capital raising - a new formulation by amir sufi ..city/chicago

8/12/2019 capital raising - a new formulation by amir sufi ..city/chicago

1/40

The Society for inancial Studies

Capital Structure and Debt StructureAuthor(s): Joshua D. Rauh and Amir SufiSource: The Review of Financial Studies, Vol. 23, No. 12 (December 2010), pp. 4242-4280Published by: Oxford University Press. Sponsor: The Society for Financial Studies.

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2/40

CapitalStructurend DebtStructure

Joshua

D.

Rauh

Kellogg

chool

of

Management

nd

NBER

Amir

Sufi

University

f

Chicago,

Booth

chool

of

Business,

ndNBER

Using

a novel dataset

that records individual debt issues on the balance sheets of

public

firms,

we demonstrate hat raditional

apital

structure tudies that

gnore

debt

heterogene-

ity

miss substantial

capital

structure

ariation. Relative to

high-credit-quality

irms,

ow-

credit-quality

irms re more

likely

to have a multi-tiered

apital

structure

onsisting

of

both secured

bank debt with

tight

ovenants

and subordinated non-bank debt with loose

covenants.

We discuss the extent o

which these

findings

re consistentwith

existing

the-

oretical models

of debt structure

n which firms

imultaneously

use

multiple

debt

types

to

reduce

incentive

onflicts.

(JEL

G32)

What etermines

orporate

apital

tructure?

espite large ody

fresearch

on this uestion,tremainsne of themosthotlyontestedssues

n

financial

economics.

Our

analysis

f this

question

egins

with

simple

bservation:

Almost ll

empirical

tudies

f

capital

tructure

reat ebt s uniform.

his s

despite

he

act hat ebt

heterogeneity

s

a common

eaturefboth

heoretical

research

ndthe eal

world. or

example,

glance

t firms' alance heets

e-

veals that

orporate

ebt onsists

f a

variety

f securities ith

ifferentash

flow laims nd

control

rovisions.

urther,

here xists

large

body

of the-

oretical

esearch

hat

ecognizes

ebt

heterogeneity

nd seeks to

understand

the easons

or t

e.g.,

Diamond

1991a, 1993;

Park

000;

Bolton

nd Freixas

2000;

DeMarzo and

Fishman

007).

In this tudy, eprovide numberfnew nsightsnto apital tructuree-

cisions

by

recognizing

hat

irms

imultaneously

se different

ypes,

ources,

and

priorities

f debt.

These

nsights

re based

on a novel

dataset

hat ecords

the

ype,

ource,

nd

priority

f

every

alance-sheet

ebt

nstrument

or

large

We thank

oug

Diamond,

Anil

Kashyap,

Gordon

Phillips,

Michael

Roberts,

oni

Whited,

uigi Zingales,

and seminar

articipants

t

Emory

University,

eorgetown

niversity,

aastricht

niversity,

ice

University,

Tilburg

niversity,

he

University

f

California-Berkeley,

he

University

f

Chicago,

he

University

f Col-

orado,

he

University

f

Maryland,

he

University

f

Minnesota,

he

University

f

Toronto,

ork

University,

nd

the

pring

008

NBER

Corporate

inance

Meeting

or

omments. e

gratefully

cknowledge

inancial

upport

from heCenter

orResearch

n

Security

rices

nd he

BM

Corporation.

hanks o

RamChivukula

ndAdam

Friedlan or xcellent esearchssistance. end

correspondence

o JoshuaRauh,Kellogg choolofManage-

ment,

orthwestern

niversity,

001 Sheridan

oad,

Evanston,

L

60208;

telephone:

847)

491 4462.

E-mail:

[email protected].

The

Author 010.

Published

y

Oxford

University

ress on behalf

f The

Society

forFinancial tudies.

All

rights

eserved.

or

Permissions,

lease

e-mail:

[email protected].

doi:10.1093/rfs/hhq095

Advance

Access

publication

ctober

5,

2010

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3/40

Capital

tructure

nd Debt Structure

sample

of rated

ublic

firms. he

data are collected

irectly

rom inancial

footnotesn firms' nnual

0-K

filings

nd

supplemented

ith nformationn

pricingndcovenantsrom hree rigination-basedatasets:Reuters PC's

Dealscan,

Mergent's

ixed ncome

ecurities

atabase,

nd Thomson's DC

Platinum. o our

knowledge,

ur dataset s one of the most

omprehensive

sources f informationn thedebt tructuref a

sample

of

public

firms:t

contains

he etailed

omposition

f

the

tock

f

corporate

ebt n thebalance

sheet,

which

oes

far

eyond

what s available rom

rigination-based

atasets

alone.

We

beginby showing

he

mportance

f

recognizing

ebt

heterogeneity

n

capital

tructuretudies.We

classify

ebt ntobank

debt,

traight

ond

debt,

convertibleond

debt, rogram

ebt

such

as commercial

aper),mortgage

debt,

nd ll other ebt. or lmost 0% of

firm-year

bservationsnour am-

ple,

balance-sheetebt

omprises ignificant

mounts f at east woof these

types.

venmore

triking

s the act hat

5%

of he

bservations

nour

ample

experience

o

significantne-year hange

n

their otal ebtbut

ignificantly

adjust

he

underlying

omposition

f their ebt.

Studies

hat reat

orporate

debt s uniformave

gnored

his

heterogeneity,resumably

n

the nterestf

building

more ractable

heory

models

r due

to

a

previous

ack of data.The

drawback f

treatingorporate

ebt s uniforms

highlightedy

thefact hat

different

ypes

fdebt nstrumentsave

very

ifferent

roperties

s far s their

cashflow laims, heirensitivityoinformation,ndtheir ncentiveroper-

ties for

managers.

or

example,

subordinatedonvertibleebt ssue

may

have more

n

commonwith

traight

quity

han t

does

with

secured ank

revolver,

lthough mpirical

tudies hat ocus n the

dynamics

f

totaldebt

ratios

ave

raditionally

reatedhese wodebt nstruments

niformly.

onsis-

tentwith his

ntuition,

e show hat

many

f the ross-sectionalorrelations

shown n the iteratureetween

everage

atios nd

firm

haracteristics

ary

significantly

hen

ebt

omponents

reexamined

eparately.

After

emonstrating

he

mportance

fdebt

heterogeneity

n

corporateap-

ital

tructure,

e

focus

n

how debt tructurearies cross he

redit-quality

distribution.ur focuson credit uality ollows rom xtant heoreticale-

search

n

which redit

uality

s the

rimary

ource fvariation

riving

firm's

optimal

ebt

tructure

e.g.,

Diamond

1991b;

Bolton

nd

Freixas

000).

Our

first ain

inding

s shown n

Figure

. As shown n

Panel

A,

relative o

high-

credit-quality

irms,

ower-credit-quality

irms

spread"

he

priority

f their

capital

tructure.

igh-credit-quality

irms

ely

lmost

xclusively

n two iers

of

capital:

enior nsecured

ebt nd

equity.

n

contrast,

ower-credit-quality

firmsse

multiple

iers f

debt,

ncluding

ecured,

enior

nsecured,

nd ubor-

dinated

ssues. anel

B

shows

hat he ncreasen

ecured ebt or

ower-credit-

quality

irmss driven

y

secured ank

debt,

nd the

ncrease

n

subordinated

debt s driven

y

ubordinatedonds ndconvertibleebt.

While

ow-credit-quality

irms

se

arm's-length

ubordinatedonds

n

their

capital

tructure,

hesefirmsack

access

to

arm's-length

hort-term

ources

4243



4/40

TheReview

f

Financial tudies v23

n 12

2010

Figure

1

Priority

tructure

fdebt and credit

atings

These

figures

how he

priority

tructuref

debt

by

credit

ating

or he 1

829

rated

irm-year

bservations

n

the 05

firmsn the andom

ample.

of

iquidity.

n

particular,

ow-credit-quality

irms o nothaveaccess toshelf

registration

ebt,

medium-termote

programs,

r commercial

aper.

nstead,

they

ely

n bankdebt

with

ight

ovenants or

iquidity.

