Growth Opportunities, Leverage and Financial Contracting: Evidence from
Exogenous Shocks to Public Spending
Jeffrey Callen
Rotman School of Management
[email protected]
Mahfuz Chy
Rotman School of Management
[email protected]
Growth Opportunities, Leverage and Financial Contracting: Evidence from
Exogenous Shocks to Public Spending
Abstract
This study examines how exogenous negative shocks to firms’ growth opportunities affect
capital structure and financial contracting policy. Specifically, we exploit staggered shocks to firmlevel growth opportunities arising out of exogenous increases in state-level government spending
driven by newly elected Senate/House committee members. Both difference-in-differences and
Instrumental Variable techniques reject the hypothesis that firms’ leverage is inversely related to
growth opportunities. We also fail to find support for the conjecture that bondholder-shareholder
conflicts are mitigated by shorter-term debt maturities, convertible debt or public debt covenants.
However, we do find that negative shocks to growth opportunities lead to a reduction in debt
covenants for private loans consistent with the notion that bondholder-shareholder conflicts are
managed through financial contracting policies. Our results are robust to a battery of sensitivity
tests.
1
1. Introduction
This study examines how negative shocks to firms’ growth opportunities affect capital
structure and financial contracting policy in the context of a quasi-natural experiment ostensibly
free from endogeneity concerns. Specifically, we exploit staggered shocks to firm-level growth
opportunities arising out of exogenous increases in state-level government spending driven by
newly elected Senate/House committee members.
Our empirical results contrast with the extant literature in which the confounding effects
of endogeneity are at issue. Specifically, we fail to find support for a negative relation between
growth opportunities and firm leverage. We also fail to find support for the conjecture that
bondholder-shareholder conflicts are mitigated by shorter-term debt maturities, convertible debt
or public debt covenants. However, we do find that negative shocks to growth opportunities lead
to a reduction in debt covenants for private loans consistent with the notion that bondholdershareholder conflicts are managed through financial contracting policies. Our results are robust to
a battery of sensitivity tests.
Neoclassical macroeconomics posits that government spending crowds out private
investments; that is, when government spending increases, economic agents consume more and
work less. Reduced labor lowers marginal productivity of capital and leads to a decline in optimal
capital stock. This raises firms’ cost of capital, which in turn forces firms to reduce investments.
In short, increased government spending reduces investment/growth opportunities for firms.
Cohen, Coval, and Malloy (2011) (hereafter CCM) use the election of politicians into powerful
Senate/House committees to identify exogenous changes to government spending. They show that
when a powerful politician is elected into a Senate/House committee, her state receives
significantly more federal funding. The election of politicians into Senate/House committees is
1
exogenous because it depends on seniority rules as well as the party in power. These two factors
in turn depend mostly on the population of all other states and the age of the politician relative to
other members in the committee. As a result, election to Senate/House committees is plausibly
exogenous with respect to firm financing policies. CCM find that these shocks to government
spending indeed significantly reduce growth opportunities in the private sector. More specifically,
they observe a large decline in investments for firms located in states receiving government
funding relative to firms located in other states.
We first replicate CCM’s results and show that even after controlling for the determinants
of corporate leverage, the election of powerful politicians into Senate/House committees causes a
large decline in capital expenditures, R&D expenditures, and sales and employment growth. Next,
we show that the election of powerful politicians into Senate/House committees is associated with
a large and statistically significant decline in firms’ market-to-book ratio, the proxy most
frequently used to measure growth options. We also find that other growth options proxies react
similarly.
These findings imply that the election of powerful politicians into Senate/House
committees can be used to identify firms’ growth opportunities unencumbered by endogeneity
concerns. Importantly, the shocks are staggered over time, spread out in geographic locations and
are quite numerous. The treatment firms in one period become control firms in another period
when chairmanships in congressional committees change and control firms become treatment
firms over the years. These features, along with the unexpected nature of the shocks, provide a
powerful environment within which to examine how adverse shocks to firm’s growth opportunities
affect firm’s capital structure and financial contracting policies.
2
The prior empirical literature mostly finds a negative relation between firm’s growth
opportunities proxies and financial leverage (e.g., Rajan and Zingales 1995; Goyal, Lehn, and
Racic 2002). In sharp contrast, we do not find any support for a negative relation between growth
opportunities and firm leverage. We conjecture that firms use financial contracting mechanisms ex
ante to mitigate stockholder-bondholder conflicts that give rise to the negative effect of growth
options on financial leverage in the first place (Myers 1977; Smith and Warner 1979; Billet et. al
2007). Since the costs arising out of stockholder-bondholder conflicts are ultimately borne by
shareholders, the latter have an incentive to reduce the agency costs of debt by way of financial
contracting. Supporting this notion, we find that negative shocks to growth options lead to a
reduction in debt covenants for private loans. Interestingly, and in contrast to prior literature, we
do not observe any significant effect of negative shocks to growth options on public debt
covenants. This is consistent with private debtholders being more efficient monitors of debt
covenants and having more effective coordination devices than public debtholders. The findings
collectively suggest that firms employ debt covenants to circumvent the agency costs of private
debt owing to the existence and exercise of growth options.
In what follows, Section 2 provides a brief literature review and the hypotheses
development. Section 3 describes the data and the estimation procedures. Section 4 and 5 give the
empirical results. Section 6 concludes.
2. Literature Review and Hypotheses Development
2.1 The Relation between Growth Opportunities and Leverage
3
The literature offers two primary arguments rationalizing a negative relation between
growth opportunities and leverage both of which are based on stockholder-debtholder conflicts.
Myers (1977) argues that leverage induces an underinvestment problem for firms with growth
opportunities. Specifically, shareholders of firms with value-enhancing growth opportunities have
an incentive to underinvest if (some of) the investment benefits accrue to debtholders. To remedy
this potential underinvestment problem, shareholders will choose to limit leverage ex ante before
the growth opportunities are manifest or, alternatively, renegotiate the debt to reduce leverage ex
post prior to undertaking the value enhancing investments. In an alternative argument, Jensen and
Meckling (1976) argue that leverage induces shareholders to substitute more risky investments,
such as high growth opportunity investments, for less risky investments to the detriment of
debtholders. 1 As a result potential debtholders are less likely to lend to firms with growth
opportunities unless fully compensated for the additional risk, thereby reducing shareholders’
incentives to use debt to finance growth opportunities.
Empirical studies find evidence that is by and large consistent with the view that growth
opportunities reduce leverage (see Frank and Goyal (2005) for a survey). For example, Rajan and
Zingales (1995) find that the negative association between market-to-book, a growth options
proxy, and leverage holds in all G7 countries. Goyal, Lehn, and Racic (2002) use the case of U.S.
defense industry and show that when growth opportunities increased for these firms in the early
1980s, they used less debt. 2
1
See also Barnea, Haugen, and Senbet (1980) and Leland and Toft (1996).
Some studies maintain that the stockholder-debtholder conflict may not be significant enough to have a discernible
effect on firm leverage policy (Andrade and Kaplan 1998; Parrino and Weisbach 1999). Brealey and Myers (1996,
493) suggest that the underinvestment problem is likely to be unimportant to corporate debt policy unless firms are
facing financial distress. Survey evidence by Graham and Harvey (2001) also indicates that managers fail to view the
stockholder-debtholder conflict as being of importance to their capital structure decisions.
2
4
The literature also argues that firms will employ financial contracting mechanism in the
form of debt covenants to mitigate stockholder-bondholder conflicts (Myers 1977; Smith &
Warner 1979). Firms have incentives to agree to restrictive covenants because monitoring costs
are ultimately borne by shareholders (Myers 1977). As argued by Smith & Warner (1979), debt
contracts that contain restrictive covenants have “been in use for hundreds of years and evolved
into most involved financial document ever devised.”
