Research
PUBLICATIONS
“How do Large Banking Organizations Manage their Capital Ratios?” (with Allen N. Berger, Robert DeYoung, Mark J. Flannery and David Lee), Journal of Financial Services Research 34, 2008, 123-149.
U.S. banks hold significantly more equity capital than required by their regulators. We test competing hypotheses regarding the reasons for this “excess” capital, using an innovative partial adjustment approach that allows estimated BHC-specific capital targets and adjustment speeds to vary with firm-specific characteristics. We apply the model to annual panel data for publicly traded U.S. bank holding companies (BHCs) from 1992 through 2006, an extended period of increasing bank capital that ended just before the subprime credit crisis of 2007-08. The evidence suggests that BHCs actively managed their capital ratios (as opposed to passively allowing capital to build up via retained earnings), set target capital levels substantially above well-capitalized regulatory minima, and (especially poorly capitalized BHCs) made rapid adjustments toward their targets.
“Firm- and country-level determinants of corporate leverage: Some new international evidence” (with Ali Gungoraydinoglu), Journal of Corporate Finance 17, 2011, 1457-1474.
This research analyzes the determinants of capital structure across 37 countries. Institutional arrangements matter for capital structure decisions; however, firm-level covariates drive two-thirds of the variation in capital structure across countries, while the country-level covariates explain the remaining one-third. The observed relationships between the country-level determinants and leverage provide strong support to the predictions of both the trade-off and the pecking-order theories. Country-level determinants serve as substitute mechanisms for the firm-level, industry-level, and macroeconomic determinants by moderating their marginal impact on leverage.
“Equity Mispricing and Capital Structure Adjustment Costs” (with William B. Elliott, Johanna Koëter-Kant, and Richard S. Warr), Journal of Financial and Quantitative Analysis 47, 2012, 589-616.
We find that market-timing impacts the speeds at which firms adjust to their target leverage in predictable ways depending on whether the firm is over- or under-levered. For example, firms that are above their target leverage and should therefore issue equity, adjust more rapidly to their target when their equity is overvalued. However, when a firm is undervalued, but needs to reduce leverage, the speed of adjustment is much slower. Our findings support the role of market-timing not as a competing theory to the trade-off model, but as a significant adjustment cost or moderating effect within a dynamic trade-off theory.
“Leverage Expectations and Bond Credit Spreads” (with Mark J. Flannery and Stas Nikolova), Journal of Financial and Quantitative Analysis 47, 2012, 689-714.
Bond credit spreads reflect the issuer’s expected default probability. In an efficient market, spreads will reflect both the issuer’s current risk and investors’ expectations about how that risk might change in the future. Collin-Dufresne and Goldstein (2001) show analytically that a firm’s expected future leverage importantly influences the appropriate spread on its bonds. We implement this insight empirically by using capital structure theory to create proxies for investors’ expectations about future leverage changes. We find that expected future leverage does significantly affect bond yields and that this effect is above and beyond that of contemporaneous leverage. Expectations formed under the trade-off, pecking order and credit-rating theories of capital structure all enjoy empirical support suggesting that investors view them as complementary when pricing corporate bonds.
“Institutional Determinants of Capital Structure Adjustment Speeds” (with Mark J. Flannery), Journal of Financial Economics 103, 2012, 88-112.
This paper examines international differences in firms’ adjustment speeds to optimal capital structure across 37 countries. A firm’s ability to adjust its leverage is greatly influenced by economic, legal, political institutions, corporate governance, tax systems, and the structure of credit and securities markets of the countries. In institutional environments with higher adjustment costs, due to the severity of external financing costs and regulatory cash constraints, the adjustment is significantly slower; in settings with greater adjustment benefits as implied by higher tax shields and ability to prevent distress and deviation costs, the adjustment is considerably faster, consistent with the dynamic trade-off theory.
