Academic journal article International Journal of Management

The Effect of Firm Characteristics on Choice of Debt Financing

Academic journal article International Journal of Management

The Effect of Firm Characteristics on Choice of Debt Financing

Article excerpt

This study examines the effects of a firm's credit rating, size, market-to-book ratio, profitability, degree of leverage, and tangible assets on its choice of debt financing. Using a comprehensive U.S. sample of 3077 public debt offerings, 2164 private placements/144a issues, and 6903 syndicated bank loan agreements downloaded from the Security Data Company's New Issues Database, I find several interesting results for the period 1984 to 2004. I find that, while larger and highly rated firms with a lot of tangible assets tend to prefer public debt to private placements/144a issues, non-rated firms with relatively high M/B ratios tend to do the opposite. When choosing between public debt financing and syndicated bank loan financing, while large, highly rated, but at the same time, highly levered firms with a lot of tangible assets tend to prefer public debt financing, non-rated firms with relatively high M/B ratios tend to prefer syndicated bank loan financing. Finally, when choosing between private placement/144a financing and syndicated bank loan financing, while large, highly levered firms with a lot of tangible assets tend to prefer private placement/144a financing, non-rated firms with relatively high M/B ratios tend to prefer syndicated bank loan financing.

(ProQuest: ... denotes formula omitted.)

Introduction

In this paper, I focus on three different debt financing events, the public debt offering, the private placement/144a issue, and the syndicated bank loan agreement, in an attempt to measure the impact of firm-specific factors on firms' financing choice. In other words, I attempt to answer these two questions: (1) What are the factors that affect a firm's decision to use a specific type of debt financing? (2) Does the credit rating of the borrower have an impact on the choice of debt financing? To the best of my knowledge, this is the first study that deals with a firm's financing choice between public debt, private placement/ 144a, and syndicated bank loan.

Huang and Ritter (2004) examine firms' choice among equity and public debt, while using some explanatory variables that approximate for the relative cost of equity versus debt. A major contribution of this paper is to link equity issuance explicitly to a direct measure of cost of equity capital, which is the beginning-of-year implied equity risk premium, as well as several indirect measures, like lagged values of the average first-day return of IPOs, average closed-end fund discount, lagged realized market returns, and past and future realizations of the Fama-French SMB and HML factors. They find that firms are more likely to issue equity instead of debt when the implied equity risk premium is lower, the first-day return of IPOs is higher, the closed-end fund discount is smaller, prior market returns are higher and future market returns are lower, prior realizations of HML are lower and future realizations of HML are higher, and the expected default spread is higher, even after controlling for firm characteristics.

Elliott, Koeter-Kant, and Warr (2008) examine the public equity vs. public and private debt issuance decision in a framework that controls for the static trade off and pecking order theories. They find that overvalued firms are more likely to issue equity, while those that are fairly valued or undervalued issue debt. Their study also provides some insight into the choice between public and private debt securities. The decision to issue debt publicly or privately does not appear to be influenced by the level of equity misvaluation, but rather by the characteristics of the firm. Their evidence suggests that younger, riskier firms, seeking smaller amounts of capital are more likely to utilize the private debt market.

Elliott, Koeter-Kant, and Warr (2007) examine the impact of market misvaluation on the firm's choice of security for funding the financing deficit. This study is veiy similar to their other study mentioned above. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.