Upload
dinhque
View
218
Download
0
Embed Size (px)
Citation preview
Financial Flexibility, Firm Size and Capital
Structure∗
by
Soku ByounHankamer School of Business
Baylor UniversityOne Bear Place 98004
Waco, TX 76798Tel: (254) 710–7849Fax: (710) 710-1092
Email: Soku [email protected]
October 2007(Preliminary results. Do not quote without author’s permission.
Comments are welcome.)
∗We would like to thank the GAMF. We appreciate the support for this project that was provided bythe Hankamer School of Business at Baylor University.
Financial Flexibility, Firm Size and Capital Structure
Abstract
We examine financial flexibility as an alternative explanation to existing capital structure
theories. The financial flexibility hypothesis suggest non-linear inverted V-shape relation-
ship between leverage ratio and firm size. Consistent with this prediction, we find that
small firms have lower leverage ratios, not because of internally generated funds (as implied
by the pecking order theory) but because of additional equity financing (consistent with our
financial flexibility hypothesis). On the other hand large firms have low leverage because
they rely on internally generated fund. This finding can not be explained by either the
pecking order theory or the tradeoff theory; the pecking order may be reversed for small
firms that prefer external equity to debt financing, while the tradeoff theory may miss some
important aspects of capital structure decisions. The financial flexibility hypothesis suggest
that small firms maintain low leverage by issuing equity and building up cash holdings for
financial flexibility. Debt covenants often carry restrictions on financing and investment
decisions that are especially cumbersome for small, growing firms. Equity financing allows
small firms to raise cash without impeding financial flexibility. We find supporting evidence.
We also find that the positive relationship between firm size and leverage ratio found in
previous studies holds only for small firms, but there is a clear negative relationship for
large firms, supporting the financial flexibility hypothesis.
JEL Classification: G32
Keywords: Financial Flexibility; Trade-off theory; Pecking-order theory
2
I. Introduction
Empirical studies on capital structure find a positive relationship between firm size and
leverage.1 Suggested explanations in the literature include: large firms tend to have more
leverage perhaps because they are more transparent; have lower asset volatility; are more
diversified; naturally sell large enough debt issues so that the fixed costs of public borrowing
are not prohibitive; have lower probability of default and lower financial distress costs. On
the other hand, small firms incur higher costs of issuing debt because they are more likely
to be growing firms with volatile cash flows and hence have less access to debt capital
than do large firms. Further, the costs of financial distress are likely to be particularly
severe for small firms because much of their value comes from growth options whose value
depreciates rapidly if the firm experiences financial distress. In addition, small firms have
a large fraction of their assets that are firm specific or intangible, limiting their value as
collateral.
We suggest the desire for “financial flexibility” as an alternative explanation for small
firms’ low leverage. By taking firms’ financial choices to be the outcome of the interplay
between today’s capital demand and future supply of capital, we are able to explain some
of the unexplained empirical regularities: e.g., why the pecking order theory of financing
appears to break down for small risky firms (Frank and Goyal, 2003), why firms issue too
much equity (Frank and Goyal, 2003) at the wrong times (Fama and French 2004, and
Leary and Roberts, 2005), and why there is a negative relationship between firm size and
leverage ratio (Faulkender and Petersen (2006)).
Given that small firms grow faster than large firms (Evans (1987)), there are two al-
ternative explanations for small firms to have lower leverage; by financing their growth
exclusively through retained earnings or through external equity. Most explanations for
the positive relationship between firm size and leverage assume implicitly or explicitly that
1 For example, see Titman and Wessels (1988), Rajan and Zingales (1995), Graham,Lemmon, and Schallheim (1998), Hovakimain, Opler, and Titman, (2001), Booth et al.(2001) and Fama and French (2002). However, Faulkender and Petersen (2006) find a weakor negative relationship between the leverage and firm size.
1
external equity is prohibitively expensive for small firms and hence small firms’ financing
should come exclusively from internal funds.2 There is also evidence that firms prefer in-
ternal financing to external financing.3 According to the pecking order theory (Myers and
Majluf (1984)), adverse selection costs of external equity are much greater than those of
debt. Issuance costs are also much greater for equity than for debt.4 Facing such high
adverse selection/transaction costs, small firms should avoid issuing equity by all means.
Hence, the literature has paid little attention to the potential role of external equity in
relaxing financial constraints of small firms in debt financing.
We argue that small firms with lack of financial flexibility maintain low leverage by rely-
ing on external equity financing. Financial flexibility is desired in order to handle financial
uncertainties in the future. Here the future orientation is critical; financial flexibility concern
arises from a formal decision problem in which the financial choices in the future are af-
fected by the financial choices made today. In other words, financial flexibility is a property
of today’s financial decisions that affect the options management will have in response to
unforeseeable future changes. Thus, our study is distinguished from most previous studies
which focus on how current or past shocks affect firms’ financial decisions.
Even though financial flexibility is very important for a firm to respond optimally to
future changes, it would be fundamentally inappropriate to maximize financial flexibil-
ity. Therefore, we define financial flexibility as the extent to which a firm can mobilize its
financial resources to take preventive and exploitive actions in response to subsequent in-
formation in order to maximize the firm value. According to this view, the optimal capital
structure from the static point of view may not be “optimal” once financial flexibility, i.e.,
the interplay between today’s financial decisions and future financial decisions, is taken into
2 See, for example, Frank and Goyal (2003), Leary and Roberts (2005), Strebulaev (2006),and Kurshev and Strebulaev (2006) for such arguments.
3 See Hovakimian, Opler, and Titman (2001) and Hovakimian, Hovakimian, and Tehra-nian (2004).
4 Altinkilic and Hansen (2000) find that equity issuing costs are on average 5.38% of theissue proceeds while debt issuing costs are on average 1.09%. Leary and Roberts (2005)also report significantly larger equity issuance costs.
2
account.
In order to examine the importance of “financial flexibility hypothesis” in financial
decisions, we focus on firms’ decisions on cash holdings and debt/equity financing which
are the main sources of financial flexibility (DeAngelo and DeAngelo (2006)). Firms lacking
in financial flexibility would increase cash holdings while reducing leverage ratios. Even
though we consider the dividend policy in relation to financial flexibility, we do not take it
as a source of financial flexibility but rather as the decision following from having ample
flexibility. Thus, the dividend policy is taken as an identifier of a firm’s flexibility. We also
consider firm size, retained earnings and long-term credit ratings as interrelated measures of
the firm’s financial flexibility. Small growing firms typically have high demand for financial
flexibility and have accumulated less profits than large firms, causing them to concern for
financial flexibility. For example, small firms with accumulated losses (measured by retained
earnings) are likely to have little financial flexibility and debt capacity but ample need for
additional cash. Our main hypothesis is that small firms with negative retained earnings
are more likely to issue equity to build up cash holdings and preserve debt capacity for
financial flexibility and hence will have low leverage. A corollary to this hypothesis is that
cash holdings will be negatively associated with leverage. We find supporting evidence for
these predictions.
On the other hand, large mature firms with ample retained earnings are almost self-
financing and have low leverage. Thus, their large cash flows are subject to opportu-
nity/agency costs of free cash flow (Jensen and Meckling (1976)). Increasing debt financing
may address the free cash flow problem but it may reduce financial flexibility to cope with
future uncertainties. Thus, they prefer paying dividends in order to preserve debt capacity
while reducing free cash flow. This implies that large firms with ample retained earnings
also have lower leverage.
The important implication of the financial flexibility hypothesis is that there is a negative
relationship between firm size and leverage ratio, conditional on negative retained earnings,
whereas there a positive relationship between firm size and leverage ratio, conditional on
positive retained earnings.
3
We find that low leverage for small firms results from external equity financing rather
than internal funds. While small firms avoid debt financing, they are much more active
in tapping into external equity capital. Firms with negative retained earnings have lower
leverage ratios and issue several times more equity than firms with positive retained earn-
ings. We also find that small firms with negative retained earnings have more cash holdings
than other firms. Thus, our findings are consistent with the argument that small firms
build financial flexibility by increasing cash holdings and equity financing to cope with
their earnings shortfalls.
We further show that firm size has an overall strong and significant positive association
with leverage ratios. However, the positive relationship between firm size and leverage
ratios is reversed for large firms when we re-estimate regressions for firms divided by size,
consistent with our financial flexibility hypothesis. We also find that negative retained
earnings are negatively associated with leverage ratio, suggesting that firms with negative
retained earnings are issuing more equity. On the other hand, positive retained positive
retained earnings are significantly and negatively associated with leverage ratios. Thus, our
results show that firms with large negative retained earnings build up cash holdings through
equity financing in order to preserve financial flexibility, whereas firms with more positive
retained earnings maintain lower leverage ratios by relying on internally generated equity
financing and financial flexibility. Overall, the results show strong support for the financial
flexibility hypothesis.
Our study brings new evidence to bear on an important issue in the capital structure
literature. The literature has wrestled with the problem of sorting out the effects of adverse
selection costs of asymmetric information on capital structure.5 On the one hand, the
literature finds that larger firms appear to provide a better fit for the pecking order theory
(Shyam-Sunder and Myers (1999) and Frank and Goyal (2003)) despite the fact that large
5 For example, see Myers and Majluf (1984), Viswanath (1993), Chang and Dasgupta(2003), and Lemmon and Zender (2004) under the pecking order framework, and Frankand Goyal (2003), Fama and French (2002), Barclay and Smith (2005), Leary and Roberts(2005), Leary and Roberts (2005a), Strebulaev (2006) and Byoun (2007) under the tradeoffframework.
4
firms are less subject to information asymmetry than small firms. Our finding suggests that
large firms prefer using internal funds to preserve financial flexibility. On the other hand,
our results show that small firms issue equity and increase cash holdings despite having
low leverage in order to cope with the lack of financial flexibility. Lemmon and Zender
(2004) argue that equity issuers are prevented from issuing debt because of concerns over
financial distress or financial slack for future investment. This justification is essentially in
the same vein as our financial flexibility argument which does not require the presence of
asymmetric information. Further, Fama and French (2002) and Leary and Roberts (2005a)
show that firms are more likely to use external equity as investment increases and/or cash
flow decreases but the majority of equity financings occur when firms still have sufficient
debt capacity to fill their investment needs. Their findings are also consistent with the
financial flexibility argument.
As an explanation for violating the financing hierarchy specified by the pecking order
theory, Fama and French (2005) and Leary and Roberts (2005a) suggest that firms are
able to issue securities in a manner that avoids the adverse selection costs associated with
information asymmetry. Alternatively, managers may time the market when information
asymmetry and the corresponding costs are low so that deviations from the hierarchy do
not incur a significant penalty.6 Our findings suggest that the external financing hierarchy
suggested by the pecking order theory is reversed for small firms due to the concern for
financial flexibility. Consistent with our evidence, the findings in Byoun (2007a) suggest
that small firms become debt-free by having raised much external equity while having
reduced debt and paid large dividends.
In conclusion, asymmetric information falls short of providing a plausible explanation for
motivation behind firms’ external financing decisions. A more comprehensive explanation
should include the benefits and costs of financial flexibility, which may require a substantial
6 Rajan and Zingales (1995), Jung, Kim, and Stulz (1996), Pagano, Panetta, and Zingales(1998), Hovakimian, Opler, and Titman (2001), Baker and Wurgler (2002), and Learyand Roberts (2005a)) examine managers’ market-timing attempts. The survey results inGraham and Harvey (2001) suggest that managers issue equity following an increase instock price.
5
alteration to the traditional tradeoff argument. The rest of the paper proceeds as follows:
Section II provides a literature review and discusses the concept of financial flexibility.
Section III develops financial flexibility hypotheses. Section IV describes the data. Section
V provides the estimation results and Section V concluding remarks.
II. A Literature Review and the Concept of Financial Flexibility
Despite managers’ contention that financial flexibility is an important factor in their
decision-making process,7 the capital structure literature has to date remained aloof to
recognize financial flexibility as a potentially important factor in explaining firms’ capital
structure decisions. Frank and Goyal (2005) reason, “the stress on financial flexibility is
interesting, but potentially open to a variety of interpretations. In our view the survey
evidence is of interest, but it is best regarded as being interesting and suggestive, rather
than providing definitive tests.” In addition to considerable ambiguity in the use of the
term, judgments about financial flexibility are subjective and informal and flexibility levels
are rarely monitored or even measured. Accordingly, dealing with financial flexibility may
be criticized as being less than practical and based on speculation on the ability of a firm to
respond to hypothetical future events. It is therefore not surprising that there is relatively
little systematic study of financial flexibility in the capital structure literature.8
Financial flexibility is distinguished from “financial slack.” Firms facing an adverse
selection problem desire financial slack in order to avoid the need for external funds in the
future, whereas financial flexibility is desired in order to handle uncertainties and variations
in both internal and external environments. Thus, finding that managers value financial
flexibility is not sufficient to prove that the pecking-order model is the true description of
7 The survey results of Graham and Harvey (2001), Bancel and Mittoo (2004), andBrounen et al. (2004) show that corporate managers explicitly express that they are mostlyconcerned about “financial flexibility” in their capital structure decisions.
