Capital structure and corporate investment choices under imperfections

Leng, Rong (2007) Capital structure and corporate investment choices under imperfections. Doctoral thesis, University of London: London Business School.

Abstract

This thesis analyzes how firms make capital strucure and corporate investment decisions when there are imperfections in firms' financing activities. This thesis consists of two studies. In Chapter 2, I develop a model nesting two existing theories for why non-fundamental stock price movements affect corporate investment. In the financing-constraint theory. a non-fundamental increase in stock price relaxes financing constraints, thereby increasing investment. In the market-driven theory, managers use the current stock price to compute the cost of capital. Therefore, a non-fundamental increase in stock price raises investment via discount factors. I test the model on a panel of US firms. I find support for the financing-constraint theory but none fror the inarket-driven theory. Controlling for the endogeneity of financing constraints to non-fnndarnental stock price movements is crucial: spurious support for the market-driven theory obtains, absent this control but disappears once I add it. Finally, I expect shareholders with long (short) horizons to favor investment as in the financing-constraint (market-driven) theory. Consistent with this. I find partial support for the market-driven theory for firms in which shareholders have short horizons. In Chapter 3, a central tradeoff in the efficiency of a bankruptcy code is considered. This tradeoff concerns the possibility of too many continuations, if the code is equityholder-friendly versus too many liquidations if the code is creditor-friendly. We provide evidence that firm-level leverage is affected by this tradeoff, as measured by the anticipated deadweight cast from liquidating the firm under the applicable bankruptcy code. In particular. we relate variation in firm leverage to time-series and cross-country variation in bankruptcy codes. Both the time-series and the cross-sectional evidence lend support to the hypothesis that firms use capital Structure as am earns to unwind the inefficiency of bankruptcy codes.