The observed negative relation between growth options and firm leverage is, therefore,
consistent with debt covenants being either too costly for firms to employ or too inefficient as ex
ante contracting mechanism to fully mitigate stockholder-debtholder conflicts. In other words, if
covenants mitigate stockholder-bondholder conflicts, one should not observe a strong relation
between growth options and firm leverage. In support of this contention, Billett, King, and Mauer
(2007) find that the negative association between growth options and firm leverage is attenuated
by covenant protection in public debt. 3
One key challenge in interpreting the extant empirical results in the literature is that the
availability of growth opportunities is unobservable to the econometrician. The literature has
generally used market-to-book ratio as a proxy for growth opportunities. The underlying
assumption is that market value captures the discounted cash-flows that the firm is expected to
generate both with assets-in-place and with the optimal exercise of its growth options, whereas
book value of assets is more likely to reflect the returns from assets-in-place. The ratio of market
value of assets to the book value of assets, therefore, should be highly correlated with the crosssectional and temporal variations in the availability of firms’ growth options. 4 The literature has
3
In contrast, we do not find a significant effect of changes in growth opportunities on public debt covenants.
However, market timing would also predict a negative association between market-to-book ratio and firm leverage,
irrespective of the availability of growth opportunities. For instance, Baker and Wurgler (2002) argue that firms are
4
5
also employed other growth opportunity proxies. Examples include the ratio of capital
expenditures to book assets, R&D expenditures to book assets, and capital expenditures to
property, plant and equipment (PPE). 5
While these proxies are likely to be highly correlated with the availability of growth
opportunities, it is unlikely that they capture the cross-sectional and temporal variations in growth
opportunities without measurement error. 6 Measurement issues aside, exercise of growth options
and firm financing policies are likely to be affected by a host of unobservable correlated variables
because both the exercise of growth options and usage of debt in capital structures are choice
variables to managers. All of these concerns make Ordinary Least Squares (OLS) regressions of
firm leverage on growth option proxies sensitive to endogeneity concerns, making it difficult to
interpret the coefficient estimates which could be asymptotically biased and possibly inconsistent. 7
Although simultaneous equation approaches are helpful, they do not necessarily completely
eliminate endogeneity concerns.
2.2 Changes in Public Spending and Shocks to Growth Opportunities
more likely to issue equity when their market values are high and repurchase equity when their market values are low
(relative to past market values).
5
In an assessment of the suitability of growth options proxies, Adam and Goyal (2008) find that market-to-book ratio
captures the underlying notion of growth opportunities more appropriately than all other proxies used in the literature.
6
In particular, accounting conservatism inherent in the measurement of these proxies may make them systematically
biased upwards for some firms while underestimating the available growth opportunities for others. To illustrate, take
the example of R&D expenditures. Firms are required to expense all of their in-house R&D expenditures on their
income statement. However, in-process R&D obtained when acquiring another firm has to be recorded on the balance
sheet. These accounting differences will make the cross-sectional and temporal calculation of R&D expenditures and
the book value of assets systematically biased, making proxies for growth options based on these measures susceptible
to measurement error.
7
Goyal, Lehn, and Racic (2002) use the defense industry in the 1980s as quasi-natural experimental setting to test
how growth opportunities affect firm leverage. They argue that growth opportunities for firms in the defense industry
increased exogenously in the 1980s due to Reagan defense buildup and subsequently deteriorated with the end of the
cold war. Their findings generally support the negative effect of growth opportunities on firm leverage. However,
their sample is very small, 61 treatment and 61 benchmark firms. As a result, it is not clear whether their findings can
be generalized beyond defense firms.
6
CCM investigate whether public spending affects firm investment using changes in
congressional committee chairmanships to measure exogenous shocks in state-level spending.
They show that when a politician from a particular state is elected to congressional committees,
her state receives significantly more federal funds in earmark spending, government transfers and
government contracts. Subsequent to these increases in public spending, firms located in the state
reduce investments. Reductions in investment are significant statistically and large economically.
They argue that increased spending by the government increases the economic agents’
consumption and leisure and reduces the marginal utility of labor. This in turn causes a decline in
the marginal productivity of capital, forcing companies to retrench investments. In other words,
firms’ costs of capital rise following increases in state level federal spending, turning some
investment projects that were otherwise positive NPV into unattractive investment projects.
CCM further argue that congressional committee chairmanships are determined entirely by
seniority rules; ascendancy in Senate/House committees could either result from resignation (or
defeat/death) of the incumbent or a change in the party controlling the Senate/House. In particular,
most politicians do not contest for elections in the year they ascend to these committees. “And
because both of these events depend almost entirely on political circumstances in other states”
(CCM, p. 1016), it is reasonable to assume that congressional committee chairmanships are
exogenous to firm outcomes. They also argue that the economic conditions prevailing in the state
do not influence the ascendancy of politicians in influential Senate/House committees. In
particular, it seems unlikely that firms will manipulate (by lobbying or otherwise) the ascendancy
of politicians into congressional committees to hurt their own performances, given that firm values
decline substantially following the election of state politicians to influential Senate/House
committees.
7
Given the arguments in CCM, we contend that changes in government spending, by
increasing the cost of capital, unexpectedly lead to reduced growth opportunities. Viewing it from
a real options perspective, the number of available real options (such as options to expand existing
investments or make new ones) is likely to decline when firms experience increased government
spending in their home states.
2.3 Hypotheses
The above discussion leads to the following hypothesis expressed in the alternative:
H1: There is a negative relation between firms’ growth opportunities and corporate leverage.
Myers (1977) argues that shareholder-bondholder conflicts that induce an underinvestment
problem are likely to be more severe for firms holding long-term debt than short-term debt. This
is because when investment/growth opportunities arise, shareholders can wait to invest until after
the debt overhang matures. Thus, firms subject to investment growth opportunities are likely to
use less long-term debt and more short-term debt in order to alleviate the underinvestment
problem. Similar arguments are advanced in Barnea, Haugen, and Senbet (1980) who propose that
short-term debt and callable bonds could potentially reduce the agency costs of debt associated
with growth opportunities. This argument leads to the following hypothesis.
H2: There is a negative relation between firms’ growth opportunities and long-term
corporate leverage.
Aivazian and Callen (1980) argue that convertible debt could be used to mitigate Myer’s
debt overhang problem by compensating shareholders ex ante for growth opportunities. Similarly,
Green (1984) contends that convertible bond could circumvent the issue of asset substitution
problem by aligning the objectives of debt- and equity-holders. This line of reasoning implies that
8
firms with growth options may use more convertible bond financing leading to our next
hypothesis:
H3: There is a positive relation between firms’ growth opportunities and convertible debt.
Since the agency costs of debt arising out of stockholder-bondholder conflicts are
ultimately borne by shareholders in a well-functioning capital market, it seems reasonable that the
latter will attempt to mitigate these conflicts through financial contracting. Efficient contracting
ex ante could eliminate or at least mitigate the concerns of debtholders that firms will take ex post
actions detrimental to debtholders’ interest. This argument follows from the costly contracting
hypothesis (Smith and Warner 1979). In particular, by employing restrictive debt covenants, firms
could avoid/mitigate the agency costs of stockholder-bondholder conflicts. This mode of argument
implies that negative shocks to growth options will also lead to a decline in restrictive covenants,
particularly those that relate to the stockholder-bondholder conflicts arising out of the potential
exercise of growth opportunities. We formulate the following hypothesis to test this prediction:
H4: There is a positive relation between firms’ growth opportunities and debt covenants.