8 In contrast, a branch of real options literature has been developed to deal with “in-vestment flexibility.” Gamba and Triantis (2005) note that most real options models aredesigned to measure the value of “investment flexibility” under the assumption of perfect“financial flexibility.”
6
capital structure choice (Opler et al., 1999). Graham and Harvey (2001) make this point
explicit:
The most important item affecting corporate debt decisions is management’s
desire for “financial flexibility,”... However, the importance of flexibility in the
survey responses is not related to informational asymmetry (size or dividend
payout) or growth options in the manner suggested by the pecking-order theory.
In fact, flexibility is statistically more important for dividend-paying firms, op-
posite the theoretical prediction (if dividend-paying firms have relatively little
informational asymmetry). Therefore, a deeper investigation indicates that the
desire for financial flexibility is not driven by the factors behind the pecking-
order theory.
Graham Harvey (2001) see financial flexibility as “preserving debt capacity to make future
expansions and acquisitions” or “minimizing interest obligations, so that they do not need to
shrink their business in case of an economic down turn.” Gamba and Triantis (2005), in their
attempt to model the value of financial flexibility, define, financial flexibility as “the ability
of a firm to access and restructure its financing with low transaction costs.” They further
elaborate by adding that “financially flexible firms are able to avoid financial distress in the
face of negative shocks, and to fund investment at low cost when profitable opportunities
arise.” Donaldson (1969, 1971) uses “financial mobility” to describe “the capacity to redirect
the use of financial resources in a manner consistent with the evolving goals of management
as it responds to new information about the company and its environment.” Donaldson
particularly relates financial mobility to capital structure decisions where the goal is to find
the optimal mix of financing sources.
Heath (1978) describes a financially flexible firm as one that can take corrective action
that will eliminate an excess of required cash payments over expected cash receipts quickly
and with minor adverse effect on its present and future earnings or on the market value of
its stock. The American Institute of Certified Public Accountants (AICPA, 1993) adopts
Heath’s view by defining financial flexibility as “the ability to take action that will eliminate
an excess of required and expected cash payments over expected resources.” The Financial
7
Accounting Standards Board’s (FASB) defines financial flexibility as “the ability of an entity
to take effective actions to alter amounts and timing of cash flows so it can respond to
unexpected needs and opportunities.” Most treatments of financial flexibility in the finance
literature are more or less about the ability of a firm to meet its unexpected future needs
through large cash holdings, large unused borrowing capabilities, or large liquid assets.
There are other views from different functional areas of business (See Koornhof (1998)
for a review). For example, the importance of flexibility in a firm is well recognized in
management and organization literature. Bueno-Campos (1992), Ahmed et al. (1996),
Albizu-Gallastegui (1997), Hitt et al. (1998) and Volberda (1998) define “flexibility” as
the ability to deliver cost-efficient responses quickly to changes in the business environment
and to adapt and anticipate changes that affect the goals of firms. Bernstein (1993) defines
flexibility as the ability of an enterprise to take steps to counter unexpected interruptions
in the flow of funds for reasons however unexpected. Koornhof (1998) defines flexibility as
an ability to take actions in order to reposition the resources and functions of the organiza-
tion to new information and environment in a manner consistent with the evolving vision,
strategies and goals of management. In this view, financial flexibility means the ability to
borrow from a variety of sources, to raise equity capital, to sell and redeploy assets, and to
adjust the level and the direction of operations in order to meet changing circumstances.
The various definitions of flexibility as addressed in the literatures recognizes the “re-
active” or “preventive” nature of flexibility, while failing to include the “exploitive” nature
of flexibility for uncertain competitiveness or opportunities. The combination of preventive
and exploitive nature of flexibility is more evident in Volberda (1998) who views flexibility
in two different perspectives: internal flexibility as the firm’s capacity to adapt to the de-
mands of the environment, while external flexibility as the firm’s capacity to influence their
environment and thereby reduce their vulnerability.
Actions initiated ahead of time are typically taken not only in anticipation of certain
events but also in an attempt to change the rules of the game. When expectations are not
met, or when events occur that have not been predicted, a firm may require flexibility after
the fact. In these cases, flexibility is needed to deal with uncertain obstacles or to capitalize
8
on an unexpected opportunity. Actions taken ahead of time, even in the absence of a specific
need, can create options that can be used at a later stage. When a new product unexpectedly
becomes an industry standard (e.g., Apple’s iPod), resulting in a rapid expansion of the
market demand, exploitive maneuvers are important to focus financial resources in order to
rapidly capitalize on the new opportunity.
The most basic form of financial flexibility may be described in terms of the amount or
the number of financial resources available in the future. However, many of the actions taken
today for future financial flexibility can be very costly. Thus, it would be fundamentally
inappropriate for a firm to maximize financial flexibility. A more intuitive measure of
financial flexibility may be described as a firm’s financial ability to respond optimally to
future changes at lower costs. In many situations, however, we may not meaningfully
separate the cost related to such a decision. Eventually, maximizing the firm value should
be the ultimate goal of optimizing financial flexibility. Accordingly, we define financial
flexibility as the extent to which a firm can mobilize its financial resources to take preventive
and exploitive actions in response to subsequent information in order to maximize the firm
value.
It is apparent that certain aspects of financial flexibility have been noted and addressed
in the capital structure literature. For example, Donaldson (1969) observes that managers
do not follow the optimizing principle proposed by the tradeoff theory of optimal capital
structure. Instead he finds that managers concentrate on the amount of debt not in use.
Goldstein, Ju, and Leland (2001) note that a firm with low leverage today preserves the
subsequent option to increase leverage. Byoun (2007) finds evidence that firms preserve bor-
rowing capacity to finance future investment or growth opportunities. Graham (2000) shows
that firms preserve debt capacity to make future expansions and acquisitions. DeAngelo,
DeAngelo and Stulz (2007) document evidence that firms issue stock to cope with “liquidity
squeeze,” a near-term need for cash. McLean (2007) shows that firms keep equity issuance
proceeds as cash as ”precautionary motives.” Motyka, Leuca, and Fawson (2005) also find
that financial institutions hold excess liquidity to cope with the unpredictable nature of loss
(infrequent but high impact risk) in order to achieve a competitive advantage for aggressive
9
pricing and better margins. Kale and Shahrur (2007) show that firms have lower leverage
in consideration of relationship-specific investments by the firm’s stakeholders. Parsons and
Titman (2007) provides a review on how a firm’s financial condition influences strategic
decisions by both the firm and its stakeholders. DeAngelo and DeAngelo (2006) argues
that firms maintain low leverage and high dividend payouts in “normal” periods to preserve
the firm’s option to borrow or issue equity in the future opportunities.
III. Firms’ Financial Flexibility: Hypothesis Development
The need for financial flexibility arises to deal with anticipated yet unforeseeable
future financial constraints. Developing testable hypotheses in relation to financial flexibility
is complicated since we need to consider not only the interactions of firms’ financial choices
but also the interplay of current decisions with future ones.
DeAngelo and DeAngelo (2006) argue that firms can develop potential sources of finan-
cial flexibility through cash accumulation, the preservation of debt capacity, and dividend
payouts. We expect that firms with a greater need for financial flexibility hold more cash,
less debt (issue more equity) and pay less dividend. Large cash holdings increase finan-
cial flexibility for the future but incur higher costs. In addition to the opportunity costs
foregone, they are exposed to a risk of inefficient uses when the firm does not have enough
investment opportunities. Financially flexible firms can pay out its free cash flow as div-
idend or repurchase securities to minimize its opportunity/agency costs. Debt financing
provides the benefits of tax savings and reduced agency costs of free cash flow but reduces
future financial flexibility. External equity financing incurs higher issuing costs but provides
greater flexibility than debt financing. Thus, growing firms with lack of financial flexibility
prefer equity financing.
Given these financial choices available for the firm to address financial flexibility con-
cerns, we develop hypotheses that predict their impacts on capital structure decisions. The
interactions among these financial choices and with investment decision are interesting but
we limit our focus to capital structure decisions in order to have a manageable scope of
the study. Thus, our objective is to examine how the various degree of financial flexibility
10
affects capital structure decisions by identifying firms that are likely or not likely to face
future financing constraints. In practice, however, the dividend and investment policies
may also be altered in the long run to mitigate financial constraint. For example, a firm
may invest in safe and liquid investments rather than in risk ones (Almeida et. al. (2006))
or alter the dividend policy, when facing financial constraints and running out of other
financial resources. However, firms are less likely to alter their investment and dividend
policies when they have other sources of financial flexibility such as cash holdings and debt
capacity. Accordingly, for the purpose of investigating the effect of financial flexibility on
the capital structure decision, we assume that firms make financing decisions in order to
accommodate future investment opportunities. Similarly, we consider a firm’s dividend pol-
icy not as in itself the immediate source of financial flexibility but as a policy to reflect the
firm’s financial flexibility condition.
In order to understand how a financial flexibility concern affects a firm’s financial deci-
sions, suppose a firm with a constant optimal debt ratio (debt/assets) of 0.5 currently has
$200 financial surplus with uncertain financing needs in the next few years. In order to pre-
serve financial flexibility for the unforeseeable future financing needs, the firm should make
financial decisions today. Considering costs and benefits, suppose the firm set the “optimal”
financing plan of raising $300 by next period (shown as negative numbers at t = 1) as follows:
Surplus = $200Debt = $400Assets = $1000
t = 0 1
-$300
The firm’s current debt ratio is 0.4. The static target adjustment model predicts that the
firm will use the current financial surplus to repurchase equity and then issue $150 debt and
$150 equity in the next period in order to maintain the optimal debt ratio of 0.5. However,
if the transaction costs of repurchasing and reissuing equity are greater than those of debt,
the firm will reduce debt rather than equity with the surplus cash and preserve the debt
capacity (as financial flexibility) for the future financing need despite the below-target debt
ratio. Or the firm may hold all or some of the surplus in order to use it in the next period, as
11
long as the opportunity/agency costs of cash holdings are lower than the costs of reducing
and reissuing debt or equity.
Only firms with no financing needs in the foreseeable future may repurchase equity to
adjust toward the target debt ratio. In the above example, assuming it is cost efficient
for the firm to keep its surplus cash for the financing plan, it still requires $100 additional
equity in order to obtain the optimal debt ratio with the plan. Knowing that they will
need to issue additional equity, managers may attempt to issue equity today if they believe
today’s market condition is better than what is expected in the future. If the firm issues
equity in the above example, then the equity issuance proceeds will be kept as cash (see Kim
and Weisbach (2007) for evidence of firms’ such behavior). This will make the firm look
inconsiderate about its capital structure as well as cash holdings since it is still issuing equity
with a below-target debt ratio and ample cash balance. Indeed, Leary and Roberts (2004)
find that most equity issuances occur when firms have sufficient debt capacity, “without
any apparent risk of entering financial distress from issuing debt.” They conclude that the
decision rule that firms use to access external capital markets is unclear. Welch (2004) also
observe that firms do not use their issuing activities to counteract the external and large
influences of stock returns on their capital structures. These “puzzles” may be explained
not through the firm’s reaction to the current financial information but through its financial
flexibility concern to cope with future financial constraints and uncertainties.
We consider firm size, dividend payout, retained earnings and long-term credit ratings
as measures of firms’ various degree of financial flexibility. We put these financial flexibility
measures together to make consistent predictions in the framework of financial flexibility.
Small firms are more likely to be growing firms with more future investment opportunities,
less credit history and less internal funds available. Thus, small firms are expected to be in
need for more financial flexibility than large firms.
Retained earnings are the accumulation of a firm’s reinvested profits over time. DeAn-
gelo, DeAngelo, and Stulz (2005, 2007) argue that retained earnings measure a firm’s life-
cycle stage; firms with low retained earnings relative to total assets (or total equity) tend
to be in the capital infusion stage, whereas firms with greater retained earnings tend to be
12
more mature with ample cumulative profits that make them largely self-financing. Large
cash holdings for a mature firm are exposed to a risk of inefficient uses when the firm does
not have enough investment opportunities. Issuing debt reduces the agency costs, but it
reduces financial flexibility as well. On the other hand, dividend payouts reduce the agency
costs of free cash flow (Easterbrook (1984)) without reducing financial flexibility. Thus,
large firms with greater retained earnings tend to be more mature with ample cumulative
profits and are likely to pay dividends (DeAngelo, DeAngelo, and Stulz (2005)) and pre-
serve financial flexibility through low leverage while limiting agency costs on cash balances
(DeAngelo and DeAngelo (2006)). With positive earnings, small growth firms still lacking
in their financial resources are likely to invest them in their growth options or hold them as
cash for future financing needs since they are less subject to the agency costs of free cash
flow. Overall, we propose that large mature firms with positive retained earnings maintain
lower leverage, lower cash holdings and high dividend payouts than small firms with positive
retained earnings (proposition 1).
