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<a href=International Review of Financial Analysis 25 (2012) 28 63 Contents lists available at SciVerse ScienceDirect International Review of Financial Analysis Credit market conditions and the impact of access to the public debt market on corporate leverage ☆ Amrit Judge, Anna Korzhenitskaya ⁎ Economics and Statistics Department, Middlesex University Business School, The Burroughs, Hendon, London NW4 4BT, UK article info Available online 2 October 2012 JEL classi fi cation: G3 G32 Keywords: Capital structure Credit ratings Bond market access Financial crisis abstract This study examines the role played by credit ratings in explaining corporate capital structure choice during a period characterised by a major adverse loan supply shock. Recent literature has argued that supply-side factors are potentially as important as demand-side forces in determining corporate leverage. This is based on the pre- mise that debt markets are segmented and that those fi rms that have access to the private debt markets do not necessarily have access to the public debt markets. The question of access to debt fi nance has become a major issue for public policy makers in several developed economies during the 2007 – 2009 fi nancial crisis. The UK economy has been subjected to a period of severe tightening of credit market conditions resulting in a signi fi cant reduction in the availability of bank credit to the corporate sector. An important question is whether the contrac- tion in the fl ow of bank credit to fi rms has affected fi rms equally or whether fi rms with access to alternative sources of debt fi nance have been able to mitigate the effect of adverse changes to the cost and availability of bank credit. To investigate this issue, this study employs data over a 20 year period that includes two recessions and three noticeable periods of credit market tightening. Despite the fact that a severe recession has accompa- nied the 2007 – 2009 fi nancial crisis we argue that the underlying forces driving the weakness in bank lending to the corporate sector are mainly supply side rather than demand side factors. In this study we use the posses- sion of a credit rating as an indicator of access to the public debt markets. Our results provide support for the notion that having a rating is associated with higher leverage ratios, even after controlling for demand-side lever- age determinants and macroeconomic conditions. More importantly, the study fi nds that the impact on leverage of having a credit rating varies over our sample period with the effect being greatest in those years when credit market conditions were tightest. The results are robust to the use of an alternative measure for public debt market access, different proxies for measuring the tightness of the credit markets, alternative econometric speci fi cations and various sub-periods within our overall sample period. © 2012 Elsevier Inc. All rights reserved. 1. Introduction The seminal work of Modigliani and Miller (1958) assumes that in the absence of market imperfections supply of capital is perfectly elastic and capital structure decision of a fi rm depends entirely on its demand-side considerations ( Lemmon & Roberts, 2007 ). The key assumption is that fi rms can borrow as much as they wish at the same cost of capital and a fi rm's capital structure is purely a function ☆ We are very grateful to Standard and Poor's and Fitch Ratings for providing us with credit rating data. Thanks also to Ian Byrne, Bridget Gandy, John Grout, John Redwood and Ian Stewart for useful comments and suggestions. We thank seminar participants at the University of Santiago de Compostella, University of Porto, ISCTE Business School, Standard and Poor's, Joint Seminar at the Department for Business, Innovation and Skills and HM Treasury, GdRE Symposium on Money, Banking and Finance at Read- ing University, Money Macro and Finance Research Group 43rd Annual International Conference at the University of Birmingham, European Conference on Banking and the Economy at the University of Southampton, and Middlesex University for helpful comments and suggestions. The usual disclaimer applies. ⁎ Corresponding author. E-mail address: A.Korzhenitskaya@mdx.ac.uk (A. Korzhenitskaya). 1057-5219/$ – see front matter © 2012 Elsevier Inc. All rights reserved. http://dx.doi.org/10.1016/j.irfa.2012.09.003 of fi rm's characteristics, such as, size, pro fi tability, asset tangibility, and growth opportunities, that in fl uence its demand for debt. In the real world market frictions, such as information asymmetry, imply that the supply of capital is inelastic and fi rms can be rationed by their lenders in terms of both pricing and debt availability. Most of the previous empirical literature concentrates on the demand-side determinants of capital structure while paying little attention to the supply of capital (see Frank & Goyal, 2007; Rajan & Zingales, 1995 ). Recently researchers have recognised the importance of the supply- side factors as a potential driver of the capital structure decision. For example, Faulkender and Petersen (2006) argue that in the presence of information asymmetry fi rms that can access the public debt capital markets face less fi nancial constraints and are able to borrow more. Conversely, they suggest that fi rms that desire to raise funds but are constrained by lack of access to capital markets might be signi fi cantly under-levered. The importance of supply side factors has come to the fore since the onset of the current fi nancial crisis in the latter half of 2007. During the last three years, banks have attempted to repair their balance sheets " id="pdf-obj-0-7" src="pdf-obj-0-7.jpg">

Contents lists available at SciVerse ScienceDirect

International Review of Financial Analysis

<a href=International Review of Financial Analysis 25 (2012) 28 63 Contents lists available at SciVerse ScienceDirect International Review of Financial Analysis Credit market conditions and the impact of access to the public debt market on corporate leverage ☆ Amrit Judge, Anna Korzhenitskaya ⁎ Economics and Statistics Department, Middlesex University Business School, The Burroughs, Hendon, London NW4 4BT, UK article info Available online 2 October 2012 JEL classi fi cation: G3 G32 Keywords: Capital structure Credit ratings Bond market access Financial crisis abstract This study examines the role played by credit ratings in explaining corporate capital structure choice during a period characterised by a major adverse loan supply shock. Recent literature has argued that supply-side factors are potentially as important as demand-side forces in determining corporate leverage. This is based on the pre- mise that debt markets are segmented and that those fi rms that have access to the private debt markets do not necessarily have access to the public debt markets. The question of access to debt fi nance has become a major issue for public policy makers in several developed economies during the 2007 – 2009 fi nancial crisis. The UK economy has been subjected to a period of severe tightening of credit market conditions resulting in a signi fi cant reduction in the availability of bank credit to the corporate sector. An important question is whether the contrac- tion in the fl ow of bank credit to fi rms has affected fi rms equally or whether fi rms with access to alternative sources of debt fi nance have been able to mitigate the effect of adverse changes to the cost and availability of bank credit. To investigate this issue, this study employs data over a 20 year period that includes two recessions and three noticeable periods of credit market tightening. Despite the fact that a severe recession has accompa- nied the 2007 – 2009 fi nancial crisis we argue that the underlying forces driving the weakness in bank lending to the corporate sector are mainly supply side rather than demand side factors. In this study we use the posses- sion of a credit rating as an indicator of access to the public debt markets. Our results provide support for the notion that having a rating is associated with higher leverage ratios, even after controlling for demand-side lever- age determinants and macroeconomic conditions. More importantly, the study fi nds that the impact on leverage of having a credit rating varies over our sample period with the effect being greatest in those years when credit market conditions were tightest. The results are robust to the use of an alternative measure for public debt market access, different proxies for measuring the tightness of the credit markets, alternative econometric speci fi cations and various sub-periods within our overall sample period. © 2012 Elsevier Inc. All rights reserved. 1. Introduction The seminal work of Modigliani and Miller (1958) assumes that in the absence of market imperfections supply of capital is perfectly elastic and capital structure decision of a fi rm depends entirely on its demand-side considerations ( Lemmon & Roberts, 2007 ). The key assumption is that fi rms can borrow as much as they wish at the same cost of capital and a fi rm's capital structure is purely a function ☆ We are very grateful to Standard and Poor's and Fitch Ratings for providing us with credit rating data. Thanks also to Ian Byrne, Bridget Gandy, John Grout, John Redwood and Ian Stewart for useful comments and suggestions. We thank seminar participants at the University of Santiago de Compostella, University of Porto, ISCTE Business School, Standard and Poor's, Joint Seminar at the Department for Business, Innovation and Skills and HM Treasury, GdRE Symposium on Money, Banking and Finance at Read- ing University, Money Macro and Finance Research Group 43rd Annual International Conference at the University of Birmingham, European Conference on Banking and the Economy at the University of Southampton, and Middlesex University for helpful comments and suggestions. The usual disclaimer applies. ⁎ Corresponding author. E-mail address: A.Korzhenitskaya@mdx.ac.uk (A. Korzhenitskaya). 1057-5219/$ – see front matter © 2012 Elsevier Inc. All rights reserved. http://dx.doi.org/10.1016/j.irfa.2012.09.003 of fi rm's characteristics, such as, size, pro fi tability, asset tangibility, and growth opportunities, that in fl uence its demand for debt. In the real world market frictions, such as information asymmetry, imply that the supply of capital is inelastic and fi rms can be rationed by their lenders in terms of both pricing and debt availability. Most of the previous empirical literature concentrates on the demand-side determinants of capital structure while paying little attention to the supply of capital (see Frank & Goyal, 2007; Rajan & Zingales, 1995 ). Recently researchers have recognised the importance of the supply- side factors as a potential driver of the capital structure decision. For example, Faulkender and Petersen (2006) argue that in the presence of information asymmetry fi rms that can access the public debt capital markets face less fi nancial constraints and are able to borrow more. Conversely, they suggest that fi rms that desire to raise funds but are constrained by lack of access to capital markets might be signi fi cantly under-levered. The importance of supply side factors has come to the fore since the onset of the current fi nancial crisis in the latter half of 2007. During the last three years, banks have attempted to repair their balance sheets " id="pdf-obj-0-15" src="pdf-obj-0-15.jpg">

Credit market conditions and the impact of access to the public debt market on corporate leverage

Amrit Judge, Anna Korzhenitskaya

Economics and Statistics Department, Middlesex University Business School, The Burroughs, Hendon, London NW4 4BT, UK

article info

Available online 2 October 2012

JEL classication:

G3

G32

Keywords:

Capital structure Credit ratings Bond market access Financial crisis

abstract

This study examines the role played by credit ratings in explaining corporate capital structure choice during a

period characterised by a major adverse loan supply shock. Recent literature has argued that supply-side factors are potentially as important as demand-side forces in determining corporate leverage. This is based on the pre- mise that debt markets are segmented and that those rms that have access to the private debt markets do not necessarily have access to the public debt markets. The question of access to debt nance has become a major issue for public policy makers in several developed economies during the 20072009 nancial crisis. The UK economy has been subjected to a period of severe tightening of credit market conditions resulting in a signicant reduction in the availability of bank credit to the corporate sector. An important question is whether the contrac- tion in the ow of bank credit to rms has affected rms equally or whether rms with access to alternative sources of debt nance have been able to mitigate the effect of adverse changes to the cost and availability of bank credit. To investigate this issue, this study employs data over a 20 year period that includes two recessions and three noticeable periods of credit market tightening. Despite the fact that a severe recession has accompa- nied the 20072009 nancial crisis we argue that the underlying forces driving the weakness in bank lending to the corporate sector are mainly supply side rather than demand side factors. In this study we use the posses- sion of a credit rating as an indicator of access to the public debt markets. Our results provide support for the notion that having a rating is associated with higher leverage ratios, even after controlling for demand-side lever- age determinants and macroeconomic conditions. More importantly, the study nds that the impact on leverage of having a credit rating varies over our sample period with the effect being greatest in those years when credit market conditions were tightest. The results are robust to the use of an alternative measure for public debt market access, different proxies for measuring the tightness of the credit markets, alternative econometric specications and various sub-periods within our overall sample period. © 2012 Elsevier Inc. All rights reserved.