“Capital Structure, Equity Mispricing, and the Stock Repurchases” (with Alice Adams Bonaime and Richard S. Warr), Journal of Corporate Finance 26, 2014, 182-200.
We evaluate motives for share repurchases using a unified framework where a firm has a target capital structure and has equity that can be mispriced. We document that capital structure adjustments are a value-increasing motive for repurchases and that the extent to which adjusting capital structure through a repurchase creates value depends on the undervaluation of the firm. Underlevered and undervalued firms enjoy the greatest economic gains from a repurchase, as evidenced by the stock price reaction to the repurchase announcement, and these firms are more likely to announce a share repurchase program.
“Bank Capital Management: International Evidence” (with Olivier De Jonghe), Journal of Financial Intermediation 24, 2015, 154-177.
We examine the dynamic behavior of bank capital using a global sample of 64 countries during the 1994–2010 period. Banks achieve deleveraging through active capital management (equity growth) rather than asset liquidation. In contrast, they achieve leveraging through passive capital management (reduced earnings retention) and substantial asset expansion (but also cash hoarding). The speed of capital structure adjustment is heterogeneous across countries. Banks make faster capital structure adjustments in countries with more stringent capital requirements, better supervisory monitoring, more developed capital markets, and high inflation. In times of crises, banks adjust their capital structure significantly more quickly.
“Capital Structure Decisions Around The World: Which Factors are Reliably Important?”, Journal of Financial and Quantitative Analysis 50, 2015, 301-323.
This paper examines which leverage factors are consistently important for capital structure decisions of firms around the world. The most reliable determinants are past leverage, tangibility, firm size, research and development, depreciation expenses, industry median leverage, and liquidity. The impact of leverage factors on capital structure are systematically driven by cross-country differences in the quality of institutions that affect bankruptcy costs, agency costs, tax benefits of debt; agency costs of equity; and information asymmetry costs. The signs and the relative impact of the reliable determinants across different institutional settings give consistent support to the dynamic tradeoff theory.
“Political Environment, Financial Intermediation Costs, and Financing Patterns” (with Ali Gungoraydinoglu and Gonul Colak), Journal of Corporate Finance 44, 2017, 167-192.
Political environment is an important determinant of financial intermediation costs, which eventually affects the external financing patterns of firms. Political gyrations create policy uncertainty, which increases the information risk, weakens the investor demand, and reduces the offer size. This raises the securities’ placement costs for the financial intermediaries, who pass on these costs to the issuing firms in the form of higher underwriter spreads. The issuance costs for new equity and debt capital increase, leading to lower leverage. Simultaneous equation analysis of financing, investment, and cash policies reveals that this channel is distinct from previously documented effects of policy uncertainty on corporate outcomes.
“Global Leverage Adjustments, Uncertainty, and Country Institutional Strength” (with Gonul Colak and Ali Gungoraydinoglu), Journal of Financial Intermediation 35, 2018, 41-56
Using a broad range of uncertainty measures, we show that uncertainty dramatically slows down firms’ adjustments toward their optimal capital structure. At the upper bound, the estimated speed of leverage adjustments almost halves when uncertainty is high. High quality institutions (common law legal origin, more disclosure to congress and/or to the public, and higher public sector ethics) and presidential political systems offset some of the adverse effects of uncertainty on leverage adjustments. The financial crisis has altered the relationships among uncertainty, adjustment speeds, and a country’s institutions; more so for countries with weak institutions and parliamentary systems.
“Systemic banking crises, institutional environment, and corporate leverage”, Journal of Financial and Quantitative Analysis, 1-27. doi:10.1017/S0022109020000861.
This study examines corporate leverage during systemic banking crises in an international setting including 85 countries from 1987 to 2017. Using the historically determined component of institutions and exogenous variations in institution building, the analyses show that leverage cyclicality varies substantially across institutional settings. Leverage is strongly counter-cyclical under more binding constraints on the capital supply, suggesting important supply effects of such crises on leverage. Weak institutions are more conducive to crises and uncertainty. Leverage counter-cyclicality is more pronounced during crises that coincide with higher uncertainty, whereas leverage is pro-cyclical with stronger legal systems and information sharing in capital markets.