Negative retained earnings reflect firms’ earnings shortfalls over time. To the extent that
a firm’s retained earnings are the proxy for its life-cycle stage, we expect small firms with
negative retained earnings are in the greatest need of financial flexibility. For small growing
firms with little financial flexibility, facing shortfalls in cash flow over time, even a little debt
may cause them to be in financial distress. The limitation on debt issuance that results
from the risk of asset substitution (Jensen and Meckling (1976)) are more important for
such firms. Firms with accumulated losses without financial flexibility lack investible funds
for their profitable investments and hence sources of free cash flow tend to be relatively low
for them, and thus reducing the benefit of debt that limits the scope of overinvestment and
perquisites by managers (Jensen (1986), Stulz (1990) and DeAngelo and DeAngelo (2006)).
Hence debt is less helpful both in providing capital and in reducing the costs of free cash
flow for these firms. Further, debt financing renders firms with little financial flexibility
vulnerable to predatory strategies such as price wars by established firms to exhaust less-
flexible firms financially (Poitevin (1989)), thus further deteriorating financial flexibility.
In addition, debt covenants often carry restrictions on financing and investment decisions
13
that are especially cumbersome for firms with lack of financial flexibility. In short, growing
firms with negative retained earnings are constrained in borrowing. At the same time,
they face little concern for agency costs of free cash flow. Thus, they can accumulate cash
holdings through equity financing in order to increase financial flexibility. Equity issues
neither require collateral or restrictive covenants, nor accentuate moral hazard problems
that are associated with leverage, nor raise the probability of financial distress. Thus,
equity financing provides greater financial flexibility than debt financing for less flexible
firms such as small firms with negative retained earnings. Accordingly, we suggest that
small growing firms with large negative retained earnings issue more equity, maintain lower
leverage, have higher cash holdings and pay no dividend(proposition 2).
Thus, propositions 1 and 2 imply lower leverage ratios for both small growth firms and
large mature firms, but for different reasons; while large mature firms have been able to
finance most their investments with the greatest financial flexibility through internal equity
funds, small growing firms have been relying on external equity to preserve financial flex-
ibility for the future. Between these flexibility-sufficient and flexibility-deprived firms are
medium firms with mediocre retained earning that are still in much need of external financ-
ing. Medium firms generating some positive earnings have better financial flexibility than
firms struggling with negative earnings and are able to use debt financing. Also, firms with
built-up financial flexibility will use up their financial resources such as debt capacity and
accumulated cash when they face “abnormal” periods characterized by earnings shortfalls
over time ((DeAngelo and DeAngelo (2006)). Only when these firms run out of cash and
debt capacity, they will turn to equity financing. Based on these arguments, we propose
the following “financial flexibility hypothesis.”
The Financial Flexibility Hypothesis Small growing firms and firms with
large negative retained earnings are in the most need of financial flexibil-
ity and they issue more equity, maintain lower leverage ratios, have higher
cash holdings and pay no dividend. Medium firms and firms with mediocre
retained earnings have some flexibility to issue debt and meet their capi-
tal needs. Large firms and firms with large retained earnings are the most
14
financially flexible as they maintain lower leverage ratios, lower cash hold-
ings and high dividend payouts.
We summarize specific predictions based on the implications of the financial flexibility hy-
potheses in Table I. The hypothesis states that firms with large positive retained earnings
are more likely to pay dividend (consistent with the findings in DeAngelo, DeAngelo, and
Stulz (2005)), while limiting debt financing. This implies a negative relationship between
leverage ratio and dividend payout, consistent with evidence documented in previous stud-
ies (Graham (2000), Frank and Goyal (2003), Minton and Wruck (2001) and Byoun (2007)).
However, non-dividend-paying firms are most likely firms with low or negative retained earn-
ings and we expect lower leverage for such firms. Thus, the relationship between leverage
ratio and dividend payout is not clear within non-paying firms.
The novelty of the financial flexibility hypothesis is its prediction of non-linear (inverted
V-shaped) relationships between firm size and leverage ratio as well as between retained
earnings and leverage ratio. The hypothesis implies that there is a positive relationship
between retained earnings and leverage ratio conditional on negative retained earnings, while
there is a negative relationship between retained earnings and leverage ratio conditional on
positive retained earnings. Also, the hypothesis states that small firms or firms with negative
retained earnings are more likely to issue equity, implying a positive relationship between
firm size and leverage ratio, conditional on negative retained earnings. However, conditional
on positive retained earnings, there is a negative relationships between firm size and leverage
ratio. This prediction is contrary to the general finding in the literature, but consistent with
the finding in Faulkender and Petersen (2006) who report a negative relationship between
firm size and leverage ratio when they consider a sample of firms only with credit ratings.
According to the financial flexibility hypothesis, large firms with positive retained earnings
are most likely to use only safe debt and hence have better long-term credit ratings. Thus,
the contradictory results regarding the relationship between firm size and leverage can be
explained by the financial flexibility hypothesis.
Faulkender and Petersen (2006) argue that market frictions may cause firms to be ra-
tioned by their lenders, leading some firms to appear under-levered relative to unconstrained
15
firms. They use firms’ long-term credit ratings as a measure of accessibility to the public
debt markets (see also Lemmon and Zender (2004) and Byoun (2007a). The market friction
argument may imply that firms with better credit ratings should use more leverage than
those with worse credit ratings. However, according to our hypotheses, large mature firms
with large retained earnings use only safe debt and as a result have better credit ratings. We
expect that good credit ratings are associated with large mature firms with lower leverage.
Thus, contrary to the implication of the market friction argument, we expect a negative re-
lationship between leverage and credit ratings, conditional on having credit ratings. On the
other hand, given that small firms with negative retained earnings are least likely to have
credit ratings, we expect a lower leverage for firms with no credit ratings than for those with
ratings and hence a positive relationship between leverage ratio and firms size, conditional
on no credit ratings. The financial flexibility hypothesis also implies a negative relationship
between leverage ratio and cash holdings as firms with lack of financial flexibility increase
cash reserves through equity issues.
Firms’ preference for financial flexibility generally depends on the uncertainty around
expected earnings and investment opportunities. Issuing risky debt implies the firm loses its
financial flexibility. Firms with greater needs for financial flexibility should issue safe debt
whose payments are covered by earnings next period. Firms with less expected earnings or
much uncertainty about the earnings will be better off issuing equity and/or maintaining
high cash balances since issuing equity in the event of a low-profit outcome in the future will
bear prohibitively high issuing costs for the firm. Thus, if the probability of low earnings is
high, the firm with lack of financial flexibility will abstain from issuing risky debt. Consis-
tent with this argument, firms appear issuing equity before declining earnings (McLaughlin,
Safieddine, and Vasudevan (1996), Loughran and Ritter (1997) and Hansen and Crutchley
(1990)). The demand for financial flexibility will also increase with expected investment
opportunities and their uncertainties since future capital needs are more likely to create
financial constraints. Only firms with high probability of great earnings and less expected
investment opportunities can safely borrow more against the anticipated profits. In that
case, large cash holdings incur high opportunity/agency costs without obtaining greater
16
financial flexibility. Accordingly, we expect that expected earnings (expected investment
opportunities) will be associated positively (negatively) with leverage and negatively (pos-
itively) with cash holdings, consistent with the documented findings in the literature. We
examine these predictions as well.
IV. Data
The initial sample consists of all available U.S. firms for the period of 1971–2005
from the annual Compustat files. Following previous studies, we exclude financial firms and
regulated utilities from the sample.9 We also require firms to have positive total assets,
book and market value of equity and net sales. These variables are used to deflate other
variables and it is difficult to interpret the results when they have non-positive values.
We also delete observations with missing or non-positive values for the number of shares
outstanding and stock price at the end of the fiscal year. Accordingly, we drop bout 8 %
of firm-year observations in the sample that does not meet these requirements. After these
initial requirements are applied, the sample consists of 179,418 firm-year observations.
While Shyam-Sunder and Myers (1999) and Myers (1984) argue that there are rational
reasons for managers to specify debt targets in terms of book values, Titman and Wessels
(1988) and Welch (2004) are inclined toward the use of debt level measured at market value.
Accordingly, we test our hypotheses using total and long-term debt ratios measured with
both book and market value of total assets. The definitions of all the variables used in this
study are provided in the Appendix.
9 Financial firms are represented by SIC codes 6000-6799 and utilities by SIC codes 4800-4999. These firms have very different capital structures and their financing decisions maynot convey the same information as non-financial and non-regulated firms. For example, arelatively high leverage ratio is normal for financial firms, but the same high leverage ratiofor non-financial firms may indicate possible financial distress.
17
V. Univariate Analyses
A. Firm Size, Credit Ratings and Leverage
In order to examine the relationship between firm size and leverage closely, we divide
the sample into size deciles each year and report the leverage ratios measured in long-term
and total debt to book/market value of assets.10 We delete all observations with leverage
ratios less than zero or greater than one.11 We define size in three different ways based on
book value of total assets, market value of total assets and net sales, but the results are
similar and we report only those based on the book value of total assets.
Panel A of Table II shows that regardless of the various definitions of leverage ratios,
there is a positive monotonic relationship between firm size and leverage ratio especially
for smaller size deciles. We also report the percentage of zero-debt firms in each size decile.
Small firms are associated with much more zero-debt firms than large firms. Byoun (2007a)
suggests that zero-debt firms are constrained by debt market while unconstrained by equity
market. This implies that zero-debt firms lack financial flexibility. In order to examine
whether the negative relationship between firm size and leverage ratio is driven by these
zero-debt firms, we report the results excluding zero-debt firms in Panel B of Table II.
Even though there still exists a fairly positive relationship between firm size and leverage
ratio without the zero-debt firms, the positive relationship between size and leverage ratio
became weaker for the largest three size deciles. Thus, our results confirm that there exists
strong positive relationship between firm size and leverage except for firms in the largest
three deciles in which the positive relationship is weakened or reversed.
10 The results does not change when we exclude deferred taxes and investment tax creditor include convertible debt (item 79) in the definition of book equity as in Alti (2006) andKayhan and Titman (2006).
11 Without this requirement, the average book leverage ratio of the sample firms in thefirst size decile are greater (but market leverage ratios are smaller) than firms in larger sizedeciles since there are a few firms with book leverage ratios greater than one in the firstsize decile. When we winsorize leverage ratios at 99 percentile, there still exist firms withleverage ratios greater than one.
18
Table II
In Table III, we divide the sample into prior- and post-1985 subperiods. Since S&P
credit rating information is available only from 1985, on the one hand, this allows us to
examine the distribution of rated firm across size deciles for this period. On the other
hand, it allows us to examine if there is any discernible change in the relationship between
firm size and leverage. For the period of 1971-1984, the relationship between firm size and
leverage is positive and monotonic except for market total debt ratio. On the other hand,
for the period of 1985-2005, the positive relationship holds only up to 7th deciles and the
relationship becomes weakly negative in the largest three deciles. The results also show
that small firms rarely have long-term credit ratings and most ratings are concentrated in
the largest three deciles. The sample in Faulkender and Petersen (2006) includes firms with
credit ratings that are mainly from the largest three size deciles for the period after 1985,
which may explain their finding of a negative association between firm size and leverage.
Table III
In order to explicitly examine the implication of the financial flexibility hypothesis that
there is a negative relationship between leverage and credit ratings, conditional on credit
ratings. We examine firms’ leverage ratios based on long-term credit ratings (Rating) in
Table IV. Consistent with the prediction of our hypothesis, the results show that firms with
higher credit ratings are larger firms and have lower leverage ratios, confirming a negative
relationships between credit rating and leverage ratio, conditional on having credit ratings.
There is also a negative association between firm size and leverage ratio for rated firms, but
unrated firms tend to be smaller and have lower leverage ratios on average than firms with
credit ratings.
Table IV
19
B. Firm Size, Cash Holdings, Retained Earnings, Dividends and External Fi-
nancing Activities
In order to examine weather the lower leverage for small firms results from accumulated
internal equity (as suggested by the pecking order theory) or external equity (as suggested
by the financial flexibility hypothesis), we report retained earnings, net long-term debt
issue, net total debt issue and net new equity issue as proportions of total assets. We also
examine the ratio of cash and marketable securities to total assets.12 We drop observations
with missing values in any of the reported variables.