1. Introduction

The seminal work of Modigliani and Miller (1958) assumes that in the absence of market imperfections supply of capital is perfectly elastic and capital structure decision of a rm depends entirely on its demand-side considerations (Lemmon & Roberts, 2007). The key assumption is that rms can borrow as much as they wish at the same cost of capital and a rm's capital structure is purely a function

We are very grateful to Standard and Poor's and Fitch Ratings for providing us with credit rating data. Thanks also to Ian Byrne, Bridget Gandy, John Grout, John Redwood and Ian Stewart for useful comments and suggestions. We thank seminar participants at the University of Santiago de Compostella, University of Porto, ISCTE Business School, Standard and Poor's, Joint Seminar at the Department for Business, Innovation and Skills and HM Treasury, GdRE Symposium on Money, Banking and Finance at Read- ing University, Money Macro and Finance Research Group 43rd Annual International Conference at the University of Birmingham, European Conference on Banking and the Economy at the University of Southampton, and Middlesex University for helpful comments and suggestions. The usual disclaimer applies. Corresponding author. E-mail address: A.Korzhenitskaya@mdx.ac.uk (A. Korzhenitskaya).

1057-5219/$ see front matter © 2012 Elsevier Inc. All rights reserved.

of rm's characteristics, such as, size, protability, asset tangibility, and growth opportunities, that inuence its demand for debt. In the real world market frictions, such as information asymmetry, imply that the supply of capital is inelastic and rms can be rationed by their lenders in terms of both pricing and debt availability. Most of the previous empirical literature concentrates on the demand-side determinants of capital structure while paying little attention to the supply of capital (see Frank & Goyal, 2007; Rajan & Zingales, 1995). Recently researchers have recognised the importance of the supply- side factors as a potential driver of the capital structure decision. For example, Faulkender and Petersen (2006) argue that in the presence of information asymmetry rms that can access the public debt capital markets face less nancial constraints and are able to borrow more. Conversely, they suggest that rms that desire to raise funds but are constrained by lack of access to capital markets might be signicantly under-levered. The importance of supply side factors has come to the fore since the onset of the current nancial crisis in the latter half of 2007. During the last three years, banks have attempted to repair their balance sheets

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

29

12 10 8 6 4 % 2 0 -2 -4 -6 -8 Annual Real GDP Growth
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Fig. 1. Real GDP growth 19622010.

and consequently have signicantly cut back on their lending commit- ments to the corporate sector. 1 The Bank of England's (BOE) credit conditions surveys have reported that between the fourth quarter of 2007 through to the end of 2008 nancial market turbulence reduced signicantly UK banks' capacity to extend credit to the corporate sector. 2 The credit conditions surveys report that during this period there was a signicant tightening of price and non-price terms on loans to the corporate sector. Banks widened their spreads and raised the fees and commissions they charged on loans to rms. In addition banks imposed stricter covenants, raised collateral requirements and reduced maximum credit lines. This has made raising bank loan nance extremely difcult for creditworthy rms since the fourth quarter of 2007 and consequently has limited the availability of debt-based nance for rms that are heavily reliant on banks for their debt capital. Post the nancial crisis the future level of bank lending could be subject to greater restrictions as the new Basel capital requirements, which will more than double the core Tier 1 capital ratio from 2% to 4.5%, come into force. Some have argued that the Basel guidelines do not go far enough. For example, David Miles, an external member of the Bank of England monetary policy committee, has suggested a target capital ratio of between 15 and 20% (Mallaby, 2011). Kernan, Wade, and Watters (2010) argue that the forthcoming Basel III requirements will increase the amount of capital banks need to hold to support their corporate lending operations which will hike lending costs and lead to a reduction in lending capacity within the banking system. They anticipate that this will be likely to result in a longer term structural impetus for rising bond issuance over bank loans(Kernan et al., 2010, page 9). The drying up of the ow of bank credit could have serious conse- quences for the UK economy's ability to pull itself out of recession and therefore prolonging the economic downturn slowing down economic recovery. The problem is potentially more acute in the UK because banks have traditionally been the main source of capital for the private sector with 76% of debt being currently provided by banks (Kernan et al., 2010). The situation is however likely to change according to Kernan et al. (2010) who point out that since the events of September 2008, corporate bond issuance by U.K. businesses with a credit rating had increased by £22.1 billion, while U.K. nancial institutions have reduced their net lending (both in sterling and foreign currencies) to U.K. companies by £59.1 billion. Kernan et al. (2010) suggest that this makes corporate bond issuance the main provider of new debt

  • 1 Balance sheet repairs may also take the form of injection of new equity capital and selling assets.

    • 2 See Bank of England, 2007a,b and 2008a,b,c,d Credit Conditions Survey.

nancing on a net basis since the third-quarter of 2008. Bacon, Grout, and O'Donovan (2009) survey chief nancial ofcers and treasurers of UK rms and nd that the possession of a credit rating and the resulting access to public debt markets it offers has become especially important during the 20072009 nancial crisis. Recent trends in lending data from the Bank of England (2009d) points to rated rms raising capital market debt to pay back bank loans and issuing bonds rather accessing new bank loan facilities. The BOE suggest that access to the debt capital markets has enabled rated rms to mitigate the impact of a shortening in the maturity of bank lending available since the onset of the nancial crisis(Bank of England, 2009d). The BOE in its August 2009 Trends in Lending report suggested that while companies with bond market access had turned to arm's length sources of nance, smaller businesses without access still remained severely nancially constrained. Bacon et al. (2009) report that many rms that did not have a rating during the crisis were seeking to obtain one. A credit rating by providing access to the public debt markets can offer considerable benets to a rm. Not only does it widen the investor base and improves debt pricing but also provides an opportunity to enter foreign bond markets and gain international visibility, thereby reducing the reliance on local banks. Faulkender and Petersen (2006), Mitto and Zhang (2008), Kisgen (2009) nd that companies with a rat- ing have access to broader sources of debt nance, and as a result have higher leverage ratios compared to unrated rms. There is also evidence that rated companies suffer less during adverse economic conditions. For example, Chava and Purnanandam (2009) nd that in the US, bank-dependent rms suffered larger valuation losses and greater sub- sequent decline in their capital expenditure during and after the Rus- sian crisis of 1998 as compared to their rated counterparts. Similarly, Campello, Giambona, Graham, and Harvey (2009a) nd that the major- ity of US rms have been adversely affected by the 2008 credit supply shock but the impact has been greatest for nancially constrained rms. Adverse economic conditions and distortions in the supply of capital can severely affect rms' leverage and especially those rms that do not have access to alternative sources of nance, such as the public debt markets. The last two decades provide periods when the macroeco- nomic environment was stable and turbulent together with periods that experienced signicant movements in credit market conditions. This study investigates the role played by access to public debt markets over a twenty year period during which there were three episodes of credit market tightening with the most recent being the severest. Signicantly, the second of these periods (20002003) of tight credit was not associated with an economic downturn whereas the rst (19911992) and the third period (20072009) were. Although we

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A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

Net Monthly Flows (millions)

50 40 30 20 10 0 -10 -20 -30 Nominal Real Annual Real GDP Growth Percentage
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Source: Bank of England and Office for National Statistics

Fig. 2. Sterling lending to UK PNFCs year-on-year growth 19642010.

demonstrate that the recent weakness in bank lending is largely supply driven this additional fact helps to further downplay any potential effects of credit demand on our results. During the 20072009 crisis we have witnessed the largest reduc- tion of bank lending to the UK corporate sector in recent economic his- tory. At the peak of the nancial crisis several major banks experienced nancial distress resulting in a severe lack of liquidity in the banking system forcing all banks to change considerably the terms of their lending to the corporate sector. Commitment fees and interest spreads went up, while debt maturities went down. The nancial crisis there- fore provides a very unique opportunity to investigate the role of access to public debt markets in determining rms' leverage during a period of reduced bank loan supply. To the best of our knowledge, this study is the rst to investigate the impact of access to public bond markets on corporate leverage during a period characterised by a major tightening in credit market conditions in a UK context. The remainder of the paper is organised as follows. Section 2 pre- sents an overview of the literature on credit market conditions and capital structure. Section 3 presents an analysis of the conditions of the UK credit markets between 1998 and 2010. In this section we also examine whether the weakness in bank lending during the nancial

20000

15000

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-5000

-10000

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Source: Bank of England

crisis reects a reduction in the supply of credit or weaker demand for funds from rms as their investment opportunities have dried up during the recession. We present a robust analysis of the underlying forces driving the reduction in the ow of credit to the corporate sector. Section 4 describes the rating characteristics of our sample. Sections 5 and 6 present our empirical analysis and the results from robustness tests, respectively. Finally, Section 7 concludes.

