Essays in Capital Structure

The costs and constraints to financing, and the factors that influence them, play critical roles in the determination of corporate capital structures.

Chapter 1 estimates firm-specific marginal cost of debt functions for a large panel of companies between 1980 and 2007. The marginal cost curves are identified by exogenous variation in the marginal tax benefits of debt. The location of a given company's cost of debt function varies with characteristics such as asset collateral, size, book-to-market, intangible assets, cash flows, and whether the firm pays dividends. Quantifying, the total cost of debt is on average 7.9% of asset value at observed levels, reaching as high as 17.8%. Expected default costs constitute approximately half of the total ex ante cost of debt.

Chapter 2 uses the intersection between marginal cost of debt functions and marginal benefit of debt functions to examine optimal capital structure. By integrating the area between benefit and cost functions, net benefit of debt at equilibrium levels of leverage is calculated to be 3.5% of asset value, resulting from an estimated gross benefit of debt of 10.4% of asset value and an estimated cost of debt of 6.9%. Furthermore, the cost of being overlevered is asymmetrically higher than the cost of being underlevered. Case studies of several firms reveal that, for some firms, the cost of being suboptimally levered is small while, for other firms, this cost is large, suggesting firms face differing sensitivities to the capital structure choice.

Finally, Chapter 3 examines the role of financing constraints on intertemporal capital structure choices of the firm via a structural model of capital investment. In the model, firms maximize value by choosing the amount of capital to invest and the amount of debt to issue. Firms face a dividend non-negativity constraint that restricts them from issuing equity and a debt capacity constraint that restricts them from issuing non-secured debt. The Lagrange multipliers on the two constraints capture the shadow values of being constrained from equity and debt financing, respectively. The two financing constraint measures are parameterized using firm characteristics and are estimated using GMM. The results indicate that these measures capture observed corporate financing behaviors and describe financially constrained firms. Finally, between the two financing constraints, the limiting constraint is the debt restriction, suggesting that firms care about preserving financial slack.