Enforcement of remedial actions subsequent to debt covenant violations require
coordination among debtholders. Because coordination among public debtholders is more costly
and public debt covenants more boilerplate than for private debt, growth options may not have
much of an impact on public debt covenants. In contrast, private debtholders are likely to have
expertise in monitoring debt covenants and put more efficient covenants in place (Smith and
Warner 1979). In addition, it is likely to be less costly for private debtholders to coordinate among
themselves for remedial actions subsequent to the violations of debt covenants or enforce transfer
of control rights relative to public debtholders. As a consequence, we conjecture that shocks to
9
growth opportunities are more likely to affect the debt covenants of privately placed loans than
public debt.
H5: There is a positive relation between firms’ growth opportunities and private debt
covenants.
3. Data and Estimation Procedures
3.1 Sample and Variable Construction
CCM collected more than 200 instances of changes in congressional committee
chairmanships between 1967 and 2008. We exploit the attendant negative shocks to firms’ growth
opportunities in order to investigate how shocks to growth opportunities influence firm leverage
policy. 8
We begin our sample selection procedure by retrieving annual financial data items for all
Compustat-CRSP merged firms for the period between 1967 and 2008 as in CCM. We drop
financial and utility firms, firms with missing assets or sales, and firms located outside the U.S.
We also require that the book value of assets be larger than $1 million. Further requiring the
availability of control variables, we obtain a sample of 154,773 firm-year observations. 9 In our
debt covenant analyses, we use the Mergent Fixed Income Securities Database (FISD) for public
debt covenants and the Loan Pricing Corporation (LPC)’s DealScan for private debt covenants.
DealScan does not cover data prior to 1982. Thus, our sample is reduced for the private debt
8
9
We thank CCM for making the data available.
The number of observations in CCM is 168,975 as they include financials and utilities in their sample.
10
covenant tests. 10 We use the up-to-date DealScan-Compustat link as in Chava and Roberts (2008)
to connect DealScan loans with Compustat’s identifier gvkey.
The political spending shock variable, NegGrowthShocks, equals one for all firms located
in a state if a senator (representative) from that state was appointed chairman or ranking minority
member of an influential Senate (House) committee and zero otherwise. These committees include
Finance, Veteran Affairs, and Appropriations (Ways and Means, Appropriations, and Energy and
Commerce) for the Senate (House). We use the ratio of market value of assets to book value of
assets (Market-to-Book) as the main proxy for growth options. Market-to-Book has been used by
many prior studies to measure growth options available to the firm (e.g., Rajan and Zingales 1995;
Goyal, Lehn, and Racic 2002). We also use the sum of capital and R&D expenditures scaled by
book value assets, Investment, as an alternative measure of growth options. Prior literature has
used both R&D and Capital expenditures as growth options proxies (Johnson 2003; Cao, Simin,
and Zhao 2008). We follow prior literature in constructing our two key leverage measures Book
Leverage and Market leverage (Lemmon, Roberts, and Zender 2008). Book (Market) Leverage
scales the total amount of short- and long-term debt by Book (Market) value of assets. In further
analyses, we use long-term leverage and convertible bond measures, which are constructed in a
similar fashion.
We construct covenant variables as the number of covenants employed in a firm’s loan
portfolio in a given fiscal year. We assume that loan covenants agreed upon at the time of loan
origination remain in force until the particular loan matures. To mitigate the skewness of the
covenant counts, we take the log of (one plus) the number of covenants in effect for a firm’s loan
10
DealScan’s database actually starts from 1987. However some loans in DealScan originated between 1982 and
1987. As a result, we employ the 1982-2008 sample period for private debt covenant tests. In additional (untabulated)
analyses, we restrict our sample to the 1987-2008 period and all inferences remain unaffected.
11
portfolio. We also construct a measure of covenant slack (SlackRank) following Vasvari (2006)
and Callen et al. (2015). The measure SlackRank is increasing in covenant slack. Further details
on the construction of SlackRank are provided in the appendix. We follow Lemmon, Roberts, and
Zender (2008) and include LogSale, Profitability, Tangibility, Industry Median, CashFlowVol,
DivPay as controls in our regressions. In addition, we also include Size and Age to control for the
effects of firm scale and age. All variables are defined in the appendix.
3.2 Descriptive Statistics
Table 1 reports the descriptive statistics. The mean value for NegGrowthShocks is 0.06,
suggesting that 6% of firm-years are affected by the election of state politicians to influential
Senate or House committee. This is very similar to the mean in CCM of 0.07. The standard
deviation is also similar (0.24 vs. 0.255). Firms’ capital expenditures are 7% of assets on average.
R&D expenditures as a fraction of assets are 4%. Employment growth for a representative firm is
10% and sales growth 25%. 11 Book (Market) leverage is 25% (27%), which is very close to the
leverage ratios in Lemmon, Roberts, and Zender (2008). Other variables (LogSale, Profitability,
Tangibility, CashFlowVol, DivPay, Size, Market-to-Book) also have similar summary statistics to
those of Lemmon, Roberts, and Zender (2008).
3.3 Empirical Strategy
Lemmon, Roberts, and Zender (2008) provide evidence that firms’ leverage policy are
persistent and that time-invariant firm-specific factors explain a disproportionately large amount
of variation in leverage relative to the determinants of leverage identified in the prior literature. To
11
These numbers are very close to CCM. They do not set missing value of R&D equal to zero, whereas we follow
prior innovation literature and set missing values for R&D expenditures to zero. Following CCM in this case does not
alter the inferences.
12
account for such time-invariant factors, we employ firm fixed-effects specifications. We estimate
variants of the following specification:
𝑦𝑦𝑖𝑖,𝑡𝑡+1 = 𝛽𝛽0 + 𝛽𝛽1 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺ℎ𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑖𝑖𝑖𝑖 + 𝛽𝛽2 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝜇𝜇𝑖𝑖 + 𝜏𝜏𝑡𝑡+1 + 𝜖𝜖𝑖𝑖,𝑡𝑡+1
(1)
where y is one of the outcome variables. The main coefficient of interest is 𝛽𝛽1 which captures the
causal effect of growth opportunities on the particular outcome variable employed. In our OLS
and Instrumental Variable (IV) estimations, we use Market-to-Book and Investment as proxies for
growth options. 12 𝜇𝜇𝑖𝑖 captures firm fixed-effects and 𝜏𝜏𝑡𝑡+1 captures year fixed-effects. 𝜖𝜖𝑖𝑖,𝑡𝑡+1 is the
error term that allows for within cluster correlations. We cluster standard errors by firm to mitigate
the overstatement of test statistics due to within-cluster correlations (Petersen 2009). 13
Controls refer to time-varying determinants of financial leverage as identified in the prior
literature. LogSale and Profitability both capture the availability of internal funds. When firms
have internal funds, they may not seek outside sources of funding such as debt. This implies a
negative association between these two variables and firm leverage. Tangibility is the amount of
fixed tangible assets that could be used for collateral. We expect a positive association of
Tangibility with firm leverage. Firms may tend to follow industry peers in capital structure
decisions. Industry Median captures the median industry-year leverage ratio in the firm’s 3-digit
SIC industry. We expect a positive association between Industry Median and firms’ use of debt.
CashFlowVol is the extent to which firm’s earnings are volatile. Volatile earnings are riskier from
debtholders’ perspective. As such, we expect a negative association between CashFlowVol and
firm leverage. Size captures the scale of the firm. Larger firms are less likely to go bankrupt and,
12
In additional analyses, we also use the ratio of capital expenditures to property, plant and equipment (CAPEX/PPE)
as another proxy for growth options. All inferences remain unaffected.
13
Inferences are not sensitive to clustering by state or state-year.
13
hence, have larger debt capacity. Thus, we expect a positive association between Size and leverage.
Finally, we include Age as another control variable because older firms could face less information
asymmetry, which allows them to tap into information-sensitive equity markets (Myers and Majluf
1984). This implies a negative association between Age and leverage.
