The Journal of Finance

Debt, Liquidity Constraints, and Corporate Investment: Evidence from Panel Data

Published: 09/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04664.x

TONI M. WHITED

This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. I test this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained groups, but is rejected for the others.

Is It Inefficient Investment that Causes the Diversification Discount?

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00385

Toni M. Whited

Diversified conglomerates are valued less than matched portfolios of pure‐play firms. Recent studies find that this diversification discount results from conglomerates' inefficient allocation of capital expenditures across divisions. Much of this work uses Tobin's q as a proxy for investment opportunities, therefore hypothesizing that q is a good proxy. This paper treats measurement error in q. Using a measurement‐error consistent estimator on the sorts regressions in the literature, I find no evidence of inefficient allocation of investment. The results in the literature appear to be artifacts of measurement error and of the correlation between investment opportunities and liquidity.

Agency Conflicts and Cash: Estimates from a Dynamic Model

Published: 05/28/2014   |   DOI: 10.1111/jofi.12183

BORIS NIKOLOV, TONI M. WHITED

Which agency problems affect corporate cash policy? To answer this question, we estimate a dynamic model of finance and investment with three mechanisms that misalign managerial and shareholder incentives: limited managerial ownership of the firm, compensation based on firm size, and managerial perquisite consumption. We find that perquisite consumption critically impacts cash policy. Size‐based compensation also matters, but less. Firms with lower blockholder and institutional ownership have higher managerial perquisite consumption, low managerial ownership is a key factor in the secular upward trend in cash holdings, and agency plays little role in small firms' substantial cash holdings.

The Misallocation of Finance

Published: 04/28/2021   |   DOI: 10.1111/jofi.13031

TONI M. WHITED, JAKE ZHAO

We estimate real losses arising from the cross‐sectional misallocation of financial liabilities. Extending a production‐based framework of misallocation measurement to the liabilities side of the balance sheet and using manufacturing firm data from the United States and China, we find significant misallocation of debt and equity in China but not the United States. Reallocating liabilities of firms in China to mimic U.S. efficiency would produce gains of 51% to 69% in real value‐added, with only 17% to 21% stemming from inefficient debt‐equity combinations. For Chinese firms that are large or in developed cities, we estimate lower distortionary financing costs.

Threshold Events and Identification: A Study of Cash Shortfalls

Published: 05/21/2012   |   DOI: 10.1111/j.1540-6261.2012.01742.x

TOR‐ERIK BAKKE, TONI M. WHITED

Threshold events are discrete events triggered when an observable continuous variable passes a known threshold. We demonstrate how to use threshold events as identification strategies by revisiting the evidence in Rauh (2006, Investment and financing constraints: Evidence from the funding of corporate pension plans, Journal of Finance 61, 33–71) that mandatory pension contributions cause investment declines. Rauh's result stems from heavily underfunded firms that constitute a small fraction of the sample and that differ sharply from the rest of the sample. To alleviate this issue, we use observations near funding thresholds and find causal effects of mandatory contributions on receivables, R&D, and hiring, but not on investment. We also provide useful suggestions and diagnostics for analyzing threshold events.

The Corporate Propensity to Save

Published: 07/16/2009   |   DOI: 10.1111/j.1540-6261.2009.01478.x

LEIGH A. RIDDICK, TONI M. WHITED

Why do corporations accumulate liquid assets? We show theoretically that intertemporal trade‐offs between interest income taxation and the cost of external finance determine optimal savings. Intriguingly, we find that, controlling for Tobin's q, saving and cash flow are negatively related because firms lower cash reserves to invest after receiving positive cash‐flow shocks, and vice versa. Consistent with theory, we estimate negative propensities to save out of cash flow. We also find that income uncertainty affects saving more than do external finance constraints. Therefore, contrary to previous evidence, saving propensities reflect too many forces to be used to measure external finance constraints.

Debt Dynamics

Published: 05/03/2005   |   DOI: 10.1111/j.1540-6261.2005.00758.x

CHRISTOPHER A. HENNESSY, TONI M. WHITED

We develop a dynamic trade‐off model with endogenous choice of leverage, distributions, and real investment in the presence of a graduated corporate income tax, individual taxes on interest and corporate distributions, financial distress costs, and equity flotation costs. We explain several empirical findings inconsistent with the static trade‐off theory. We show there is no target leverage ratio, firms can be savers or heavily levered, leverage is path dependent, leverage is decreasing in lagged liquidity, and leverage varies negatively with an external finance weighted average Q. Using estimates of structural parameters, we find that simulated model moments match data moments.

How Costly Is External Financing? Evidence from a Structural Estimation

Published: 08/14/2007   |   DOI: 10.1111/j.1540-6261.2007.01255.x

CHRISTOPHER A. HENNESSY, TONI M. WHITED

We apply simulated method of moments to a dynamic model to infer the magnitude of financing costs. The model features endogenous investment, distributions, leverage, and default. The corporation faces taxation, costly bankruptcy, and linear‐quadratic equity flotation costs. For large (small) firms, estimated marginal equity flotation costs start at 5.0% (10.7%) and bankruptcy costs equal to 8.4% (15.1%) of capital. Estimated financing frictions are higher for low‐dividend firms and those identified as constrained by the Cleary and Whited‐Wu indexes. In simulated data, many common proxies for financing constraints actually decrease when we increase financing cost parameters.

Bank Market Power and Monetary Policy Transmission: Evidence from a Structural Estimation

Published: 05/25/2022   |   DOI: 10.1111/jofi.13159

YIFEI WANG, TONI M. WHITED, YUFENG WU, KAIRONG XIAO

We quantify the impact of bank market power on monetary policy transmission through banks to borrowers. We estimate a dynamic banking model in which monetary policy affects imperfectly competitive banks' funding costs. Banks optimize the pass‐through of these costs to borrowers and depositors, while facing capital and reserve regulation. We find that bank market power explains much of the transmission of monetary policy to borrowers, with an effect comparable to that of bank capital regulation. When the federal funds rate falls below 0.9%, market power interacts with bank capital regulation to produce a reversal of the effect of monetary policy.