Table V reports the results. The results in Panel A show that small firms tend to have
more cash holdings while having less retained earnings than large firms. In fact, the average
retained earnings are negative for firms in smaller size deciles. Thus, small firms’ growth is
not likely to come mainly from internally generated equity. Small firms’ long-term or total
debt financing is minuscule compared to that of large firms, while their equity financing
is phenomenal. On average firms in the first and second size deciles issue equity for 25%
and 12% of total assets per year, respectively. There are strong positive and monotonic
relationship between firm size and dividend payouts except for the first size decile firms
whose dividend payouts are greater than firms in the second size decile.
Table V
The results in Table V can be driven by IPO firms that are more likely to be in small
size deciles. In order to examine the IPO effect, we identify the IPO date from Compustat
and designate the first fiscal year ending after the IPO date as a IPO year. We also identify
the first year appearing in the Compustat for those that do not have IPO dates but the
Compustat begins its coverage during our sample period and treat it like the IPO year. The
results excluding these IPO years are reported in Panel B. They show that the magnitude
of external equity raised by small firms becomes smaller after excluding IPO years, but it
12 Including accounts receivable in addition to cash and marketable securities producesalmost identical results.
20
is still significantly greater than that raised by larger firms.
There is another possibility that the results could be driven by a few outliers especially
in small size deciles. To address this concern we reproduce results with exclusion of the
outliers of net equity financing variable at 1st and 99th percentiles. Again the results in
Panel C show that small firms heavily rely on external equity with little debt. The pattern
remains intact but only with less magnitudes when we exclude observations with greater
cutoff percentiles of the equity financing variable. The dividend payouts of the first decile
firms are greater than those in the second through fifth size deciles. Byoun (2007a) find
that small zero-debt firms pay higher cash dividends and issue much more equity than
other firms. Since zero debt firms are concentrated in the smaller size decile, the higher
average dividend payout for the first decile can be driven by zero-debt firms. Accordingly,
we estimate the average dividend payouts for non-zero debt firms without zero-debt firms
and find that the higher dividend payouts for the first decile firms are indeed due to high
dividend payouts of zero-debt firms.
Overall, firm size is negatively associated with cash holdings and equity financing and
positively associated with retained earnings, debt issue and dividend payout. Thus, small
firms have lower leverage ratios, not because of internally generated funds but because of
additional equity financing. Small firms also build up cash holdings through external equity
in order to preserve financial flexibility, consistent with our financial flexibility hypothesis.
Firm size and retained earnings are highly correlated, making it difficult to examine the
effect of retained earnings. Accordingly, we address this issue below.
C. Firm Size, Retained Earnings and Leverage
In order to disentangle the relationship between retained earning and leverage ratios
while accounting for the strong association of firm size with retained earnings, we first
examine the leverage ratios for firms divided into negative and positive retained earnings
groups within each size decile.
Panel A of Table VI shows cash holdings and leverage ratios for each group. The results
show that the smaller firms (in size deciles below 6) with negative retained earnings hold
21
more cash balances than similar size firms with positive retained earnings as a means of
preserving financial flexibility. Most differences are statistically significant except for the
first two deciles (not reported in the table). On the other hand, large firms with negative
retained earnings tend to carry less cash balances with higher leverage ratios than large
firms with positive retained earnings. Large firms appear to use preserved debt capacity
and cash balances to counteract to negative earnings shocks, consistent with our financial
flexibility hypothesis.
The market value leverage ratios for firms with negative retained earnings are always
smaller than book value leverage ratios because negative retained earnings tend to decrease
the book value of total assets. Since the portion of negative retained earnings relative to
total assets are significantly greater for small firms, smaller firms (in 1 to 4 size deciles)
with negative retained earnings have higher book leverage ratios whereas lower market-
value leverage ratios than firms with positive retained earnings in the same size deciles.
Accordingly, the relationship between firm size and leverage within smaller size deciles
(lower than decile 5) can be affected by whether the leverage is measured in book value
or market value because of the significant number of small firms with negative retained
earnings. For this reason, firms with negative retained earnings have higher book leverage
ratios despite their heavy reliance on equity financing as shown below. Thus, the higher
leverage ratios for small firms with large negative retained earning result not from debt
issues but from negative retained earnings.
Panel B of Table VI shows that within the same size decile firms with negative retained
earnings pay less dividend and issue substantially more equity than those with positive
retained earnings. For example, for deciles 2 through 7, firms with negative retained earnings
issue four to five time as much equity as the firms with positive retained earnings do. The
results suggest that larger equity issues of small firms are driven by firms with negative
retained earnings as they issue equity to raise cash as a means of of preserving financial
flexibility. Firms with negative retained earnings issue less debt than firms with positive
retained earnings in most size deciles except for the largest size decile in which the difference
is not significant. Clearly, firms with negative retained earnings issue both debt and equity,
22
but their equity issues, especially for small firms, are significantly greater than those issued
by firms with positive retained earnings. This finding is consistent with hypotheses 2 that
firms with negative retained earnings pay less dividend and issue more equity to preserve
financial flexibility.
Consistent with the financial flexibility hypothesis, the results in Table V show that
small firms with negative retained earnings hold more cash balances and pay less dividends
while issuing more equity than those with positive retained earnings as a means of preserv-
ing financial flexibility. However, large firms with negative retained earnings, while paying
less dividends and issuing more equity, have less cash balances and higher leverage ratios
than those with positive retained earnings, again consistent with the financial flexibility
hypothesis.
Table VI
D. Retained Earnings, Firm Size, Credit Ratings, Dividend and Leverage
The financial flexibility hypothesis states that firms with large negative retained earnings
use equity financing, firms with mediocre retained earnings use debt financing, and firms
with large positive retained earning use internally generated equity financing. In order to
test this, we divide the sample into deciles based on retained earnings and examine firms’
financing activities, dividend payouts and leverage ratios in Tables VII.
Table VII
We report retained earnings, total assets, and various leverage ratios for each decile in
Panel A. An examination of leverage ratio across retained earnings deciles reveals that
there is indeed a inverted V-shape relationship between retained earnings and leverage ra-
tios, consistent with the implication of the financial flexibility hypothesis. There is also
a similar inverted V-shape relationship between firm size and leverage, that is, a negative
relationship between leverage ratio and firm size across the upper five retained earnings
23
deciles and a positive relationship between leverage ratio and firm size across the other
lower deciles.
The results in Panel B provide further supporting evidence for our hypotheses. Firms
with large negative earnings in lower deciles hold the largest cash balances by issuing much
more equity than debt. Largest firms in the middle deciles (see Panel B in Table VII)
hold lowest cash balances, issuing more debt than firms in other deciles. As we move from
decile 7 to upward, we can observe that firms reduce both debt and equity financing while
increasing dividend. Firms in the largest retained earnings decile actually reduce both debt
and equity. Overall, the results in Tables VII are very intriguing and surprisingly consistent
with our financial flexibility hypotheses.
V. Multivariate Analyses
E. Estimation Results from Regression Model
In this section, we directly test the implications of the financial flexibility hypotheses
that are provided in Table I with the following regression models:
LEV = α0 + α1RE ·D+Re + α2RE ·D−Re + α3Cash+ α4LnA+ α5Div
+α6MB + α7RND + α8D0RD + α9OI
+α10MOI +Other V ariables+ ε (1)
LEV = α′0 + α′1RE ·D+Re + α′2RE ·D−Re + α′3DNo + α′4Rating
+α′5Cash+ α′6LnA+ α′7Div + α′8MB + α′9RND + α′10D0RD + α′11OI
+α12MOI +Other V ariables+ ε (2)
The detailed definition of each variable is provided in the Appendix. Equation (2) include
additional variables, a dummy variable for firms with no long-term credit ratings (DNo)
and long-term credit ratings (Rating) numbered 0 for non-rated firms and from 1 for the
lowest rating (below B) to 7 for the highest rating (AAA) (See Table IV). Since information
on credit ratings is available only from 1985, the estimation of equation (1) is restricted
24
to the sample of 1985-2005 period. The variables that are of main interest in testing the
implications of the financial flexibility hypotheses given in Section III are firm size (LnA),
the interaction variables between retained earnings (RE) and dummy variables for positive
(D+Re) and negative retained earnings (D−Re), . We expect, positive coefficient estimates
for D−Re and negative estimates for D+Re, DNo and Rating based on the signs given in
Table I. Given the inverted V-shape relationship between firm size and leverage, we expect
positive coefficient estimates for LnA within financially constrained groups such as small
size firms, firms with negative retained earnings, non-dividend paying firms, and non-rated
firms, whereas we expect negative coefficient estimates for the other non-constrained groups.
We also include dividend Div even though the as Table I also provides a negative pre-
diction for the relationship between dividend and leverage ratio, this prediction is consistent
with existing evidence. Also, expected earnings and investment opportunities need to be
proxied by some measures. Market-to-book assets ratio (MB), research and development
expenditures (RND) and a dummy variable equal to one for missing value for RND variable
(D0RD), are typically used in previous studies as measures of a firm’s investment opportu-
nities and are known to be negatively associated with leverage ratio, consistent with our
prediction. For expected earnings, we use operating income (OI) and industry median
operating income (MOI) as proxies for expected earnings.
Other variables include a dummy variable equal to one for the zero debt year (Zero),
dummy variable for IPO year (IPO), Fixed assets (FA), Altman’s Z-score (AZ), deprecia-
tion and amortization (Dep), marginal tax rate (Tax), operating income (OI) and industry
median debt ratio (Med). Following the common practice in handling the outliers in the lit-
erature, we winsorize variables at 1st and 99th percentiles except for those that are bounded
by 0 from below, in which case we winsorize only at 99th percentile.
Table VIII
Panel A in Table VIII reports two sets of estimation results for each dependent variable
for the entire time period and for the period of 1985-2005 which also includes credit rating
25
variables. The coefficient estimates on firm size (LnA) are highly significant and positive in
all regressions. Thus, there is a fairly strong positive relationship between leverage and firm
size even after controlling for the additional variables. The coefficient estimates on positive
retained earnings (RE ·D+Re) are all significant and negative as predicted by the financial
flexibility hypothesis. On the other hand, the coefficient estimates on negative retained
earnings (RED−Re) are mixed: they are significant and positive with total debt ratios but
either insignificant or negative with market value long-term debt ratio. This result could
be driven by the fact that debt ratios for firms with negative retained earnings may have
been inflated with market value debt ratio. But the coefficient estimates on RED−Re are
economically insignificant compared to those on RED+Re. This result suggests that firms
with large positive retained earnings have significantly lower leverage. Also, firms holding
more cash balances, consistent with the financial flexibility hypothesis. IPO firms and zero-
debt firms tend to have lower leverage as expected. All other variable are as expected and
consistent with previous results.
In order to further examine the non-linear relationship between firm size and leverage
ratio, conditional on those proxies for financial flexibility, we divide firm into two groups
based on each variable and estimate separate regressions. We also do this for samples
divided into before and after 1985 with and with credit rating variables. Since the results
are very similar, report to different sets of results between small and large firms in Panel
B and between rated and non-rated firms for the period of 1985-2005. For small and large
groups, we divide the sample by deciles greater than and less than or equal to decile 5.
By estimating the regressions for small and large firms separately, we can also examine the
non-linear relationship between retained earnings and leverage ratio.
The estimation results in Panel B show that the coefficient estimates on size (LnA) are
all significant and positive for small firms but negative and significant for large firms. Thus,
the positive relationship between firm size and leverage holds true only for small firms. This
finding strongly support our financial flexibility hypothesis. The coefficient estimates on
positive retained earnings (RE ·D+Re) are all significant and negative, while the coefficient
estimates on negative retained earnings (RED−Re) are all positive and significant for large
26
firms as predicted by the financial flexibility hypothesis. It appears that firm size better
represents the financial flexibility constraint for small firms while retained earnings and
firms size together seems catching large firms’ super financial flexibility. The coefficient
estimates on dividend (Div) are highly significant and negative for large firms but insignifi-
cant for small firms. Large firms with large internal funds seem paying more dividend while
maintaining low leverage, consistent with the financial flexibility hypothesis.
We report the results for groups divided by rated and unrated firms for the period of
1985-2005. Again, the results for rated firms are very consistent with our financial flexibility
hypothesis, while the results for non-rated firms give some mixed results.