3.4 IV Estimation Validity
We argue that growth options measures (Market-to-Book and Investment) are likely to be
systematically plagued by measurement error because it is unlikely that they capture the crosssectional and time-series variations in the availability of growth options to firms. To the extent that
our instrument (NegGrowthShocks) is valid, we can mitigate the endogeneity arising from both
measurement error and the simultaneity of growth options exercise and debt policy decisions.14
The validity of this instrument hinges on two crucial conditions: relevance and exclusion. The
relevance condition requires that, conditional on all the covariates, the instrument strongly
correlates with the endogenous regressor for which it instruments. We provide economic
arguments from CCM as to why our choice of instruments should affect firms’ growth
opportunities. We also show from our first-stage regression and the weak instruments test (AngristPischke F-test) that NegGrowthShocks strongly correlates with growth option proxies used in the
prior literature.
The exclusion restriction requires that, conditional on all the covariates, the instrument
affects the outcome variable only through the endogenous regressor. To the extent that firms
cannot manipulate the election of politicians to Senate/House committees, the assignment of firms
into the treatment and control states satisfies the exclusion restriction. Importantly, the reduced
14
We also provide estimates in the reduced form (difference-in-differences estimates).
14
form estimates show no statistically significant effect of NegGrowthShocks on firm leverage,
mitigating concerns about the exclusion restriction.
4. Empirical Analyses
4.1 Exogenous Political Spending as Growth Options Shocks
Table 2 tabulates the effects of exogenous changes in public spending on firm investment
and growth. Column (1) shows that firms decrease investment in fixed assets (capital expenditures)
in response to an exogenous increase in public spending. The effect is statistically significant at
the 1% level and economically meaningful. An average firm experiences nearly 7.5%
(=0.00526/0.07) decline in capital expenditures following an increase in public spending.
Similarly, R&D expenditures also go down by approximately 4.1% for a representative firm. Such
large decreases in investments result in significant loss in sales growth and employment growth.
Sale growth decreases by 7.6% while employment growth decreases by nearly 13.2%. Note that
the magnitude of the adverse effects of public spending on investments and growth are very close
to those found by CCM.
Table 3 reports how proxies for growth opportunities react to an exogenous increase in
public spending. Column (1) shows that the market-to-book ratio decreases by nearly 5.01%. The
effect is statistically significant and economically meaningful. Investment decreases by nearly
6.33%. Similarly CAPEX/PPE also decreases as expected. These adverse effects on growth
opportunities for firms located in treatment states obtain even after controlling for common
determinants of leverage. Having replicated CCM’s findings in our setting, we now turn to our
main tests.
15
4.2 Growth Options and Leverage
4.2.1 OLS Results
We start by estimating Ordinary Least Squares (OLS) regression of leverage on growth
opportunities proxy and other common determinants of leverage from prior literature. In these
OLS regressions, we ignore the fact that growth opportunities and leverage are endogenously
determined and refer to the tests as Naïve OLS regressions. For comparison, we benchmark our
estimates with those in Lemmon, Roberts, and Zender (2008). Table 4 reports the estimates.
Column (1) and (3) proxy growth options with the Market-to-Book ratio and Column (2) and (4)
use Investment as the growth options proxy. In line with prior literature, we find that growth
options are negatively associated with financial leverage. This relationship holds for both book
and market leverage and for both proxies of growth opportunities. Returning to the control
variables, all control variables have similar magnitude and sign as in Lemmon, Roberts, and
Zender (2008, p. 1595). 15 The adjusted R-squareds for all specifications are also very similar to
their study.
4.2.2 Reduced Form (Difference-in-Differences) and IV Estimates
While the OLS estimates provide results that are very similar to prior literature, growth
options are likely to be endogenous. As discussed, this endogeneity may come from omitted factors
affecting both growth options and capital structure policies, measurement error of the proxies for
growth options and the general non-observability of firm-specific growth opportunities to the
researcher. Endogeneity may result in inconsistent and asymptotically biased parameter estimates,
15
Lemmon, Roberts, and Zender (2008) do not include Size (log of book assets) and Age in their regressions.
However, both are likely to be associated with growth options (Berk, Green, and Naik 1999). As a result, we include
them as controls. Omitting these variables yields very similar magnitude to and the same sign as Lemmon, Roberts,
and Zender (2008) for all covariates in the regressions.
16
potentially leading to incorrect inferences. To see whether this is the case, we provide alternative
difference-in-differences estimates for the effect of an exogenous reduction in growth
opportunities on corporate leverage.
Columns (1) and (4) of Table 5 report the results. Colum (1) and (4) regress book and
market leverage on NegGrowthShocks, respectively, including firm and year fixed-effects and
time-varying controls. If growth options indeed lead to a decrease in leverage, one would expect
to see a positive and statistically significant coefficient estimate on NegGrowthShocks. However,
we find that NegGrowthShocks appears to have a negative impact on book leverage and no
statistically significant impact on market leverage. This finding is inconsistent with prior studies
which find that growth opportunities reduce leverage.
To provide more direct evidence on the effect of growth options on leverage, we turn to IV
estimation. Columns (2)-(3) and (5)-(6) of Table 5 tabulate the results from 2SLS estimation.
Similar to Table 4, we use the Market-to-Book ratio and Investment as proxies for growth options.
The direction of the effect of growth options on leverage is similar to the difference-in-differences
results; growth options appear to have a positive impact on book leverage and no statistically or
economically significant effect on market leverage contrary to H1.
4.3 Additional Analyses
4.3.1 Long-term leverage
One of the ways that firms could respond to changes in growth options is by adjusting their
use of long-term debt. Myers (1977) suggests that long-term debt exacerbates the underinvestment
problem. Additionally, risk-shifting incentives are likely to be more salient for long-term leverage.
This implies that an adverse shock to growth opportunities may lead to a more pronounced increase
17
in long-term debt relative to short-term debt. To formally examine whether this is the case, we test
how firms’ use of long-term leverage reacts to adverse shocks to growth opportunities. Table 6,
Columns (1) and (2) report the results. Column (1) suggests that use of long-term book leverage
did not change materially to these shocks. Column (2) finds the same inference for market
leverage. Collectively, we find no evidence that shocks to growth opportunities induce a change
in long-term debt.
4.3.2 Convertible Bonds
Another way that firms could potentially adjust their debt policy in response to changes in
growth opportunities is by adjusting their use of convertible debt (Aivazian and Callen 1980, Green
1984). By combining features of both equity and debt, convertible debt could lower the debt-equity
conflict and reduce the risk-shifting incentives of shareholders. We examine this hypothesis in
Columns (3) and (4) of Table 6. The evidence does not support the contention that firms adjust
convertible debt as a reaction to shocks to growth opportunities.
4.3.3 Debt Maturity and Substitution
Columns (1)-(2) of Table 6 examine whether the level of long-term debt changes following
shocks to growth options. However, the long-term debt measure incorporates debt maturing in all
fiscal years except the current year. It is conceivable that firms renegotiate to substitute near-term
debt with very long-term debt after growth options shocks. If firms replace long-term debt with
short-term debt, the ratio of long-term debt to short-term debt will change, but the level of total
debt may not be affected. We examine how the ratio of debt maturing in more than five (three)
18
years to short-term debt changes in response to growth options shocks in Column 5 (6) and find
no significant changes. 16
4.3.4 Cross-Sectional Variations
So far in all analyses, we have employed firm fixed effects specifications in light of the
finding in Lemmon, Roberts, and Zender (2008) that firm leverage policy is persistent and firm
fixed effects explain most of the variations in firm debt policy. One concern with using firm fixed
effects is that we exploit only within-firm variations in our empirical investigations. This could
potentially throw away important cross-sectional variations that respond to growth options shocks.
To examine whether this is the case, we employ less conservative tests by not including any fixed
effects nor clustered standard errors. Our inferences remain unaffected (untabulated).
