The subset of companies that do issue debt lever up substantially towards the optimum. The data are presented in Section IV. Consistent with the literature, optimal leverage is positively related to the proportion of tangible assets and negatively related to depreciation, profit volatility, and market-to-book ratios.
The zero leverage firms that do not pay dividends act as if they face friction costs that are substantially larger than issuance costs alone, such as overvalued equity or managerial aversion to taking on debt.
Some financing programs let you put even less money down. This result again highlights the puzzle of the zero leverage firms. However, if firms in the same industry have a common asset beta, Uthen differences in L within an industry are driven entirely by the net benefits to leverage.
Small and profitable firms have high optimal leverage ratios, as predicted by theory but in contrast to existing empirical evidence. In light of these issues, this paper addresses four main questions in the capital structure literature: Since the beta relation is derived from the value equation, vit is also allowed to be correlated with ujt for firms i and j in the same industry.
Of Table I these firms, had some debt in their capital structure over the sample period. However, since only one short recession occurred during the sample period March to Novemberthis result should be taken with some caution. Companies with high depreciation have lower net benefits, consistent with existing empirical evidence e.
The paper is organized as follows. Assuming these bonds have the same interest rate and credit risk, missing values are calculated from contemporaneous market-to-book values of bonds in the same group that are observed in the same month. The estimation also allows for contemporaneously correlated with uit and vit.
This implies that zero leverage firms tend to remain unlevered but does not answer the question whether they do so optimally or whether they face friction costs that are too high relative to the benefits of debt financing.
Under such an arrangement, you can purchase a property with little money down and, in some cases, no money down at all. I find that firms are generally slightly underlevered, but not as much as suggested by prior research.
The intercepts are therefore not required to equal zero. Hamada and Faff, Brooks, and Kee provide empirical support for the hypothesis that asset betas with respect to the market portfolio are the same within industries as defined by two-digit SIC codes. The low leverage portfolio slowly drifts up over time, but never reaches the optimal leverage ratio.
Overall, it is reassuring that Binsbergen, Graham and Yang and my method yield similar results, given that we use very different empirical approaches. In fact, although they may not think about it as leverage, most people are doing so if they take out a mortgage when they buy a home.
Section III describes the estimation methodology that applies the model to the data. This result highlights the distinction between analyzing observed and optimal leverage ratios.
This result is to be expected since the intention of an LBO is to pay down debt quickly in the post-LBO years, ultimately settling on the optimal leverage ratio. The net benefits are higher for highly profitable firms with low depreciation, stable profits, and low market-to-book ratios, and during economic expansions.
Figure 4 shows separate plots for interest-paying investment grade firms, non-investment grade firms, zero leverage firms with no interest-bearing debtand zero leverage firms that pay dividends. The SIC2 sample comprises firms in 22 industries, for a total of 24, firm-months.
Bhamra, Kuehn, and Strebulaev show that it is possible to have a procyclical optimal leverage ratio while observed leverage moves countercyclically when there are transaction costs, due to changes in equity market capitalization as in Welch With 2N T equations, where we observe N firms over T time periods such that N -1 T k, we can solve for all parameters exactly.
With data for 25 of the 32 firms in their sample, Table VI shows that these firms are typically profitable, with a high proportion of tangible assets and low market-to-book ratios.
The FF classification assigns firms to 48 industries based on four-digit SIC codes, and avoids some counterintuitive groupings of firms that occur within two-digit SIC industries.
When adding firm fixed effects, the coefficients on zero leverage firms largely disappear. Even though these firms are currently unlevered, their equity value is not necessarily equal to their unlevered value. Identification of the Net Benefits to Leverage Consider a simple case in which equations 6a and 6b hold without error.
In the SIC2 model, the probability that an underlevered firm increases its leverage modestly Fig.
Even at zero leverage ratios, the present value of future net benefits is about 2. Since they do not consider non-tax benefits, such as reductions in agency problems between management and shareholders, when calculating the benefits to debt financing, Almeida and Philippon underestimate optimal leverage.
In reality, firms choose their capital structures in a dynamic setting. The coefficient on market-to-book value has conflicting signs and is therefore difficult to interpret. Similarly, small firms face higher issuance costs and therefore wait longer between refinancings, resulting in lower average leverage than big firms, even though in theory they may have higher optimal debt ratios.
At high leverage, net benefits decline faster for high market-to-book firms, and for companies with few tangible assets.Korteweg () estimated the market's valuation of the net benefits to leverage based on some data over the perioddetermined from market values and betas of a firm's debt and equity.
Korteweg January 16, Hoffman Hall, Room [email protected] Korteweg, A.,The Net Benefits to Leverage, Journal of Finance, 65(6), Korteweg, A.,Financial Leverage and Expected Stock Returns:. The median firm captures net benefits of up to % of firm value. Small and profitable firms have high optimal leverage ratios, as predicted by theory but in contrast to existing empirical evidence.
Companies are on average slightly underlevered relative to the optimal leverage ratio at refinancing. This result is mainly due to zero leverage firms. Their combined citations are counted only for the first article.
Merged citations This "Cited by" count includes citations to the following articles in Scholar. THE JOURNAL OF FINANCE • VOL. LXV, NO. 6 • DECEMBER The Net Benefits to Leverage ARTHUR KORTEWEG ∗ ABSTRACT I estimate the market’s valuation of the net benefits to leverage using panel data from toidentified from market values and betas of a.
Korteweg, p.2 of 5 Korteweg, A.,The Net Benefits to Leverage, Journal of Finance, 65(6), - Winner, Brattle Group Prize for Distinguished Paper.Download