Overall, the regression results show support evidence for our financial flexibility hypoth-
esis that the positive relationship between leverage ratio and firm size hold only for small
firms but there is a strong negative relationship between leverage ratio and firms size for
large firms. We find similar non-linear relationship between leverage ratio and firm size
when we divide firms based on credit rating and non-rating, dividend paying and non-
paying, or positive and negative retained earnings. This finding is very significant because
previous studies overlooked such non-linear relationship between leverage ratio and firm
size. The non-linear relationship between leverage and firm size suggest that small firms’
lower leverage ratios result from their concern for financial flexibility (issuing equity and
building up cash holdings) and large firms with positive retained earnings also have lower
leverage as they mostly rely on internal funds while preserving debt capacity.
VI. Robustness Check
IN PROGRESS
VI. Summary and Conclusions
We examine the relationship between firm size and leverage in the view of finan-
cial flexibility. We define financial flexibility as the extent to which a firm can mobilize
its financial resources to take preventive and exploitive actions in response to subsequent
information in order to maximize the firm value.
27
We hypothesize that small growing firms and firms with large negative retained earnings
are in the most need of financial flexibility and they issue more equity, maintain lower
leverage ratios, have higher cash holdings and pay no dividend. Medium firms and firms
with mediocre retained earnings have some flexibility to issue debt and meet their capital
needs. Large firms and firms with large retained earnings are the most financially flexible
as they maintain lower leverage ratios, lower cash holdings and high dividend payouts.
Consistent with our hypothesis, firms with negative retained earnings issue several times
more equity than firms with positive retained earnings. While small firms avoid debt fi-
nancing, they are much more active in tapping into external equity capital. We also find
that small firms often have negative retained earnings with no less cash holdings than other
firms and that small firms with negative retained earnings have lower leverage than firms
with positive retained earnings.
We further show that firm size has an overall strong and significant positive associa-
tion with leverage. However, the positive relationship between firm size and leverage are
reversed for large firms when we divide the firms into small and large group, credit rating
and non-rating, dividend paying and non-paying, or positive and negative retained earn-
ings. Our regression results, coupled with univariate results, suggest that small firms with
negative retained earnings build up cash holdings through equity financing, lowering lever-
age ratios, whereas large firms with positive retained earnings rely on internal equity for
their capital needs and still pay dividends resulting in lower leverage ratios. Thus, the
relationship between leverage and firm size is not linear—this is what is predicted by the
financial flexibility hypothesis. Overall, small firms have lower leverage ratios, not because
of internally generated funds or additional debt financing but because of additional equity
financing. Small firms also build up cash holdings in order to preserve financial flexibility
through external equity.
This finding can be explained by neither of the pecking order theory and the tradeoff
theory—the pecking order may be reversed for small firms that prefer external equity to
debt financing while the tradeoff theory may miss out some important aspects of capital
structure decisions. On the other hand, our study brings new insights into several unresolved
28
issues in the capital structure literature. For example, why do larger firms appear to provide
a better fit for the pecking order theory (Shyam-Sunder and Myers (1999) and Frank and
Goyal (2003)) despite the fact that large firms are less subject to information asymmetry
than small firms? Our finding suggests that large firms prefer using internal funds to
preserve financial flexibility. On the other hand, small firms issue equity and increase cash
holdings despite having low leverage in order to cope with the lack of financial flexibility,
thus reversing the external financing hierarchy suggested by the pecking order theory. This
also answers why most equity issuances occur when firms have sufficient debt capacity
(Fama and French (2002) and Leary and Roberts (2005a)), “without any apparent risk of
entering financial distress from issuing debt.”(Leary and Roberts (2004)) Our findings may
also have bearings on Welch (2004) who observe that firms do not use their issuing activities
to counteract the external and large influences of stock returns on their capital structures.
In conclusion, asymmetric information falls short of providing a plausible explanation
for motivation behind firms’ external financing decisions. The benefits and costs associated
with financial flexibility influence firms’ capital structure decisions—but not in the manner
hypothesized by the traditional trade-off theory. Thus, a substantial alteration may be
required to the tradeoff argument. Future study should address the crux of the financial
flexibility, how uncertainty affects a firm’s financial decisions.
29
Appendix. Variable Definitions
Total assets = Compustat item 6;
Net sales = item 12;
The number of shares outstanding = item 25;
Stock price at the end of the fiscal year =item 199;
Accounts receivable =item 2;
Net long-term debt issue = item 111 - item 114;
Net total debt issue = item 111 − item 114 − item 301 if item 318 = 1 and item 111
− item 114 + item 301, otherwise. Changes in current debt (item 301) represent an
increase in working capital for format code 1 but a decrease in working capital for
format codes;13 1 to 3, OCF equals item 123 + item 124 + item 125 + item 126 +
item 106 + item 213 + item 217 + item 218. For firms reporting format code 7, OCF
equals iitem 123 + item 124 + item 125 + item 126 + item 106 + item 213 + item
217 + item 314;14
13When we evaluate the Statement of Cash Flows or Changes in Financial Position for any company in
Compustat, we first consider Format Code (item 318). This is important because the format code directs us
to the data that are available for a particular company. Prior to the adoption of the Statement of Financial
Accounting Standards (SFAS) #95 for U.S. companies and currently for foreign companies, the format code
may have changed from one year to the next depending on the manner in which a company reported its
data. Effective for fiscal years ending July 15, 1988, the SFAS #95 required U.S. companies to report the
Statement of Cash Flows (format code = 7). Prior to the adoption of SFAS #95, companies had the option
of reporting any one of the following: 1) Working Capital Statement; 2) Cash Statement by Source and Use
of Funds; or 3) Cash Statement by Activity. These formats were specified beginning in 1971, which is the
reason our sample period begins with this year. (See Compustat manual.)
14Following Frank and Goyal (2003), we treat missing values that are not reported or combined with
other data items in the definition of OCF as zero.
30
Net equity issues = item 108 − item 115;
Ratio of cash and marketable securities to total assets =[item 162 + item 193] /
item 6;
AZ = Altman’s Z-score modified by MacKie-Mason (1990): (3.3EBIT (item 178) + sales
(item 12) + 1.4 retained earnings (item 36) + 1.2 working capital (item 4 - item 5))
divided by total assets (item 6). Altman’s Z-score measures the ex ante probability
of distress (Graham (1996, 2000));
Cash = Cash and short-term investments (item 1) ;
Dep = depreciation and amortization (item 14) as a proportion of total assets. Firms with
more depreciation expenses have less need for the interest deductions associated with
debt financing;
DIV = common stock dividends (item 127) divided by total assets. DIV controls for
possible trade-off between debt and dividend in reducing agency costs of free cash
flow (Fama and French (2002));
D0Div = dummy variable equal to one if the firm has missing values for common stock
dividends (item 127) and zero otherwise;
∆Eit = net equity issues for firm i from time t− 1 to t: item 108 − item 115;
FA = fixed assets (item 8) divided by total assets. Firms operating with greater tangible
assets have a higher debt capacity;
IPO = dummy variable equal to one for IPO year and zero otherwise;
LnA = log of total assets (item 6) as a measure of firm size. Larger firms tend to: have more
leverage (perhaps because they are more transparent); have lower asset volatility; or
naturally sell large enough debt issues so that the fixed costs of public borrowing are
not prohibitive;15
15The results are not affected whether the size is defined in terms of market value of assets or of net sales
31
MB = market-to-book ratio of assets. The market value of assets (MV ) equals total
assets (item 6) minus total equity (item 216) minus balance sheet deferred taxes and
investment tax credit (item 35) plus the market value of common equity (price (item
199) times shares outstanding (item 54)) plus preferred stock liquidating value (item
10, replaced by the redemption value of preferred stock (item 56) when missing).16
A higher MB is generally taken as a sign of more attractive future growth options,
which a firm tends to protect by limiting its leverage;
Med = industry median debt ratio based on two-digit SIC (or Fama and French (2002)
industry groupings). According to Frank and Goyal (2004), the industry median
leverage is an important determinant of a firm’s leverage ratio, acting as a proxy for
several factors, including intangibility, regulation, stock variance, uniqueness, pur-
chasing manager’s sentiment index, etc.;
OI = operating income (item 13) divided by total assets (item 6). A firm with higher
earnings could prefer to operate with either lower or higher leverage. Lower leverage
might occur, as higher retained earnings mechanically reduce leverage, or if the firm
limits leverage to protect the franchise responsible for producing these high earnings.
Higher leverage might reflect the firm’s ability to meet debt payments out of its
relatively high earnings cash flow;
MOI = Median industry operating income (item 13) divided by total assets (item 6) based
on two-digit SIC code;
Rating = numeritized long-term credit rating (item 280). If item 280 =2 (AAA), then
Rating = 7. If item 280 = 4 (AA+), 5 (AA) or 6 (AA−), then Rating = 6. If
item 280 = 7 (A+), 8 (A) or 9 (9A−), then Rating = 5. If item 280 = 10 (BBB+),
11 (BBB) or 12 (BBB−), then Rating = 4. If item 280 = 13 (BB+), 14 (BB) or 15
(item 12).
16The results do not change when we exclude deferred taxes and investment tax credit or include con-
vertible debt (item 79) in the definition of book equity (as in Alti (2006) and Kayhan and Titman (2006)).
32
(BB−), then Rating = 3. If item 280 = 16 (B+), 17 (B) or 18 (B−), then Rating = 2.
For all other ratings, Rating = 1. For unrated firms, Rating = 0.
DNo dummy variable equal to one if the firm has missing values long-term credit ratings
(item 280) and zero otherwise; Following Faulkender and Mitchell (2003) we use firms’
long-term credit ratings (item 280) as a measure of accessibility to the public debt
markets. Fualkender and Mitchell (2003) and Lemmon and Zender (2004) find that
leverage ratios of firms with credit ratings are significantly higher than firms without
ratings.
RE = retained earnings (item 36) divided by total assets. DeAngelo, DeAngelo, and Stulz
(2005) argue that firms with low RE/TE (RE/TA) tend to be in the capital infusion
stage, whereas firms with high RE/TE (RE/TA) tend to be more mature with ample
cumulative profits that make them largely self-financing, hence good candidates to
pay dividends. It is also a better measure of a firm’s lifecycle stage (hence suitability
to pay dividends) than its cash balances, because the source of the cash impacts the
dividend decision. For example, high cash holdings can reflect the proceeds of a recent
equity offering for a firm whose low RE/TE and RE/TA show it to be in the infusion
rather than the distribution stage;
D+Re = dummy variable equal to one for the firm with positive retained earnings (item
36) and zero otherwise;
D−Re = dummy variable equal to one for the firm with negative retained earnings (item
36) and zero otherwise;
RND = research and development expenditures (item 46) divided by net sales (item 12).
RND can be taken as a proxy for future expected investment (Fama and French
(2002)). They also serve as an additional proxy for non-debt tax shields. Following
previous studies (e.g., Opler, Pinkowitz, Stulz, and Williamson (1991), Loughran and
Ritter (1997), Fama and French (2002), Kayhan and Titman (2003) and Leary and
Roberts (2004)), we assume that missing values for the R&D variable are zero.;
33
D0RD = dummy variable that equals one for firms with missing RND and zero otherwise;
Tax = marginal tax rate equal to the statutory tax rate if the firm reports no net operating
loss carryforwards (item 52) with positive pretax return (item 170) and zero otherwise.
The statutory taxes are 48% from 1971 to 1978, 46% from 1979 to 1986, 40% in 1987,
34% from 1988 to 1992, and 35% from 1993 to 2003. Plesko (2003) shows that this
binary measure captures the marginal tax effects;
Zero = dummy variable equal to one for the year with zero debt and zero otherwise;
34
References
Almeida, Heitor and Murillo Campello, 2005, Firm financing-investment interactions: Ev-
idence from debt and equity issues, New York University and University of Illinois
Working paper.
Alti, Aydogan, 2006, How persistent is the impact of market timing on capital structure,
Journal of Finance 61, 1681-1710.
Altinkilic O. and R.S. Hansen, 2000, Are there economies of scale in underwriter fees?
Evidence of rising external financing costs, Review of Financial Studies 13(1), 191–
218.
Baker, Malcolm and Jeffrey Wurgler, 2002, Market timing and capital structure, Journal
of Finance 57, 1–32.
Barclay, Michael J. and Clifford W. Smith, 2005, The capital structure puzzle: The evi-
dence revisited, Journal of Applied Corporate Finance 17(1), 8–17.
Byoun, Soku, 2007, How and When Do Firms Adjust Their Capital Structures toward
Targets? Journal of Finance, Forthcoming.
Byoun, Soku, 2006, Why do some firms go debt-free? Baylor University Working Paper.
DeAngelo H. and L. DeAngelo, 2006, Capital Structure, Payout Policy, and Financial
Flexibility, University of Southern California working paper.
DeAngelo, Harry, Linda DeAngelo, and Ren M. Stulz, 2005, Dividend Policy and the
Earned/Contributed Capital Mix: A Test of the Lifecycle Theory, Journal of Financial
Economics .