2. Access to public debt markets, credit market conditions and capital structure: overview of the empirical literature

Following Modigliani and Miller (1958) theorem three competing theories emerged that attempt to explain what determines capital structure choice (Cole, 2008): the trade-off theory, pecking order theory, and market timing theory. Under the trade-off theory of capital structure, a rm chooses its leverage ratio by balancing the costs and benets of using debt. The primary gains of debt are the tax-shields, which arise from the deductibility of interest on debt on the prot and loss account, whereas, the costs of debt are principally direct and indirect nancial distress costs (Frydenberg, 2011). Cole (2008) points out that the trade-off theory is often set up as a competitor theory to the pecking

0

Net Monthly Flows (millions) 01-Jan-98 01-Aug-98 01-Mar-99 01-Oct-99 01-May-00 01-Dec-00 01-Jul-01 01-Feb-02 01-Sep-02 01-Apr-03 01-Nov-03 01-Jun-04
Net Monthly Flows (millions)
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Fig. 3. Net monthly ow of lending to UK rms.

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

31

40 3 month growth 30 rate 20 10 12 month growth rate 0 -10 -20 12
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Source: Bank of England

Fig. 4. Growth rate of monetary nancial institutions' loans to private non-nancial corporations.

order theory of capital structure (e.g. Frydenberg, 2011; Myers, 1984) Pecking order theory was introduced by Myers (1984) and Myers and Majluf (1984), which states that there is a nancing hierarchy of retained earnings, debt and then equity. Myers (1984) and Myers and Majluf (1984) argue that due to the information asymmetry between managers and investors, rms will use their retained earning whenever is possible, then issue bonds for external capital, and raise equity only as a last resort. Another theory that has gained prominence in recent capital structure literature is the market-timing theory. This theory, proposed by Baker and Wurgler (2002), argues that capital structure is the cumulative outcome of past attempts to time the market. 3 The theory suggests that managers issue equity when they believe it is overvalued (as measured by market-to-book ratio) and repurchase equity or issue debt when they believe it is undervalued, i.e. managers time the marketand make their nancing decisions according to favourable conditions in the debt or equity markets (Baker & Wurgler,

2002).

Each of these theories identies key factors in determining capital structure choice, such as rm size, tangibility, market-to-book and prof- itability, but according to Frank and Goyal (2007) neither of them can fully explain capital structure choice (Frank & Goyal, 2007). Frank and Goyal (2007) argue that currently there is no unied model of leverage available that can simultaneously account for all the stylised facts. They claim that different theories apply to rms under different circum- stances. Frydenberg (2011) in his overview of capital structure theories declares that capital structure is a too complex fabric to t into a single model. 4 Factors suggested by the capital structure theories and widely examined in the previous literature largely represent demand-side determinants of leverage. In the world with information asymmetry and loan supply frictions, rms can nd it difcult to raise the desired amount of debt and can be signicantly under-levered (Faulkender & Petersen, 2006). This issue becomes especially relevant during the periods when credit market conditions are tight and the supply of cap- ital becomes an important determinant of capital structure choice. Recently there has been a move in the empirical literature towards examining the link between credit market conditions and rms' capital structure decisions. Lemmon and Roberts (2007) explore the relation- ship between the loan supply shock of 1989 and rms' nancing deci- sions. Their ndings underline that even large rms with access to public debt market are affected by capital supply shocks. Chava and Purnanandam (2009) examine the shock to the US banking system during the Russian crisis of 1998 using full sample analysis and matching sample techniques. They nd that bank-dependent rms lost

  • 3 Baker and Wurgler (2002), p.23.

  • 4 Frydenberg (2011), p.25.

disproportionally higher market value and suffered larger declines in capital investments and growth rates following the crisis as compared to rms with access to the public debt market(Chava & Purnanandam, 2009, p.30). Leary (2009) in a study of the relevance of capital market supply frictions for corporate capital structure decisions following the 1966 credit crunch in the United States nds that larger rms with access to public debt market were less affected by contraction in bank loan supply due to their greater ability to substitute toward arm's length debt nancing. Leary (2009) nds that the use of bond debt by rms with access to public debt markets increased, relative to that of small, bank-dependent rms. As a result the leverage of bank-dependent rms signicantly declined compared to rms with access to public bond markets. By using rm size as a proxy for debt market access, he nds that following the 1966 loan supply contraction, leverage ratios of small, bank-dependent rms signicantly decreased relative to large rms with bond market access. When Leary (2009) expands his sample period to cover the 35 years from 1965 to 2000, he nds the leverage difference between rms with and without public debt market access becomes greater in periods of reduced loan supply and tighter credit markets. Voutsinas and Werner (2011) examine how - nancial constraints and uctuations in the supply of credit affect rm capital structure. They investigate the impact of asset bubble in the 1980s and the credit crunch of the late 1990s on corporate capital struc- ture decisions of publicly listed Japanese rms. They nd that both eventsthe asset bubble burst of the 1980s and the credit crunch in the 1990swere followed by severe reductions in leverage (total lever- age was reduced by 0.0239 when the bubble burst). Voutsinas and Werner (2011) conclude that uctuations in the supply of credit and changes in monetary conditions have a serious impact on rms' capital structures. During the Japanese credit crunch all rms experienced a severe reduction in their leverage levels, but especially smaller sized bank-dependent ones. The question of access has become a major issue since the latter half of 2007, when the banking systems around the world experienced major liquidity problems, resulting in a severe tightening of credit market conditions leading to signicant falls in lending to the corporate sector. Ivashina and Scharfstein (2009) indicate that in the US bank lending dropped considerably across all loans types during the 20072009 crisis. They nd that new bank loans fell by 47% during the peak of the nancial crisis (fourth quarter of 2008) relative to the third quarter. When compared to the peak of the credit boom (second quarter of 2007) they nd that bank loans dropped by 79% in the fourth quarter of 2008. The terms and conditions of bank lending have also worsened. Campello, Giambona, Graham, and Harvey (2009a) report that the tightening of US credit markets during the 20072009 nancial

32

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

%

25.0 20.0 15.0 10.0 5.0 0.0 -5.0 Jan 2003 Apr 2003 Jul 2003 Oct 2003 Jan
25.0
20.0
15.0
10.0
5.0
0.0
-5.0
Jan 2003
Apr 2003
Jul 2003
Oct 2003
Jan 2004
Apr 2004
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Oct 2004
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Apr 2005
Jul 2005
Oct 2005
Jan 2006
Apr 2006
Jul 2006
Oct 2006
Jan 2007
Apr 2007
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Oct 2007
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-10.0

Major UK lenders Source: Bank of England

32 A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 28 – 63
32 A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 28 – 63

Foreign lenders

32 A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 28 – 63

Other monetary financial institutions

Fig. 5. Contributions to growth in lending to UK businesses (12 month growth rate (%) in the stock of lending).

crisis has manifested itself in the form of an increase of commitment fees by 14 basis points, mark-ups over LIBOR/Prime rate by 69 basis points and decline in maturity by 2.6 months from 30 months on aver- age. Empirical evidence suggests that debt market segmentation has resulted in differential sensitivity to the recent credit market shock. For example, Campello, Graham, and Harvey (2009b) provide evidence on how nancially constrained and unconstrained US rms manage their investment expenditure during the 2007 nancial crisis. In partic- ular they nd that the nancial crisis has had a severe impact on credit constrained rms, leading to deeper cuts in planned R&D (by 22%), employment (by 11%), and capital spending (by 9%). Furthermore, the inability of these rms to borrow externally has caused many rms to cancel or postpone attractive investment projects, with 86% of CFOs in the US stating that they had to restrict investments in attractive projects during the credit crisis. Similarly, Kisgen (2007) suggests that having access to alternative sources of debt capital can help rms raise funds during adverse economic conditions and prevent underinvestment in positive-NPV projects. All rms have suffered from the credit supply shock but the impact has been greatest on those rms heavily reliant on the banking sector for their funding. The UK's corporate sector has also been adversely affected by the re- duction in the bank lending during the 20072009 crisis. Bacon et al. (2009) in their survey of chief nancial ofcers and corporate treasurers on the impact of changing banking and credit market conditions on corporate funding plans during the 20072009 nancial crisis, found that with increased borrowing margins and reduced maturity periods, the availability of funds from the banking sector fell signicantly. In addition, they point out that if banking market capacity is reduced in the foreseeable future, bond markets are likely to become an alternative source of capital. Several studies have looked at the effect of macroeconomic condi- tions on rms' capital structure decisions. Cantillo and Wright (2000) suggest that macroeconomic conditions have a powerful effect on how rms choose their lenders. They nd that less constrained compa- nies tend to issue more debt during favorable economic conditions (Cantillo & Wright, 2000; Korajczyk & Levy, 2003; Levy, 2000). Levy (2000) investigates how rms' capital structure choice varies with macroeconomic conditions in the presence of agency problems. He nds counter-cyclical patterns for debt issues for rms that access pub- lic capital markets. This nding is supported in the later work of Korajczyk and Levy (2003) who point out that capital structure choice varies over time and across rms. By splitting their sample into nancial constrained and nancial unconstrained rms, they also nd that leverage of nancially unconstrained rms varies counter-cyclically

with macroeconomic conditions. In other words, unconstrained rms time their issue choice to coincide with periods of favorable macroeco- nomic conditions, while constrained rms do not. In a similar manner, Bougheas, Mizen, and Yalcin (2006) evaluate the inuence of rm- specic characteristics on the response of corporate nance to mone- tary policy. They examine UK manufacturing rms over two periods:

the rst, 19901992, a period of tight monetary policy that coincided with a recession and a harsh environment for existing and new corpo- rate borrowers. The second, 19931999, was a period of loose monetary policya time of sustained economic growth, falling unemployment and in ation, relatively low interest rates, and less constrained borrowing conditions. Their results show that there was a marked dif- ference in the response to rm specic characteristics when interacted with monetary policy. In particular, they found that small, young and risky rms were more noticeably affected by monetary tightening than large, old and secure rms.

