Charles A . Dice Center for Research in Financial Economics Macroeconomic Conditions and the Structure of Securities

Economic theory, as well as commonly-stated views of practitioners, suggests that macroeconomic conditions can affect both the ability and manner in which firms raise external financing. Traditional theory focuses on the demand for capital and suggests that downturns are likely to be associated with a shift in the supply of securities toward less information sensitivity. Alternatively, financing could be affected by supply of capital in terms of both availability of funds and changes in investor preferences during periods of economic uncertainty. We evaluate these hypotheses on a large sample of publiclytraded debt issues, seasoned equity offers, and bank loans. We find that the issuance of convertibles and public bonds, especially those of higher quality, is counter-cyclical, while equity issues and private loans are pro-cyclical. This pattern is consistent with a credit crunch in intermediary capital and a shift towards relatively safe securities during recessions. Moreover, proceeds raised from investment grade bonds are more likely to be held in cash in recessions than in expansions. Poor market conditions also affect the structure of securities offered, shifting them towards shorter maturities and more security. Overall, these findings suggest that the channel through which macroeconomic conditions affect corporate finance is more likely to be the supply of capital rather than the demand. * Contact information: Isil Erel, Department of Finance, Fisher College of Business, Ohio State University, Columbus, OH 43210: email: erel@fisher.osu.edu; Brandon Julio, London Business School, Regent’s Park, London NW1 4SA, United Kingdom. email: bjulio@london.edu; Woojin Kim, Korea University Business School, AnamDong, Seongbuk-Gu, Seoul 136-701, Korea, email: woojinkim@korea.ac. kr; Michael S. Weisbach, Department of Finance, Fisher College of Business, Ohio State University, Columbus, OH 43210, email: weisbach.2@osu.edu. We would like to thank Effi Benmelech, Murillo Campello, Naveen Daniel, Mike Faulkender, John Graham, Campbell Harvey, Christopher Hennessy, Mark Huson, Mike Lemmon, Laura Liu, Gordon Phillips, Per Stromberg, René Stulz, and Ralph Walkling, as well as seminar participants at The 2009 AFA Meetings, University of Alberta, Carnegie Mellon University, University of Cincinnati, Drexel University, Harvard University, Hong Kong University of Science and Technology, KDI School of Public Policy and Management, Korea University, University of Illinois, NBER, Ohio State University, Oxford University, Seoul National University, Southern Methodist University, Stockholm School of Economics, University of Utah, Washington University, and Yale University for very helpful suggestions. As illustrated so dramatically by the Financial Crisis of 2008, macroeconomic conditions can affect firms’ access to capital and the manner in which they raise it. Practitioners view the possibility that macroeconomic conditions will adversely affect a firm’s access to capital markets as an important factor in their firms’ financial policies. For example, Richard Passov, the longtime treasurer of Pfizer, argues that the possibility of being shut out of the capital markets during market downturns is the primary reason why Pfizer and other technology companies often place such importance on a high bond rating [See Passov 2003]. According to Graham and Harvey (2001)’s well-known survey, an important goal of Chief Financial Officers is to maintain financial flexibility “so that they do not need to shrink their business in case of an economic downturn (p.218). ” The extent to which this concern is justified and macroeconomic factors can affect a firm’s access to capital is an important issue in finance and has clear policy implications. While the practitioners view the potential shocks to supply of capital (or demand for securities) as having the first order impact in shaping financial decisions, academic corporate finance has focused more on the demand for capital (or supply of securities) as the key determinant in security design (see for example Baker (2009)). In this paper, we develop a set of stylized facts about the way in which macroeconomic conditions affect both firms’ access to external capital and the manner in which they raise it. We then categorize theories based on demand for capital versus those based on supply of capital, and test the implications about the equilibrium issuances of different kinds of securities in market downturns. To perform this analysis, we assemble a database containing information on alternative ways in which firms can raise capital. Our sample contains detailed information on 21,657 publicly-traded debt issuances and 7,746 seasoned equity offerings in the U.S. between 1971 and 2007. The latter part of our sample (from 1988 to 2007) also includes data on 40,097 completed and mostly syndicated loan tranches. We first provide statistics documenting the average quantity of capital raised though issuance of different kinds of securities during different market conditions. A complicating factor when interpreting 1 The primary sources of capital omitted from this sample are regular bank loans, commercial paper, and private placements of equity and debt.