4.3.5 Local and Industry Shocks
If contemporaneous shocks at the state level correlate with the growth shocks
systematically and affect firm debt policy, then such contemporaneous changes may attenuate the
estimated treatment effects in our tests, leading to misleading inferences. Ideally, we would like to
include a set of state-year indicator variables to control for such contemporaneous shocks. Since
our growth options shocks vary at the state-year level, inclusion of state-year dummies is not
possible due to collinearity concerns. Instead, we follow the approach of Bertrand and
Mullainathan (2003) and include state-year means of leverage for all firms located in a state
(excluding the firm itself) in our regressions as controls. The idea is that if unobservable state-year
shocks correlate with the growth options shocks and affect firm leverage, then such
contemporaneous shocks are likely to affect all firms in a given state-year. Controlling for state16
We also consider other substitution of debt measures such as the ratio of debt maturing in more than two or four
years to short-term debt changes. The inferences are similar to those reported in Table 6.
19
year average, thus, mitigates concerns about contemporaneous state level changes. Untabulated
analyses show that all inferences remain unaffected.
4.3.6 Shocks to Lenders in the Same State
One could argue that shocks to growth opportunities in a given state are also likely to affect
the lenders in that state. Lenders in the same state may be financially constrained and advancing
loans to the firms in the same state may not be a viable option. This may explain why we do not
see any significant effect of shocks to growth options on firm leverage. Firms could, however,
choose to place public loans instead of private loans to circumvent the unwillingness of lenders in
the same state to advance loans. We investigate this issue in Table 7. Columns (1)-(2) test how the
likelihood of having a public loan and the logarithm of (one plus) the number of public loans
outstanding in the loan portfolio do not respond to changes in growth opportunities. The estimates
suggest that firms do not issue more public loans.
5. Growth Options and Debt Covenants
In this section, we investigate whether changes in growth options lead to changes in debt
covenants in a firm’s loan portfolio. Covenants could serve as an efficient contracting mechanism
to resolve stockholder-debtholder conflicts. Since we do not find a robust relationship between
growth options and firm leverage, we conjecture that either growth options do not lead to
stockholder-debtholder conflicts or that firms employ financial contracting mechanisms to
mitigate these conflicts. 17 Prior literature suggests that firms agree to restrictive covenants to
17
Another possibility is that our research setting is not powerful enough to detect changes in firm leverage. However,
as discussed previously, the shocks we employ are plausibly exogenous and result in large changes in growth options
proxies used in prior literature. As such, it is unlikely that the shocks lack power.
20
alleviate debtholders’ concerns that shareholders might expropriate their wealth (Myers 1977;
Smith & Warner 1979). This follows because the agency costs of debt are ultimately borne by
shareholders. If the perceived benefits of covenant restrictions outweigh the associated costs of
those covenants with respect to mitigating stockholder-debtholder conflicts, then shareholders are
better off agreeing to restrictive covenants.
We separately test for public and private debt covenants. Columns (3) of Table 7 tabulates
the estimates for the effect of negative shocks to growth options on the likelihood that the firm’s
public loan portfolio contains at least one covenant. Column (4) reports the effect on the log of
(one plus) the number of debt covenants in a firm’s public debt portfolio. The estimates suggest
that negative shocks to growth options do not induce a change in public debt covenants.
In our next set of analyses, we investigate how the growth options shocks affect private
debt covenants. Since DealScan does not cover the full sample period, the sample size is
significantly smaller. This makes our tests less powerful for private debt covenants. First, we
validate that the ascension of politicians constitute negative growth shocks even in the reduced
sample. Table 8 shows that the NegGrowthShocks coefficient estimate is statistically significant
across all specifications and the magnitudes of the coefficient estimates are generally similar to
those for the full sample in Tables 2 and 3.
Table 9 reports the effects of negative shocks to growth options on the use of debt
covenants in private debt. DealScan reports three broad categories of debt covenants: financial, net
worth and general covenants (sweeps). Column (1) regresses the logarithm of (one plus) the
number of total financial covenants in a firm’s private loan portfolio in a fiscal year. Column (2)
– (3) calculate the net worth covenants and sweeps in a similar fashion. We find a statistically
significant impact of changes in growth options on the use of private debt covenants across all
21
three columns. The economic magnitude is also meaningful; the treatment effect lies between 3%4%. The results suggest that a decrease in growth options lead to a decrease in the use of covenants
in private debt. The fact that we do not find an impact of growth options on public debt covenants
but find such an effect on private debt covenants is consistent with private debtholders being more
effective monitors. Private debtholders are also able to coordinate more effectively in order to take
remedial/corrective actions subsequent to covenant violations.
In Columns (1)-(2) of Table 10, we disaggregate the financial covenants into performance
covenants and capital covenants following Christensen and Nikolaev (2012). Performance
covenants serve as trip wires for transferring control rights to the lenders whereas capital covenants
tend to align stockholder-debtholder conflicts. The estimates suggest that growth options shocks
induce changes in both covenants. However, consistent with prior arguments, changes in capital
covenants (3.4%) are higher in absolute magnitude than performance covenants (1.9%). Sweeps
have covenants that are either related to dividend/payout or to assets sales, debt issuance and equity
issuance. Myers (1977) provides intuition that dividend covenants could potentially mitigate
stockholder-debtholder conflicts with respect to the exercise of growth options. We separate
dividend covenants from all other covenants in sweeps and test how dividend covenants respond
to changes in growth options. Column (3) of Table 10 shows that negative growth shocks lead to
a significant decrease in the use of dividend covenants. We do not find any statistically significant
effect for other types of sweeps (untabulated).
One concern with the above results is that lenders may be agreeing to a decrease in
covenants in exchange for greater restrictiveness of existing covenants. In other words, lenders
may be removing extraneous covenants on the one hand but increasing covenant restrictiveness on
the other hand. If that is the case, then one cannot argue from the evidence provided in this paper
22
that debt covenants mitigate stockholder-debtholder conflicts. Column (4) of Table 10 shows that
negative shocks to growth options lead to an increase in covenant slack. That is, lenders agree to
less restrictiveness of the remaining covenants in a firm’s loan portfolio. Overall, the analyses in
this section suggest that firms mitigate stockholder-debtholder conflicts with respect to growth
options ex ante by employing debt covenants in private loans.
6. Conclusion
This study examines how shocks to firms’ growth opportunities affect capital structure and
financial contracting policy in the context of a quasi-natural experiment ostensibly free from
endogeneity concerns. Specifically, we exploit staggered shocks to firm-level growth opportunities
arising out of exogenous increases in state-level government spending driven by newly elected
Senate/House committee members. Both difference-in-differences and Instrument Variable
techniques reject the hypothesis that firms’ leverage is inversely related to growth opportunities.
We also fail to find support for the conjecture that bondholder-shareholder conflicts are mitigated
by shorter-term debt maturities, convertible debt or public debt covenants. However, we do find
that negative shocks to growth opportunities lead to a reduction in debt covenants for private loans
consistent with the notion that bondholder-shareholder conflicts are managed through financial
contracting policies. Our results are robust to a battery of sensitivity tests.
23
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25
Appendix: Variable Definitions
Variable
Definitions
NegGrowthShocks
= 1 for firms located in a state if a politician from that state is
appointed as either chairman or ranking minority member in an
influential senate or house committee, and zero otherwise. These
committees include Finance, Veteran Affairs, and Appropriations
(Ways and Means, Appropriations, and Energy and Commerce)
for the Senate (House).
Capital expenditures, scaled by the book value of assets; set to
CAPEX/Assets
zero if missing
Research and development expenditures, scaled by the book
R&D/Assets
value of assets; set to zero if missing
Year-on-year growth in employment
EmpGrowth
SaleGrowth
Year-on-year growth in sales
Leverage – Book
Long-Term Book Lev
Total short- and long-term debt scaled by the book value of
assets
Total short- and long-term debt scaled by the market value of
assets. Market value of assets equals market value of equity at the
fiscal year-end plus total short- and long-term debt.