3. Credit market conditions in the U.K. 19982010

In this section we present an analysis of the conditions of the UK credit markets before, during and after the 20072009 nancial crisis. We are interested in establishing whether the period under study pro- vides a good setting for identifying the effect of supply frictions on the capital structure of UK rms. Leary (2009), in the context of the 1966 US credit crunch, suggests that there are three elements to this. Firstly, did the 20072009 nancial crisis and any earlier credit crisis represent a change in credit supply? Secondly, if these periods were subject to credit supply shocks were they bank-specic or shocks to total capital supply? And, thirdly, could the effects on capital structure be driven by simultaneous changes in credit demand? To nd answers to these questions we investigate three aspects of the UK credit markets: the ow and stock of bank lending to the corporate sector, capital market issuance and the pricing of bank loans. We will utilise evidence from these areas to examine whether the observed weakening in bank lend- ing to the corporate sector is an indicator of a reduction in the supply of credit due to a tightening in bank's credit provision or weaker demand for nance from rms as a result of the recession. Fig. 1 shows that between 2008 and 2009 the UK has been mired in the deepest as well as longest postwar recession since the 1930s with seven quarters of negative growth. 5 The recession began in the second quarter of 2008 and by the end of 2009 the annual rate of

5 A recession is dened as two or more consecutive quarters of falling real GDP.

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

33

70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 2003 2003 2004 2004 2005 2005 2006 2006
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
2009
2010
-10.0
H1
H2
H1
H2
H1
H2
H1
H2
H1
H2
H1
H2
H1
H2
H1
-20.0
-30.0
-40.0
Loans
Bonds & CP
Equity
Source: Bank of England
£ £ billions

Fig. 6. Net capital market and net bank loan funds raised by UK rms 20032010.

decline in GDP reached nearly 5.6%the biggest fall since records began in 1955. 6

3.1. Bank lending to the UK corporate sector

Fig. 2 provides a historical perspective on the annual growth in

bank sterling lending to UK rms over the period 19642010. The shad- ed areas indicate periods when the UK economy was in recession (1974 to 1975, 1980 to 1981, 1990 to 1991 and 2008 to 2009). The gure shows that recessions are always associated with decreases in the growth of lending and that growth has become negative in real terms during the last four recessions. The 20082009 recession has seen the deepest real terms contraction in bank lending. For example, in July

  • 2009 sterling-only net lending to private non-nancial corporations

was £8.4 billion which was the weakest ow since the series began in 1963. 7 However, it is worth pointing out that a slowdown in bank lending does not always take place in the midst of a recession. Fig. 2 shows that there have been three occasions in the last fteen years where lending has weakened during periods of positive economic growth, these being around 1994, 19971999 and 20022003. We be- lieve that this fact makes it less likely that any credit rating or access ef- fects on capital structure we observe will be due to simultaneous changes in credit demand. Fig. 3 presents Bank of England (BOE) data on net monthly bank lending ows to the UK corporate sector for the period 1998 to 2011 and includes lending in both sterling and foreign currency (expressed

in sterling millions). 8 The chart shows that from 1999 through to the end of 2003 net monthly lending ows made several forays into nega- tive territory indicating a net repayment of bank loans in those months. Net monthly lending ows were negative in 17 out of 60 months (28% of months) during this period with an average ow of £1559 million. In

stark contrast, during the four year period from 2004 to 2007 lending ows were negative in only 2 months out of 48 (4% of months) and the average net monthly lending ow had nearly tripled to £4634 million. This was then followed by the nancial crisis which resulted in the biggest reduction in bank lending to corporates since the BOE started collecting this data in 1998. For the three years between January 2008 and January

  • 2011 the net monthly bank lending ow was negative in 25 out of

37 months (68% of months) with an average net monthly lending ow

  • 6 Sourced from the Ofce For National Statistics website.

  • 7 See www.bankofengland.co.uk/statistics/fm4/2009/jul/FM4.pdf or see Bank of England (2009f) Trends in lending, September, page 4.

  • 8 Monthly changes of monetary nancial institutions' sterling and all foreign curren- cy loans (excluding securitisations) to private non-nancial corporations (in sterling millions) seasonally adjusted.

equal to £698 million. 9 Over these 37 months the stock of bank lending to non-nancial rms shrank by £25.8 billion. Fig. 4 shows the twelve-month and three-month growth rates of the stock of lending over the period January 1999 to January 2011. 10 There was a dip in both growth rates towards the end of 1999, during the rst half of 2002 and then again over the second half of 2003 which is consistent with the tightening of credit markets experienced during these years. From the middle of 2004 to the middle of 2005 we see a rapid increase in both growth rates. For a two year period the twelve month growth rate of the stock of lending averages around 15% and then it picks up again in the middle of 2007. Twelve month lending growth peaks at 24% in April 2008 after which it commenced a rapid decline hitting negative growth in May 2009 for the rst time since the monthly series began in 1999. 11 The annual rate of contrac- tion (negative growth rate) of the stock of loans peaked in the rst quarter of 2010 and since then the rate of contraction has slowed. The strong ow and growing stock of lending to the corporate sector shown in Figs. 3 and 4 during the pre-crisis years of 2004 to 2007 is con- sistent with the notion that during this period the banks were very pro- active in encouraging rms to take on higher levels of debt and most borrowers could not resist the cheap nancing facilities available. The BOE points out that during this period the macroeconomic environment was very favorable, asset prices were rising and interest rates around the world were relatively low which facilitated an increase in the amount of lending to companies in the UK and the rest of the world. Furthermore, the BOE suggests that before the credit crisis borrowing margins were on the whole at historically low levels and at the peak of the boom in the latter part of 2006 banks were competing aggressive- ly to provide credit on favorable terms (Bank of England, 2009a). Fig. 5 presents a breakdown of the growth of UK lending by geo- graphical source. During the pre-crisis years 2005 to 2007 there was an increasing contribution by foreign lenders to the growth of UK lending with about half of the growth in lending to private non-nancial rms in 2007 being attributed to the activities of foreign lenders. However, with the onset of the nancial crisis the balance sheets of banks globally came under severe pressure during the latter part of 2007 and conse- quently the contribution of those foreign lenders began to fall. This de- cline gathered momentum in the second half of 2008, as foreign banks cut back on new lending abroad. Fig. 5 shows that the growth in lending

  • 9 Bank of England data covering lending by all UK-resident banks and building societies showed that there was a net repayment of loans in 21 of the months over the period Jan- uary 2009 to January 2011.

    • 10 Monthly 12 and 3 month growth rate of monetary nancial institutions' sterling and all foreign currency loans (excluding securitisations) to private non-nancial cor- porations (in percent) seasonally adjusted

      • 11 The three month growth rate peaked at 36.5% in October 2007.

34

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

Jun 2004

Aug 2008

Jun 2009

Apr 2010

Jul 2006

Apr 2005

Aug 2003

Jan 2004

Jan 2009

Nov 2004

Nov 2009

Oct 2007

Mar 2008

May 2007

Sep 2010

Dec 2006

Mar 2003

Feb 2006

Sep 2005

Jul 2011

Dec 2011

Feb 2011

350 Sep 09 (327bp) 300 250 Sep 08 (190bp) 200 150 100 50 Basis points
350
Sep 09 (327bp)
300
250
Sep 08 (190bp)
200
150
100
50
Basis points

0

Sep 07 (42bp)

Source: Bank of England

Fig. 7. Average estimated spreads on investment-grade syndicated loans.

100 80 60 40 20 0 -20 -40 US EUROPE UK Net % indicating tight credit
100
80
60
40
20
0
-20
-40
US
EUROPE
UK
Net % indicating tight credit conditions
1990Q2
1991Q1
1991Q4
1992Q3
1993Q2
1994Q1
1994Q4
1995Q3
1996Q2
1997Q1
1997Q4
1998Q3
1999Q2
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3

Source: US Federal Reserve Board, European Central Bank and Bank of England

Fig. 8. Credit market conditions in the US, Europe and the UK (Positive net% implies tight credit conditions for corporates).

by UK lenders has also decreased, but their relative contribution to over- all growth is now greater than in 2007.

3.2. Capital market issuance by UK rms 20032010

In this section we examine whether the credit supply shocks described above affected the ow of credit from both the bank and cap- ital markets or were isolated to the banking sector. This is important for this study for two reasons. Firstly, if the nancial crisis resulted in a re- duction in total capital supply then we would expect to observe a zero impact of access on leverage during these periods. Secondly, if rms re- duce their borrowing from banks during the nancial crisis but are able to switch to another source of nance, such as capital market debt, then we would expect to observe a positive access effect. Furthermore, in this case the resulting weakness in bank lending is more likely to reect tighter credit supply than weaker demand. Rated rms in the UK raise debt funds from public debt capital mar- kets as well as by borrowing from banks. This allows them to diversify their sources of debt nance though in the UK bank lending tends to be the dominant source of debt funds for private non-nancial rms (Kernan et al. (2010)). The Bank of England (2009c) reported that the average maturity of new lending during the crisis fell relative to before the crisis. The BOE noted that before the crisis the term premium

associated with borrowing over longer periods had been relatively small, and so loan facilities were mainly arranged with maturities of ve to seven years. However during the crisis, banks found it very dif- cult and costly to raise longer-term funding and this was reected in the prices they charged for longer-term facilities. The BOE suggest that a re- luctance by companies to lock in those higher costs over a long period, given uncertainty about future demand contributed to a decline in the maturity of new bank lending to two to three years. The BOE suggested that large investment-grade companies requiring longer-term nanc- ing were able to borrow in the capital markets given improved public debt market conditions in early 2009. Bond issuance by investment- grade companies was relatively strong in the early months of 2009, allowing these companies to mitigate the impact of a shortening in the maturity of bank lending available (see Bank of England, 2008c). There were indications that during the nancial crisis large rms were issuing capital market debt and using the proceeds to repay bank debt. Fig. 6 shows that during 2009 large non-nancial rms were accessing capital markets reected by higher public debt and equity issuance, with some using equity proceeds to repay bank debt in order to reduce leverage. 12 It is clear to see from Fig. 6 that there was greater equity issuance during the crisis years as rms were seeking

