THREE ESSAYS IN CORPORATE FINANCE

Abstract

<p>This thesis focuses on three important topics in corporate finance: corporate governance, management efforts to avoid debt covenant violations and the cost of such violations. The thesis adds to these aspects of the finance literature and the findings are reported in chapters two, three and four.</p> <p>The second chapter focuses on the role of corporate governance in determining the interactions between financial leverage and profits and attests to the validity of the trade-off theory of capital structure. It examines management’s financing choice behaviour in distinctly different corporate governance settings to ascertain the effect of governance mechanisms on such behavior. The estimation methodology allows for financial leverage, profits and governance to be determined jointly, using an instrumental variable approach. The results of the paper demonstrate that leverage is increasing in profits when controlled for agency problems, and good governance firms exhibit the results predicted by the trade-off theory of capital structure.</p> <p>The third chapter examines management’s earnings manipulation activities around debt covenant violation through accrual manipulation and real earnings management. Covenant restrictions are expected to influence these activities in the quarters surrounding and the quarter of the violation. Cross-sectional analyses reveal the use of such strategies to report higher earnings in the periods surrounding the covenant violation. The results also show disparity in the use of accrual based and real earnings management techniques.</p> <p>The fourth chapter investigates the relation between debt covenant violation and the cost of new borrowing from three different aspects: the incidence of violation, the timing of violation and the frequency of violation. The results show that there are significant benefits to not violating a debt covenant and violators are penalized by the creditors for not upholding the contractual restrictions.</p>