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Four essays on capital structure dynamics: special reference to level of leverage, state ownership, corporate governance and climate risk

My thesis consists of four essays that investigate the issues regarding speed of adjustment of capital structure (SOA). Since any deviation in the observed leverage from the optimal level will reduce a firm’s value, the questions pertaining to the existence of target capital structure and how fast firms adjust their leverage draw the attention of researchers and practitioners. To this end, two major approaches have been adopted to address the SOA issues. While some researchers discuss the best method to estimate the speed of leverage adjustment, others explore the determinants of SOA. In contrast to prior studies which focus on developed markets, we explore both a developed market (United States) and a developing market (Vietnam). Two of the four essays here focus on the U.S. market when examining the method of calculating SOA and the new determinant (drought) of SOA. The remaining two essays concentrate on Vietnam, an emerging market and a transitional economy. Nguyen, Locke, and Reddy (2015), after considering the relationship between corporate governance and firm performance in Vietnam, reveal that the legal system, the rule of law, and investor protection in developing countries are not as effective as in developed countries. As such, corporate governance in developing countries plays a more important role in mitigating the agency problem and severe information asymmetry. Hence, the impact of corporate governance on SOA in developing countries can be different from developed countries (Buvanendra, Sridharan, & Thiyagarajan, 2017). Additionally, the role of state ownership is essential in transitional countries where the economy moves from a centrally-planned system to a market-oriented one. Hence, it is important to understand the impact of state ownership on SOA in transitional economies. The first essay introduces a new approach to estimate SOA and investigates the relationship between the level of leverage and SOA of capital structure. Instead of applying a blanket total leverage measurement, we consider three leverage settings: total leverage, long-term leverage, and short-term leverage to review other sources of debt. The drawbacks of different approaches, such as a sub-sampling model, applying optimal leverage as a criterion to measure the degree of leverage, or penalized quantile regression, are disclosed. Moreover, we prove that our framework, of employing the quantile regression model and excluding zero-leverage firms, is the best way to investigate the influences of the level of leverage on SOA. For the total and long-term leverage setting, our findings support Leary and Roberts (2005) who contend that the high- and low-levered firms are likely to make leverage adjustments quicker than mid-levered firms. Moreover, we extend the literature to reveal the asymmetry dynamics derived from low-versus high-levered firms. That is, the low-levered firms have a higher SOA than highly levered firms. While the existence of optimal short-term debt and the ways in which firms adjust their short-term debt are sources of controversy among researchers, our findings show that SOA becomes smaller and changes from positive to negative to positive across quantile levels, indicating that the existence of optimal short-term leverage is for firms with low short-term debt. The second essay discusses the impact of state ownership on SOA by using a quantile regression approach in Vietnam – a transitional economy. This relationship has been only recently explored in China, and Vietnam, as an important transitional emerging market in Asia, warrants attention. Since privatisation is still ongoing, state-owned enterprises, which contribute 29% to the country’s GDP, play a crucial role in the Vietnamese economy. The linkage between state ownership and SOA in the literature has produced mixed results thus far and we obtain new evidence that the effect of state ownership on SOA is conditional on the level of leverage. Specifically, the effect is significant where there are extreme leverage values, both very high and very low, but it is not significant in the central area of leverage distribution. This effect is adverse for low-leveraged firms but positive for high-leveraged firms. Moreover, the magnitude of adverse effects on SOA is greater than those of favourable effects, implying an average negative effect of state ownership on SOA. The third study investigates the impact of corporate governance in Vietnam. First, we disclose the effect of fundamental corporate governance mechanisms, namely gender diversity, foreign ownership and managerial ownership on SOA, which are left unexplored by the literature. Second, we are the first attempt to demonstrate the linkage between corporate governance and SOA in Vietnam. While most studies on capital structure dynamics and corporate governance concentrate on the United States (Chang, Chou, & Huang, 2015, 2014), minimal attention has been paid to the relationship between corporate governance and SOA in a developing country. The corporate governance system in Vietnam is in its initial stage of development and remains underdeveloped. Applying the GMM (Generalized Method of Moment) two step framework, we find the significant impact on SOA of six corporate governance mechanisms: board size, board independence, CEO duality, gender diversity, managerial ownership and foreign ownership. Our evidence indicates that board size, board independence, gender diversity, and managerial ownership positively affect SOA while CEO duality and foreign ownership have adverse influences. These findings have important policy implications for firms and Vietnamese authorities. The fourth study demonstrates how firm respond, in terms of SOA of capital structure, to climate-change risk, namely, drought. Using a fractional dependent estimator (DPF) approach and 130,511 U.S. firm-year observations over the period 1970-2015, we document an adverse and significant influence of drought on capital structure and the speed of leverage adjustment. Our study makes four significant contributions to the extant literature in climate finance. First, while there is virtually no disagreement among researchers that climate change poses substantial costs to the economy (e.g., Burke, Hsiang, & Miguel, 2015; Dietz, Bowen, Dixon, & Gradwell, 2016; Lesk et al., 2016), the impact of climate change in the form of drought on individual firms has yet to be well researched. Second, while the extant literature documents the impact of drought, mostly in food and agriculture industries (Blackhurst, Hendrickson, & Sels, 2010; Hong et al., 2019; Lesk et al., 2016), we report evidence of the spill over effect of drought on nonfood industry firms. Third, our firm–level examination takes advantage of the heterogeneity in corporate policies and allows us to draw implications for managers as to how firms can palpably address climate risks in general and drought risk in particular. Last, we find that the role of cash flow and financial unconstrained factors are effective in mitigating the negative impact of drought on capital structure and the speed of leverage adjustment.
Type of thesis
Nguyen Huu, T. (2020). Four essays on capital structure dynamics: special reference to level of leverage, state ownership, corporate governance and climate risk (Thesis, Doctor of Philosophy (PhD)). The University of Waikato, Hamilton, New Zealand. Retrieved from https://hdl.handle.net/10289/13660
The University of Waikato
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