12 The BOE suggest that rms were also repaying bank debt from other forms of funding such as internally generated funds.

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

35

Number of Firms

Percentage

Number of Firms

Percentage

80 35% 70 30% 25% 25% 27% 28% 29% 27% 27% 60 23% 25% 20% 50
80
35%
70
30%
25% 25% 27% 28% 29% 27% 27%
60
23%
25%
20%
50
18%
20%
40
15%
30
10% 11% 11%
8%
8% 9%
10%
20
6% 7%
5%
4%
5%
10
10
14 17
20
24
24 28
35
39
41 63
67
65 67
68
69
67
63
55
51
0
0%
Fig. 9. Number and proportion of firms with S&P rating between 1989 and 2008.
60
23%
25%
20%
20%
50
20%
17%
15%
40
15%
15%
13%
12%
12%
12%
12%
30
10%
20
5%
10
42
47 44
36 35
43
43 45
53
43 39
0
0%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Fig. 10. Number and proportion of rms with Fitch rating between 1998 and 2008.

to reduce their leverage given the severe economic conditions. Fig. 6 also shows that non-nancial rms' net equity and bond issuance was considerably higher in 2009 than its average over the 20032008 peri- od. Furthermore, the BOE reports that between January and October of 2010 gross bond issuance in the UK was greater than its annual average over the 20002007 period which was partly the result of strong issu- ance by non-investment grade rms (Bank of England, 2010b, Quarter 4, page 252). Survey evidence also points to a preference for capital market issuance during this time. For example, Deloitte Chief Financial Ofcer (CFO) Survey, 2009a, reported that sentiment among chief nancial ofcers (CFOs) about equity and corporate bond issuance rose in June 2009, to its highest level since the survey started in 2007 and for the rst time there was a preference for bond and equity issu- ance over bank borrowing. The Deloitte Chief Financial Ofcer (CFO) Survey, 2009b reported that a net balance of CFOs perceived UK compa- nies to be overleveraged and expected a long-term shift in the corporate funding mix towards capital market issuance and away from bank borrowing. The proportion of UK rms issuing bonds for the rst time has been increasing since the second half of 2008. 13 Bank of England, 2010b, suggests that the majority of the new issuers in the UK have used the proceeds to repay maturing bank loans which they argue is consistent with ongoing disintermediation of banks by UK rms. Bank of England (2010a) points out that there is evidence that since 2010 a wide range of companies have been accessing the public debt markets instead of borrowing from the banks. The report indicates that around 40% of those rms that have issued corporate bonds in 2010 did so for the

13 Bank of England (2010b), Quarter 4, page 252.

rst time and suggests the fall in the cost of bond nance (corporate bonds yields have fallen) might be the factor behind such issuance. The Bank of England (2009h) provides a number of explanations for the strength of capital market issuance, relative to bank lending during the nancial crisis years. Firstly, it is suggested that increased equity is- suance may have reected a desire by some rms to reduce their lever- age in light of the weaker economic environment and the belief that corporate leverage had risen too far. Secondly, the reduced availability of bank lending, and its increased cost relative to reference rates such as three-month Libor, particularly for loans of longer maturities, might have encouraged companies to raise funds from capital markets. Third- ly, it is suggested that bank debt is considered to have a greater adverse affect on rms' credit ratings than capital market debt, due to a belief of greater renancing risk associated with shorter debt maturities. The BOE suggest that this may have led some rms to prefer bond issuance over bank borrowing. In addition to BOE data and corporate surveys there has been a large volume of anecdotal evidence pointing to increasing bond issuance by non-nancial rms during the nancial crisis. For example,

In the US and even more so in Europe, it is the small to medium-sized companies that will most drastically be affected by a signicant con- traction in bank lending because they do not have access to bond mar- kets.(Davies, 2008, FT.com)

Companies have been turning to the bond markets to renance debt as bank lending has become constrained.(Sakoui & Lee, 2009, FT.com)

With banking market capacity much reduced for the foreseeable future the capital markets are seen as a replacement funding source even for those that have traditionally not made use of bonds. Some unrated

36

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

15% 160 16% 14% 13% 13% 140 14% 120 11% 12% 100 10% 8% 80 8%
15%
160
16%
14%
13%
13%
140
14%
120
11%
12%
100
10%
8%
80
8%
5%
60
6%
4%
3%
3%
40
3%
4%
2%
2%
1%
20
1%
1%
2%
0%
0%
34
27
27
70
119
134 118
97
128
47
20
15
25
7 10
6
1
2
0
0%
Percentage
Number of Firms
36 A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 28 – 63http://www.risk. net/credit/ ) “ British companies, including Cadbury, Vodafone, Tesco and National Grid, have issued a swath of bonds in recent months, dipping into a pool of pension fund money while the banks were closed for lending . ” ( Mortished, 2009, page 41 ) “ Bond markets virtually closed following Lehman Brothers' collapse last September but co-ordinated state bail-outs have since reassured debt investors, with the number of global issues recovering from 133 in October to 315 last month. The UK also enjoyed its best January in at least three years, with pounds 15.7 bn placed across 15 issues. … Bond issuance is vital if companies are to fund future investment and is particularly critical now that the banks are making less credit avail- able . ” ( Aldrick & Ebrahimi, 2009, page 3 ) The Financial Times (31st August 2010) reports that “ The effect of the fi nancial crisis on bank lending is prompting companies to develop oth- er funding channels. In 2009 companies around the world with investment-grade ratings raised record volumes of debt in capital markets, much of it to re fi nance bank loans. In the US, investment- grade bond issuance by non- fi nancial companies totalled $512bn ( € 402bn, £330 bn). In Europe — which has a much smaller bond inves- tor base — it hit € 218 bn and in the UK, £47 bn was raised, according to data from Citigroup. Peter Goves, credit strategist at Citi, says sub- investment grade bond issuance in the fi rst half of this year was also at a record, with companies seeking to re fi nance the bank loans they used for leveraged buy-outs . ” ( Cohen & Goff, 2010, page 7 ). Our analysis would seem to suggest that the UK provides a good setting for identifying the effect of supply frictions on capital struc- ture. The preceding analysis has demonstrated that large UK corpo- rates have been reducing their borrowing from banks and switching to alternative sources of fi nance such as capital market debt. It follows that the resulting weakness in bank lending is more likely to re fl ect tighter credit supply than weaker demand. The evidence we have presented also indicates that the credit supply shocks that have taken place during our sample period were speci fi c to bank credit and not shocks to total debt capital supply. 3.3. Corporate loan pricing and interest rate spreads In the sections above we have shown that there has been a signi fi - cant weakening in bank lending to the UK corporate sector during the 2007 – 2009 fi nancial crisis. We have argued that an important question is whether this weakening in lending is due to a reduction in the supply of credit, as banks have restricted the fl ow of lending to fi rms, or sub- dued demand for funding from fi rms as growth prospects have declined during the recession. The evidence we have presented so far points to a decrease in the supply of bank credit and hence a credit market tighten- ing. However, this analysis is incomplete without an examination of the behaviour of interest rate spreads during this period. If the lending slowdown is largely driven by a fall in demand then, all else being equal, we would expect spreads charged on lending to decrease. How- ever, if a tightening of supply is the dominant factor, spreads would be expected to increase ( Bank of England, 2009a ). Therefore, in order to more fully disentangle the demand and supply effects on bank lending we need to look at the behaviour of interest rate spreads before and during the fi nancial crisis. The cost of bank loan fi nance to a fi rm can be broken down into the fees charged by a bank to provide loan facilities, the spread over a given reference rate at which loans are provided, and the prevailing level of that reference rate in the markets ( Bank of England, 2009g ). The BOE Usually three-month Libor or the Bank Rate. The Bank Rate is the of fi cial rate paid on commercial bank reserves by the Bank of England. " id="pdf-obj-8-11" src="pdf-obj-8-11.jpg">

Fig. 11. Frequency and proportion of rating grades assigned by S&P amongst UK non-nancial rms (19892008).

corporates are expecting to seek their rst rating in order to gain access to new sources of funding.(Bacon et al., 2009, page 3).

New investment grade corporate bond issuance in Euros for the rst 4 weeks of January 2009 reached the same level as the rst 15 weeks last year…” (Bacon et al., 2009, page 5)

Businesses, frozen out by the world's biggest banks, have ocked to the corporate bond market to raise new funds, triggering a 160 per cent surge in debt issuance since the beginning of the year. About $331 billion (£229 billion) has been raised through corporate bond is- sues since January in Europe, America and Britain, compared with $127 billion for the same period last year. Financiers say that the rise has happened because banks effectively stopped lending competitively to business after the collapse of Lehman Brothers, the Wall Street invest- ment bank, last September.(Jagger & Power, 2009)

“… since the events of September 2008, U.K. nancial institutions have reduced their net lending (both in sterling and foreign currencies) to U.K. companies by £59.1 billion, while corporate bond issuance by U.K. businesses had increased by £22.1 billion, according to Bank of England gures.(Kernan et al., 2010, page 7)

According to Dealogic, European bond issuance reached 557.2 billion in 2009 compared with 338.4 billion of loans, the rst time bond mar- ket volumes have exceeded loans.(Churchill, 2010, http://www.risk. net/credit/)

British companies, including Cadbury, Vodafone, Tesco and National Grid, have issued a swath of bonds in recent months, dipping into a pool of pension fund money while the banks were closed for lending.(Mortished, 2009, page 41)

Bond markets virtually closed following Lehman Brothers' collapse last September but co-ordinated state bail-outs have since reassured debt investors, with the number of global issues recovering from 133 in October to 315 last month. The UK also enjoyed its best January in at least three years, with pounds 15.7 bn placed across 15 issues. Bond issuance is vital if companies are to fund future investment and is particularly critical now that the banks are making less credit avail- able.(Aldrick & Ebrahimi, 2009, page 3)

The Financial Times (31st August 2010) reports that The effect of the nancial crisis on bank lending is prompting companies to develop oth- er funding channels. In 2009 companies around the world with investment-grade ratings raised record volumes of debt in capital markets, much of it to renance bank loans. In the US, investment-

grade bond issuance by non-nancial companies totalled $512bn (402bn, £330 bn). In Europewhich has a much smaller bond inves- tor baseit hit 218 bn and in the UK, £47 bn was raised, according to data from Citigroup. Peter Goves, credit strategist at Citi, says sub- investment grade bond issuance in the rst half of this year was also at a record, with companies seeking to renance the bank loans they used for leveraged buy-outs.(Cohen & Goff, 2010, page 7).

