Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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452 Answers to Chapter Discussion Questions

traded in financial markets enabling them to diversify risk better than other

claimants (although bond markets are a close second). Still, incentive conflicts

can cause problems through time. After issuing debt contracts, managers have

an incentive to take self-serving actions such as asset substitution or under-

investment choices described in the chapter. Bond contracts are designed to

minimize this risk and indeed the use of compensation plans may increase the

difficulty for shareholders to convince the board to induce suboptimal actions

through the compensation plan. That is, managerial compensation adds another

layer of complication in pursuing these actions. As the links between compen-

sation and the costs of debt indicate, the concern with expropriating actions

remains substantial.

CHAPTER 7 WORLDWIDE PATTERNS IN

CAPITAL STRUCTURE

1. Evidence shows that firm-specific factors identified as main determinants of

leverage ratios for U.S. firms influence the leverage ratios for non–U.S. firms.

Leverage ratios are positively related to both the tangibility of assets and firm

size and negatively related to profitability, growth opportunities, interest rates,

and share price performance. However, some determinants vary across various

countries such as the equity premium, effective tax rates, payout ratios, and

merger and acquisition (M&A) activity. For example, in Germany