4244



5/40

Capital

tructurend DebtStructure

To address he obustness

f the

ross-sectional

atterns,

e assess the m-

pact

fcredit

uality

n

capital

tructure

sing

n additional

ataset

f

"fallen

angels,"which re firmshat redowngradedromnvestmentrade ospec-

ulative

radeby Moody

s Investors

ervices

during

he

sampleperiod.

The

main

dvantage

f an

analysis

f fallen

ngels

s

the

vailability

f

Moody's

downgradeeports,

hich

xplain

hevariationhat rives

redit-quality

ete-

rioration. e isolate he

ample

o fallen

ngels

hat re

downgraded

ue to

business onditionshat re outside he ontrol f

the

manager,

nd we

exam-

inetheir

apital

tructurenddebt tructurerom wo

years

efore

hrough

wo

years

fter he

downgrade.

We show

that,

wo

years

before he

downgrade,

allen

ngels

have simi-

lar characteristicso firms

n

the ame

rating

lass

that re not ubsequently

downgraded.

e also showthat here re no

sharp hanges

nfallen

ngels'

capital

tructuresrom wo

years

before he

downgrade

o

one

year

before

the

downgrade.

owever,

fter he

downgrade,

e find

imilar esults s in

the ross-sectional

nalysis.

More

specifically,

allen

ngels

movefrom av-

ingonly

enior nsecured ebt nd

equity

n their

apital

tructureefore he

downgrade

o an

ncreasingependence

n

both ecured ank

debt nd subor-

dinated onds ndconvertiblesfter he

downgrade.

n

addition,

allen

ngels

lose accessto

arm's-length

hort-termources f

iquidity

fterhe

owngrade.

Our

empirical

esults re most

losely

elated o

empirical

tudies n debt

compositionBarclayand Smith1995; Houston and James1996, 2001;

Johnson

997;

Cantillo nd

Wright

000;

Hadlock ndJames

002;

Denis and

Mihov

003;

Gomes nd

Phillips

005).

However,

ur

findings

rovidempor-

tant ew

nsights

nto

apital-structure

ecisions n a

number f dimensions.

We are he

irst,

o our

knowledge,

o show he

preading

fthe

riority

fdebt

structurecross he

redit-quality

istribution.n

addition,

ur

findings

emon-

strate

hat irms

imultaneously

se different

riorities,

ypes,

nd

sources f

corporate

ebt.This result

oints

o a

conceptual

roblem

with

conometric

techniques

n the

xtantiteraturehat ssume hat

irmschoose" o use

either

bank ebt rbonds. or

xample,

ur

findings

how hat allen

ngels

imulta-

neouslyncrease heir sageofboth ubordinatedonds nd ecured ank ebt

in

the wo

years

fter

downgrade.inally,

o our

knowledge,

e

provide

he

most etailed reak own f

thedebt

nstrumentssed

by public

irms

n

this

literature.

Our

findings

lso

shed

ight

n models

of bank debt

nd bond

financing

across he

redit-quality

istribution.ore

pecifically,

ur esult

hat irmsn-

crease heir

ependence

n

subordinated

onds venwhen

aving peculative-

grade

redit

atings

isputes

he

hypothesis

ade

n

many

heories

hat ow-

credit-quality

irms o

notuse

arm's-length

ebt.

nstead,

ur

findings

uggest

that

ow-credit-quality

irms

ose access

to

arm's-length

hort-termources f

liquidity,

utnot

ong-term

rm's-length

onds.

In

the inal

ection,

e

nterpret

hese

indings

n

the ontext

f

existing

he-

oreticalmodels n

capital

tructure.

he two

eading

xplanations

or

ariation

4245



6/40

TheReview

f

Financial tudies

v 23 n 12 2010

in

capital

tructurecrossfirmsre the rade-off

heory

ndthe

pecking-order

theory.

owever,

either f these heoriesn theirmost

imple

orm s well

suitedfor xplaining ur central act:Firms imultaneouslyssue different

types

f debt rom ifferentources

nd with

ifferent

riority

tructures. e

discuss ur

findings

s

they

elate o

these wo

heories,

ut

ur

entral onclu-

sion s that heoverall vidence s farmore onsistent ithmodels

n

which

optimal

ebt

riority

nd

composition

s setto

mitigate anagerial

nd credi-

tor

gency roblems.

We discusshowour

findings

re

related o these

ptimal

securityesign

models,

nd we also discusshowour

findings

otivateuture

theoreticalesearch

n

capital

tructure.

The rest f the rticle

roceeds

s follows. he next ection escribes he

data nd

presentsummary

tatistics.ection

shows he

mportance

f debt

heterogeneity

n

capital-structure

tudies. ection examines herelatione-

tween

redit

uality

nd debt tructure.ection

interprets

he

findings

n

the

context f

existing

heoretical

odels,

nd Section concludes.

1.

Data,

Summary

tatistics,

nd the

mportance

f

Debt

Heterogeneity

1.1 Data

The

sampling

niverse or urrandom

ample

ncludes on-financialirms

n

Compustat

ith

long-term

ssuer redit

ating

n

at

east

ne

year

rom

996

to 2006. Ourdecision o restricthe amplingniverseo firms ith n issuer

credit

ating

s based on

theoreticalesearchnwhich redit

uality

s a main

determinantf

corporate

ebt tructure.

he

empirical

nalysis

ecessitates

summary

easure f credit

uality,

purpose

erved

y

ssuer redit

atings.

Issuer redit

atings

renot

pecific

o

any

nedebt ssued

y

he

irm,

nd

hey

reflect

nly

he

probability

f

default,

ot

xpected

oss

given

efault. here

is a

very

lose

correspondence

etween

heuniverse f firms ith n issuer

credit

ating

nd theuniverse f

firms ith

ublic

debt

utstanding

Houston

andJames

996;

Cantillo

nd

Wright

000).

Credit

atingsmayrespond

lowly

o new

nformation,

ut

hey

re

a fo-

calpoint or inancial arketsHand,Holthausen,ndLeftwich992;Kisgen

2006).

Whilerated

irms re

certainly

ot dentical o unrated

irms

Faulk-

ender nd

Petersen

006),

they

make

up

a

large

ractionf the sset-

eighted

universe f

public

non-financial

irms. lmost 5%

ofthe otal

ebt

and

90%

of

total

ssets)

on

thebalance sheet

of

public

non-financial

irmss

on the

balance

heet f

firmsated

or t east ne

year

etween 996

and 2006.

1

An alternative ould

be to use

market-impliedrobabilities

f default

ased on

Merton-type

odels r

credit

default

wap

CDS)

markets.

owever,

DS

markets

nly

xist

or much maller

ractionf the

universe f

public irms.elative omarket efaultmodels, reditatingsave he dvantagehathey onot epend nany

one

sset-pricing

odel,

lthoughhey

o of ourse

epend

n the

udgment

f he

atinggency.

ote hatwhile

the

financialrisis

has called

nto

uestion

ating gencies'

bility

o assess

therisks f

complex

nstruments

such s collateralized

ebt

bligations,

he

ratings

f

corporate

ebt

re

generally erceived

s more ccurate

and

correspond

losely

o bond

yields.

4246



7/40

Capital

tructurend DebtStructure

We restricthe

sampling

niverse o

years

fter

996

given

hat heSEC

mandatedlectronicubmissionfSEC

filings

n

that

ear.

he

availability

f

electronicilingsignificantlyeduces he ost of ourdata-collectionrocess

described elow.

We limit he

ample

o firms ith t least two consecutive

years

fdata

given

hatmuch f our

nalysis

ocuses n

patterns

ithin

irms

over

ime.