Our analysis would seem to suggest that the UK provides a good setting for identifying the effect of supply frictions on capital struc- ture. The preceding analysis has demonstrated that large UK corpo- rates have been reducing their borrowing from banks and switching to alternative sources of nance such as capital market debt. It follows that the resulting weakness in bank lending is more likely to reect tighter credit supply than weaker demand. The evidence we have presented also indicates that the credit supply shocks that have taken place during our sample period were specic to bank credit and not shocks to total debt capital supply.

3.3. Corporate loan pricing and interest rate spreads

In the sections above we have shown that there has been a signi- cant weakening in bank lending to the UK corporate sector during the 20072009 nancial crisis. We have argued that an important question is whether this weakening in lending is due to a reduction in the supply of credit, as banks have restricted the ow of lending to rms, or sub- dued demand for funding from rms as growth prospects have declined during the recession. The evidence we have presented so far points to a decrease in the supply of bank credit and hence a credit market tighten- ing. However, this analysis is incomplete without an examination of the behaviour of interest rate spreads during this period. If the lending slowdown is largely driven by a fall in demand then, all else being equal, we would expect spreads charged on lending to decrease. How- ever, if a tightening of supply is the dominant factor, spreads would be expected to increase (Bank of England, 2009a). Therefore, in order to more fully disentangle the demand and supply effects on bank lending we need to look at the behaviour of interest rate spreads before and during the nancial crisis. The cost of bank loan nance to a rm can be broken down into the fees charged by a bank to provide loan facilities, the spread over a given reference rate 14 at which loans are provided, and the prevailing level of that reference rate in the markets (Bank of England, 2009g). The BOE

14 Usually three-month Libor or the Bank Rate. The Bank Rate is the ofcial rate paid on commercial bank reserves by the Bank of England.

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

37

120 25% 22% 100 20% 17% 17% 80 14% 15% 60 9% 10% 40 5% 4%
120
25%
22%
100
20%
17%
17%
80
14%
15%
60
9%
10%
40
5%
4%
4%
5%
20
3%
2%
2%
1%
1%
6
22
10 19
41
79 66
80 104
12
17
6
8
0
0%
AAA
AA+
AA
AA-
A+
A
A-
BBB+ BBB
BBB-
BB+
BB
BB-
Percentage
Number of Firms

Fig. 12. Frequency and proportion of rating grades assigned By Fitch amongst UK non-nancial rms (19982008).

reported that the extra cost associated with borrowing over longer pe- riods had been relatively small in the years leading up to the crisis (Bank of England, 2009c). Furthermore, in communications with the BOE, UK banks suggested that spreads and fees had fallen to unsustainably low levels by early 2007 (Bank of England, 2009a). The BOE Credit Condi- tions surveys in 2008 and early 2009 indicated that since onset of the crisis spreads over reference rates increased substantially across all types of lending. Fig. 7 shows that the period from September 2007 to September 2008 witnessed a signicant increase in the cost of syndicat- ed bank credit as loan spreads widened. Spreads over reference rates on new-investment-grade syndicated lending jumped by 148 basis points (bp) during this 12 month period and peaked at 327 basis points a year later in September 2009. During this two year period syndicated loan spreads went up by nearly eight times (42 bp to 327 bp). The Credit Condition surveys also found that the net percentage balances of lenders were reporting increased fees on secured lending and that fees or commissions on loans to rms also went up. As the weakness in bank lending is associated with higher spreads this would suggest that a tightening in credit supply is most probably the key driver for weak bank lending during the nancial crisis. In order to shed further light on this issue we can examine the rea- sons put forward to explain why loan spreads increased during the nancial crisis. Firstly, UK banks reported to the BOE that spreads over reference rates had increased to better reect the higher costs of longer-term funding. From the start of the crisis banks found it ex- tremely difcult and costly to raise longer-term funding and conse- quently this was reected in the prices they charged for long-term loans. At this time UK banks were under pressure to lengthen the term structure of wholesale funding to better match that of assets, as a result using Libor as a reference rate was no longer appropriate since longer-term funding rates were a better reection of the banks marginal cost of funding. Banks indicated that the spreads charged on longer-term facilities had been increased to better account for the risks of funding over the lifetime of the loan (Bank of England, 2009b). Secondly, the BOE reported that increases in spreads might also have reected in part a re-pricing of risk due to increased percep- tions of credit risk, following a lengthy period earlier in the decade when corporate credit risks were underpriced. Banks suggested that deteriorating credit quality of borrowers had led to higher capital re- quirements and costs, which had acted to fuel the hike in spreads (Bank of England, 2009c). Thirdly, higher capital requirements under the new Basel II capital adequacy framework explained in part the in- creased charges for unused loan facilities (Bank of England, 2009a). As these reasons are strongly linked with credit supply factors this evi- dence also points to an independent tightening in the supply of credit during the nancial crisis.

3.4. Measuring credit market conditions: loan ofcer surveys

The US Federal Reserve Board, European Central Bank (ECB) and the Bank of England (BOE) conduct a quarterly survey of commercial banks under their jurisdiction to measure the extent to which banks are will- ing to provide loans to the corporate sector. Of the three surveys the US Federal Reserve's Senior Loan Ofcer Opinion Survey is the oldest established survey running since 1967, although it was suspended from the rst quarter of 1984 through to the second quarter of 1990. 15 The ECB survey started in 2003 and is conducted in each member country by the respective national central bank, and the results are then collated and analysed at the aggregate level. The ECB credit condi- tions survey is sent to senior loan ofcers of a sample of euro area banks. The banks participating in the survey comprises around 90 banks from all euro area countries and takes into account the characteristics of their respective national banking systems. The questionnaire examines issues relating to both loan demand and loan supply. The loan supply questions address issues relating to credit standards and credit condi- tions and terms, as well as to the various factors that may be behind any loan supply changes. 16 The BOE ran their survey for the rst time in the second quarter of 2007. 17 The BOE survey asks questions about both how bank lending trends have changed over the past three months (relative to the previ- ous three months), and how they are expected to change over the next three months (relative to the latest three months). The survey also asks about changes in the amount of credit lenders are willing to supply and about how both price and non-price terms are changing such as col- lateral requirements and loan covenants. The latter gives an indication of whether the terms and conditions on which banks are willing to lend have improved or worsened. To calculate aggregate survey results, the BOE assigns to each lender a score based on their response. Lenders who report that credit conditions have changed a lotare assigned twice the score of those who report that conditions have changed a little. These scores are then weighted by lenders' market shares. The results are analysed by calculating net percentage balances’—the differ- ence between the weighted balance of lenders reporting that, for example, terms and conditions were looser/tighter. The net percentage balances are scaled to lie between ±100. Negative balances indicate

38

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

that lenders, on balance, reported/expected credit availability to be lower than over the previous/current three-month period, or that the terms and conditions on which credit was provided became expensive or tighter respectively. This is opposite to the Federal Reserve and ECB surveys where a positive net percentage balance indicates a credit market tightening. Therefore, in this study we multiply the BOE net per- centage balances by minus 1 to make them consistent with those of the Federal Reserve and ECB. Thus, for all three surveys a positive (negative) net percentage balance indicates an overall tightening (loosening) in the supply of credit. In this study we use the net percentage balance of respondents to the question How has the availability of credit provided to the corpo- rate sector overall changed?to get an overall assessment of the condi- tions of the UK credit markets. We use the results to the corresponding question in the Federal Reserve and ECB surveys to measure the condi- tions of the credit markets in the US and Europe, respectively. Fig. 8 pre- sents net percentage balance data for the US, European and UK credit condition surveys for the period from 1990 to 2010. Fig. 8 indicates that since the middle of 2005 there appears to be some degree of synchronicity in the state of the credit markets in the US, Europe and the UK. Simple correlation analysis conrms that credit market conditions are highly correlated with a correlation coefcient around +0.8, although credit markets in Europe and the UK are slightly more closely aligned with each other than with the US. Fig. 8 also sug- gests that the severity of the tightening in credit conditions during the nancial crisis was greatest in the US.

4. Sample description

Our sample employs data for the top 500 UK listed non-nancial rms by market capitalization for the period from 1989 through to 2008. Following previous studies on capital structure (Byoun, 2008; Faulkender & Petersen, 2006; Hovakimian, Kayhan, & Titman, 2008; Kisgen, 2006; Kisgen, 2009) we exclude all nancial rms from the sample, resulting in a panel of 7258 rm-year observations. According to Faulkender and Petersen (2006) and Chava and Purnanandam (2009) rms with no debt might either not be able to access debt markets or they might simply not want to have access and prefer to nance themselves with equity. If rms in this category qualify to have a rating but do not want to obtain it, they will be misclassied as rms without access. There are 707 of rms (around 10%) with zero debt in our sample. To avoid any misclassication bias in our analysis we follow Faulkender and Petersen (2006) and Chava and Purnanandam (2009) and exclude all zero-debt rms from the analysis. This leaves us with a panel of 6551 rm-year observations.

