Essays on determinants and implications of extreme financing policies

Ebrahimi, Tahera

November 2017

Thesis or dissertation

© 2017 Tahera Ebrahimi. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright holder.

Within this thesis, we address the continuing puzzle that a growing number of firms follow a capital structure policy, which is far from the optimal level. These firms adopt an extreme financing policy, either as a conservative or as an aggressive debt policy. We investigate the different causes and implications of such capital structure policies in three empirical chapters.

In study 1, we document that both supply and demand sides contribute to conservative debt policy, i.e., firms using zero or very low debt. The results suggest that these firms face different supply conditions, while based on their debt capacity they generally are restricted in their ability to issue debt. Further, over-optimistic investors seem to create a good stock supply condition (overvalued equity) to rely more on equity financing. Moreover, the findings suggest that the current decision of zero/very low leverage is driven by the significant future demand of capital. The results regarding the other side of the extreme financing policy, i.e., firms using aggressive debt, appear to be opposite to what we document for zero/very low leverage firms, with the exception of supply side effects; very high levered firms neither have better access to debt markets nor face less optimistic investors (undervalued equity). Furthermore, while an average firms with extreme financing policy actively rebalance their leverage to stay within an optimal zone, the degree of urgency to shift toward the optimal leverage varies, depending on how far firms deviate from being under- (or over-) levered.

In study 2, our evidence reveals that CEO characteristics also affect conservative debt policy: this policy tends to be employed when CEOs are overconfident and younger, have higher equity shareholdings and maintain longer tenure. However, results from the analysis of aggressive debt users do not reveal any significant influence of CEO ability on such decisions.

Finally, in study 3, we investigate the extent to which extreme financing policies affect the probability of bankruptcy. We document that the failure of firms with different levels of indebtedness is attributable to different factors. Furthermore, in favour of optimal capital structure, this study empirically confirms that having an optimal level of leverage increases the probability of survival of firms. However, paradoxically to economists’ concerns, the evidence of this chapter shows that the likelihood of bankruptcy is greater where firms have relatively little debt compared to their over-levered counterparts.

Business School, The University of Hull
Rhodes, Mark J.
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University of Hull
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