Total long-term debt scaled by the book value of assets
Long-Term Market Lev
Total long-term debt scaled by the market value of assets
Convertible Bond - Book
Total convertible bonds scaled by the book value of assets, set to
zero if missing
Total convertible bonds scaled by the market value of assets, set
to zero if missing
Log of sales
Leverage – Market
Convertible Bond – Market
LogSale
CashFlowVol
Earnings before interest, taxes, depreciation, and amortization
(EBITDA) scaled by the book value of assets
Property, Plant, and Equipment (PPE) scaled by the book value
of assets
Standard deviation of current and last four years’ EBITDA
DivPay
=1 if the firm pays dividend, and zero otherwise
Size
Logarithm of the book value of assets
Age
No. of years a firm is in Compustat database
Market-to-Book
Investment
Market value of assets to book value of assets. Market value is
calculated as the Market capitalization at the fiscal year-end plus
short- and long-term liabilities plus book value of preferred stocks
minus deferred taxes and investment tax credits.
(CAPEX+R&D)/Assets
CAPEX/PPE
Capital Expenditures scaled by PPE
Profitability
Tangibility
26
logFinCov
= log (1+ # of financial covenants)
logNWCov
=log(1+# of net worth covenants)
logSweep
=log(1+all other covenants)
logCapCov
= log (1+ # of capital covenants)
logPerfCov
=log(1+# of performance covenants)
SlackRank
Measure of covenant slack, increasing in covenant slack
(decreasing in tightness). Slack for the firm-year is calculated as
the sum of slacks across all individual loan covenants. Slack for
individual covenant with a maximum accounting number/ratio is
calculated as follows: (Required – Actual) / Required, where
Required is the accounting number/ratio that has to be maintained
and actual is current accounting number/ratio from the financial
statement. For covenants that specify a minimum accounting
number/ratio, slack equals (Actual – Required) / Required. Since
loan covenants are heterogeneous, we take the rank of firm-year
slack (SlackRank). The rank is relative to the peers in SIC 3-digit
industry-year.
27
Table 1: Descriptive Statistics
Variable
N
Mean
Std. Dev
NegGrowthShocks
154773
0.06
0.24
CAPEX/Assets
154773
0.07
R&D/Assets
154773
EmpGrowth
Median
Min
Max
0
0
1
0.07
0.05
0.00
0.41
0.04
0.08
0.00
0.00
0.50
144731
0.10
0.38
0.03
-0.62
2.33
SaleGrowth
153871
0.25
0.70
0.11
-0.65
5.15
Leverage – Book
154773
0.25
0.21
0.23
0.00
0.92
Leverage – Market
154773
0.27
0.25
0.21
0.00
0.90
Long-Term Book Lev
154773
0.19
0.18
0.15
0.00
0.79
Long-Term Market Lev
154773
0.20
0.21
0.13
0.00
0.80
Convertible Bond - Book
154773
0.02
0.06
0.00
0.00
0.38
Convertible Bond – Market
154773
0.02
0.05
0
0
0.32
LogSale
154773
4.62
2.18
4.60
-1.41
9.67
Profitability
154773
0.08
0.20
0.12
-0.94
0.41
Tangibility
154773
0.32
0.24
0.26
0.01
0.92
CashFlowVol
154773
0.08
0.12
0.04
0.00
0.83
DivPay
154773
0.40
0.49
0
0
1
Assets
154773
867.09
2704.83
89.61
1.79
19956
Age
154773
15.53
11.80
12
2
59
Market-to-Book
154773
1.56
1.57
1.03
0.28
10.15
Investment
154773
0.11
0.11
0.08
0
0.62
CAPEX/PPE
154773
0.27
0.21
0.21
0
1
Note: The table reports summary statistics for the empirical analyses. The sample period ranges
from 1967 to 2008. All COMPUSTAT firms (excluding financials and utilities, firms located
outside the U.S., and firm-years with missing sales and book value of assets) are included in the
sample. All continuous variables, with the exception of Age, are winsorized at the 1% and 99%
levels. See the appendix for variable definitions.
28
Table 2: Exogenous Changes in Public Spending as Growth Shocks
(1)
(2)
(3)
Variables
CAPEX/Assets R&D/Assets
SaleGrowth
(4)
EmpGrowth
NegGrowthShocks
-0.00526***
(-5.341)
-0.00163***
(-2.634)
-0.0190**
(-2.350)
-0.0132***
(-2.641)
LogSale
-0.00157**
(-2.381)
0.0209***
(10.06)
0.184***
(47.60)
-0.0490***
(-8.139)
0.0199***
(5.885)
0.00617***
(7.640)
0.000767
(1.171)
-0.000272***
(-4.321)
0.0142***
(20.90)
-0.123***
(-38.20)
0.0255***
(12.57)
-0.0371***
(-8.839)
0.00853*
(1.747)
0.00519***
(11.97)
-0.0206***
(-26.58)
0.000705***
(14.51)
0.0162
(1.465)
0.764***
(23.25)
-0.242***
(-7.741)
-0.0719
(-1.186)
1.148***
(17.64)
-0.0334***
(-5.645)
0.0380***
(3.632)
-0.0128***
(-21.14)
-0.146***
(-25.76)
0.558***
(39.17)
-0.135***
(-7.586)
-0.114***
(-3.273)
0.353***
(12.94)
-0.00107
(-0.259)
0.165***
(30.94)
-0.00836***
(-20.06)
Profitability
Tangibility
Ind Median
CashFlowVol
DivPay
Size
Age
Observations
154,773
154,773
153,871
144,731
Adjusted R-squared
0.547
0.832
0.262
0.191
Firm FE
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on investment and growth. The sample period ranges from 1967 to 2008. All
specifications are estimated using OLS regression. Test statistics (two-sided) based on robust
standard errors clustered at the firm level are reported in parenthesis. Asterisks ***, **, and *
indicate statistical significance at the 1%, 5%, and 10% level respectively. See the appendix for
variable definitions.
29
Table 3: The Effect of Exogenous Changes in Public Spending on Growth Options
(1)
(2)
(3)
Variables
Market-to-Book
Investment
CAPEX/PPE
NegGrowthShocks
-0.0782***
(-3.732)
-0.00697***
(-5.444)
-0.0123***
(-4.571)
LogSale
-0.113***
(-5.997)
1.173***
(14.98)
-0.413***
(-6.652)
-0.606***
(-4.555)
2.041***
(15.71)
0.170***
(10.70)
-0.190***
(-9.616)
-0.0141***
(-9.870)
0.0124***
(11.92)
-0.108***
(-25.01)
0.216***
(44.60)
-0.0882***
(-11.46)
0.0285***
(4.391)
0.0115***
(11.64)
-0.0202***
(-18.24)
0.000511***
(6.128)
-0.0268***
(-12.05)
0.163***
(22.34)
-0.184***
(-20.83)
-0.0830***
(-4.910)
0.120***
(9.153)
0.0164***
(7.482)
0.0201***
(9.204)
-0.00152***
(-8.191)
Profitability
Tangibility
Leverage – Ind Median
CashFlowVol
DivPay
Size
Age
Observations
154,773
154,773
154,773
Adjusted R-squared
0.559
0.655
0.434
Firm FE
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on proxies for growth options. The sample period ranges from 1967 to 2008.
All specifications are estimated using OLS regression. Test statistics (two-sided) based on robust
standard errors clustered at the firm level are reported in parenthesis. Asterisks ***, **, and *
indicate statistical significance at the 1%, 5%, and 10% level respectively. See the appendix for
variable definitions.