The final

ampling

niversencludes

,889

rated

irms,

rom hichwe ran-

domly ample

05

firms

16%).2

For

all

firm-year

bservations

or

hese 05

firms,

e constructwodatasets. he

first

ataset

s a

balance heet ssue evel

dataset,

which

s

constructed

y examining

hedebtfinancial ootnoteson-

tained n the

10-K

filings

f thefirms. he dataon each

ndividual ebt ssue

are availabledue to two

SEC

reportingegulations.egulation

-X

requiresfirmso detail heir

ong-term

ebt nstruments.

egulation

-K

requires

irms

to discuss heir

iquidity,apital

esources,

nd

operating

esults.3 s a

result

of hese

egulations,

irmsetail heir

ong-term

ebt ssues ndbank

evolving

credit acilities. irms ften lso

provide

nformationn

notes

ayable

within

a

year.

While hedebtfinancial ootnotes

ypically

ist ach ndividual

ebt

ssue,

there s oftennsufficient

nformation

n

thefootnoteslone to

categorize

he

issue.For

xample,

n ssue abeled

9.5% notes ue

2004" couldbe medium-

term

otes,

ublic

debt,

erm ank

debt,

r a

private

lacement.

o aid in

the

categorizationfbalance-sheetebt ssues,we also constructn origination

issue

eveldataset

or

hese 05

firms,

sing

Dealscanfor

yndicated

nd sole-

lender ank oans and

SDC Platinum or

private lacements

nd

public

debt

issues.This

origination

ssue-level

ataset onsists f

2,184

new bank oans

and

2,241

non-bank

ebt

ssues,

or total

f

4,425

ssues

by

303 of our

305

sample

irms. e

cross-checkhebalance-sheet

ssue-level atawith

he

rig-

inationssue-level ata

when heres

any

doubt n the

ype

f

particular

ebt

instrumentn the

financial

ootnotes.

rigination

ssue-level atasets re n-

sufficient

y

themselvesor

xamining

ebt

tructure

ecause

hey

ontain

o

information

n debt etirementsr

renegotiations.

Using hedescriptionsnthe10-K financialootnotesndtheoriginations

in

SDC Platinumnd

Dealscan,

we

classify

ach debt

ssue

discussed

n

the

debt

inancialootnotesnto

ne of

seven road

ategories:

1.

BankDebt:

Consists f twomain

ategories:

1)

revolving

ank

debt,

which ncludes

ommitted

evolving-credit

acilities

r inesof

credit;

and

2)

term ank

ebt,

which

ncludes erm

oans,

ank

verdrafts,

nd

borrowings

n

uncommitted

ines

f

credit.

2

We eliminate

ny

firm-year

bservationhat s in

Chapter

1

proceedings.

n

such

ituations,

re-petition

ebt s

not

ecordedn

Compustat,

hich

makes he

nalysis

foverall

ebt tructure

mpossible.

3

See Johnson

1997),

Kaplan

nd

Zingales

1997),

and Sufi

2009)

for

more iscussion n

these

egulations.

4247



8/40

TheReview

f

Financial tudies v23 n

12

2010

2. Bonds: Consists f

public

debt

ssues,

ndustrial

evenue

onds,

nd

Rule 144A

private

lacements.4

3. Program ebt: Consists f commercialaper, helf egistrationebt,

andmedium-

erm otes

MTNs).

These

programs

reoften

xempt

rom

SEC

registration

equirements,

nd

thus onstitute

program"

ebt.

4. Private lacements: onsists

f non-Rule

44A

privatelylaced

debt

issues,

nd

mbiguous

otes

rdebentureshatwe cannotmatch o

SDC

Platinum.

5.

Mortgage

r

Equipment

ebt: Consists f

mortgage

onds,

mortgage

loans,

quipment

rust

ertificates,

ndother

quipment-based

ebt.

6. Convertible

ebt

7. Other ebt: Includes cquisition otes, apitalizedeases, nd unclas-

sified ebt.

In theData

Appendix,

e

provide

wo

xamples

f thedata-collection

ro-

cess and

howwe

place

debt ssues

nto ne ofthe bove

categories.

We also

classify

he

priority

f

each ssue

nto ne of three

ategories:

e-

cured,

enior

nsecured,

nd subordinated.

n issue s considered

ecured

f

the

irmtates hat

he ssue s collateralized

y ny

f

he

irm's

ssets,

r

f

he

issue

s a

mortgage

ond

or

equipment

oan.

An

issue

s

considered

ubordi-

nated

f

he

ssue

description

ncludes

heword subordinated."

ny

ssues a-

beled eniorubordinated,ubordinated,nd unior ubordinatedre ncluded

in the ubordinated

ategory.

f the ssue

description

ither

tates he ssue

s

senior

nsecured

r fthe ssue

does notfall

nto he ecured r

subordinated

categories

iscussed

bove,

we

classify

he

ssue as senior nsecured.

While

the classification

f

priority

ased

on these

hree

ategories

s

coarse,

both

academic

nd

practitioner

vidence

uggests

t s a

meaningful

eterminant

f

cash-flow

nd

control

ights

uring

he

Chapter

1

bankruptcy

rocess.5

While the

majority

f our

analysis

focuses

on the balance-sheet

ebt-

instrument-level

ata,

we also use

the ssuance-level

ata

from

DC

Platinum,

Dealscan,

nd

Mergent's

ISD

for nformation

n

covenants

nd

maturity.

e

utilize he ssuance-levelataseto examine owcovenantsnd debtmaturity

vary

y

credit

ating.

In addition

o the

ample

escribed

bove,

we

also

collect

hese ata

for he

sample

f "fallen

ngels,"

which

re

firms hat re

downgraded

rom nvest-

ment

rade

Baa3

or

better)

o

speculative

rade

Bai

or

worse)

by

Moody's

Investorservices

t

some

point

rom 996

through

006.6

There re a

total

4

There

s substantial

vidence hat

ule

144A

private lacements

re more

ikebonds han oncentrated

rivate

placements

eld

by

one or

two

nsurance

ompanies

Fenn

2000;

Gomes

nd

Phillips

005).

We used

theMer-

gent/FISD

ataset

or ur andom

ample

f

305 firms

ocalculate

hat t a

minimum,

5%

ofRule 144A

private

placements

re

subsequentlyegistered

s

public

onds.

This

finding

s consistent

ith he

rguments

n these

papers

nd

upports

ur reatmentf Rule144A privatelacementss bonds atherhan rivatelyelddebt.

5

See

Table in

Barclay

nd Smith

1995)

and Baird

ndRasmussen

2006)

for

upport

f this lassification.

6

Our

focus n

Moody's

redit

atings

nd credit

eports

nstead f S&P

is driven

y

data

vailability

onsidera-

4248



9/40

Capital

tructurend Debt Structure

of

158

fallen

ngels

n

the

Compustat

niverse.7 e make he

following

hree

additional estrictions

o the

ample

f

fallen

ngels.

First,

we excludefirms

that ileforChapter 1bankruptcyntheyear f thedowngradesix firms),

given

hat

he

pre-petition

ebt s not ncluded

n

Compustat

ebt

igures

fter

the

firm nters

ankruptcyroceedings.

econd,

we excludefirms orwhich

thedebt inancial ootnoteso not

provide

ufficientetail n debt ssues

six

firms).

hird,

we excludefirms hathave over

50%

of their ebt ssued

by

financialubsidiarieswo

years

efore he

downgrade

six

firms).

his

atter

restriction

s made

given

hat urfocus

s

on thedebt f non-financial

irms,

andthe ehavior ffirms

ith

arge

inancialubsidiaries

ay

be

significantly

different

ollowing

he

owngrade.

his

eaves 140

fallen

ngels.

or hese 40

fallenngels,we collect hedatafor wofiscal ears eforehroughwofiscal

years

fter he

year

fthe

downgrade

a

total ffive

ears

er

firm).

We referothe bservationsor he 05

randomly

elected irmss the ran-

dom

ample"

nd the

bservationsor

he

140

fallen

ngels

s the fallen n-

gels ample."

he

samples verlap

y

29

firms,

s

29

of he irms

n

the andom

sample

were

downgraded

rom nvestment

rade

o

speculative radeduring

the

1996-2006

period.