DeAngelo, Harry, Linda DeAngelo and Rene M. Stulz, 2007, Fundamentals, market timing,
and seasoned equity offering, National Bureau of Economics Research working paper
13285.
35
Evans, D. 1987, Tests of alternative theories of firm growth, Journal of Political Economy
95, 657-674.
Fama, E. F. and French, K. R., 2002, Testing trade-off and pecking order predictions about
dividends and debt, Review of Financial Studies 15(1), 1–33.
Fama, Eugene F. and Kenneth R. French, 2005, Financing decisions: Who Issues Stock?,
Journal of Financial Economics 76, 549–582.
Faulkender, Michael, and Mitchell A. Petersen, 2006, Does the source of capital affect
capital structure?, Review of Financial Studies 19, 45–79.
Frank, M. Z. and Vidhan K. Goyal, 2003, Testing the pecking order theory of capital
structure, Journal of Financial Economics 67(2), 217–248.
Frank, M. Z. and Vidhan K. Goyal, 2005, Trade-off and Pecking Order Theories of Debt,
B. Espen Eckbo(ed.), Handbook of Corporate Finance: Empirical Corporate Finance
(Handbooks in Finance Series, Elsevier/North-Holland), Chapter 7.
Goldstein, R. N. Ju, and H. Leland, 2001, An EBIT-based Model of Dynamic Capital
Structure, Journal of Business 74, 483–512.
Graham, John R. and Campbell R. Harvey, 2001, The theory and practice of corporate
finance: evidence from the field, Journal of Financial Economics 61, 187–243.
Hansen, R. and C. Crutchley, 1990. Corporate earnings and financings: An empirical
analysis. Journal of Business 63, 347-371.
Hovakimian, Armen, Tim C. Opler, and Sheridan Titman, 2001, The debt-equity choice:
An analysis of issuing firms, Journal of Financial and Quantitative Analysis 36(1),
1–24.
Hovakimian, Armen, Gayane Hovakimian and Hassan Tehranian, 2004, Determinants of
target capital structure: The case of dual debt and equity issues, Journal of Financial
Economics 71, 517–540.
36
Jensen, M.C., 1986, Agency costs of free cash flow, corporate finance and takeovers, Amer-
ican Economic Review 76, 323-339.
Jensen, M.C. and W. Meckling, 1976, Theory of the firm: Managerial behavior, agency
costs, and capital ttructure, Journal of Financial Economics 3, 305-360.
Jung, Kooyul, Yong-Cheol Kim, and Rene M. Stulz, 1996, Timing, investment oppor-
tunities, managerial discretion, and the security issue decision, Journal of Financial
Economics 42, 159–185.
Kale, Jayant and Husayn Shahrur, 2007, Corporate capital structure and the characteris-
tics of suppliers and customers, Journal of Financial Economics 83, 321-365.
Kayhan, Ayla and Sheridan Titman, 2006, Firms’ histories and their capital structures,
Journal of Financial Economics, forthcoming.
Kim, Woojin and Michael Weisbach, 2007, Motivations for public equity offers: An inter-
national perspective, Journal of Financial Economics, Forthcoming.
Kisgen, Darren J., 2006, Credit Ratings and Capital Structure, Journal of Finance 61 (3),
1035-1072.
Leary, Mark T., Micheal R. Roberts, 2004, Financial slack and tests of the pecking order’s
financing hierarchy, Duke University working paper.
Leary, Mark T. and Michael R. Roberts, 2005, Do firms rebalance their capital structures?
Journal of Finance 60, 2575–2619.
Leary, Mark T. and Michael R. Roberts, 2005a, The Pecking Order, debt capacity, and
information asymmetry, Duke University and University of Pennsylvania working pa-
per.
Lemmon, Michael L. and Jaime F. Zender, 2004, Debt capacity and tests of capital struc-
ture theories. University of Utah and University of Colorado working paper.
37
Loughran, T. and J. Ritter, 1997. The operating performance of firms conducting seasoned
equity offerings. Journal of Finance 52, 1823-1850.
McLaughlin, R., Safieddine, A., and G. Vasudevan, 1996. The operating performance of
seasoned equity issuers: Free cash flow and post-issue performance, Financial Man-
agement 25, 41-53.
McLean, R. David, 2007, Share Issuance and Cash Holdings: Evidence of Market Timing
or Precautionary Motives? University Alberta working paper.
Myers, S.C., 1984, The Capital structure puzzle, Journal of Finance 39, 575–592.
Myers, S.C. and N.S. Majluf, 1984, Corporate financing and investment decisions when
firms have information that investors do not have, Journal of Financial Economics
13, 187–221.
Pagano, Marco, Fabio Panetta, and Luigi Zingales, 1998, Why do companies go public?
An empirical analysis, Journal of Finance 53, 27–64.
Parsons, Chris and Sheridan Titman, 2007, Capital Structure and Corporate Strategy,
University of Texas working paper.
Poitevin, M., 1989, Financial signalling and the ”deep-pocket” argument, Rand Journal of
Economics 20, 26-40.
Rajan, R.G. and L. Zingales, 1995, What do we know about capital structure? Some
evidence from international data, Journal of Finance 50, 1421–1460.
Shyam-Sunder, L. and S.C. Myers, 1999, Testing static trade-off against pecking order
models of capital structure, Journal of Financial Economics 51, 219–244.
Titman, S. and R. Wessels, 1988, The determinants of capital structure choice, Journal of
Finance 43, 1–19.
Welch, Ivo, 2004, Capital structures and stock returns, Journal of Political Economy 112,
106–131.
38
Table I. Financial Flexibility Considerations and Leverage Decisions
Financial Decisions
Leverage
Firm size conditional on positive retained earnings, long-term credit rating or dividend paying.
(Theses firms are likely to use them to pay off existing debt for financial flexibility, while small firms invest in their growth option)
-
Firm size conditional on negative retained earnings, no credit rating, or no dividend paying (small firms issue equity to increase cash and lower the
leverage, while large firms utilize built-up cash and debt capacity)
+
Positive retained earnings (As a firm accumulates more positive earnings, it will increase dividend and
reduce leverage)
-
Negative retained earnings (As a firm accumulates large negative earnings, it will reduce dividend,
issue equity and hold more cash)
+
No Long-term credit rating (Firms with no credit rating are most likely to have negative retained
earnings without access to bond market and have lower leverage than firms with credit ratings)
-
Long-term credit ratings (Firms with higher credit ratings maintain low leverage than firms with lower
ratings)
-
Cash Holdings
(Firms with little flexibility hold high cash balances with low leverage)
-
Dividend (Dividend paying firms maintain low leverage)
-/+
Expected earnings (Add flexibility to firm’s financing resources allowing to hold less cash, issue
more debt and pay dividend)
+
Expected investment opportunities (Increase the need for financial flexibility)
-
Table II. Firm Size Deciles and Leverage Ratios
The data consists of 179,418 firm-year observations for the period 1971-2005. Observations with missing values in any of
the reported variables are deleted. Size is size deciles based on total assets. Book (Market) Long-term Debt is long-term
debt over book (market) value of total assets and Book (Market) Total Debt is total debt over book (market) value of total
assets. The market value of assets equals total assets minus total equity minus balance sheet deferred taxes and investment
tax credit plus the market value of common equity plus preferred stock liquidating value. % of Firms with Zero Debt is
the percentage of firms relative to the total number of firms in each size decile. A zero-debt firm is a firm with no debt.
A. All firm-year observations (179,418)
Size Decile Total Assets
Book Long-term Debt
Book Total Debt
Market Long-term Debt
Market Total Debt
% of Firms with Zero
Debt
1 3.62 0.0974 0.2074 0.0590 0.1164 0.2035
2 10.39 0.1241 0.2184 0.0943 0.1647 0.1578
3 21.66 0.1356 0.2186 0.1137 0.1828 0.1487
4 40.62 0.1452 0.2170 0.1295 0.1936 0.1480
5 71.75 0.1651 0.2286 0.1482 0.2062 0.1293
6 128.62 0.1916 0.2493 0.1687 0.2217 0.0994
7 240.64 0.2188 0.2725 0.1890 0.2378 0.0744
8 496.17 0.2437 0.2942 0.2089 0.2537 0.0445
9 1354.40 0.2476 0.2968 0.2125 0.2552 0.0299
10 15673.95 0.2387 0.3017 0.2138 0.2679 0.0063
B. Non-zero-debt firm-year observations (155,435)
Size Decile Total Assets Book Long-
term Debt Book Total
Debt Market Long-
term Debt Market Total
Debt
1 3.67 0.1223 0.2604 0.0741 0.1462
2 10.26 0.1474 0.2593 0.1120 0.1955
3 21.17 0.1593 0.2568 0.1335 0.2147
4 39.21 0.1704 0.2547 0.1520 0.2273
5 68.78 0.1896 0.2626 0.1702 0.2368
6 123.99 0.2127 0.2768 0.1873 0.2461
7 237.02 0.2364 0.2944 0.2042 0.2569
8 490.26 0.2550 0.3079 0.2187 0.2655
9 1347.74 0.2553 0.3060 0.2190 0.2630
10 15694.31 0.2402 0.3036 0.2151 0.2696
Table III. Firm Size Deciles and Leverage Ratios for Sub-periods Divided into Before and After 1985
The data consist of firm-year observations for the period 1971-2005. Observations with missing values in any of the
reported variables are deleted. Size is size deciles based on total assets. Book /Market Long-term/Total Debt is long-
term/total debt over book/market value of total assets. The market value of assets equals total assets minus total equity
minus balance sheet deferred taxes and investment tax credit plus the market value of common equity plus preferred stock
liquidating value. % of Firms with Zero Debt is the percentage of firms with no debt relative to the total number of firms
in each size decile. % of Firms with Bond Rating is the percentage of firms with long-term credit ratings relative to the
total number of firms in each size decile.
A. For 1971 – 1984 Period (53,702 Obs)
Size Decile Total
Assets Book Long-
term Debt Book Total
Debt
Market Long-term
Debt Market
Total Debt
% of Firms with Zero
Debt
1 4.19 0.1132 0.2046 0.0873 0.1525 0.1734
2 9.75 0.1481 0.2350 0.1345 0.2123 0.1034
3 17.06 0.1727 0.2552 0.1658 0.2453 0.0812
4 27.68 0.1923 0.2695 0.1939 0.2719 0.0594
5 44.14 0.2035 0.2750 0.2031 0.2754 0.0540
6 71.33 0.2193 0.2873 0.2189 0.2880 0.0352
7 122.58 0.2315 0.2941 0.2293 0.2926 0.0374
8 239.36 0.2326 0.2893 0.2322 0.2884 0.0239
9 631.22 0.2470 0.3008 0.2488 0.3016 0.0121
10 4276.30 0.2505 0.3044 0.2638 0.3172 0.0019
B. For 1985 – 2005 Period (119,813)
Size Decile
Total Assets
Book Long-term Debt
Book Total Debt
Market Long-term
Debt Market
Total Debt
% of Firms with Zero
Debt
% of Firms with Credit
Rating
1 3.36 0.0903 0.2087 0.0463 0.1003 0.2170 0.0000
2 10.67 0.1134 0.2110 0.0763 0.1433 0.1822 0.0004
3 23.72 0.1190 0.2023 0.0903 0.1548 0.1790 0.0006
4 46.41 0.1241 0.1934 0.1006 0.1586 0.1877 0.0022
5 84.14 0.1479 0.2078 0.1236 0.1751 0.1631 0.0128
6 154.28 0.1792 0.2323 0.1461 0.1920 0.1282 0.0551
7 293.57 0.2131 0.2628 0.1709 0.2133 0.0910 0.1533
8 611.28 0.2486 0.2963 0.1985 0.2382 0.0538 0.3279
9 1678.72 0.2479 0.2950 0.1962 0.2343 0.0379 0.5758
10 20778.29 0.2334 0.3005 0.1914 0.2458 0.0083 0.7800
Table IV. Credit Ratings, Firm Size, and Leverage Ratios
The data consist of firm-year observations for the period 19851-2005. Observations with missing values in any of the
reported variables are deleted. Credit ratings are Standard and Poor’s long-term credit ratings. Book /Market Long-
term/Total Debt is long-term/total debt over book/market value of total assets. The market value of assets equals total
assets minus total equity minus balance sheet deferred taxes and investment tax credit plus the market value of common
equity plus preferred stock liquidating value. Dividend is cash dividend divided by total assets. N is the number of
observations.
