Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 THE DETERMINATION OF OPTIMAL CAPITAL STRUCTURE: THE EFFECT OF FIRM AND INDUSTRY DEBT RATIOS ON MARKET VALUE Gay B. Hatfield The University of Mississippi Louis T.W. Cheng Murray State University Wallace N. Davidson, III Southern Illinois University Abstract DeAngelo and Masulis (1980) demonstrated that the presence of corporate tax shield substitutes for debt implies that each firm has a "unique interior optimum leverage decision..." Masulis (1983) argued further that when firms which issue debt are moving toward the industry average from below, the market will react more positively than when the firm is moving away from the industry average. We examine this hypothesis by classifying firms' leverage ratios as being above or below their industry average prior to announcing a new debt issue. We then test whether this has an effect on market returns for shareholders. Our overall finding is that the relationship between a firm's debt level and that of its industry does not appear to be of concern to the market.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 THE USE OF SECURITY OPTIONS TO GAIN STRATEGIC FINANCING ADVANTAGES: THEORY AND PRACTICE Bruce C. Payne University of Southwestern Louisiana Nancy C. Rumore University of Southwestern Louisiana Philip A. Boudreaux University of Southwestern Louisiana Abstract Security options such as convertibles and warrants that create hybrid securities have been the subject of a great deal of research in finance for many years. Most studies have attempted to find methods to establish the value of those options to investors. This study examines the strategic financing advantages that have been reported by financial managers as reasons for issuing such options and to consider whether or not those reasons are consistent with theory. If such advantages exist to the extent reported by those financial managers, there is no reason to believe that they remain static over time or exist to the same degree over time. Capital market conditions are constantly changing. Thus, it was necessary to identify a unique, episodic time period in capital market history on which to base the study. That market was characterized by very high interest rates. It was found that corporations were simply using options in an attempt to escape those high rates and lower the cost of capital. That reported strategy is observed not to be consistent with the basic theory of financial management. It could be concluded that either the theory or the practice at that time was wrong. Instead, it is suggested that the period itself was an anomaly that allowed firms to achieve a lower cost of capital by issuing options regardless of theory.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 ASYMMETRIC INFORMATION: THE CASE OF BANK LOAN COMMITMENTS James E. McDonald University of Northern Colorado Abstract This study analyzes common stock return behavior around the announcement date of a bank loan commitment to a firm. The results demonstrate that loan commitments are viewed as positive when the more formal revolving credit agreement is used. Straight lines of credit do not show any significant reaction. Loan commitment announcements are associated with signals transmitted by banks and is an implied audit of the firm. One interpretation of the results is that for the loan commitment to provide relevant new information to the market, the loan commitment must confirm an identifiably concrete relationship between the bank and the firm. When investors are unable to account for some guarantee of reliability, no reaction occurs.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 ACCOUNTING CHOICE DECISIONS AND UNLEVERED FIRMS: FURTHER EVIDENCE ON DEBT/EQUITY HYPOTHESIS V. Gopalakrishnan George Mason University The author acknowledges the helpful comments of P. R. Chandy, Joseph Cheung, Mohinder Parkash and participants at the 1992 Annual Meetings of the Decision Sciences Institute held at San Francisco. Abstract This study extends the accounting choice literature by empirically examining a set of firms that do not have long-term debt (unlevered) in their capital structure. Currently, evidence on how these firms make accounting choice decisions is scarce. Empirical evidence on this issue is important for two reasons. First, the case of unlevered firms serves as an additional testing ground for the positive theory of accounting choice and the findings are likely to enhance our understanding of accounting choice decisions per se. Second, it offers light in the area of generalizability of debt/equity and political cost hypotheses, particularly to smaller firms. The results indicate that unlevered firms tend to choose income-increasing accounting methods more than their levered counterparts. This is particularly true in the case of inventory method choice. It appears that even without the presence of long-term debt, leverage, measured as total short-term liabilities over equity, is a significant determinant of accounting choice. Finally, political cost hypothesis does not seem to apply to smaller firms.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 REDUCING THE SHORT TERM VARIABILITY OF SMALL PORTFOLIO BETAS Bruce R. Kuhlman The University of Toledo Herbert J. Weinraub The University of Toledo Abstract Management of portfolio risk is difficult if beta is nonstationary, due to an inability to predict the level of beta in subsequent periods. Since large, well diversified portfolios have stationary betas, this study focuses on the variability of small portfolio betas. Common stocks are combined into small portfolios based on their individual beta variability. The variability of the resultant portfolio betas is then compared to randomly generated portfolios. Results indicate it is possible to significantly reduce the variability of the portfolio beta by systematically combining stocks according to their individual beta variability.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 RELAXING THE GLASS-STEAGALL ACT: DO DIVERSIFICATION BENEFITS EXIST? William A. Christiansen Florida State University R. Daniel Pace Valparaiso University Abstract The relaxation of the Glass-Steagall Act (GSA), the Act which separates commercial and investment banking, is currently under debate. Central to this debate is the potential risk reduction of commercial banks due to diversification. This paper, through a thorough and complete examination of the diversification potential, establishes an upper bound of diversification benefits. The results do support a relaxation of the GSA as well as the allowable amount of investment banking and other securities activities by commercial banks.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 AN INVESTIGATION OF THE RELATIONSHIP BETWEEN MULTINATIONAL COMPANIES' ATTRIBUTES AND THE MARKET EFFECTS OF SFAS NO. 52 Zabihollah Rezaee Middle Tennessee State University Abstract This study examines the relationship between firms' attributes and the market effects of SFAS No. 52. The accumulation of abnormal residuals during the eleven-day test period is used as a dependent variable and the firms' size and leverage as independent variables. The results suggest that the market effects of SFAS No. 52 depend on firm size and leverage. Stock price changes are directly attributed to the increase in contractual constraints defined in terms of political costs and financial information.

Journal of Financial and Strategic Decisions Volume 7, Number 3   Fall 1994 A PECKING ORDER APPROACH TO LEASING: THE AIRLINE INDUSTRY CASE Suzanne M. Erickson Seattle University Ruben Trevino Seattle University Abstract This paper investigates the determinants of both short-term and long-term leasing in the airline industry. By examining leasing within a pecking order framework, profitability and growth are introduced as potentially important determinants of leasing. Financial leases are found to substitute for debt and to be used relatively more by firms with higher credit risk. On the other hand, short-term operating leases do not substitute for debt. Operating leases are used by smaller firms, non-tax paying firms and firms experiencing more rapid sales growth. By confining the sample to one industry, asset factors which are potential determinants of lease use can be controlled for.

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