1.2

Summary

tatistics

Table 1

presents

ummary

tatisticsor he305 firms

2,453

firm-year

bser-

vations)n the andomample. he firstolumn fPanelA presentshe otals

of each

type

f

debt,

caled

by

total

apital.8

he

average

otal ebt o

capital

ratio s

50%

in our

ample.

ondsmake

up

19% of

capital

tructure,

ndbank

debt

makes

up

13%

of

capital

tructure.ank debt s almost

venly

ivided

between erm ebt nd drawdowns n

revolving-credit

acilities.

urther,

s

the hird olumn

hows,

onds ndbankdebt reboth sed

by

the

majority

f

firms

n

the

ample.

onvertibleebt

5.5%),

program

ebt

4.4%),

and

private

placements

3.3%)

make

p

a smaller ractionftotal

apital

tructurend re

used

by

fewer irms.

Although

very

irmn

the

ample

has an

issuer redit

ating

t some

point

between 996and2006,there re somefirm-yearbservations here hefirm

does nothavea credit

ating.

he second olumn f

Table

1

shows hemean

shares f total

apital

or

nly

he

rated

irm-years

n the

ample.

Mostof the

averages

re similar.

owever,

ated

irm-years

tilize hree

ercentageoints

more otal ebt s a share ftotal

apital.

Rated irmschieve his

higher

ebt

tions:We have

Moody

s data

hat

rovide

s with he xact ate f

he

owngrade,

ndwe have he redit

eports

that escribe he easons or he

owngrade.

owever,

oody's

ndS&P

downgrades

re

highly

orrelated:3%

of firmswo

years

efore he

Moody'sdowngrade

re

nvestment

rade y

S&P's

ratings,

nd

75% of firmshe

year

fter he

owngrade

re lso

speculative

rade y

S&P's

ratings.

7

We do not xamine

rising

tars,"

r firms

hat

re

upgraded

rom

peculative rade

o nvestment

rade,

ecause

upgradesrevery ften ue to active apital-structureecisions fmanagers. orexample, ising tars ften

actively

educe heir

everage

atios

y

paying

own ebt

efore

n

upgrade.

n

contrast,

any allingngels

re

downgradediven

usiness-conditionhocks hat

re unforeseen.

8

Total

apital

s definedo be

total ebt

lus

he

bookvalue f

shareholders'

quity.

4249



10/40

TheReview

f

Financial tudies v23

n 12 2010

Table

1

Summary

tatistics

n debt

composition

nd

priority,

andom

ample

PanelA: CompositionndPriorityfTotalDebt

Mean

Share

fTotal Nonzero bservations

Capital

D+E)

(Share

f

Total)

All Rated

All

Rated

Observations

Only

Observations

Only

Equity

Book

Value)

0.498 0.470

Total

Debt,

byType

0.502 0.530 0.967

0.985

Bonds

Non-Program,

on-Convertible)

0.192

0.230 0.651 0.777

Public

0.076

0.099 0.327 0.426

Revenue onds

0.008 0.009

0.207 0.237

144A Private lacements

0.108 0.122

0.338 0.400

Bank

0.132 0.119

0.679 0.689

DrawnRevolvers

0.068

0.055 0.516 0.506

Term oans

0.064

0.064 0.413 0.432

Convertibleonds 0.055 0.055 0.257 0.293

Program

ebt

0.044 0.055

0.255 0.328

Commercial

aper

CP)

0.015 0.019 0.155

0.197

Medium ermNotes

MTN)

0.011 0.014

0.114 0.147

Shelf-Registered

ebt

0.018 0.022 0.144 0.190

Private lacements

Excluding

44A)

0.033 0.027

0.200 0.222

Mortgage

ebt

nd

Equipment

otes

0.021 0.021 0.225 0.237

Other ebt

0.024 0.023 0.714 0.745

Acquisition

otes

0.003 0.002

0.077 0.073

Capitalized

eases

0.011 0.009 0.347

0.352

Unclassified

0.011 0.012 0.524 0.578

Total

Debt,

byPriority

0.502 0.530

1.000 1.000

Secured ebt

0.149 0.138 0.715

0.723

Bonds

Non-Convertible)

0.011 0.012 0.089

0.104

Bank 0.093 0.085 0.397 0.390

Mortgage

ebt&

Equipment

otes

0.021 0.021 0.225

0.237

SeniorUnsecured

ebt

0.238 0.270

0.797 0.856

Subordinated

ebt

0.114 0.121

0.369 0.412

Bonds

Non-Convertible)

0.059 0.071

0.179 0.220

Convertible

onds

0.043

0.042 0.183

0.204

Observations

2453

1829 2453

1829

PanelB:

Sample

ummary

tatisticsn Standard

inancial ariables

All Observations

W=2453)

Rated

Only

N=1829)

Standard

Standard

Mean Deviation

Median Mean

Deviation Median

Book Assets

6185

17862 1305

7950 20302

1998

Total

Capital

4078

11408 926

5217 12963

1398

Profitability 0.103 0.149 0.109 0.114 0.133 0.113

Tangibility

0.513

0.347 0.465

0.532

0.346 0.488

Debt/

Market alue

0.263 0.194

0.238

0.282

0.190 0.252

Debt/Total

apital

0.502

0.343

0.478 0.530

0.318

0.503

Market Book

1.849

1.364

1.420 1.708

1.153

1.361

RatedA

or

Higher

0.2

17 0.4

1

Rated

BBB

0.259 0.438

RatedBB

0.286

0.452

Rated

B

0.214

0.410

Rated

CCC or

Lower

0.024 0.

1

3

Panel

A of this able

presents

ummary

tatisticsn

debt

omposition

nd

priority

or random

ample

f 305

rated

irms.n the

olumns

All

Observations,"

ll available

iscal

ears

rom 996 o

2006 are ncluded

or ach

firm.

n

the

olumns

RatedFirm-

ears,"

nly

hose

irm-years

ith vailable &P

credit

atings

re

ncluded.

Debt ompositionatawere ollected romhe ebt inancialootnotesontained

n he

nnual

eport

f he10-K

filings.

o aid in the

ategorization,

ssue-level atafrom ealscan and SDC Platinum ere

mployed.

anel

B shows

ample

ummary

tatistics

n standard

inancial

ariables s measured

n

Compustat.

otal

apital

s

defined

s debt

plus equity

t book

value.

Profitability

s

defined

s

earnings

efore nterest

nd taxes

after

depreciation)

caled

by agged

ook

apital.

ebt

s measuredt book

value.

4250



11/40

Capital

tructure

nd DebtStructure

share

primarily

y using

morebonds

nd

program

ebt,

onsistent ith he

findings

fFaulkender

ndPetersen

2006).

The bottomart f PanelA in Table1 shows he verage rioritytructure

of debt

for

ample

bservations.

lmost 5%

of

capital

tructureonsists f

senior nsecured

ebt. ecured

debt

makes

up

15%

of

capital

tructure,

nd

secured

ank

debt s over 0%

oftotal ecured ebt. ubordinatedebt

makes

up

1

1%

of

capital

tructure,

nd s dominated

y

subordinated

onds nd sub-

ordinated

onvertible

ebt.

The

averages

re similar or oth

hefull

ample

andthe

ample

frated

irm-years.

Panel

B of Table

1

shows

ample

ummary

tatisticsn standard

inancial

variables. ated

firm-year

bservations

ave mean sset ize of

$8.0

billion

and

mean otal

apital debtplus equity)

f

$5.2billion,

hedifference

eingattributedonon-debtiabilitiesnd net

workingapital.

rofitability,

efined

as

earnings

efore

nterestnd taxes

after

epreciation)

caled

by

book

cap-

ital,

has a meanof 0.1

14

among

ated

irm-year

bservations,

nd a standard

deviation

f

0.133.

In terms f the

redit-rating

istribution,

irms atedA or

higher

omprise

21.7% of the

ample.