30
Table 4: Naïve OLS – Growth Options and Leverage
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑡𝑡+1
Variables
(1)
(2)
Market-to-Book
-0.00424***
(-6.421)
-0.0189***
(-31.22)
Investment
LogSale
Profitability
Tangibility
Ind Median
CashFlowVol
DivPay
Size
Age
𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑡𝑡+1
(3)
(4)
-0.0222**
(-2.114)
-0.00493**
(-2.059)
-0.158***
(-20.99)
0.182***
(17.18)
0.289***
(13.43)
0.0148
(1.088)
-0.0317***
(-10.72)
0.0378***
(14.43)
-0.00213***
(-8.606)
-0.00426*
(-1.785)
-0.165***
(-22.09)
0.189***
(17.22)
0.289***
(13.43)
0.00692
(0.508)
-0.0322***
(-10.90)
0.0382***
(14.53)
-0.00212***
(-8.574)
-0.157***
(-14.78)
0.000277
(0.126)
-0.220***
(-31.03)
0.165***
(14.85)
0.306***
(20.94)
-0.00972
(-0.832)
-0.0484***
(-14.69)
0.0564***
(22.01)
-0.000335
(-1.203)
0.00398*
(1.774)
-0.260***
(-33.85)
0.207***
(17.82)
0.316***
(21.31)
-0.0430***
(-3.593)
-0.0498***
(-14.94)
0.0571***
(21.75)
-0.000268
(-0.951)
Observations
139,099
139,099
139,099
139,099
Adjusted R-squared
0.647
0.646
0.685
0.680
Firm FE
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Note: The table reports estimates for the association between growth options proxies and firm
leverage. The sample period ranges from 1967 to 2008. All specifications are estimated using OLS
regression. Test statistics (two-sided) based on robust standard errors clustered at the firm level
are reported in parenthesis. Asterisks ***, **, and * indicate statistical significance at the 1%, 5%,
and 10% level respectively. See the appendix for variable definitions.
31
Table 5: Exogenous Shocks to Growth Options and Leverage
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑡𝑡+1
Variables
NegGrowthShocks
Market-to-Book
Investment
LogSale
Profitability
Tangibility
Ind Median
CashFlowVol
DivPay
Size
Age
Reduced
Form
(1)
2SLS 2nd Stage
(2)
(3)
-0.00571*
(-1.763)
𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑡𝑡+1
Reduced
Form
(4)
2SLS 2nd Stage
(5)
(6)
0.00146
(0.392)
0.0777*
(1.692)
-0.0192
(-0.420)
0.880*
(1.773)
-0.00455*
0.00263
-0.0159**
0.00189
(-1.911)
(0.529)
(-2.328)
(0.842)
-0.163***
-0.256***
-0.0675
-0.243***
(-22.09)
(-4.564)
(-1.240)
(-31.93)
0.184***
0.214***
-0.0110
0.172***
(17.35)
(10.15)
(-0.0996)
(15.16)
0.291***
0.337***
0.369***
0.332***
(13.56)
(9.445)
(7.482)
(22.38)
0.00622
-0.145
-0.0153
-0.0467***
(0.456)
(-1.583)
(-0.801)
(-3.855)
-0.0325*** -0.0460*** -0.0426*** -0.0515***
(-11.03)
(-5.371)
(-6.645)
(-15.43)
0.0386***
0.0547***
0.0568***
0.0604***
(14.82)
(5.402)
(5.295)
(23.31)
-0.00212*** -0.00213*** -0.00247*** -0.000347
(-8.565)
(-8.103)
(-7.679)
(-1.225)
-0.219
(-0.416)
0.000260
(0.0579)
-0.220***
(-4.040)
0.165***
(8.526)
0.306***
(4.783)
-0.00932
(-0.104)
-0.0483***
(-5.817)
0.0563***
(5.641)
-0.000335
(-1.259)
0.00482
(0.662)
-0.267***
(-4.522)
0.221*
(1.872)
0.310***
(5.710)
-0.0415**
(-2.434)
-0.0491***
(-7.360)
0.0558***
(4.872)
-0.000238
(-0.638)
Observations
139,099
139,099
139,099
139,099
139,099
139,099
Adjusted R-squared
0.646
0.03
0.03
0.679
0.26
0.24
Firm FE
Yes
Yes
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Yes
Yes
AP F-Stat
13.67
28.34
14.02
28.36
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on firm leverage. The sample period ranges from 1967 to 2008. Columns (1)
and (4) use OLS regression while Columns (2)-(3) and (5)-(6) use 2SLS regression. Test statistics
(two-sided) based on robust standard errors clustered at the firm level are reported in parenthesis.
Asterisks ***, **, and * indicate statistical significance at the 1%, 5%, and 10% level respectively.
See the appendix for variable definitions and Table 3 for corresponding 2SLS 1st stage estimates.
Angrist-Pischke (AP) F-test generates cluster-robust F-statistics for the null hypothesis that the
instrument is weak.
32
Table 6: Reduced Form - Growth Options, Long-Term Leverage and Convertible Bonds
Long-Term Leverage
Convertible Bonds
Maturity Substitution
Variables
(1)
(2)
(3)
(4)
(5)
(6)
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝑡𝑡+1
𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑡𝑡+1
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝑡𝑡+1
𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑡𝑡+1 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷5𝑆𝑆ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑡𝑡+1 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷3𝑆𝑆ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑡𝑡+1
NegGrowthShocks
LogSale
Profitability
Tangibility
Ind Median
CashFlowVol
DivPay
Size
Age
-0.00263
(-0.933)
0.00364
(1.109)
-0.000583
(-0.502)
0.000328
(0.308)
0.00600
(0.695)
0.00607
(0.690)
-0.0137***
(-6.854)
-0.0766***
(-12.64)
0.171***
(18.93)
0.223***
(9.163)
0.0182*
(1.693)
-0.0259***
(-9.786)
0.0422***
(19.26)
-0.00153***
(-7.315)
-0.00842***
(-4.447)
-0.137***
(-23.27)
0.169***
(17.44)
0.236***
(14.65)
-0.0115
(-1.215)
-0.0397***
(-13.42)
0.0577***
(26.36)
-0.000184
(-0.762)
-0.00136
(-1.539)
-0.0305***
(-11.23)
0.00234
(0.740)
-0.00370
(-0.536)
0.00869*
(1.703)
-0.00493***
(-4.677)
0.00861***
(8.918)
-0.000168**
(-2.219)
-0.000362
(-0.542)
-0.0274***
(-13.30)
0.000689
(0.248)
0.00533
(1.331)
0.00433
(1.168)
-0.00611***
(-5.921)
0.00887***
(11.74)
-0.000105
(-1.473)
-0.0275***
(-4.965)
-0.0171
(-0.886)
0.0667***
(2.723)
0.117***
(2.633)
0.0602
(1.348)
-0.0130*
(-1.772)
-0.0133**
(-2.224)
-0.000613
(-1.049)
-0.0280***
(-4.922)
-0.0318
(-1.617)
0.0884***
(3.566)
0.148***
(3.266)
0.0767*
(1.688)
-0.0177**
(-2.373)
-0.00764
(-1.248)
0.000397
(0.670)
Observations
139,099
139,099
139,099
139,099
130,579
130,579
Adjusted R-sq
0.629
0.653
0.428
0.445
0.221
0.226
Firm FE
Yes
Yes
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on long-term leverage, convertible bond and debt maturity. The sample period
ranges from 1967 to 2008. All specifications are estimated using OLS regression. Test statistics
(two-sided) based on robust standard errors clustered at the firm level are reported in parenthesis.
Asterisks ***, **, and * indicate statistical significance at the 1%, 5%, and 10% level respectively.
See the appendix for variable definitions.
