Capital structure dynamics and risks : empirical evidence

Despite ample research on corporate financing decisions, there is a growing interest in deepening our understanding of how firms structure their financing needs. In this dissertation, we build upon previous work on capital structure by examining the impact of firm-specific and macroeconomic risks on the capital structure of UK manufacturing firms. In particular, the dissertation consists of three separate, yet related essays. Each essay intends to serve a specific objective. The essays, in the order in which they appear, are entitled as follows: Essay I: The Response of Firms' Leverage to Risks: Evidence from UK Public versus Non-Public Firms Essay II: Capital Structure Adjustments: Do Macroeconomic and Business Risks Matter? Essay III: Macroeconomic Dynamics, Idiosyncratic Risk, and Firms' Security Issuance Decisions: An Empirical Investigation of UK Manufacturing Firms In the first essay, we empirically investigate whether the sensitivity of leverage to firm-specific (idiosyncratic) and macroeconomic risk differs across publicly listed and privately owned firms. We also study the implications of cash reserves-risk interactions for firms' leverage decisions. Using data from the Financial Analysis Made Easy (FAME) database, the analysis is carried out for a large panel of UK manufacturing firms over the period 1999-2008. The results provide significant evidence that UK manufacturing firms use less short-term debt in their capital structure during periods of high risk. This finding holds for both types of risk. The results on the differential effects of risk across public and non-public firms indicate that while the leverage of non-public firms is more sensitive to firm-specific risk in comparison to their public counterparts, the effects of macroeconomic risk on leverage are similar for both types of firms. The results of the indirect effects of risk show that firms with high levels of cash holdings are more (less) likely to reduce their leverage in periods when firm-specific (macroeconomic) is risk. On the whole, the results that we document in this essay provide strong evidence of the heterogenous sensitivities of leverage to risk across both types of firms and across different levels of firms' cash holdings. Essay II examines how risk affects firms' leverage adjustment decisions. Specifically, in this essay, we study the impact of risk about firms' own business activity and macroeconomic conditions on the speed with which firms adjust their capital structure toward their specific leverage targets. In doing this, we use an annual panel data obtained from the WorldScope file via DataStream for a fairly large sample of quoted UK manufacturing, covering the period 1981-2009. The results suggest that the adjustment is asymmetric and it depends on the magnitude of risk, the type of risk, and whether firms' actual leverage is above or below the target. Further, we find that firms with financial surpluses and above-target leverage adjust their leverage faster when firm-specific risk is low and when macroeconomic risk is high. In contrast, firms with financial deficits and below-target leverage are more likely to align their leverage toward their target in periods when both types of risk are low. Taken as a whole, our results suggest that firms adjust their leverage toward the target very asymmetrically across different levels and types of risk. This finding holds true even when we take into account several firm characteristics known to affect firms' adjustment speeds. The third essay analyzes how risk about firms' own business activity and macroeconomic conditions influences the security issuance decisions of listed UK manufacturing firms appeared on the WorldScope database during the period from 1981-2009. Estimating dynamic panel models using the system GMM estimator, we show that the issuance of new debt is significantly negatively related to idiosyncratic risk while both the issuance of new equity and the use of internally generated funds (retained earnings) are positively related to the risk. In contrast, we find that all these three sources of financing are significantly negatively associated with macroeconomic risk. Nevertheless, our results suggest that the aggregate dynamics of firms' target leverage are significantly negatively linked with these two types of risk. The results, from the debt-equity choice regression, indicate that the effect of both firm-specific and macroeconomic risk is significant and negative, implying that firms are likely to have low debt-equity ratio in periods when either type of risk is high.