Mostfirms ave

BBB,

BB,

or B

rating.

nly

2.4% of

firmsre rated CC

or worse.This

partially

eflects

he

ampling

estriction

that

xcludes

irmsn

Chapter

1

proceedings.

iven

he mall

ample

ffirms

rated CC

or

worse,

we arecautious

n our nferencesor his

roup

f

firms.

2. The

Importance

fDebt

Heterogeneity

n

Capital-structure

tudies

Most

mpirical

apital-structure

tudies reat ebt s uniform.

here re everal

possible

xplanations

or his

ractice,ncluding

desire ormodel

ractability

and data imitations.

n this

ection,

we use our detailed

alance-sheet ebt-

composition

ata o show

he imitationsfthis

pproach.

In

Panels

A and

B

of Table

2,

we show hat he

grand

majority

f firms

n

the

ample

imultaneously

se more han ne

type

f debt

inancing.

anel

A

conditions

he

ample

n firms orwhich 0% of their otal ebt omes

from

a given ype fdebt, ndthen xamineswhich therypes f debt re also a

significant

ortion

f totaldebt.For

example,

he

op

rowof Panel A shows

that 3%

of

firm-year

bservationstilize

significant

mount f

bankdebt.

Thesecond

ow hows

hat,

onditionaln these 3% of

firm-year

bservations

that se a

significant

mount f

bank

ebt,

5% also

use a

significant

mount f

bonds

n

their

apital

tructure.his

findingirectly isputes

he

ccasionally

heard laimthat irms

ely

n

only

ither

onds

or

bankdebt:

A

substantial

fractiontilize oth.9

PanelB of Table

2

shows hefractionf

firm-year

bservationshat se a

significant

mount f

multipleypes

f

debt,

where

ignificant

s

again

defined

9

For

xample,

illett,

ing,

nd Mauer

2007,

p.

701)

state: .

public

orrowersnd

private

orrowers

end o

be distinct

roups

ffirms Sinceour

ample

s

composed

f

public

ebt

ssuers,

t s

unlikely

hat hese irms

use

arge

mounts

f

private

ebt."

4251



12/40

TheReview

f

Financial tudies

v 23 n

12

2010

Table

2

Importance

f

debt tructure or

apital

tructure

PanelA: Share fObservations ith ignificantmounts fDebtTypesOutstanding> 10% ofTotalDebt)

Private

Mortgage/

Bank

Program

Bonds Placements Convertibles

Equipment

Other

Unconditional

0.526

0.214 0.593 0.116 0.213 0.102 0.191

Bank>

10%

1.000

0.109

0.549 0.116 0.156 0.083 0.146

Program

10%

0.268 1.000 0.708

0.116

0.108 0.099

0.241

Bonds

>

10%

0.486 0.255 1.000 0.095

0.148 0.080 0.156

Private

lacements 10%

0.526 0.215 0.489 1.000 0.109

0.088 0.109

Convertibles

10% 0.385 0.109

0.413 0.060 1.000 0.093 0.131

Mortgage

nd

Equipment

10% 0.426 0.207 0.467

0.099

0.194

1.000 0.293

Other 10%

0.401

0.269 0.485 0.066 0.145 0.156 1.000

PanelB: Distribution

f Number f Different

ypes

ofDebt

>

10% ofTotal

Debt)

Number

f

ypes

0

12 3

4

5

6

NumberfObservations 8 743 1076 443 96 5 0

Percent

0.3 31.3 45.4 18.7

4.1 0.2 0.0

Percent

sing

t LeastThis

Many

100.0 99.7

68.3 22.9 4.3

0.2 0.0

Panel

C:

Adjustments

o Debt Structure

nd

Adjustments

o TotalDebt

>2.5%

ofTotal

Capital)

Change

nTotal

Debt

s a Share fTotalBook

Capitalization

-2.5%

or below "Stable"

-2.5%

to

+2.5%)

+2.5% or above

Share f

Sample

n Each

Category

0.423 0.299 0.278

Share fStable-Debt

irms

0.255

Adjusting

t LeastOne

Component y

>2.5%

of

Capital

Private

Mortgage/

For

Stable-Debt

irms

nly

Bank

Program

Bonds

Placements

Convertibles

Equipment

Other

Share

ncreasing y

>

2.5%

0.058 0.045 0.067 0.011

0.016 0.016 0.023

of

Capital

Share

Decreasing y

>

2.5%

0.086 0.039

0.039 0.016 0.019 0.011

0.033

of

Capital

The

sample

s

the

2,371

observations

97%

of thefull

ample)

for

which

ebt

s nonzero. anel A shows he

share f observations

n the

ample

with

ignificant

mounts f thevarious ebt

ypes

utstanding.

n

amount

is defineds

significant

f t

s

at east

10% ofdebt. he firstow

hows hese ractions

nconditionally,

nd the

following

ows

how hese ractions

or irms ith

ignificant

mounts feach of the even ebt

ypes.

anelB

shows he istribution

fobservations

y

number fdifferent

ypes

fdebt sed.PanelC

compares djustments

to total

ebtwith

djustments

o debt

tructure,

herewe consider

ignificant

djustments

o

be

those

reater

than .5%

of

agged

otal

apital

debt

lus quity

t book

values).

to

be 10%

or more f

total ebt.As

it

shows,

8%

of

firm-year

bservations

significantly

tilize

t least two

types

f

debt

financing.

aken

ogether,

he

findings

n

Panels

A and

B demonstrate

hat tudies

hat reat

ebt s uniform

ignore

substantial

ractionf

variationn

capital

tructure.

Further,

s shown

nPanelC

ofTable

2,

an

analysis

hat ocuses

nly

n total

debtmisses

substantial

raction

fvariation

n

changes

n

capital

tructure.

n

Panel

C,

we

split

he

ample

nto hree

roups:

irmshat

xperience

change

in total ebt

caled

by

agged

otal

apitalization

f -2.5%

or

more,

etween

-2.5%

and

2.5%,

and above 2.5%.

The

middle

roup

ncludes

stable"

irms

thatncrease r decrease heir otal ebt y ess than .5% of agged otal ap-

italization.

revious

tudies

hat ocus

nly

n total ebt

would onclude

hat

these

irms o

not

djust

heir

apital

tructure.

4252



13/40

Capital

tructurend Debt

Structure

Table 3

Leverageregressions y

debt

type

PanelA: YearFixedEffectsnly

Debt

ype

Share

f

TotalBook

Capital)

TotalDebt Bank

Program

Bonds PPs

Convertibles All Other

Profitability

0.549***

0.135* 0.007 -0.069

-0.108** -0.422***

-0.092***

(0.149) (0.072)

(0.031) (0.093)

(0.055) (0.110)

(0.031)

Tangibility

0.158*** -0.019 0.044**

0.090*** 0.025*

-0.045*** 0.063**

(0.038)

(0.022)

(0.017) (0.031)

(0.014) (0.015)

(0.025)

M/B -0.031**

-0.025*** 0.003 -0.024*** -0.001

0.020* -0.004

(0.012)

(0.004) (0.003)

(0.005) (0.004) (0.011)

(0.003)

ln(Sales)

-0.013 -0.026*** 0.017***

-0.003

-0.005* 0.002 0.002

(0.011) (0.005) (0.004)

(0.007)

(0.003) (0.004)

(0.003)

Constant 0.550*** 0.352*** -0.104***

0.150*** 0.063***

0.058* 0.031

(0.068) (0.035) (0.024) (0.049)

(0.021) (0.030)

(0.025)

Adjusted 0.14 0.08 0.12 0.05 0.03 0.16 0.06

R-Squared

Panel

B:

Industry

nd YearFixedEffects

Debt

type

Share

fTotalBook

Capital)

TotalDebt Bank

Program

Bonds PPs

Convertibles All Other

Profitability

0.615*** 0.094 -0.001

-0.066 -0.115** -0.441***

-0.085**

(0.153)

(0.063) (0.027) (0.096)

(0.057) (0.113)

(0.036)

Tangibility

0.230***

0.018 0.033* 0.090** 0.019

-0.026

0.096***

(0.044) (0.027) (0.020)

(0.041) (0.018)

(0.022) (0.033)

M/B -0.019 -0.021***

0.004 -0.021***

0.002 0.017

-0.002

(0.012) (0.004)

(0.003) (0.005)

(0.004) (0.011) (0.002)

ln(Sales)

-0.012 -0.026***

0.018*** -0.002 -0.007**

0.006 -0.002

(0.012) (0.005) (0.005)

(0.008) (0.003) (0.005) (0.003)Constant 0.124* 0.312*** -0.127*** -0.063 0.012 0.028 -0.039

(0.065)

(0.033) (0.024) (0.051)

(0.023)

(0.035) (0.033)

Adjusted

0.21 0.17 0.23

0.12 0.13

0.24 0.28

R-Squared

The

sample

s the

,453

observationsrom

able

1

minus ne forwhich ata

necessary

or inancialatios

were

missing.

ach

panelbegins

with

standard

everage egression

f total

ebt caled

by

total ook

capitalization

(debt

lus quity

t book

values)

n thefour

xplanatory

ariables.

ach

panel

hen hows

egressions

f each

of five ebt

ypes

n the ame four

xplanatory

ariables.All

dependent

ariables re scaled

by

total

book

capitalization

D+E).

