2014 Theses Doctoral
Three Essays in Corporate Finance
This dissertation consists of three essays on corporate finance. In the first chapter, I investigate how a liquidity cost associated with debt- `debt servicing cost' affects a firm's capital structure policy. In contrast to the standard capital structure theory prediction that builds on a trade-off between interest tax shields and expected bankruptcy costs, public firms use debt quite conservatively. To address this well known debt conservatism puzzle (Graham 2000), I argue that servicing debt drains valuable liquidity for a financially constrained firm and hence endogenously creates `debt servicing costs,' which have received little attention in the literature. To examine the influence of debt servicing costs on capital structure choices, I develop and estimate a dynamic corporate finance model with interest tax shields, liquidity management, investment, external debt and equity financing costs, and capital adjustment costs. By using the marginal value of liquidity as a natural measure of the debt servicing costs, I find that (1) an increase in financial leverage results in higher debt servicing costs, even with risk-free debt. (2) a smaller firm tends to experience greater debt servicing costs because of its endogenously large investment demands; and (3) in the majority of cases, equity proceeds are used for cash retention as well as capital expenditure, especially when a firm faces large current and future investment needs. In addition, I quantitatively show that large debt servicing costs are closely associated with low leverage and frequent equity financing by analyzing the role of fixed operating costs and convex capital adjustment costs.
In the second chapter, I empirically support the theoretical debt servicing costs analysis of the previous chapter. I firstly examine the structural estimation method used for the calibration of my model in the first chapter. The statistical property of the simulated method of moments estimator and detailed identification scheme for the calibration are investigated in the first half of this chapter. Then I cross-sectionally confirm the validity of debt servicing costs predictions on capital structure choices. I study how each firm's convex capital adjustment costs, operating leverage, profit volatility, and future investment needs influence capital structure policies. Consistent with the debt servicing costs predictions, firms with higher convex capital adjustment costs, higher operating leverage, higher profit volatility and larger future investment demands show lower leverage ratios and more frequent equity financing activities. These findings shed new lights on pervasively conservative debt policy in U.S. public firms. A higher profitability observed in large future investment demands firms also suggests the importance of debt servicing costs consideration in resolving the puzzling negative correlation between profitability and leverage ratios.
In the third chapter, I examine how macroeconomic conditions affect the cyclical variations in capital structure policies. As in the financial crisis of 2008, economic contractions affect a firm's profitability, investments and external financing conditions altogether. To address the effects of these simultaneous changes on capital structure dynamics, I develop and estimate a dynamic trade-off model with investment, payouts, and liquidity policies with macroeconomic profitability and financing shocks. Investment dynamics and a higher value of liquidity of economic downturn are pivotal in capital structure dynamics; the former drives the issuance of debt and equity, and the latter leads to active debt retirements and conservative debt issues in upturns. My model yields the following main results: (1) Equity issues are pro-cyclical, and concentrated for small, low profit, and large investment demand firms in earlier stage of economic upturns. (2) Payouts peak in later stages of upturns and co-move positively with equity issues; (3) Debt policies move counter-cyclically, and leverage ratios after debt issuance and retirement are even higher during economic downturns. My comparative static analysis predicts pro-cyclical debt policy for financially constrained firms, and pervasively conservative use of debt for firms expecting financial market shutdowns, a sharp profitability drop, or a longer stay in economic downturns.
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More About This Work
- Academic Units
- Thesis Advisors
- Bolton, Patrick
- Ph.D., Columbia University
- Published Here
- July 7, 2014