33
Table 7: Public Debt Issuance and Covenants
Public Debt Issuance
(1)
(2)
Variables
𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑡𝑡+1
𝑙𝑙𝑙𝑙𝑙𝑙#𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑡𝑡+1
NegGrowthShocks
LogSale
Profitability
Tangibility
Leverage (Book)
CashFlowVol
DivPay
Size
Age
(3)
𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡+1
(4)
𝑙𝑙𝑙𝑙𝑙𝑙#𝐶𝐶𝐶𝐶𝐶𝐶𝑡𝑡+1
-0.00331
(-0.222)
0.0374
(0.874)
-0.413***
(-5.530)
0.437***
(9.086)
0.206*
(1.809)
-0.0478**
(-2.149)
0.126***
(7.332)
0.0550***
(29.75)
-0.000861
(-0.129)
-0.000550
(-0.0589)
-0.00313
(-0.357)
-0.00266
(-0.678)
0.0443***
(3.675)
0.0135
(0.749)
-0.00775
(-0.676)
0.0818***
(2.775)
-0.00379
(-0.738)
0.0253***
(5.734)
0.00386***
(8.773)
-0.00437
(-0.826)
0.0443***
(2.824)
-0.0487*
(-1.914)
0.00662
(0.399)
0.0555
(1.363)
-0.00127
(-0.178)
0.0280***
(4.648)
0.00551***
(9.332)
-0.000492
(-0.107)
-0.00115
(-0.0840)
-0.0784***
(-3.467)
0.119***
(7.914)
0.0542
(1.459)
-0.00423
(-0.627)
0.0439***
(8.385)
0.0158***
(29.58)
-0.0225
(-0.810)
Observations
130,452
130,452
130,452
130,452
Adjusted R-squared
0.345
0.416
0.707
0.767
Firm FE
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on firm’s likelihood (frequency) of issuing public corporate bonds and the
number of covenants associated with those issues. The sample period ranges from 1967 to 2008.
All specifications are estimated using OLS regression. Test statistics (two-sided) are reported in
parenthesis. Asterisks ***, **, and * indicate statistical significance at the 1%, 5%, and 10% level
respectively. See the appendix for variable definitions.
34
Table 8: Growth Shocks for the Reduced Sample (1982-2008)
(1)
(2)
(3)
Variables
CAPEX/Assets
R&D/Assets
Investment
(4)
Market-to-Book
NegGrowthShocks
-0.00487***
(-4.776)
-0.00175**
(-2.334)
-0.00658***
(-4.671)
-0.0638***
(-2.686)
LogSale
-0.000254
(-0.367)
0.00601***
(2.835)
0.188***
(45.31)
-0.0277***
(-14.83)
0.00573
(1.150)
0.00375***
(3.990)
0.00168**
(2.355)
-0.00113***
(-16.29)
0.0132***
(17.08)
-0.127***
(-35.20)
0.0297***
(11.54)
-0.0112***
(-5.810)
0.0255***
(3.912)
0.00435***
(7.695)
-0.0211***
(-23.46)
0.000694***
(10.87)
0.0132***
(11.54)
-0.129***
(-27.71)
0.224***
(42.40)
-0.0397***
(-13.52)
0.0342***
(3.805)
0.00808***
(6.871)
-0.0202***
(-16.12)
-0.000360***
(-3.547)
-0.0617***
(-2.885)
0.933***
(10.93)
-0.280***
(-3.833)
-0.323***
(-6.171)
2.037***
(11.72)
0.154***
(7.613)
-0.256***
(-11.45)
-0.00989***
(-6.146)
Profitability
Tangibility
Leverage - Ind Median
CashFlowVol
DivPay
Size
Age
Observations
109,023
109,023
109,023
108,279
Adjusted R-squared
0.561
0.844
0.690
0.560
Firm FE
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on proxies for growth options. The sample period ranges from 1982 to 2008.
All specifications are estimated using OLS regression. Test statistics (two-sided) based on robust
standard errors clustered at the firm level are reported in parenthesis. Asterisks ***, **, and *
indicate statistical significance at the 1%, 5%, and 10% level respectively. See the appendix for
variable definitions.
35
Table 9: Growth Shocks and Private Debt Covenants
(1)
(2)
(3)
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
Variables
𝑡𝑡+1
𝑡𝑡+1
𝑡𝑡+1
NegGrowthShocks
-0.0412***
(-2.640)
-0.0305**
(-2.289)
-0.0395*
(-1.915)
LogSale
0.0304***
(3.955)
0.0499**
(2.272)
-0.0906**
(-2.060)
0.301***
(10.03)
-0.100*
(-1.804)
-0.139***
(-8.416)
0.0832***
(8.286)
0.0292***
(25.23)
0.0256***
(4.598)
0.00283
(0.175)
0.0564*
(1.698)
0.0806***
(3.694)
-0.154***
(-3.630)
-0.0506***
(-3.866)
0.0349***
(4.926)
0.00598***
(7.335)
0.0340***
(3.727)
-0.0436*
(-1.672)
-0.138**
(-2.476)
0.348***
(9.470)
-0.0223
(-0.353)
-0.204***
(-9.513)
0.111***
(9.415)
0.0322***
(22.71)
Profitability
Tangibility
Leverage (Book)
CashFlowVol
DivPay
Size
Age
Observations
95,468
95,468
95,468
Adjusted R-squared
0.645
0.509
0.672
Firm FE
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on firm’s use of private debt covenants. The sample period ranges from 1982
to 2008. All specifications are estimated using OLS regression. Test statistics (two-sided) are
reported in parenthesis. Asterisks ***, **, and * indicate statistical significance at the 1%, 5%,
and 10% level respectively. See the appendix for variable definitions.
36
Table 10: Growth Shocks and Private Debt Covenants - Disaggregation of Covenants
(1)
(2)
(3)
(4)
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙
𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆
Variables
𝑡𝑡+1
𝑡𝑡+1
𝑡𝑡+1
𝑡𝑡+1
NegGrowthShocks
-0.0337***
(-3.021)
-0.0187**
(-2.076)
-0.0036***
(-3.164)
0.0164***
(2.716)
LogSale
0.0300***
(5.555)
-0.0367**
(-2.480)
0.0254
(0.852)
0.303***
(4.703)
-0.101***
(-2.635)
-0.0368***
(-3.298)
0.0337***
(5.009)
0.0154***
(18.77)
0.0144***
(3.063)
-0.0228*
(-1.824)
-0.0464*
(-1.789)
0.262***
(4.694)
0.0159
(0.532)
-0.0866***
(-8.616)
0.0594***
(9.555)
0.0195***
(25.53)
-0.000241
(-0.629)
0.000507
(0.279)
0.000255
(0.130)
0.0102*
(1.780)
0.00413
(1.412)
-0.00276*
(-1.664)
0.000919
(1.212)
2.47e-06
(0.0292)
-0.00891***
(-2.977)
0.0155*
(1.829)
-0.00817
(-0.505)
-0.252***
(-7.029)
0.0202
(0.938)
0.0420***
(7.317)
-0.0270***
(-7.388)
-0.0171***
(-37.37)
Profitability
Tangibility
Leverage (Book)
CashFlowVol
DivPay
Size
Age
Observations
95,648
95,648
95,648
95,648
Adjusted R-squared
0.593
0.618
0.427
0.639
Firm FE
Yes
Yes
Yes
Yes
Year FE
Yes
Yes
Yes
Yes
Note: The table reports estimates for the effect of adverse shocks to firm growth options
(NegGrowthShocks) on firm’s use of private debt covenants. The sample period ranges from 1982
to 2008. All specifications are estimated using OLS regression. Test statistics (two-sided) are
reported in parenthesis. Asterisks ***, **, and * indicate statistical significance at the 1%, 5%,
and 10% level respectively. See the appendix for variable definitions.
37