Profitability

s

operating

ncome

fter

epreciation

caled

by

total

apital.Tangibility

s

PP&E scaled

by

otal

apital.

tandardrrorslustered

y

firm

re

n

parentheses.

***

significant

t the1%

evel,

*

significant

t the %

level,

significant

t the10% evel.

Incontrast,e examinewhetherhese stable" irmsxperienceignificant

changes

n

the

underlying

tructurefthe

debt,

espite eeping

he otal ook

debt onstant.We

find hat

5.5% of firms

ignificantly

lter

heir

nderlying

debt tructure

espite eeping relatively

onstantevel

of debt. n

particular,

theres

significant

ovement

mong

ank

debt,

rogram

ebt,

nd bonddebt

in

this

ategory

f

firms ith

table

ebt-to-capital

atios.

his

apital-structure

variations

completely

missed

by

studies hat reat

ebt s

uniform. hese

findings

uggest

hat irms

djust

he

ecurities

n

their

apital

tructure

ven

when otal

ebt emains

onstant.

Studies hat

ocuson total

debtmiss

a

substantialraction

f variationn

capital

tructure.able3 shows hat hisvariations

important

ndetermin-

ing

what

actors

nfluence

apital

tructure.

olumn of

PanelA

presents

e-

gression

oefficients

hat

elate he

total

debt-to-capitalization

atio o basic

4253



14/40

TheReview

f

Financial tudies v23nJ2

2010

determinants

f

capital

tructuresed

n

previous

tudies

e.g.,Rajan

and

Zin-

gales

1995).

The correlations atch hose

previously

ound:More

profitable

andhighmarket-to-bookirms se essdebt,while irms ith ighersset an-

gibility

se more ebt.

However,

henwe

break

utthedifferent

ypes

f

debt,

we see that hese

correlationshow

ubstantial

eterogeneity.

irst f

ll,

he

trong

egative

or-

relation etween

rofitability

nd

everage

atios

n

our

ample

s driven

argely

by

convertibleonds

nd non-Rule

44A

private lacements.

ank debt s in

fact

weakly ositively

orrelated ith

rofitability.

his

heterogeneity

s

im-

portant,

s

the

ingle

most itedfact

n

support

f the

pecking-order

iew of

corporate

inancial

tructures the

negative mpirical

elation etween

rof-

itability

nd

everageBradley, arrell,

nd

Kim

1984;

Harris nd Raviv

1991;

Rajan

and

Zingales

1995).

Under he

pecking-order

ypothesis,

irms

after

running

ut f nternal

ash)

will

prefer

ouse

debt

o

adjust

inancialtructure.

This

preference

erives rom

henotion hat ebt s

considerably

ess "informa-

tion ensitive"

han

quity,

n

that tsvalue

n

equilibrium

oes not

depend

s

heavily

n

managers'

nside

nformation.f a firm

asses

from

aving nough

internal

ash o fundnvestment

o

a

situation

here

tneeds

utside

inancing,

the

ecking

rder

redicts

hat

irms ill urn odebt efore

hey

urn o

equity,

which s an oft-cited

xplanation

or

he

negative

elation

etween

rofitability

and

everage

e.g.,Rajan

and

Zingales

1995;

Fama andFrench

002).

Takinghis rgumenturther,hepecking-orderypothesisould herefore

also

predict

hat

rofitability

hould

be more

negatively

orrelated ith

he

least nformation-sensitive

ypes

fdebt. f nternalunds or nvestment

rop,

thefirm houldfirst urnmost f all

to the east

nformation-sensitive

ypes

of

financing.

ankdebt s

generally

iewed s the east nformation

ensitive,

as bankswrite

ovenantsnto oan

agreements

hat

ut

borrowers

nto

echni-

cal default. onvertible

ebt,

eing

most ike

equity,

s themost nformation

sensitive

f all debt ecurities.

he fact hat

n

our random

ample

of rated

firmshe

negative

elationship

etween

rofitability

nd

everage

s

strongest

for hemost

nformationensitive

f all debt ecuritiesnd weakest or he

least nformationensitiveuggestshat he iteratureas to some xtentmis-

interpreted

he

negative

orrelationetween

rofitability

nd

everage.

ne

ex-

planation

onsistent

ith

oth

his esult nd the

pecking

rderwouldbe that

more-profitable

irms

an avoid

equity

nd

information-sensitiveebt

more

than

ess-profitable

irms,

lthough

his s not

he raditional

nterpretation

n

the iterature.

The use of convertible

ebt

by

ess-profitable

irms

s of coursenot ncon-

sistent ith

n

important

olefor

symmetric

nformation

n

capital

tructure.

It is consistent

ith

tein

1992),

in

which

irms ith

trong

nvestment

p-

portunities

ut

high

ostsof financial

istress

eedto raise

xternal

inancing

anddo so

through

onvertibleso avoid he emons roblemnequityssuance.

Thismodel ontains

oth osts

fdebt

hrough

inancial

istressnd an

asym-

metric

roblem

n

equity

ssuance.

Alternatively,

he

inding

s consistent

ith

4254



15/40

Capital

tructurend

Debt

Structure

agency-based

xplanations,

here

onvertiblesre

useful

n

mitigating

isk

shifting

Brennan

nd

Schwartz

988).

The

tax side

of

the

rade-off

heory

s

consistentith his esult: onvertiblesave ower oupons ndthus remore

appropriate

or irms

hat re

ess

ikely

o

have

axable

ncome.

Table

3 also

shows

hat he

ositive

orrelation

etween

sset

angibility

nd

leverage

s

focused n

non-convertible

rms-length

ypes

f

debt.

Bank

debt s

a share

f

total

apital

oes not

ppear

o

risewith

he

xtent

o

which

ssets

are

angible.

raditional

xplanations

or

he

ositive

elation

etween

angibil-

ity

nd

everage

ave

onsidered

angible

ssets s

useful n

mitigating

gency

costs r

as

having igh

iquidation

alues.

Berger

nd

Udell

1995)

argue

hat

collaterals

less

important

hen

here

s a

banking

elationship

etween

he

borrower

nd

the ender,s bankmonitoringansubstituteor hysicalollat-eral.

Rajan

and

Zingales

1995),

however,

ind

hat

angibility

ppears

o

play

a

lesser ole n

the

everage

atios f

Japanese

irms

nd

therefore

uestion

he

Berger

nd

Udell

1995)

interpretation.

ur

finding

hat ank

ebt

oes

not ise

with

angibility

s a

share f

total

apital

rovides

ithin-country

vidence or

the

ubstitutability

f

bank

elationships

or

hysical

apital.