“The Impact of COVID-19 Pandemic on Bank Lending Around the World” (with Gonul Colak), Special Issue: The Way Forward for Banks during the Covid-19 Crisis and Beyond, Journal of Banking and Finance 133, 2021, 106207.
We evaluate the influence of the coronavirus pandemic on global bank lending and identify bank and country characteristics that amplify or weaken the effect of the disease outbreak on bank credit. Using a dataset comprising banks from 125 countries and a difference-in-difference methodology, we find that loan growth contracts considerably around the globe. This adverse effect depends on bank financial condition, bank market structure, country features including regulation and supervision of the banking systems, financial intermediary and debt market development, ease of access of corporate firms to debt capital, and the response of the public health sector to the crisis.
“Can Machines Learn Capital Structure Dynamics?” (with Shahram Amini, Ryan Elmore, and Jack Strauss), Journal of Corporate Finance 70, 2021, 102073.
Yes, they can! Machine learning models that exploit big data identify leverage determinants and predict leverage better than classical methods. By allowing for nonlinearities and complex interactions, machine learning boosts the out-of-sample R2 from 36% to 56% over linear methods such as LASSO. The best performing model (random forests) selects market-to-book, industry median leverage, cash & equivalents, Z-Score, profitability, stock returns, and firm size as reliable predictors of market leverage. Improved target measurement through machine learning yields 10%-34% faster adjustment relative to LASSO. Machine learning identifies uncertainty, cash flow, and macroeconomic considerations among primary drivers of leverage adjustments.
“What Matters Most in Board Independence? Form or Substance? ” (with Arun Upadhyay), Journal of Corporate Finance 71, 2021, 102099.
Theory suggests that agency problems associated with the separation of ownership and control can be mitigated by an independent board, yet nominal measures of board independence, such as the ratio of independent directors are not associated with better firm performance. We propose a novel measure and argue that CEO-directors with higher compensation than the appointing firm’s CEO are more independent of appointing firm’s top management and are more effective monitors. Controlling for conventional measures of board monitoring, we establish a positive association between the presence of PCDs and long-term firm performance. PCDs help appointing firms by improving CEO pay-performance sensitivities.
“The impact of COVID-19 and its Policy Responses on Local Economy and Health Conditions” (with Ali Gungoraydinoglu and Ilke Oztekin), Special Issue: Risk and Financial Management of COVID-19 in Business, Economics and Finance, Journal of Risk and Financial Management 14 (6), 2021, 233.
U.S. states have implemented lockdown measures to contain the COVID-19 pandemic. We assess the impact of state policy responses on local economic and health conditions, with the goal to shed light on marginal health benefits and economic costs associated with social distancing. We find that lockdown measures are effective in alleviating disease severity, but yield significant contraction of the economy. Deteriorating health conditions are disruptive to the labor supply, financial health, and economic output. The adverse economic impact of lockdowns exceeds the economic damage brought by the disease itself, but health conditions have better ability of forecasting economic contraction outcomes.
“Financial Leverage and Debt Maturity: International Evidence” (with Ali Gungoraydinoglu), Special Issue: Economics and Finance, Accounting, International Finance, and Economic Development with Applications, Journal of Risk and Financial Management 14 (9), 2021, 437.
We provide evidence on leverage and debt maturity targeting in a large international setting. There are key differences in the relative importance of institutional factors in explaining actual as opposed to target capital structures. Targets and target deviations are plausibly influenced by the institutional environment. Firms from countries with strong institutions target lower leverage and higher long-term debt, whereas a financial structure based on the effectiveness of capital markets and better-functioning financial systems result in lower target leverage and lower long-term debt. Financial crisis has led to more prevalent target deviations. Better institutions significantly decrease the likelihood of target deviations.
