Debt-to-equity ratio

Summary

The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leveraging, the ratio is also known as risk, gearing or leverage. The two components are often taken from the firm's balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's debt and equity are publicly traded, or using a combination of book value for debt and market value for equity financially. Usage Preferred stock can be considered part of debt or equity. Attributing preferred shares to one or the other is partially a subjective decision but will also take into account the specific features of the preferred shares. When used to calculate a company's financial leverage, the debt usually includes only the Long Term Debt (LTD). Quoted ratios can even exclude the current portion of the LTD. The compositio

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https://en.wikipedia.org/wiki/Debt-to-equity_ratio

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In the first chapter of this thesis, I empirically show that the time delay firms face in raising outside capital affects cash holdings. I exploit the 2005 US Securities Offering Reform (the Reform) as a quasi-natural experiment. For a subset of large public US firms, the Reform relaxed the requirement to undergo the standard review process with the Securities and Exchange Commission (SEC) before raising new public capital, leading to a reduction in regulatory delay of approximately 1-1.5 months on average and exceeding half a year in extreme cases. Difference-in-differences estimates based on the event suggest a causal channel from time delay to cash holdings. Over the course of the year following the Reform, affected firms reduced their cash holdings by approximately 2-3% as a fraction of book assets relative to unaffected control-group firms. As predicted by theory, the effect is strongest among firms in cash flow volatile industries. The second chapter investigates whether seasoned equity offerings (SEOs) are accompanied by price pressure effects that models of investor inattention and slow-moving capital predict. In line with theoretical predictions, I find that the share prices of issuing firms exhibit a drop in the pre-offer week, and a positive trend in the first four to eight weeks thereafter. The pattern is systematically related to the size of an offering and to measures of the amount of attention the issuing firm receives by market participants. The resulting costs to the issuing firm are on the order of 2% as a fraction of offer proceeds for the average firm, and nearly twice as large for the tercile of firms issuing the largest quantities of illiquid stock. The price impact is so sizable and long-lasting that simple monthly trading strategies that purchase SEO stocks in the first calendar month after an offering yield monthly five-factor alphas exceeding 1.5 percentage points. The abnormal returns are most pronounced in periods of low aggregate stock market liquidity, as measured by the Pástor and Stambaugh (2003) liquidity index. The results are consistent with the interpretation that the return pattern represents a compensation to temporary liquidity providers, who require the largest compensation during periods in which funding liquidity is scarce. The third chapter is joint work with Cornelius Schmidt from the University of Lausanne. We propose a novel setting to test how the presence of attention constraints affects stock prices. Our setting exploits the particular industry exposure of vertically integrated firms. Because of inter-segment sales of goods, the relative size of individual segments within such firms, in an accounting sense, is a misleading indicator for the firm's overall exposure to industry shocks. We hypothesize that attention constrained investors will tend to neglect this detail, leading to systematic pricing mistakes after confounding, industry-specific news shocks. In line with this hypothesis, we find evidence of predictable price corrections in post-news periods – in particular in the time around firms' earnings announcements. A fully implementable long-short equity strategy based on the phenomenon leads to significant risk-adjusted excess returns. Security analysts' earnings forecasts exhibit a predictable error in the same direction as stock prices.

EPFL2012

Essays in Dynamic Corporate Finance

Francesca Maria Zucchi

This thesis examines the effects of financing frictions on corporate decisions using dynamic models. Accounting for financing frictions helps reconcile a number of regularities that are hard to explain within the Modigliani-Miller framework. For instance, financing frictions provide incentives for firms to keep liquidity on their balance sheets as a precautionary hedge---a pattern that has been heavily debated in light of the secular increase of cash-to-asset ratios of U.S. firms. The first chapter develops a model that investigates the relation between corporate policies and secondary stock market liquidity. I show that secondary market illiquidity limits a firm's ability to hold precautionary liquidity, exacerbates financial constraints, reduces investment, and decreases firm value. The model reproduces the positive relation between market liquidity and corporate cash holdings observed in the data. This relation might be surprising since firms with illiquid stocks, which have been documented to be more financially constrained than more liquid peers, should be willing to keep more precautionary cash. I also show that the illiquidity-driven drop in firm value can feed back into the secondary market by deterring the participation of liquidity providers, thereby making the market more illiquid. The self-reinforcing nature of this relation gives rise to an internal-external liquidity loop, which singles out a propagation mechanism between financial markets and the corporate sector. From a banking perspective, liquidity hoarding has been a hotly debated topic among academics and policy-makers in the aftermath of the 2007-2009 financial crisis. The second chapter, which is a joint work with Prof. Erwan Morellec and Marco Della Seta, develops a dynamic model of the effects of liability structure and liquid reserves on banks' insolvency risk. When a bank relies on short-term debt financing, negative operating shocks get amplified as the bank weaker fundamentals also translate into losses when rolling over short-term debt. This amplification mechanism leads to an increase in default risk that gets more pronounced as debt maturity decreases and rollover losses increase. Because of this amplification mechanism, banks with identical debt ratios and liquid reserves but different debt structures have different default risk. Heavy exposure to rollover risk can also lead banks to implement gambling strategies when close to default. The third chapter, which is a joint work with Prof. Semyon Malamud, analyzes firms' optimal policies in a general equilibrium setting. It characterizes optimal liquidity management, innovation, and production decisions for a continuum of firms facing financing frictions and the threat of creative destruction. We show that liquidity constraints lead firms to cut production and increase markups, which are then countercyclical with respect to firm-specific shocks. We also illustrate that liquidity constraints may spur firms' investment in innovation and give rise to a non-monotonic cash-investment relation. We embed our single-firm dynamics in a Schumpeterian model of endogenous growth and demonstrate that financing frictions have a non-monotonic effect on economic growth and may increase aggregate consumption. When the corporate sector is constrained, liquidity injections by the government have real effects and can stimulate growth.

EPFL2015

Essays in Dynamic Corporate Finance

Francesca Maria Zucchi

EPFL2015

EPFL2012