Panel B

of

Table

3

presents

stimates

ith

year-

nd

2-digit

ndustry-fixed

effects,

ielding

imilar

esults. he

addition f

firm-fixed

ffects

not

hown)

removes

omeof

the

tatistical

ignificance

ue

to a

combination

f the

mall

sample

nd

the

mportance

f

firm-fixed

ffectsn

capital-structure

egressions

(Lemmon, oberts,ndZender 008). However,urresultslearlyhow ub-

stantial

ariation

cross

different

ypes

f

debt n

terms f

the

esponse

o

the

usually ypothesized

ross-sectional

eterminantsf

capital

tructure.

The

findings

n

Table

3 show

that

ven

basic

cross-

ectional

orrelations

shown

n

previous

tudies

etween

everage

atios

nd

firm

haracteristics

mask

mportant

ariation

cross

ifferent

ypes

f

debt

nstruments.

his

ikely

reflectshe

act

hat

ifferent

ypes

f

debt re

fundamentally

istinctn

terms

of

cash-flow

laims,

ensitivity

o

asymmetric

nformation

etween

managers

and

nvestors,

nd

managerial

ncentive

ffects.

While he

orrelationsn

Ta-

ble

3 do

not eflect

he

mportance

f

dynamic

apital-structure

hoice r

firm-

investmentecisionsHennessy004;HennessyndWhited005;Leary nd

Roberts

005),

they

ighlight

he

mportance

f

recognizing

ebt

heterogene-

ity

n

capital-structure

tudies.

3.

Debt

Structure

nd

Credit

Quality

3.1

Theoretical

motivation

The

results n

the

ection

bove

suggest

hat

n

explicit

ecognition

f

debt

heterogeneity

s

necessary

o

understand

he

determinantsf

capital tructure.Inthis ection, emotivateur

mpirical

nalysis

fthe elationetween ebt

structure

nd

credit

uality

y

examining ypotheses

rom

he

heoretical

it-

erature

n

debt

omposition

nd

priority.

4255



16/40

TheReview

f

Financial

tudies

v

23

n 12

2010

The first

roup

f theories

ypothesizes

hat irms

houldmovefrom

ank

debt

o non-bank ebt s credit

uality mproves

Diamond

1991b;

Chemma-

nur ndFulghieri994;Boot andThakor 997;Bolton ndFreixas 000).The

seminal rticle s

Diamond's

1991b)

modelof

reputation

cquisition.

n

his

model,

irms

raduate

rom

ankdebt

o

arm's-length

ebt

by

establishing

reputation

or

high arnings.

More

specifically,

hemainvariable

hat

ener-

ates cross-sectional

redictions

s the x ante

probability

hat firm

s a bad

type

with bad

project;

his x ante

probability

s

updated

ver

periods

ased

on

earnings erformance,

nd s

interpreted

s a credit

ating.

ad firms ave

a lower

history

f

earnings,

nd

a

higher robability

f

selecting

bad

project

in

the

future.

igh-quality

irms orrow

irectly

rom

rm's-length

enders

and avoid dditional

ostsof bankdebt

ssociatedwith

monitoring;

edium-

quality

irmsorrowrom anks hat

rovide

ncentivesrom

monitoring;

nd

the

owest-quality

irmsrerationed.10

The model

y

Bolton

ndFreixas

2000)

explores

he

ptimal

mix

f

bonds,

bank

ebt,

nd

equity.

he

key

distinction

etween onds ndbank

debt s the

monitoring

bility

f

banks.

f

currenteturns

re ow and

defaults

pending,

banks an

nvestigate

he

borrower'suture

rofitability,

hereas

ondholders

always

iquidate

he

borrower.

n

their

model,

igh-quality

irms o

notvalue

the

bility

f

banks o

nvestigate,

nd

therefore

ely

rimarily

n

arm's-length

debt.

ower-quality

orrowersalue he

bility

o

nvestigate

y

the

bank,

nd

thus elymore eavily nbankfinancing.1

The second

group

of theories

xamines

why

firms

tructureebt into

multiple

lasses based on

priority, aturity,

r

type

Besanko

and

Kanatas

1993;

Diamond

993;

Park

000;

DeMarzo and

Sannikov

006;

DeMarzo

and

Fishman

007).

For our

analysis,

particularlymportant

odel s

by

Park

(2000),

who examines

hereasons

why

enderswith

monitoring

uties

may

be senior n

priority.

n

Park's

2000)

model,

orrowers

ay

undertake

isky

negative

PV

projects,

nd the

moral-hazard

roblem

s severe

nough

hat

external

inancing

s

possible

nly

fa debt laimant

monitorsheborrower's

activities.

Twomainhypothesesmerge romhis ind fmodel. irst,he enderwith

monitoring

uties

thebank)

hould e the

most enior

n

the

apital

tructure.

The ntuitions as follows:A bank's

ncentive

o

monitors maximized hen

the ank

ppropriates

he ull eturnromts

monitoring

ffort.

n

the

resence

of senior r

paripassu

non-monitoring

enders,

hebank s

forced o share he

10 Diamond1991b,p. 715) interpretsis model s describinghe rade-offetween ankdebt nd commercial

paper,

ot

necessarily

ll

types

fnon-bank ebt.

1

Bolton ndFreixas

2000)

also

nvestigate

he se of

quity,

hich

s

used s the

rimary

ource f

financingy

the

owest-quality

orrowers.

4256



17/40

Capital

tructure

nd DebtStructure

returno

monitoring

ith ther

reditors,

hich educes hebank's ncentive

to monitor.12

Second, he resencefunior on-bankreditorsnhances he enior ank's

incentive

o monitor.

his result ollows rom he omewhat ounterintuitive

argument

hat bankhasa

stronger

ncentive

omonitorf ts

laim

s

smaller}*

Park

2000,

p.

2159)

describes his ntuitions follows: .

if

he

project

on-

tinues,

n

mpaired

eniorenderwill

get

ess than sole ender

imply

ecause

hisclaim s smaller. n

the ther

and,

f

he

project

s

liquidated,

n

mpaired

senior

enderwill

get

he ame mount s a sole

ender,

he

iquidation

alue."

Given

ts ower

alue n the

going

oncern,

bankwith smaller laim ctu-

ally

has a

stronger

ncentiveo monitornd

iquidate

he

irm. he

presence

f

junior

ebt educes he ize of he ank's

laim,

which ncreases he mount f

socially

eneficial

onitoring.

The

intuitionf this atter esult

s

evident

f

one

considers

bank

credi-

tor

with claim hat

epresentsvery arge

raction

f theborrower's

apital

structure.

n such

situation,

hebankhas less of an incentiveo

iquidate

risky

orrower,

iven

hat hebank's

arge

laimbenefits

elatively

ore rom

risk-taking

han smaller

laim. n other

words,

large

bank laim s more

"equity-like"

han smallbank

laim,

given

ts

upsidepotential.

s a

result,

reducing

he ize of

the enior ank laim

by addingunior

ebt

mproves

he

banks'

ncentiveo detect

isk-shifting.lternatively,yholding

small take

in thefirm,ank enders re able tocrediblyhreatenorrowers ith iqui-

dation,

whichmakes heir

monitoring

ore

powerful

n

reducing

managerial

value-decreasing

ehavior.

There re at least

two

ways,

however,

n

which

he

existing

heories o

not

map

ntoour

empirical

esign.

First,

heories uch as Diamond

1993),

Besanko nd Kanatas

1993),

and Park

2000)

derive

priority

tructures

the

ptimal

ontractnderncentive

onflicts,

ut

hey

o not

xplicitly

erive

the

omparative

tatic f how

optimal riority

tructure

hould

vary

cross

continuumf

ncentiveonflict

everity. thoughtxperiment

lose to this s

provided

y

DeMarzo and Fishman

2007),

who do

examine he

omparative

statics fdebt tructureith especto iquidationalues,managerialatience,

and

managerial rivate

enefits.

owever,

heir

redictions

re

about he

mix

between

ong-term

ebt nd ines f

credit,

atherhan

riority

tructure

er

e.