All nancial data is sourced from DataStream. Credit rating data is sourced directly from Standard and Poor's (S&P) and Fitch. For credit rating we use a company's long-term credit rating. Credit rating data from S&P covers the 20 years from 1989 to 2008 and Fitch credit rat- ings are available for the 11 years from 1998 to 2008. In our sample 1010 or 15.4% of rm-year observations possess a rating (either S&P or Fitch). This percentage is similar to Mitto and Zhang's (2010) 15% for a sample of Canadian rms and to Faulkender and Petersen's (2006) 19% for US rms. Fig. 9 illustrates the frequency of rms with a S&P credit rating for the period from 1989 to 2008 and the proportion of rms in our sample

that possess a S&P rating. Fig. 9 shows that only 4% (10 rms) of rms in our sample were rated by S&P in 1989. The percentage of S&P rated rms peaked at 29% in 2006 and stood at 27% in 2008. Fig. 10 shows the frequency and percentage of rms with a Fitch credit rating for the period from 1998 to 2008. Twelve percent of our sample possessed a Fitch rating in 1998 and this had reached 20% in

2008.

4.1. Rating categories

The ratings assigned to the rms in our sample range from the highest AAA to the lowest CC, indicating each rm's individual credit quality (see Appendix, Table A). All ratings above and including BBB- fall into the category of investment grade ratings and ratings below and including BB+ are considered to be non-investment or speculative grade ratings. In our sample of 1010 rm-years with a rating, 909 pos- sess an investment grade rating and 101 have a non-investment grade rating. Figs. 11 and 12 illustrate frequencies of the rating categories assigned by S&P and Fitch credit rating agencies to UK non-nancial rms. Fig. 11 presents frequencies of the rating grades assigned by S&P to UK rms. Fig. 11 shows that the highest concentration of S&P rated rm-years is observed within the A+ to BBB rating interval with 596 out of 887 rm-years observations (66% of S&P rated rm-year observations). The rating category with the highest frequency is Awith 134 rm-years observations (15% of the S&P rated rm-years). Fig. 12 pre- sents frequencies of the rating grades assigned by Fitch to UK non- nancial rms. Similar to the S&P ratings data Fig. 12 indicates that most of the Fitch rated rm-year observations are concentrated within the A to BBB credit rating interval with 70% of the rated rm-years possessing a Fitch rating between these grades (329 out of 470 of the rm-year observations). The highest frequency is observed in the BBB category with 22% of the rm-years in this rating category (104 of the rm-year observations).

25% 23% 19% 20% 15% 15% 13% 11% 11% 10% 10% 9% 9% 10% 8% 6%
25%
23%
19%
20%
15%
15%
13%
11%
11%
10%
10%
9%
9%
10%
8%
6%
5%
4%
5%
3%
3%
2%
2%
0%

Fig. 13. Proportion of European non-nancial rms with a S&P rating in 2010. (Source: Author's calculation using Standard and Poor's data).

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

39

Table 1 Differences in leverage between rms with and without access to public bond market. The table reports tests for differences in the mean and median of rms' leverage ratios for rms with and without access to public bond market. The sample is based on listed non-nancial rms for the period between 1989 and 2008 and contains rm-year obser- vations with positive debt only. Access to the public debt markets is measured by: 1) the possession of long-term corporate credit rating (Panel A); 2) rm size, where Top20% are classied as having access and Remaining80% are classied as not having access (Panel B); 3) rm size, where Top20% are classied as rms with access and Bottom20% as rms without access (Panel C); 4) rms with rating as having access and rms in the bottom 20% as not having access (Panel D). Leverage is measured by debt-to-asset ratio. The rst two columns measure leverage on a market value of assets basis, the last two columns on a book value of assets basis. Columns I and III display results for gross value of leverage and columns II and IV for net leverage (total debt less cash and equivalents). ***, **, * indi- cate signicance at 1%, 5% and 10% level respectively.

 

I

II

III

IV

Gross leverage Net leverage Gross leverage Net leverage

 

MV

MV

BV

BV

Panel A: Access proxied by credit rating

 

Firms with access N

1007

1007

999

999

Mean

0.2794

0.1858

0.3047

0.2072

Percentiles 25

0.1465

0.0554

0.1750

0.0729

Median

0.2474

0.1670

0.2876

0.2075

Percentiles 75 Firms without access

0.3896

0.2940

0.4083

0.3266

N

5455

5455

5470

5470

Mean

0.2283

0.1272

0.2228

0.1057

Percentiles

25

0.0708

0.0058

0.1007

0.0119

Median

0.1724

0.0945

0.1990

0.1160

Percentiles 75

0.3316

0.2493

0.3097

0.2430

Firms with access vs. rms without access (mean difference test)

 

Mean difference

0.0511***

0.0586*** 0.0818***

 

0.1015***

T-Stat

8.0039

8.6906

14.5352

14.2398

Signicance

0.0000

0.0000

0.0000

0.0000

Firms with access vs. rms without access (median test)

 

Median

0.0750***

0.0725***

0.0886***

0.0915***

difference

Chi-squared

124.254

99.616

151.007

108.796

Signicance

0.0000

0.0000

0.0000

0.0000

Panel B: Access proxied by rm size (Top20Remaining 80) Firms with access

 

N

1361

1361

1359

1359

Mean

0.2930

0.1947

0.2816

0.1886

Percentiles 25

0.1540

0.0669

0.1709

0.0766

Median

0.2533

0.1752

0.2622

0.1928

Percentiles 75 Firms without access

0.3985

0.3101

0.3657

0.2924

N

5088

5088

5087

5087

Mean

0.1649

0.0875

0.1968

0.1106

Percentiles

25

0.0649

0.0097

0.0958

0.0194

Median

0.1649

0.0875

0.1968

0.1106

Percentiles 75

0.3250

0.2418

0.3135

0.2439

Firms with access vs. rms without access (mean difference test)

 

Mean difference

0.0715***

0.0736*** 0.0582***

 

0.0851***

T-Stat

12.2208

11.5828

12.3625

14.0578

Signicance

0.0000

0.0000

0.0000

0.0000

Firms with access vs. rms without access (median test)

 

Median

0.0884

0.0877

0.0654

0.0822

difference

Chi-squared

206.785

189.604

151.433

136.775

Signicance

0.0000

0.0000

0.0000

0.0000

Panel C: Access proxied by rm size (Top20Bottom20) Firms with access

 

N

1361

1361

1359

1359

Mean

0.2930

0.1947

0.2816

0.1886

Percentiles 25

0.1540

0.0669

0.1709

0.0766

Median

0.2533

0.1752

0.2622

0.1928

Percentiles 75

0.3985

0.3101

0.3657

0.2924

Firms without access

 

N

1109

1109

1112

1112

Mean

0.1399

0.0244

0.1635

0.0290

Percentiles

25

0.0129

0.0763

0.0335

0.2046

Median

0.0604

0.0009

0.1129

0.0027

Percentiles 75

0.1663

0.0943

0.2235

0.1428

Table 1 (continued)

 

I

II

III

IV

Gross leverage Net leverage Gross leverage Net leverage

 

MV

MV

BV

BV

Panel C: Access proxied by rm size (Top20Bottom20)

 

Firms with access vs. rms without access (mean difference test)

 

Mean difference

0.1530***

0.1703*** 0.1181***

 

0.2176***

T-Stat

19.3147

19.6379

17.5575

20.7819

Signicance

0.0000

0.0000

0.0000

0.0000

Firms with access vs. rms without access (median test)

 

Median

0.1929***

0.1761*** 0.1493***

 

0.1955***

difference

Chi-squared

529.824

486.072

376.025

357.441

Signicance

0.0000

0.0000

0.0000

0.0000

Panel D: Access proxied by the possession of credit rating and rm size (RatedSmall20) a

 

Firms with access

 

N

906

906

899

899

Mean

0.2651

0.1787

0.2959

0.2008

Percentiles 25

0.1430

0.0549

0.1740

0.0723

Median

0.2413

0.1600

0.2800

0.2037

Percentiles 75

0.3605

0.2794

0.3933

0.3146

Firms without access

 

N

1097

1097

1100

1100

Mean

0.1388

0.0230

0.1624

0.0295

Percentiles

25

0.0134

0.0763

0.0339

0.2037

Median

0.0609

0.0001

0.1133

0.0007

Percentiles 75

0.1663

0.0943

0.2233

0.1414

Firms with access vs. rms without access (mean difference test)

 

Mean difference

0.1263***

0.1557*** 0.1335***

 

0.2303***

T-Stat

14.9524

16.8948

17.4246

20.4751

Signicance

0.0000

0.0000

0.0000

0.0000

Firms with access vs. rms without access (median test)

 

Median

0.1804***

0.1601*** 0.1667***

 

0.2044***

difference

Chi-squared

427.283

356.270

342.211

294.127

Signicance

0.0000

0.0000

0.0000

0.0000

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 28 – 63 39

a Note that some rms that have a rating fall into the bottom 20% of rms by size dis- tribution. This may be due to the fact that our sample consists of the top 500 UK rms by market capitalisation, and therefore, while these rms are considered to be small, in our sample they are large enough to have a rating.

  • 4.2. Credit ratings in Europe

Fig. 13 shows the percentage of non-nancial rms in European countries that possess a long-term S&P credit rating in 2010. For the three largest European economies Germany, France and the UK we re- strict our sample to around the largest 300 non-nancial listed rms. On this basis, the UK has the highest proportion of rated rms with 19% of listed non-nancial rms possessing a rating followed by France with 15% and Germany with 13%. This suggests that the UK is a good setting to examine the role of ratings in determining capital structure decisions. 18

5. Empirical analysis

  • 5.1. Methodology

The empirical analysis that follows presents results from univariate and multivariate analyses. Bond market access is proxied by the posses- sion of a credit rating (Faulkender & Petersen, 2006; Mitto & Zhang, 2008). Following Faulkender and Petersen (2006) and Leary (2009) leverage is measured as a ratio of gross total debt to market value of as- sets. The univariate analysis examines differences in leverage and other rm characteristics between rms with and without a rating in our sample and other alternative measures of debt capital market access. The multivariate analysis shows the impact of credit rating on leverage while controlling for other rm characteristics and macroeconomic conditions. Following Chava and Purnanandam (2009) all variables

  • 18 In our sample Luxembourg has a small number of listed rms (26 rms) which ex- plains the relatively large percentage of rated rms.

