Capital Structure and Debt Structure

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Capital Structure and Debt Structure*

Joshua D. Rauh Kellogg School of Management and NBER

Amir Sufi University of Chicago Booth School of Business and NBER

February 2010

*We thank Doug Diamond, Anil Kashyap, Gordon Phillips, Michael Roberts, Toni Whited, Luigi Zingales, and seminar participants at Emory University, Georgetown University, Maastricht University, Rice University, Tilburg University, the University of California-Berkeley, the University of Chicago, the University of Colorado, the University of Maryland, the University of Minnesota, the University of Toronto, York University, and the Spring 2008 NBER Corporate Finance meeting for comments. We gratefully acknowledge financial support from the Center for Research in Security Prices and the IBM Corporation. Thanks to Ram Chivukula and Adam Friedlan for excellent research assistance. Rauh: (847) 491 4462, joshua-rauh@kellogg.northwestern.edu; Sufi: (773) 702 6148, amir.sufi@chicagobooth.edu

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Electronic copy available at: http://ssrn.com/abstract=1097577

ABSTRACT

Using a novel data set that records individual debt issues on the balance sheets of public firms, we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation. Relative to high credit quality firms, low credit quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants. We discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts.

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Electronic copy available at: http://ssrn.com/abstract=1097577

What determines corporate capital structure? Despite a large body of research on this question, it remains one of the most hotly contested issues in financial economics. Our analysis of this question begins with a simple observation: almost all empirical studies of capital structure treat debt as uniform. This is despite the fact that debt heterogeneity is a common feature of both theoretical research and the real world. For example, a glance at firms’ balance sheets reveals that corporate debt consists of a variety of securities with different cash flow claims and control provisions. Further, there exists a large body of theoretical research that recognizes debt heterogeneity and seeks to understand the reasons for it (e.g, Diamond, 1991a, 1993; Park, 2000; Bolton and Freixas, 2000; DeMarzo and Fishman, 2007). In this study, we provide a number of new insights into capital structure decisions by recognizing that firms simultaneously use different types, sources, and priorities of debt. These insights are based on a novel data set that records the type, source, and priority of every balance-sheet debt instrument for a large sample of rated public firms. The data are collected directly from financial footnotes in firms’ annual 10K filings and supplemented with information on pricing and covenants from three origination-based datasets: Reuters LPC’s Dealscan, Mergent’s Fixed Income Securities Database, and Thomson’s SDC Platinum. To our knowledge, this data set is one of the most comprehensive sources of information on the debt structure of a sample of public firms: It contains the detailed composition of the stock of corporate debt on the balance sheet, which goes far beyond what is available from origination-based datasets alone. We begin by showing the importance of recognizing debt heterogeneity in capital structure studies. We classify debt into bank debt, straight bond debt, convertible bond debt, program debt (such as commercial paper), mortgage debt, and all other debt. For almost 70% of firm-year observations in our sample, balance sheet debt comprises significant amounts of at least two of these types. Even more striking is the fact that 25% of the...
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