Second,

with

he

xception

fDeMarzoandFishman

2007)

and

ome ther

recent

ynamic ontracting

ork,

hese heoriesre staticn

nature,

ndthere-

fore o not

redict

owdebt tructurehould

hange

with

espect

o

the volu-

tion

f

stochasticash flows. n this

ense,

he

heory

s more elevant

or ur

'2

This

hypothesis

s not

rivial.

or

n alternative

iew,

ee

Fama

1990).

13

One caveat s that f

thebank

s

to have

any

ncentive

o

monitor,

ts claim must

e

at

least

arge nough

o

be

impaired y iquidation.

his

ssumption

s

supportedy

the act

hat bserved ank ebt

ecovery

ates re

75%,

according

oS&P.

See Hamiltonnd

Carty

1994).

Conditionaln the ender

eing mpaired

n

iquidation,

a smaller laimwill

trengthenonitoring

ncentives.

4257



18/40

TheReview

f

Financial tudies

v23n 12 2010

random

ample

ross-sectionalesults

han or ur

panel

results

n fallen n-

gels.

ndeed,

esanko nd Kanatas

1993),

Diamond

1993),

and Park

2000)

are ex antemodels n whichmoralhazard xplains heexistence fpriority

structure;owever,

hey

o not

consider

ynamic

eteriorationn

the

firm's

credit

uality.

n DeMarzo and

Fishman

2007),

agents

rawdownon credit

lineswhen ash

flows re nsufficiento

pay

debt

oupons.

However,

here re

no

dynamic

models o

our

knowledge

hat erive oth n increase

n

secured

and subordinated

ebt s a

percentage

f total

ebt,

.e.,

the

preading

f

the

debt tructurehat

we find s credit

uality

eteriorates.

With hese aveats

n

mind,

ur

empirical nalysis

f debt tructures fo-

cused

on three road

uestions

aised

y

the heoreticaliterature.

irst,

when

the

potential

ostofasset ubstitution

s

large,

o firms

lace

bankdebtwith

monitoring

unctionenior o all other ebtn the

apital

tructure?

econd,

s

the

priority

tructuref debt

particularly

vident hen irmsre

ikely

o face

more erious

gency

osts

of debt?

Third,

o firmsf ower redit

uality

se

moremonitored

ources fdebt inance?We examine

hese

uestions

elow.

3.2 Random

ample

results

Figure presents

ur

first ain esult n the

elationship

etween redit

ual-

ity

nddebt tructure:

irms ower

n the

redit-quality

istribution

pread

he

priority

tructure

f their ebt

bligations.

While

nvestment-grade

irms

ely

uniquelyn senior nsecuredebt ndequity, peculative-gradeirmsely n

a combination

f secured

ank

debt,

enior nsecured

ebt,

ubordinatedon-

vertibles

nd

bonds,

nd

equity.

Table

4

presents

stimates f

these

patterns

n

a

regression

ontext.14

n

Panel

A,

the eft-hand-side

ariables rethe

ebt-priority-class

mountscaled

by

total ebt.

he omitted

redit-qualityroup

s

firms

ated

orbetter. s the

coefficients

how,

peculative-grade

irms ave much

igher

ractionftheir

debt

n secured nd subordinated

bligations.

he

magnitude

s

economically

significant:

ecured

nd

subordinated

ebt s a fraction

f total ebt s more

than 0%

higher

or irms ith

B

rating

han or

irms ith

rating

f

A or

better.

In Panel

B of Table

4,

the

eft-hand-side

ariable or ach

regression

s

the

debt-priority-class

mount caled

by

total

apitalization.

he

results re

qualitatively

imilar o the esults

n PanelA:

Lower-credit-quality

irms se a

substantially

igher

ractionf secured

nd subordinated

ebt

n their

apital

structure.

nce

again,

he

magnitudes

re

triking:

he combination

f ecured

and subordinated

ebt s a

fractionf

total

apital

tructure

s

higher y

more

than

0%

forB-rated

irms

ompared

o

firms ated

A

or

higher.

eanwhile,

senior

nsecured ebt

ctually

ecreases

n

the

capital

tructure

espite

he

14

The

analysis

n Table

4 is limited o the

1,829

firm-year

bservations

here hefirms

ave credit

ating.

ur

results re

materially

nchanged

f

we

use all firms

n thefull

ample

nd

predict atings

sing

ize,

the

market

leverage

atio,

rofitability,

nd

themarket-to-book

atio.

4258



19/40

Capital

tructurend Debt

Structure

Table

4

Priority

tructure fdebt nd

credit

uality

PanelA: ScaledbyTotalDebt

Secured

Senior

Unsecured Subordinated

Rated

BBB

-0.017

-0.036

0.054**

(0r029) (0.039)

(0.025)

RatedBB

0.231***

-0.534*** 0.303***

(0.039)

(0.045)

(0.034)

RatedB

0.176***

-0.488*** 0.310***

(0.039)

(0.050)

(0.042)

RatedCCC or Below 0.274***

-0.591***

0.295***

(0.073)

(0.079)

(0.077)

R-squared

0.14

0.37

0.21

PanelB: Scaled

by

Total

Capital Debt+Equity)

t

Book

Value

Secured Senior

Unsecured Subordinated

RatedBBB

0.005

0.038

0.037***

(0.013)

(0.035)

(0.007)

Rated

BB

0.151***

-0.172***

0.177***

(0.024)

(0.035)

(0.019)

RatedB

0.162***

-0.094** 0.253***

(0.025) (0.042)

(0.036)

RatedCCC or Below

0.361*** -0.091

0.386***

(0.068)

(0.090)

(0.097)

R-squared

0.17

0.11

0.20

Thistable

presents

stimates rom

egressions

f

secured,

enior

nsecured,

nd

ubordinatedebt n ndicator

variables or redit

atings.

he

sample

s

therandom

ample

f rated irms

ummarized

n

Table

1

Data on

secured,

enior

nsecured,

nd ubordinatedebt

recollected rom 0-K

filings

nd

cross-checked ith

rigi-

nation ataseis. n Panel

A,

the ebt

measures re caled

by

otal ebt nd

the

ample

onsists f the

1,802

ated

firm-yearbservationsith onzero ebt, epresenting04 firms.n PanelB, thedebtmeasures re scaledby

total

apital

debt

plus equity

t book

value)

and the

ample

s thefull

1,829

rated bservationsn

305

firms.

The omitted

roup

n

both

anels

s firms atedA or

higher.

egressions

ontain

ear-fixed

ffects. tandard

errors

lustered

y

firm

re

n

parentheses.

***

significant

t the1%

level,

*

significant

t the %

level,

significant

t the

10% evel.

fact hat otaldebt ncreases.

Naturally,

he decrease n

senior nsecureds

smallerwhen

caled

by

total

apitalization

han

y

total ebt.This

reflectshe

fact hat

ower-credit-quality

irms

se more otal ebt nd

ess

equity.

n other

words,

s firms

ove

down

he

redit-quality

istribution,

hey

eplace

enior

unsecured ebt nd

quity

with

ecured ankdebt nd

ubordinatedebt. his

findingsalso evidentnPanelA ofFigure inthe ntroduction.

One

potential

oncernwith

heresultsn Table 4

is that

heymight

eflect

twodistinct

ets f firms:

erhaps

omeofthe

ower-credit-quality

irms ave

more ecured

ebt

n

their

apital

tructurehile thers

avemore f

subordi-

nated ebtwithout

verlap

etween

he wo

groups.

o

the

ontrary,

igure

shows hat

many

ow-credit-quality

irms

imultaneously

se both

ecured nd

subordinated

ebt.Panel A

illustrateshat

mong

nvestment-grade

irms,

l-

most 0% haveno

significant

mount feither

ecured r

subordinatedebt n

their ebt

tructure,

here

ignificant

s defined

obe at

east10% of

otal ebt.

In

contrast,

ess than

0% have

significant

mount fboth

ecured nd

ubor-

dinated ebt.PanelB shows hat

mong

peculative-grade

irms,

lmost 5%

have

significant

mount f

both ecured

nd

subordinatedebt n

their ebt

structure.

hile 0% of

nvestment-grade

irms aveno

significant

mount f

4259

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