40

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

Table 2 Mean differences in rm characteristics between rms with and without access. The table presents the results from Univariate independent sample t-tests for the sample of UK listed non-nancial rms with and without access to public bond market for the period from 1989 to 2008 and contains rm-year observations with positive debt only. Access to the public debt markets is measured by: 1) the possession of long-term corporate credit rating (Panel A); 2) rm size, where Top20% are classied as having access and Remaining80% are classied as not having access (Panel B); 3) rm size, where Top20% are classied as rms with access and Bottom20% as rms without access (Panel C); 4) rms with rating as having access and rms the bottom 20% as not having access (Panel D). Mean values are reported. Fifth column reports mean differences between the rms with and without access. *** indicates statistical signicance at 1% level, **at 5% level, *at 10% level.

 

Access

N

No access

N

Mean difference

t-stat

P-value

R vs. NR

Panel A: Access is measured by credit rating

 

Size

15.5565

1003

12.8937

5447

2.6628

61.5640

0.0000

R>NR

Age

3.5237

1007

3.2751

5438

0.2486

7.5004

0.0000

R>NR

Protability

0.1269

1002

0.1017

5415

0.0252

3.6673

0.0002

R>NR

Asset tangibility

0.6543

1007

0.5347

5454

0.1196

16.0639

0.0000

R>NR

Market-to-book

1.4841

999

1.6349

5444

0.1508

2.9988

0.0028

R b NR

R&D expenditure

0.0112

1007

0.0149

5454

0.0038

3.8371

0.0001

R b NR

Asset volatility

0.2275

993

0.2442

5288

0.0167

4.0735

0.0000

R b NR

Equity return

0.0106

997

0.0071

5296

0.0036

0.2514

0.8015

R>NR

Short-term debt

0.2529

1007

0.3713

5455

0.1184

14.4944

0.0000

R b NR

Tax paid

0.2494

1000

0.2520

5441

0.0027

0.2649

0.7911

R b NR

Panel B: Access is measured by rm size (Top20Remaining80)

 

Size

15.6249

1361

12.6831

5080

2.9418

96.1117

0.0000

R>NR

Age

3.5127

1356

3.2637

5076

0.2491

8.5686

0.0000

R>NR

Protability

0.1016

1351

0.1066

5054

0.0050

1.1583

0.2468

R b NR

Asset tangibility

0.6898

1361

0.5171

5088

0.1727

25.8194

0.0000

R>NR

Market-to-book

1.1872

1361

1.7255

5078

0.5383

15.6919

0.0000

R b NR

R&D expenditure

0.0093

1361

0.0156

5088

0.0064

7.6340

0.0000

R b NR

Asset volatility

0.2070

1348

0.2505

4924

0.0435

12.8165

0.0000

R b NR

Equity return

0.0117

1348

0.0068

4932

0.0049

0.4020

0.6877

R>NR

Short-term debt

0.2498

1361

0.3801

5088

0.1302

17.8304

0.0000

R b NR

Tax paid

0.2666

1361

0.2477

5074

0.0189

2.1258

0.0336

R>NR

Panel C: Access is measured by rm size (Top20Bottom20)

 

Size

15.6249

1361

11.0939

1105

4.5310

105.1458

0.0000

R>NR

Age

3.5127

1356

2.8152

1109

0.6975

18.0569

0.0000

R>NR

Protability

0.1016

1351

0.0883

1102

0.0133

1.2721

0.2036

R>NR

Asset tangibility

0.6898

1361

0.4059

1109

0.2839

31.5714

0.0000

R>NR

Market-to-book

1.1872

1361

2.8684

1107

1.6811

18.3599

0.0000

R b NR

R&D expenditure

0.0093

1361

0.0347

1109

0.0254

12.3439

0.0000

R b NR

Asset volatility

0.2070

1348

0.3110

1023

0.1040

15.7111

0.0000

R b NR

Equity return

0.0117

1348

0.0607

1027

0.0490

2.1932

0.0284

R b NR

Short-term debt

0.2498

1361

0.5526

1109

0.3028

26.5421

0.0000

R b NR

Tax paid

0.2666

1361

0.2041

1106

0.0625

5.4052

0.0000

R>NR

Panel D: Access is measured by the possession of credit rating and rm size (RatedSmall20)

 

Size

15.6774

905

11.0919

1093

4.5855

87.8429

0.0000

R>NR

Age

3.5524

906

2.8287

1097

0.7238

16.8188

0.0000

R>NR

Protability

0.1386

902

0.0867

1090

0.0519

4.5496

0.0000

R>NR

Asset tangibility

0.6606

906

0.4065

1097

0.2541

26.0053

0.0000

R>NR

Market-to-book

1.5044

898

2.8619

1095

1.3575

13.5655

0.0000

R b NR

R&D expenditure

0.0112

906

0.0345

1097

0.0233

10.7972

0.0000

R b NR

Asset volatility

0.2228

895

0.3094

1015

0.0867

12.3808

0.0000

R b NR

Equity return

0.0245

896

0.0619

1019

0.0374

1.6205

0.1053

R b NR

Short-term debt

0.2614

906

0.5554

1097

0.2940

24.1281

0.0000

R b NR

Tax paid

0.2615

899

0.2037

1094

0.0578

4.3555

0.0000

R>NR

are winsorised at 1% level to eliminate outliers that could inuence the results. The rst stage of our analysis employs univariate tests to identify if rated rms possess different characteristics compared to those without a rating. We begin by comparing the leverage of rated and non-rated rms. We then compare rm characteristics of rated and non-rated rms that capital structure theories predict to have an impact on rms' leverage. We follow the prior literature in our choice of variables (Faulkender & Petersen, 2006; Leary, 2009). These characteristics include: rm size, rm age, protability, asset tangibility, market-to- book ratio, R&D expenditure, asset volatility, equity return, a portion of short-term debt and tax paid. To verify that our results are not driven by the way we dene access (possession of a credit rating), we follow Leary (2009) and Voutsinas and Werner (2011) and create alternative measures of access based on rm size. Leary (2009) indicates that while this may not be a perfect proxy, size is clearly highly correlated with public debt market access(Leary, 2009, page 1160). In addition, Leary (2009) points out

that according to Johnson (1997), and Krishnaswami, Spindt, and Subramaniam (1999), the proportion of outstanding debt from public sources is strongly correlated with rm size. He denes rms with ac- cess based on the upper two (three) deciles of book assets, while those without access are those in the lower two (three) deciles. In Leary's sam- ple the upper two deciles contain large rms with assets greater than $100 million, whilst the lower two deciles contain small rms with as- sets between $1 million and $10 million (Leary, 2009, page 1161). 19 Following Leary's (2009) and Voutsinas and Werner's (2011) ap- proach, we create three sized-based measures of access:

1. Firms with access are dened as being in the top 20% (30%) of the distribution by book value of assets, and rms without access are

  • 19 The exception could be large multinational companies. According to Aggarwal and Kyaw (2010) multinational companies, while being large and diversied, have signi- cantly lower debt ratios compared to domestic companies, with such debt ratios de- creasing with the degree of multinationality.

A. Judge, A. Korzhenitskaya / International Review of Financial Analysis 25 (2012) 2863

41

Table 3

Access and capital structure, access is measured by the possession of a credit rating: Pooled OLS. The table presents estimates of Eq. (1) using annual data of UK listed non-nancial rms for the period from 1989 to 2008. The dependent variable is the ratio of total debt to the market value (MV) of assets. Total debt incorporates short-term debt and long-term debt. MV of assets is the sum of MV of equity and BV of total debt. Public bond market access is proxied by the possession of a credit rating. Credit rating is interacted with the year

dummies to measure the variation in the effect of credit rating over time. Firm size is the natural logarithm of MV of assets. Age is the natural log of rm age plus one. Protability is measured as return on invested capital (ROIC) which calculated as the sum of pre-tax prots and total interest charges divided by invested capital. Asset tangibility is calculated as the difference of total assets minus current assets divided by total assets. Market-to-book ratio of assets is MV of assets over BV of assets. Firm's spending on R&D is expressed as natural logarithm of the ratio of one plus R&D expenditure scaled by total assets. Riskiness of operations is calculated as equity volatility multiplied by the equity-to-asset ratio. Equity volatility is expressed as square root of number of trading days multiplied by standard deviation of natural log of the daily price growth rate. Past equity returns are calcu- lated as natural log of share price at the end of the year over share price at the beginning of the year. Portion of short-term debt is calculated as the sum of short-term debt and current portion of long-term debt due to within one year divided by total debt. Average tax paid is calculated as income taxes over pre-tax income (taxable income). All variables are winzorised at 1% level in order to prevent potential outliers driving the results. All specications include annual stock market return and annual GDP growth rate to control for macro- economic conditions. Annual stock market return is calculated as natural logarithm of FTSE at the end of the year over FTSE at the beginning of the year. Annual GDP growth rate is sourced from the IMF ofcial website. a Industry dummies are included across all specications to control for industry-specic effects. Variables denitions are presented in Appendix, Table B. Standard errors (in parenthesis) are adjusted for heteroskedasticity and clustering by rms. ***, **, * indicate statistical signicance at 1%, 5%, and 10% levels respectively.

Variables

(1)

(2)

(3)

(4)

(5)

(6)

Credit rating

0.0524*

0.0534**

0.0537**

0.0467*

0.0548**

0.0537**

(0.027)

(0.026)

(0.026)

(0.026)

(0.025)

(0.025)

Size

0.0028

0.0008

0.0000

(0.004)

(0.004)

(0.004)

Age

0.0073

0.0085

0.0086

0.0080

0.0083*

0.0086*

(0.005)