dynamics, such as active debt management in both directions, interior optimal debt maturity, and dynamics of “fallen angels.”

The Corporate Calendar and the Timing of Share Repurchases and Equity-Based Compensation

Ingolf Dittmann
,
Erasmus University Rotterdam
Amy Yazhu Li
,
Erasmus University Rotterdam
Stefan Obernberger
,
Erasmus University Rotterdam
Jiaqi Zheng
,
University of Oxford

Abstract

This study examines whether the CEO uses share repurchases to sell her equity grants at
inflated stock prices, a concern regularly voiced in politics and media. We document that
the timing of buyback programs, like the timing of equity-based compensation, is largely
determined by the corporate calendar through earnings announcement dates and blackout
periods, inducing a spurious positive correlation between share repurchases and equity-based
compensation. Accounting for the corporate calendar, share repurchases are no longer correlated
with the granting and vesting of equity. The CEO is more likely to buy equity when
the firm announces a buyback program and less likely to sell equity when the firm actually
buys back shares. Equity compensation increases the CEO’s propensity to launch a buyback
program when it benefits long-term shareholder value. Our results suggest a novel channel
of how equity-based compensation aligns the interests of shareholders with those of the CEO.

Leverage Dynamics under Costly Equity Issuance

Patrick Bolton
,
Columbia University
Neng Wang
,
Columbia University
Jinqiang Yang
,
Shanghai University of Finance and Economics

Abstract

We propose a parsimonious model of leverage and investment dynamics featuring a jump-diffusion cash-flow process, retained earnings, short-term debt, and crucially costly external equity. Paradoxically, it is the cost of equity issuance that causes the firm to keep leverage low, in contrast to the predictions of Modigliani-Miller and Leland tradeoff and Myers’ pecking-order theories. We show that firms’ efforts to preserve financial flexibility generate lower target leverage and nonlinear, non- monotonic leverage dynamics. When the firm is at its target leverage, profits are paid out, but losses cause leverage to drift up. When leverage is low, it tends to revert to the target and the marginal source of external financing is debt, but when leverage is sufficiently high reaching a tipping point, the firm diverges into a debt death spiral and may have to deleverage by issuing equity at a cost. When leverage is too high and/or the firm is hit by a large EBIT loss, it defaults.

Share Issues versus Share Repurchases

Philip Bond
,
University of Washington
Yue Yuan
,
Tsinghua University
Hongda Zhong
,
London School of Economics

Abstract

Almost all firms repurchase shares through open market repurchase (OMR) programs. In contrast, issue methods are more diverse: both at-the-market offerings, analogous to OMR programs, and SEOs, analogous to the rarely-used tender-offer repurchases are used by significant fractions of firms. Moreover, average SEOs are larger than at-the-market offerings. We show that this asymmetry in the diversity of transaction methods in issuances and repurchases and the size-method relation in issuances are natural consequences of the single informational friction of a firm having superior information to investors. Finally, repurchasing firms are likely maximizing long-term shareholders' payoffs rather than boosting short-term share prices.

Discussant(s)
Chao Ying
,
Chinese University of Hong Kong
Alice Bonaime
,
University of Arizona
Thomas Geelen
,
Copenhagen Business School
Anjan Thakor
,
Washington University-St. Louis
JEL Classifications
  • G3 - Corporate Finance and Governance