First Day Overview (not otherwise classified)

Question 1

Jensen and Meckling 1976 JFE

Answer 1

From Leland 94: “Jensen and Meckling (1976) argue that equity holders would prefer to make the firm’s activities riskier, ceteris paribus, so as to increase equity value at the expense of debt value. The expected cost to debtholders will be passed back to equity holders in a rational expectations equilibrium, through lower prices on newly issued debt.”

Question 2

Miller 1977 JF

Answer 2

Gains to firms from the tax advantages of debt are offset by the tax costs to bondholders of fully reporting firm taxable income. Also, bankruptcy costs are negligable.

Question 3

Myers 1977 JFE

Answer 3

Debt can constrain growth firms because of the need for flexiblity in the decision of whether or not to excercise growth options. Assets in place overmortgaged, i.e., debt overhang.

Question 4

Jensen 1986 AER

Answer 4

Managers waste FCF. Debt reduces FCF –> Mngrs pursue + NPV to service debt –> efficiency increased

Doesn’t apply to growth firms

Question 5

Titman and Wessels 1988 JF

Answer 5

Seminal cross-sectional analysis of capital structure:

1. Debt levels (-) related to level of assset specificity
2. ST debt ratios (-) related to firm size

Question 6

Fisher, Heinkel, and Zechner 1989 JF

Answer 6

(Seminal) dynamic option-style model that predicts greater wider swings in optimal leverage ratios for firms that are

1. Smaller
2. Riskier
3. Low-tax rates,
4. Lower-bankruptcy costs.

Question 8

Rajan and Zingales 1995 JF

Answer 8

Seminal cross-country capital structure study. Finds that at aggregate level, firm leverage similar across G-7 countries, except in UK and Germany. Germany is also the only country where leverage is negatively correlated with size, which is particularly strange considering that bankruptcy usually leads to liquidation there. This is inconsistent with our intuition that size is an inverse proxy for distress costs and our understanding of how bankruptcy laws affect capital structure.

Question 8

Lemmons, Roberts, and Zender 2008 JF

Answer 8

Capital structure is persistent over time. High or low levered firms tend to remain as such for over two decades. This is robust to firm exit, and present prior to an IPO. Thus variation in capital structures is determined by factors that remain stable for long periods of time.

Question 9

Leary and Roberts 2010 JFE

Answer 9

Pecking order econometric model most be modified with factors attributed to alternative theories in order to accurately classify more than half the observed financing decisions. Pecking order behavior driven by incentive conflicts, not informational asymmetry.