"Financial Crises, Banking Regulations, and Corporate Financing Patterns Around the World ,” (with Ali Gungoraydinoglu), International Review of Finance, 2022, 1-34.
This study examines financing behavior during financial crises in an international sample of corporate firms including 85 countries from 1987 to 2017. Measuring “financial cyclicality” as the difference between financing levels during normal times and financial crisis times, we document counter-cyclicality in leverage and pro-cyclicality in security issuances and debt maturity. Financial crises discourage both debt and equity issuances, with a greater declines in equity. Consequently, leverage increases and debt maturity decreases. Public debt markets partially act as spare tire during crises when bank loan supply contracts significantly. Leverage financial counter-cyclicality is more pronounced in countries with weaker banking regulations.
“Capital Structure and the Yield Curve” (with Diogo Duarte and Yuri F. Saporito), Review of Corporate Finance Studies, 2022, cfac036.
We develop a dynamic capital structure model where interest rates are stochastic and driven by three state variables: level, slope, and curvature of the yield curve in an arbitrage-free Nelson-Siegel model. Our analysis suggests that the yield-curve factors are critical determinants of the capital structure of firms and that an increase in any of the three factors is followed by an increase of the firm's debt and a shortening of its debt maturity. Using data on US firms from 1985 to 2020, we perform a two-stage least squares system of equations that account for the joint determination of leverage and debt maturity and confirm our model's predictions.
“Geographic Deregulation and Bank Capital Structure” (with Allen N. Berger and Raluca A. Roman), Journal of Banking and Finance, 2023, 106761 .
Although research demonstrates many important consequences of bank geographic deregulation, its effects on bank capital management – a critical toolkit in improving bank resilience against unexpected shocks – has not been previously investigated. This paper fills this important research gap. We find strong evidence that geographic deregulation significantly increases both bank target capital ratios and speeds of adjustment to these targets. We also identify a significant regime shift towards more active capital management after interstate branching deregulation. We address potential identification concerns in many ways, including using a dynamic panel methodology and a gravity-deregulation approach with time-varying bank-specific instruments. We find evidence for competition and geographic expansion as the two important mechanisms through which deregulation affects bank capital structure.
“Short-Selling and Capital Structure ” (with Suchi Mishra and Mohammad Rahman), Journal of Financial Research, 2023, 12378.
Managers tend to issue equity when a firm is overvalued. Short selling is generally frequent among overvalued firms. By conditioning short selling on firm overvaluation, we show that short selling reduces managerial equity market timing and increases leverage. This moderating impact of short selling on market timing is more pronounced in firms with independent boards, suggesting that board independence facilitates the incorporation into financing decisions of important adverse information embedded in short selling. Furthermore, this impact is more pronounced in firms with an increased likelihood of misvaluation – smaller firms, firms with low institutional ownership, and firms with higher intangible assets. The decomposition of market-to-book ratio into misvaluation and growth components shows that the moderating effect of short selling is related to a firm’s overvaluation relative to its long-run value. These results are robust to a quasi-natural experiment utilizing an exogenous shock to the short-selling environment created by the SEC’s Reg SHO pilot program.
“Threats to Human Capital: The Effect of Health Risk on Corporate Financial Policy”, Journal of Financial Research, 2024, 12391.
We study the impact of threats to human capital on the determination of corporate financial policy. We exploit variations in health conditions using morbidity and mortality by infectious diseases and document the relationship between employee well-being and firm financing decisions. Deterioration in health causes declines in leverage by increasing human capital costs that offset the benefits of debt. When employees value human capital insurance more due to disease-induced rise in human capital costs, firms strategically respond by reducing corporate debt to enhance risk sharing with employees. This effect is more pronounced in technology firms, distressed firms, firms with a greater share of labor and at times with higher disease-induced labor uncertainty, but it is moderated when employees are better protected by labor unions.
