This paper empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Leland and Toft (1996), Longsta# and Schwartz (1995), and Collin-Dufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 1986-1997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations we find that the predicted spreads in our implementation of the Merton model are too low. However, most of the other structural models predict spreads that are too high on average. Nevertheless, accuracy is a problem, as the newer models tend to severely overstate the credit risk of firms with high leverage or volatility and yet su#er from a spread underprediction problem with safer bonds. The Leland and Toft model is an exception in that it overpredicts spreads on most bonds, particularly those with high coupons. More accurate structural models must avoid features that increase the credit risk on the riskier bonds while scarcely a#ecting the spreads of the safest bonds.

We explore behavioral explanations for sub-optimal corporate investment decisions. Focusing on the sensitivity of investment to cash flow, we argue that personal characteristics of chief executive officers, in particular overconfidence, can account for this widespread and persistent investment distortion. Overconfident CEOs overestimate the quality of their investment projects and view external finance as unduly costly. As a result, they invest more when they have internal funds at their disposal. We test the overconfidence hypothesis, using data on personal portfolio and corporate investment decisions of CEOs in Forbes 500 companies. We classify CEOs as overconfident if they repeatedly fail to exercise options that are highly in the money, or if they habitually acquire stock of their own company. The main result is that investment is significantly more responsive to cash flow if the CEO displays overconfidence. In addition, we identify personal characteristics other than overconfidence (education, employment background, cohort, military service, and status in the company) that strongly affect the correlation between investment and cash flow. We are indebted to Brian Hall and David Yermack for providing us with the data. We are very grateful to Jeremy Stein for his invaluable support and comments. We also would like to thank Philippe Aghion, George

Financing decisions seem to violate the central predictions of the pecking order model about how often and under what circumstances firms issue equity. Specifically, most firms issue or retire equity each year, the issues are on average large, and they are not typically done by firms under duress. We estimate that during 1973-2002 the year-by-year equity decisions of more than half of our sample firms violate the pecking order.

This paper examines to what extent credit ratings directly affect capital structure decisions. The paper outlines discrete costs/benefits associated with firm credit rating level differences, and tests whether concerns for these costs/benefits directly affect debt and equity financing decisions. The tests find that firms near a rating upgrade or downgrade issue less debt relative to equity than firms not near a rating change. This behavior is consistent with discrete costs/benefits of rating changes, but not explained by traditional capital structure theories. The results persist in the context of previous empirical tests of the pecking order and tradeoff capital This paper examines to what extent credit ratings directly affect capital structure decision making by financial managers. The paper outlines the reasons why credit ratings may be relevant for managers in the capital structure decision process, and then empirically tests the extent to which credit rating concerns directly impact managers ’ debt and equity decisions. The paper also

We analyze how directors with financial expertise affect corporate decisions. Using a novel panel data set, we find that financial experts exert significant influence, though not necessarily in the interest of shareholders. When commercial bankers join boards, external funding increases and investment-cash flow sensitivity decreases. However, the increased financing flows to firms with good credit but poor investment opportunities. Similarly, investment bankers on boards are associated with larger bond issues but worse acquisitions. We find little evidence that financial experts affect compensation policy. The results suggest that mandating financial expertise on boards may not benefit shareholders if conflicting interests (e.g., bank profits) are neglected.

... financial policies. These "under-leveraged" firms carry substantially less debt than predicted by dominant theories of capital structure (Graham (2000) and Myers (1984)). This paper examines the phenomenon of financial conservatism by studying firms that adopt a persistent policy of low leverage. Our major findings are as follows. 1) Conservative firms follow a pecking order style financial policy. A high flow of funds and substantial cash balances allow them to fund the bulk of discretionary expenditures internally. 2) Financial conservatism is largely transitory. Seventy percent of low leverage firms drop their conservative financial policy; almost 50% do so within five years. 3) Conservative firms stockpile financial slack or debt capacity. Their "stockpiles" are utilized later to finance discretionary expenditures, particularly acquisitions and capital expenditures.. 4) Financial conservatism is not an industry-based phenomenon. Conservative firms do, however, have relatively high market-to-book and operate relatively frequently in industries thought to be sensitive to financial distress. 5) Conservative firms do not have low tax rates, high non-debt tax shields or face severe information asymmetries.

We argue that individual characteristics of managers can explain capital structure decisions like debt conservatism and pecking-order financing choices. Moreover, they can explain cross-sectional variation in these decisions despite identical firm characteristics. We link the reluctance of (some) managers to access external capital markets, and in particular equity markets, to managerial overconfidence. Overconfident managers believe that their company is undervalued. They view external financing, and especially equity financing, as overpriced. We test the overconfidence hypothesis, using several measures of managerial overconfidence. We classify CEOs as overconfident if they persistently fail to reduce their personal exposure to company-specific risk. We also classify CEOs based on their characterization in the business press. We find that overconfident CEOs are significantly less likely than other CEOs to issue equity, conditional on tapping public securities markets. Likewise, they issue roughly 30 cents more debt to cover an additional dollar of external financing deficit than their peers. Finally, overconfident CEOs access all external capital markets (including debt markets) more conservatively.

This paper argues that the standard pecking order hypothesis is only a special case of the adverse selection argument about external financing. It only applies when there is no asymmetric information about risk so that there is no adverse selection cost of debt. As soon as outside investors are imperfectly informed about risk, debt, a concave claim, will be mispriced. Using a large unbalanced panel of publicly traded US firms, we present robust and economically significant evidence i) that there is a general adverse selection in which firms issue consistently more equity and less debt if risk matters more and ii) that the special case of the pecking order, i.e. no adverse selection cost of debt, works well when risk does not matter, irrespective of firms ’ age, size, market-to-book ratio, tangibility or the time period. We thank Heitor Almeida, Dan Bergstresser, Kobi Boudoukh, Alexander Ljungqvist, Eli Ofek, Daniel Wolfenzon, Jeff Wurgler and seminar participants at NYU for helpful comments.- 0-The pecking order theory of capital structure, one of the most influential theories of corporate leverage, has recently fallen on hard times. On the one hand, the theory has considerable intuitive appeal. Firms seeking outside finance naturally face an adverse

The notion that firms have a debt ratio target which is a primary determinant of financing behavior is influential in finance. Yet, how definitive is the evidence? We address this issue by generating samples where financing is unrelated to a firm’s current debt ratio or a target. We find that much of the available evidence in favor of target behavior based on leverage ratio changes can be reproduced for these samples. Taken together, our findings suggest that a number of existing tests of target behavior have no power to reject alternatives.

Abstract: This paper analyzes the impact of U.S. monetary policy announcement surprises on U.S. and foreign firm-level equity prices. We find that U.S. monetary policy has important influences on foreign equity prices on average, but with considerable variation across firms. We have found that this differing response reflects a range of factors, including the extent of a foreign firm's exposure to U.S. demand, its dependence on external financing, the behavior of interest rates in its home country, and its sensitivity to portfolio adjustment by U.S. investors. The cross-firm variation in the response is correlated with the firm’s CAPM beta; but it cannot fully explain this variation. More generally, we see these results as shedding some additional light on the nature and extent of the monetary and financial linkages between the United States and the rest of the world. In particular, since we are able to explain differences across foreign firms ’ responses through established theories of monetary transmission, our results are consistent with the surprisingly large average foreign response to U.S. rates reflecting fundamentals, rather than an across-the-board behavioral over-reaction.