Credit Ratings
N Total
Assets
Book Long-term
Debt Book Total
Debt
Market Long-term
Debt Market
Total Debt Dividend
Before 1985 50844 4.4917 0.2668 0.1996 0.1953 0.2592 0.0142
0 (Unrated) 80476 4.0763 0.2195 0.1452 0.1150 0.1714 0.0081
1 (Below B) 610 6.2307 0.4756 0.3422 0.2983 0.4147 0.0022
2 (B) 3560 6.2826 0.4883 0.4413 0.3648 0.4064 0.0035
3 (BB) 4510 7.0817 0.4009 0.3635 0.2957 0.3277 0.0058
4 (BBB) 5393 8.0320 0.3133 0.2677 0.2182 0.2569 0.0135
5 (A) 4799 8.4704 0.2784 0.2122 0.1597 0.2113 0.0219
6 (AA) 1611 8.8645 0.2250 0.1608 0.1175 0.1609 0.0293
7 (A) 359 9.9890 0.1788 0.1017 0.0632 0.1084 0.0371
Table V. Firm Size Deciles, Cash Holdings, Retained Earnings, Dividend and External Financing Activities
The data consist of firm-year observations for the period 1971-2005. Observations with missing values in any of the
reported variables are deleted. Size deciles are based on total assets. All the variables are reported as a proportion of total
assets.
A. All firm-year observations (173,515)
Size Decile Cash and
Equivalents Retained Earnings
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend
1 0.4141 -3.8807 0.0023 -0.0004 0.2527 0.0077
2 0.4012 -0.8725 0.0024 0.0027 0.1164 0.0068
3 0.3989 -0.4103 0.0007 0.0025 0.0852 0.0078
4 0.3958 -0.1390 0.0013 0.0024 0.0777 0.0083
5 0.3725 0.0244 0.0044 0.0059 0.0604 0.0093
6 0.3475 0.0961 0.0103 0.0113 0.0453 0.0097
7 0.3157 0.1656 0.0174 0.0183 0.0273 0.0117
8 0.2784 0.1940 0.0219 0.0229 0.0158 0.0136
9 0.2469 0.1995 0.0219 0.0227 0.0082 0.0170
10 0.2195 0.2102 0.0163 0.0172 0.0017 0.0193
B. Non-IPO firm-year observations (154,156)
Size Decile Cash and
Equivalents Retained Earnings
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend
1 0.4033 -4.4562 0.0010 -0.0016 0.1744 0.0083
2 0.3945 -0.9800 0.0015 0.0019 0.0771 0.0069
3 0.3910 -0.4492 0.0007 0.0030 0.0495 0.0074
4 0.3797 -0.1444 0.0038 0.0056 0.0357 0.0073
5 0.3615 0.0281 0.0066 0.0084 0.0283 0.0082
6 0.3426 0.1029 0.0125 0.0140 0.0230 0.0092
7 0.3146 0.1742 0.0174 0.0183 0.0153 0.0111
8 0.2791 0.2003 0.0218 0.0228 0.0096 0.0132
9 0.2473 0.2047 0.0212 0.0219 0.0046 0.0164
10 0.2187 0.2120 0.0160 0.0168 0.0004 0.0193
C. Non-IPO firm-year observations within 1st and 99th percentiles of net new equity issue (151,058)
D. Non-IPO firm-year observations with zero-debt firms excluded (123,667)
Size Decile
Cash and Equivalents
Retained Earnings
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend
1 0.3976 -3.4280 0.0025 0.0017 0.0743 0.0086
2 0.3880 -0.8900 0.0019 0.0027 0.0541 0.0067
3 0.3870 -0.4281 0.0010 0.0040 0.0432 0.0073
4 0.3776 -0.1393 0.0037 0.0057 0.0346 0.0072
5 0.3599 0.0276 0.0064 0.0084 0.0289 0.0081
6 0.3411 0.1017 0.0119 0.0134 0.0248 0.0091
7 0.3140 0.1723 0.0168 0.0177 0.0177 0.0110
8 0.2784 0.1979 0.0214 0.0224 0.0122 0.0131
9 0.2469 0.2032 0.0206 0.0212 0.0073 0.0163
10 0.2181 0.2111 0.0156 0.0164 0.0021 0.0193
Size Decile Cash and
Equivalents Retained Earnings
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend
1 0.3558 -2.8477 0.0041 0.0063 0.0194 0.0028
2 0.3474 -0.6983 0.0050 0.0076 0.0164 0.0039
3 0.3444 -0.3126 0.0025 0.0068 0.0135 0.0054
4 0.3357 -0.0751 0.0074 0.0106 0.0117 0.0059
5 0.3225 0.0388 0.0097 0.0133 0.0106 0.0077
6 0.3127 0.1059 0.0156 0.0178 0.0107 0.0086
7 0.2940 0.1580 0.0197 0.0208 0.0115 0.0104
8 0.2676 0.1839 0.0231 0.0243 0.0116 0.0126
9 0.2398 0.1940 0.0214 0.0221 0.0102 0.0159
10 0.2162 0.1999 0.0158 0.0163 0.0065 0.0187
Table VI. Leverage, Dividend and Financing Activities across Firm Size Deciles, Negative/Positive Retained
Earnings
The data consist of firm-year observations for the period 1971-2005. Observations with missing values in any of the
reported variables are deleted. Size deciles are based on total assets. Firms are divided into positive (PosRE) and negative
(NegRE) retained earnings groups within each size decile. All the variables are reported as a proportion of total assets.
A. Cash Holdings, Dividend and Leverage
Size Decile Retained Earnings
Cash and Equivalents
Book Long-term Debt
Book Total Debt
Market Long-term Debt
Market Total Debt
1(NegRE) -5.2296 0.4144 0.1014 0.2276 0.0521 0.1098
1(PosRE) 0.3082 0.4132 0.0850 0.1447 0.0806 0.1370
2(NegRE) -1.7479 0.4062 0.1365 0.2508 0.0872 0.1619
2(PosRE) 0.3014 0.3944 0.1074 0.1748 0.1039 0.1684
3(NegRE) -1.2568 0.4267 0.1439 0.2463 0.1021 0.1770
3(PosRE) 0.2991 0.3748 0.1286 0.1952 0.1235 0.1877
4(NegRE) -0.8691 0.4397 0.1518 0.2370 0.1162 0.1832
4(PosRE) 0.2892 0.3688 0.1412 0.2051 0.1374 0.1998
5(NegRE) -0.6213 0.4221 0.1872 0.2702 0.1468 0.2152
5(PosRE) 0.2934 0.3510 0.1558 0.2111 0.1488 0.2023
6(NegRE) -0.5084 0.3784 0.2442 0.3198 0.1915 0.2548
6(PosRE) 0.2899 0.3371 0.1745 0.2264 0.1612 0.2109
7(NegRE) -0.4025 0.3146 0.3214 0.3939 0.2471 0.3074
7(PosRE) 0.2968 0.3159 0.1944 0.2437 0.1752 0.2213
8(NegRE) -0.3103 0.2600 0.3723 0.4357 0.2898 0.3442
8(PosRE) 0.2903 0.2823 0.2177 0.2656 0.1926 0.2354
9(NegRE) -0.3077 0.2327 0.3787 0.4394 0.2920 0.3434
9(PosRE) 0.2747 0.2492 0.2274 0.2748 0.2002 0.2415
10(NegRE) -0.1789 0.1896 0.3590 0.4179 0.2878 0.3378
10(PosRE) 0.2459 0.2226 0.2271 0.2905 0.2067 0.2612
B. External Financing Activities
Size Decile Retained Earnings
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend Number of
Observations
1(NegRE) -5.2296 0.0029 0.0008 0.3227 0.0039 12324 1(PosRE) 0.3082 0.0004 -0.0041 0.0348 0.0195 3989 2(NegRE) -1.7479 0.0027 0.0038 0.1766 0.0051 9318 2(PosRE) 0.3014 0.0020 0.0012 0.0353 0.0091 6891 3(NegRE) -1.2568 -0.0039 -0.0008 0.1446 0.0065 7426 3(PosRE) 0.2991 0.0045 0.0052 0.0348 0.0089 8575 4(NegRE) -0.8691 -0.0051 -0.0045 0.1465 0.0043 6013 4(PosRE) 0.2892 0.0050 0.0065 0.0370 0.0106 9764 5(NegRE) -0.6213 -0.0049 -0.0033 0.1255 0.0053 4744 5(PosRE) 0.2934 0.0083 0.0098 0.0330 0.0111 10931 6(NegRE) -0.5084 0.0039 0.0029 0.1051 0.0039 3937 6(PosRE) 0.2899 0.0124 0.0141 0.0259 0.0115 11657 7(NegRE) -0.4025 0.0160 0.0168 0.0706 0.0071 3059 7(PosRE) 0.2968 0.0177 0.0186 0.0170 0.0127 12270 8(NegRE) -0.3103 0.0196 0.0185 0.0483 0.0087 2665 8(PosRE) 0.2903 0.0224 0.0239 0.0092 0.0146 12551 9(NegRE) -0.3077 0.0356 0.0344 0.0310 0.0105 2102 9(PosRE) 0.2747 0.0197 0.0209 0.0047 0.0180 12897
10(NegRE) -0.1789 0.0209 0.0172 0.0165 0.0097 1397 10(PosRE) 0.2459 0.0159 0.0172 0.0003 0.0202 13324
Total 155834
Table VII. Retained Earnings Deciles, Firm Size, Leverage Ratios, Cash Holdings, Dividend and External
Financing Activities
The data consist of 172,765 firm-year observations for the period 1971-2005. Observations with missing values in any of
the reported variables are deleted. Retained earnings represent retained earnings divided by total assets. Book /Market
Long-term/Total Debt is long-term/total debt over book/market value of total assets. The market value of assets equals
total assets minus total equity minus balance sheet deferred taxes and investment tax credit plus the market value of
common equity plus preferred stock liquidating value. All the variables are reported as a proportion of total assets except
for Total Assets.
A. Firm Size and Leverage Ratios across Retained Earnings Deciles
Retained Earnings
Decile
Retained Earnings
Total Assets
Book Long-term Debt
Book Total Debt
Market Long-term
Debt Market
Total Debt
1 -5.1484 35.03 0.1545 0.2788 0.0956 0.1606
2 -0.8008 209.05 0.1912 0.2947 0.1506 0.2271
3 -0.2533 470.45 0.2281 0.3173 0.1930 0.2690
4 -0.0299 1194.38 0.2429 0.3221 0.2161 0.2882
5 0.0797 2968.16 0.2322 0.3053 0.2126 0.2809
6 0.1532 4977.87 0.2140 0.2786 0.1952 0.2549
7 0.2239 2727.63 0.1917 0.2464 0.1733 0.2237
8 0.3058 2137.97 0.1649 0.2117 0.1472 0.1900
9 0.4152 2052.23 0.1231 0.1617 0.1041 0.1378
10 0.6316 1242.15 0.0606 0.0841 0.0470 0.0656
B. Cash Holdings, financing Activities and Dividend Payouts across Retained Earnings Deciles
Retained Earnings
Decile Cash and
Equivalents
Net Long-term Debt
Issue Net Total
Debt Issue Net New
Equity Issue Dividend
1 0.4114 0.0004 -0.0028 0.2742 0.0033
2 0.3856 0.0067 0.0077 0.1427 0.0041
3 0.3517 0.0129 0.0156 0.0981 0.0057
4 0.3255 0.0207 0.0225 0.0680 0.0078
5 0.3075 0.0184 0.0204 0.0510 0.0094
6 0.3069 0.0186 0.0197 0.0367 0.0097
7 0.3089 0.0120 0.0128 0.0240 0.0104
8 0.3150 0.0084 0.0092 0.0122 0.0119
9 0.3271 0.0027 0.0026 0.0014 0.0163
10 0.3715 -0.0020 -0.0024 -0.0155 0.0272
Table VIII
OLS Estimation Results for Panel Regressions on Determinants of Leverage Ratio
The sample consists of 132,770 (92,172) firm-year observations with relevant Compustat data from 1971 to 2005 (1985 to
2005). The dependent variable is the total/long-term debt (TD/LD) divided by book/market value of assets (BA/MA). The
independent variables are as follows: dummy variable equal to one if the firm has negative retained earnings and zero
otherwise (NegRet); dummy variable equal to one if the firm has zero debt and zero otherwise (Zero); dummy variable
equal to one for IPO year and zero otherwise (IPO); cash and equivalents divided by total assets (Cash); industry median
debt ratio (Med); marginal tax rate equal to the statutory tax rate if the firm reports no net operating loss carryforwards
with positive pretax return and zero otherwise (Tax); operating Income divided by total assets (OI); market-to-book ratio
of assets (MB); log of book value of total assets (LnA); depreciation and amortization divided by total assets (DEP); fixed
assets divided by total assets (FA); research and development expenditures divided by total assets (RND); a dummy
variable for missing values in RND (D_RND); and common stock dividends divided by total assets (DIV). T-statistics are
in the parentheses.