"Corporate Leverage: What We Learn from International Data", Forthcoming, In the Oxford Research Encyclopedia of Economics and Finance. Oxford University Press.
Capital structure theories offer a framework to understand how firms determine their mix of debt and equity financing. These theories, such as the trade-off theory, pecking order theory, market timing theory, agency theory, theories of corporate control and input/output market interactions, provide insights into the roles of internal company characteristics and external economic conditions for corporate financing decisions. They explain firms' preferences for and access to different financing sources based on factors like tax benefits, bankruptcy costs, agency costs, information asymmetry costs, and market conditions. Internationally, these theories take on additional dimensions due to differences in tax regimes, legal and institutional environments, and market structures. Empirical research provides insights into how these diverse factors play out across different legal, regulatory, economic, and cultural environments. International studies have shown that leverage determinants like corporate and personal tax rates, corporate governance and ownership structure, market conditions, and institutional frameworks significantly impact capital structure decisions globally. This comprehensive understanding helps in creating conducive environments for effective corporate financing choices on a global scale.
“Working capital balances and financial policy” (with Mark J. Flannery)
A firm’s working-capital account balances significantly affect its financial policy. Payables increase shareholder return volatility, decrease future cash flow, and crowd out debt. Receivables and inventories reduce asset volatility, increase future cash flow, and raise leverage. These effects are sizeable: a one standard-deviation (SD) increase in payables (receivables) crowds out (raises) leverage by 0.42 (0.66) SDs. While inventories and receivables raise a firm’s credit rating, encourage debt issues, and discourage equity issuances, payables reduce credit rating, discourages debt issues, and encourages equity issuances. Difference-in-difference tests based on a regulatory shock to receivable policies indicate that these relationships are causal.
WORKING PAPERS
"The Financing Role of Private Equity: Global Evidence” (with Gonul Colak and Sofia Johan)
Given the increasing importance of private equity in the world economy, we examine the strategic decision to finance a business in an international context by evaluating whether private equity is a substitute for or a complement to other sources of external finance. We find strong evidence that private equity financing significantly deters public equity financing, consistent with the crowding-out view. In contrast, debt financing increases in response to more private equity financing, consistent with certification view. We find stronger substitution effect with public equity flows under low uncertainty and greater complementary effect with debt flows under high uncertainty.
"The Heterogeneity in the Working Capital Effects of Leverage (with Mark J. Flannery)
We show heterogeneity in the effects on leverage of a company's working capital. Higher receivables are conducive to higher leverage, but this effect is weaker for firms with larger customers, longer customer relationships, and higher cost of debt and stronger for firms with higher operating performance, higher operating efficiency, and higher cost of equity. Higher payables provide a fixed, senior claim on firm earnings and substitute for interest-bearing debt and reduce leverage, but more so for firms with higher operating leverage, higher operating performance, higher operating efficiency, higher cost of debt, and lower cost of equity.
"Noisy Stock Prices and Capital Structure” (with Suchismitra Mishra and Iván M. Rodríguez, Jr.)
Using fund flows as an instrument for returns, we identify a strong effect of market prices on capital structure. The effect of returns on corporate leverage is positive. Market prices increase debt issuance while leaving equity issuance unaffected. Our results overturn prior literature that finds a negative effect between corporate leverage and returns without instrumentation. These findings imply that market prices have real effects on issuance activity over and above the mechanistic effect returns have on equity growth.
“Religiosity and Capital Structure” (with Afak Nazim)
Using dynamic panels, we test how religiosity affects bank capital structure. We find that banks located in states with a higher proportion of religious individuals have lower target capital ratios and slower adjustment towards these targets. Further investigation suggests that cost of debt and risk alignment are the most important channels explaining the results. Religious banks have lower cost of debt and better alignment of risk, leading banks to take on more debt in their capital structure.