Dirk Hackbarth

Optimal Priority Structure, Capital Structure, and Investment

We examine the role of debt priority structure in resolving stockholder-bondholder conflicts over investment policy. In a dynamic model where the firm can issue multiple classes of debt, we show that the firm may underor overinvest in future growth options. We show that when debt priority is endogenized along with capital structure there is an interior optimal priority structure which virtually eliminates equityholders’ suboptimal investment incentives and fully exploits the debt capacity of future growth options. The optimal priority structure allocates priority to initial debt to mitigate suboptimal investment incentives and yet preserves priority for subsequent debt issues to maximize future debt capacity. A key implication of our analysis is that priority structure is a critical and heretofore unrecognized financial contracting device that helps to resolve stockholder-bondholder conflicts over investment policy. Several additional results have implications for empirical research in corporate finance.

Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act

We study the effect of weakening creditor rights on distress risk premia via a bankruptcy reform that shifts bargaining power in financial distress toward shareholders. We find that the reform reduces risk factor loadings and returns of distressed stocks. The effect is stronger for firms with lower firm-level shareholder bargaining power. An increase in credit spreads of riskier relative to safer firms, in particular for firms with lower firm-level shareholder bargaining power, confirms a shift in bargaining power from bondholders to shareholders. Out-of-sample tests reveal that a reversal of the reforms effects leads to a reversal of factor loadings and returns. The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2517596

Asymmetric Information and the Pecking (Dis)Order

In this paper we show that when growth options represent a significant component of overall firm value, equity financing can dominate (i.e., be less dilutive than) debt financing under asymmetric information. In particular, we find that equity is more likely to dominate debt for younger firms with larger investment needs and with riskier growth opportunities. Thus, our model can explain why high-growth firms may prefer equity over debt, and then switch to debt as they mature. We also fid that equity financing is relatively more attractive when a firm already has debt in its capital structure. In addition, equity can dominate debt in multidivisional firms. Finally, we provide new predictions on the cross-sectional variation of capital structures.

Financing Asset Sales and Business Cycles

Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. The model reveals that financing asset sales entail a lower wealth transfer from equity to debt than otherwise identical but equity financed investments. Exploring the dynamics of this motive across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

Does Transparency Increase Takeover Vulnerability

We study how transparency affects takeover probability and stock returns. If transparency helps acquiring firms to determine target value or synergy, then it can increase takeover vulnerability. Estimated takeover probabilities produce results consistent with this view and offer better fit over 25 years of takeover data. Notably, the relation between takeover likelihood and stock returns is stronger when takeover likelihood is more precisely estimated by our augmented model that includes transparency. Moreover, a takeover factor constructed with the new takeover probability better captures variation in the cross-section of stock returns and is associated with higher premium.

Does the Potential to Merge Reduce Competition

We study anti-competitive mergers in a dynamic model with noisy collusion. At each instant, firms either privately choose output levels or merge, which trades off benefits of avoiding price wars against the costs of merging. There are three results. First, mergers are optimal when collusion fails (i.e., firms sufficiently deviate from a collusive regime). Second, long periods of collusion are likely, because colluding is dynamically stable. Therefore, mergers are rare. Third, mergers (and, in particular, lower merger costs) decrease pre-merger collusion, as punishments by price wars are weakened. Thus, although anti-competitive mergers harm competition ex-post, barriers and costs of merging due to regulation should be reduced to promote competition ex-ante.

Online Appendices to Financing Asset Sales and Business Cycles

This document contains the Online Appendices for the paper Financing Asset Sales and Business Cycles. Full paper is available at: http://ssrn.com/abstract=2356377.

Does the Dearth of Anticompetitive Mergers Mean More Competition in Imperfectly Competitive Industries

We study anti-competitive mergers in a dynamic model with noisy collusion. At each instant, firms either privately choose output levels or merge, which trades off benefits of avoiding price wars against the costs of merging. There are three results. First, mergers are optimal when collusion fails (i.e., firms sufficiently deviate from a collusive regime). Second, long periods of collusion are likely, because colluding is dynamically stable. Therefore, mergers are rare. Third, mergers (and, in particular, lower merger costs) decrease pre-merger collusion, as punishments by price wars are weakened. Thus, although anti-competitive mergers harm competition ex-post, barriers and costs of merging due to regulation should be reduced to promote competition ex-ante.

Corporate Investment and Financing Dynamics

This paper studies the behavior of leverage ratios in a dynamic trade-off model with real frictions. Firms underutilize debt when financing investment to retain financial flexibility. Underutilization of debt persists even when firms exercise their last investment options, and it is more (less) severe for more back-loaded (front-loaded) investment opportunities. Thus, leverage dynamics crucially hinge upon the structure of the investment process and otherwise identical firms appear to have significantly different target leverage ratios. Structural estimation of key parameters reveals that simulated model moments can match data moments. We obtain capital structure regression results in line with the empirical evidence, and explain the empirical puzzle that average leverage ratios are path-dependent and persistent for extended periods of time.

Online Appendices to Capital Structure, Product Market Dynamics, and the Boundaries of the Firm

This document contains the Online Appendices for the paper Capital Structure, Product Market Dynamics, and the Boundaries of the Firm.The paper to which these Appendices apply is available at the following URL: http://ssrn.com/abstract=1767483