A. All firms
TD / BA
TD /MA LD /BA LD / MA
Independent Variable
Constant 0.2878 0.5224 0.2149 0.4208 0.1384 0.4257 0.1034 0.3450
(120.69) (109.11) 97.45 102.17 66.89 102.15 56.27 98.58
RE.+Re -0.2850 -0.2163 -0.2445 -0.1742 -0.2366 -0.1745 -0.1962 -0.1377
(-108.89) (-65.95) -98.49 -60.86 -100.01 -60 -93.24 -56.32
RE.D-Re 0.0113 0.0103 0.0024 0.0006 0.0008 -0.0001 -0.0038 -0.0048
(17.72) (12.56) 3.9 0.89 1.41 -0.2 -7.51 -7.88
DNo -0.2305 -0.2136 -0.2895 -0.2477
(-59.74) -63.56 -84.69 -86.2
Rating -0.0445 -0.0496 -0.0592 -0.0557
(-46.05) -58.82 -69.11 -77.28
Cash -0.1958 -0.1838 -0.1760 -0.1604 -0.1331 -0.1220 -0.1219 -0.1123
(-72.73) (-58.35) -68.81 -58.38 -54.89 -43.84 -56.57 -48.03
LnA 0.0032 -0.0013 0.0026 0.0035 0.0132 0.0097 0.0104 0.0095
(14.94) (-3.79) 12.31 11.91 67.09 32.83 59.87 38.5
Div -0.0110 0.0271 -0.0740 -0.0432 -0.0317 0.0141 -0.0806 -0.0343
(-1.02) (1.95) -7.25 -3.58 -3.25 1.14 -9.31 -3.33
MB -0.0010 -0.0005 -0.0080 -0.0061 -0.0010 -0.0004 -0.0045 -0.0034
(-7.59) (-3.01) -62.75 -46.79 -7.83 -3.36 -41.29 -30.65
RND -0.0512 -0.0423 -0.0520 -0.0437 -0.0117 -0.0079 -0.0225 -0.0193
(-16.27) (-12.5) -17.42 -14.8 -4.12 -2.63 -8.93 -7.63
D0RD 0.0174 0.0199 0.0235 0.0259 0.0127 0.0144 0.0113 0.0151
(18.47) (16.58) 26.05 24.54 14.86 13.4 14.97 16.79
OI 0.0143 0.0140 -0.0155 -0.0136 0.0060 0.0023 -0.0175 -0.0185
(7.42) (5.88) -8.43 -6.51 3.42 1.07 -11.33 -10.39
MOI 0.1546 0.0006 0.3373 0.0397 0.0850 0.0024 0.1059 0.0044
(13.6) (0.04) 31.56 3.08 8.1 0.18 11.44 0.4
Zero -0.1676 -0.1679 -0.1200 -0.1101 -0.0980 -0.0973 -0.0664 -0.0614
(-109.61) (-93.36) -82.82 -70.27 -71.01 -61.04 -54.07 -45.85
IPO -0.0171 -0.0200 -0.0291 -0.0340 -0.0141 -0.0146 -0.0216 -0.0232
(-12.15) (-10.61) -21.74 -20.71 -11.06 -8.75 -19.06 -16.55
FA 0.0079 0.0207 0.0387 0.0532 0.0766 0.0802 0.0671 0.0800
(3.17) (6.65) 16.3 19.55 32.82 28.24 32.48 33.42
AZ -0.0085 -0.0077 -0.0013 -0.0004 -0.0009 -0.0002 0.0028 0.0034
(-18.92) (-13.28) -3.08 -0.71 -2.31 -0.42 7.77 7.73
Depr -0.0349 -0.0323 -0.0180 -0.0487 -0.0113 -0.0380 -0.0015 -0.0434
(-12.91) (-5.05) -7.02 -8.72 -4.64 -6.69 -0.67 -9.09
Tax -0.0104 -0.0167 0.0300 -0.0304 0.0218 0.0225 0.0215 0.0006
(-3.98) (-4.36) 12.14 -9.11 9.24 6.63 10.24 0.2
Med 0.3703 0.3279 0.3612 0.3044 0.3132 0.2540 0.4610 0.3372
(71.48) (50.94) 71.21 50.25 58.44 38.33 102.13 54.35
Adjusted-R2 0.4066 0.4101 0.3978 0.4155 0.3635 0.3905 0.4086 0.4178
B. Small versus Large Firms (1971-2005)
TD / BA
TD /MA LD /BA LD / MA
Independent Variable
Small Firms
Large Firms
Small Firms
Large Firms
Small Firms
Large Firms
Small Firms
Large Firms
Constant 0.2623 0.4341 0.1496 0.4454 0.0831 0.3736 0.0375 0.3418
77.06 94.77 50.23 102.56 30.75 86.96 16.22 88.48
RE.D+Re -0.2436 -0.3201 -0.1829 -0.2745 -0.1770 -0.2965 -0.1328 -0.2414
-61.46 -89.81 -51.27 -79.11 -53.62 -85.42 -46.9 -77.04
RE.D-Re 0.0049 0.0181 -0.0054 0.0317 -0.0045 0.0086 -0.0083 0.0182
5.71 11.52 -7.02 20.66 -6.34 5.62 -13.68 13.19
Cash -0.1807 -0.2084 -0.1662 -0.1919 -0.0997 -0.2010 -0.0947 -0.1794
-51.85 -45.77 -52.74 -43.25 -34.41 -45.35 -38.05 -44.94
LnA 0.0018 -0.0070 0.0136 -0.0131 0.0160 -0.0055 0.0193 -0.0077
3.13 -17.25 26.49 -33.34 33.62 -13.91 47.32 -21.7
Div 0.0375 -0.2229 -0.0021 -0.2808 0.0306 -0.2914 -0.0022 -0.3517
2.95 -9.17 -0.19 -11.87 2.9 -12.31 -0.24 -16.44
MB -0.0004 -0.0027 -0.0054 -0.0170 -0.0002 -0.0015 -0.0024 -0.0122
-2.82 -6.75 -38.59 -44.52 -1.69 -3.86 -21.56 -35.24
RND -0.0371 -0.3165 -0.0370 -0.3501 -0.0063 -0.2219 -0.0152 -0.2205
-10.64 -20.5 -11.77 -23.32 -2.16 -14.78 -6.11 -16.35
D0RD 0.0226 -0.0013 0.0290 -0.0002 0.0066 0.0039 0.0078 0.0001
16.06 -1.04 22.83 -0.2 5.61 3.11 7.74 0.06
OI 0.0001 0.0704 -0.0267 -0.1737 -0.0079 0.1073 -0.0241 -0.0798
0.03 8.71 -12.19 -22.04 -3.92 13.63 -13.86 -11.23
MOI 0.1961 0.0647 0.3773 0.2628 0.1403 -0.0365 0.1239 0.0697
12.23 4.03 26.49 16.85 10.21 -2.3 10.59 4.9
Zero -0.1748 -0.1453 -0.1283 -0.0932 -0.0961 -0.1091 -0.0690 -0.0626
-90.39 -54.43 -73.79 -35.88 -59.72 -41.99 -49.98 -26.69
IPO -0.0185 -0.0171 -0.0294 -0.0264 -0.0140 -0.0176 -0.0203 -0.0237
-9.87 -7.87 -17.45 -12.52 -8.99 -8.36 -15.18 -12.45
FA 0.0413 -0.0268 0.0474 0.0497 0.1249 0.0191 0.0951 0.0477
11.15 -7.73 14.31 14.48 39.66 5.42 35.6 14.84
AZ -0.0038 -0.0207 0.0040 -0.0147 0.0029 -0.0134 0.0058 -0.0075
-6.32 -30.64 7.26 -22.32 5.68 -20.3 13.42 -12.7
Depr -0.0181 -0.1560 0.0070 -0.2867 0.0028 -0.1466 0.0130 -0.1717
-5.74 -9.07 2.47 -17.01 1.06 -8.73 5.78 -11.23
Tax -0.0243 -0.0135 0.0181 0.0205 0.0269 -0.0118 0.0287 -0.0054
-5.86 -4.16 4.88 6.48 7.79 -3.71 9.64 -1.9
Med 0.3151 0.3819 0.3087 0.2978 0.2385 0.3105 0.3985 0.3992
40.7 55.09 42.07 43.19 31.33 40.97 61.21 63.44
Adjusted-R2 0.3629 0.4652 0.3584 0.4857 0.2779 0.4187 0.3329 0.4796
C. Rated versus Non-rated Firms (1971-2005)
TD / BA
TD /MA LD /BA LD / MA
Independent Variable
Rated Firms
Non-Rated Firms
Rated Firms
Non-Rated Firms
Rated Firms
Non-Rated Firms
Rated Firms
Non-Rated Firms
Constant 0.6679 0.2758 0.6138 0.1934 0.6435 0.1183 0.5617 0.0833
75.07 91.07 76.41 76.24 73.77 46.91 73.41 40.1
RE.D+Re -0.2868 -0.2233 -0.2583 -0.1751 -0.2998 -0.1808 -0.2536 -0.1385
-38.61 -62.81 -37.57 -57.47 -39.92 -58.77 -38.37 -54.61
RE.D-Re 0.0094 0.0065 0.0482 -0.0030 0.0074 -0.0029 0.0372 -0.0069
2.37 7.65 13.19 -4.08 1.85 -3.95 10.58 -11.33
Cash -0.1835 -0.1791 -0.2262 -0.1545 -0.1908 -0.1130 -0.2205 -0.1038
-18.47 -53.98 -24.66 -54.22 -19.01 -39.49 -25.02 -43.99
LnA -0.0293 0.0003 -0.0256 0.0038 -0.0313 0.0122 -0.0260 0.0110
-37.44 0.77 -35.24 12.83 -39.57 41.17 -37.31 44.91
Div -0.0689 0.0126 -0.1861 -0.0454 -0.2246 0.0130 -0.2519 -0.0302
-2.04 0.91 -5.95 -3.8 -6.57 1.07 -8.37 -3.03
MB 0.0008 -0.0004 -0.0119 -0.0055 0.0013 -0.0004 -0.0098 -0.0029
1.36 -2.74 -21.64 -42.01 2.09 -3.24 -18.52 -26.7
RND -0.3364 -0.0379 -0.3399 -0.0364 -0.2904 -0.0065 -0.2471 -0.0159
-10.28 -11.00 -11.25 -12.32 -8.77 -2.2 -8.51 -6.47
D0RD -0.0056 0.0242 0.0005 0.0291 0.0002 0.0145 0.0017 0.0153
-2.25 17.94 0.22 25.14 0.07 12.42 0.75 15.86
OI 0.1837 0.0049 -0.2164 -0.0200 0.1873 -0.0047 -0.1350 -0.0218
10.73 2.02 -13.64 -9.56 10.83 -2.24 -8.84 -12.54
MOI -0.0531 -0.0185 0.0622 0.0221 -0.0560 -0.0205 0.0233 -0.0102
-1.65 -1.15 2.08 1.61 -1.69 -1.46 0.81 -0.89
Zero -0.3054 -0.1644 -0.1881 -0.1088 -0.2602 -0.0951 -0.1566 -0.0611
-21.3 -90.17 -14.18 -69.78 -17.94 -60.39 -12.27 -47.1
IPO 0.0206 -0.0227 -0.0152 -0.0340 0.0235 -0.0172 -0.0107 -0.0232
3.59 -11.42 -2.85 -19.96 4.04 -10.01 -2.09 -16.39
FA -0.0818 0.0391 -0.0115 0.0621 -0.0561 0.1003 -0.0120 0.0904
-13.29 11.12 -1.96 20.68 -8.69 32.18 -2.07 35.2
AZ -0.0329 -0.0051 -0.0195 0.0023 -0.0233 0.0017 -0.0121 0.0048
-21.13 -8.38 -13.55 4.34 -14.79 3.26 -8.69 11.16
Depr -0.0179 -0.0320 -0.0282 -0.0347 -0.0216 -0.0371 -0.0301 -0.0333
-0.59 -4.79 -0.99 -6.05 -0.7 -6.43 -1.1 -6.98
Tax -0.0188 -0.0313 -0.0286 -0.0337 -0.0077 0.0119 -0.0256 -0.0023
-2.71 -7.1 -4.47 -8.93 -1.1 3.12 -4.15 -0.73
Med 0.3139 0.3347 0.2270 0.3034 0.2629 0.2537 0.3000 0.3239
23.48 47.27 17.82 45.06 17.55 34.94 21.63 47.33 Adjusted-
R2 0.3884 0.3642 0.4516 0.3622 0.3658 0.2939 0.4342 0.3256