1
Mansi, Maxwell, & Wald
May 22, 2007

2

This research builds on 2 most recently published papers:
–
The first by Wald and Long (2006), which examines the impact of state laws on corporate capital structure
–
The second by Klock, Mansi, and Maxwell (2005), which examines the relation between the Gompers et al. (2003)
Index of antitakeover amendments and the cost of debt financing

3

In this paper, we examine how state laws are valued by the credit markets. We focus our attention on two types of statutory restrictions:
–
–
State payout restrictions (restriction on minimum A/D ratio necessary to make a distribution)
Restrictions on hostile takeovers

Both of these types of restrictions are designed to protect creditors from expropriation by shareholders and are widely adopted in U.S. debt agreements.

4
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Motivation
State payout restrictions and antitakeover laws
Current empirical evidence
Research questions
Sample selection, proxies, and measures
Empirical results
Conclusion

5

Main question is whether state of incorporation (or state law) has an impact on firm value

Incorporation decision
–
–
–
–
U.S. firm are all subject to same bankruptcy laws and bankruptcy courts are federal
U.S. firms are subject to same SEC regulation
U.S. firms access same capital markets
U.S. firms pay taxes where they have operations

6

Evidence on equity side is mixed
–
Race to the top

Empirical evidence for higher firm value for firms incorporating in Delaware (Romano (1985) and Daines
(2001))
–
Race to the bottom

Empirical evidence for insignificant increase in firm value (Subramanian (2004) and Bebchuk & Ferrell
(2001), and Bebchuk et al. (2002))

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
Laws on payout restrictions
–
When debt is present, state laws differ in payouts
–
Few states (e.g., Delaware) provide few restrictions
–
Firms incorporated in NY, TX and many other states are subject to the net worth rule (TA constraint = 1)
–
Firms incorporated in CA or Alaska are subject to a more stringent test (TA constraint = 1.25)

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Can Debt Covenants Substitute for State Laws?

State payout restrictions are similar to certain bond covenants, but they are not individually negotiated

Firms used to write separate debt covenants

But that can be costly (Smith and Warner, 1979;
John and Kalay, 1982)

After 1980 or so, many of the basic restrictions were added to state laws (Eisenberg, 1983)

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
Antitakeover Laws
–
Companies are only subject to the statutes of the state which they are incorporated
–
Firms prefer to reincorporate in states with more antitakeover provisions, often to the detriment of shareholders (see Heron and Lewellen, 1998; and Bebchuk and Cohen, 2003)
–
State antitakeover laws: antigreenmail laws, control share statute, fair-price statute, freeze-out or business combination statutes, poison pills, constituencies statutes

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
Why do firms remain incorporated in more restrictive jurisdiction
–
High cost of reincorporation
–
Regulatory advantages in some states
–
Payout restrictions may reduce the agency cost of debt by restricting financial and investment policy

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
For state payout restrictions to matter, the cost of reincorporation can not be too small – otherwise no credible pre-commitment

On the other hand, if the cost of reincorporation are too high then firms remain incorporated in their home state, never change states, and do not get optimal use of state laws

12

Agency cost of debt
–
Jensen and Meckling (1976) and Myers (1977)
–
Conflicts center on firm payout policy (e.g., Dhillon and Johnson
(1994); Maxwell and Stephens (2003))
–
Antitakeover provisions (e.g., Billet, King, and Mauer (2004),
Klock, Mansi, and Maxwell (2005), and Saffieddine and Titman
(1999))

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
Payout restrictions and state antitakeover laws
–
Wald and Long (2006)
–
Heron and Lewellen (1998) – firms prefer to incorporate in states with more antitakeover laws, and these laws decrease firm market values
–
Bebchuk and Cohen (2003) – similar findings, and also firms prefer to stay in their home states

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
Debt represents the main source of financing for firms

Empirical evidence based on equity prices

Tobin Q is typically based on book rather than market value of debt

Bond characteristics are well suited for better pricing

15

Two main questions
–
–
Are there advantages to firms incorporated in states with more restrictive payout jurisdictions?
What is the impact of payout restrictions and state antitakeover laws on credit ratings & yield spreads?
•
In our paper, we find that
–
Firms incorporated in states with more restrictive payout statues (New York) have better credit ratings and lower spreads relative to firms in less restrictive states
(Delaware).

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Data sources
–
–
–
–
–
–
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Lehman Borthers Fixed Income database
IRRC data on firm decisions to opt out of state laws
State laws from a number of sources, Lexis/Nexis,
Gartman (2000) and McGurn et al (1989) for antitakeover laws
Compustat Industrial database (SIC codes 2000-3999)
Executive compensation database
Thomson Financial (institutional ownership data)
Mergent data for firm reincorporation decisions and fixed income data for debt covenants

17

Based on firms in the LBFI database

Based on financial info. from Compustat

Based on firms in Gartman (2000) index

Final sample of 8,531 firm-year observations on
1,625 firms (for the period from 1987-2003)

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1987 US Supreme Court decision CTS Corp v.
Dynamics Corp of America clarified that antitakeover laws were constitutional.
Many states then passed antitakeover legislation

19

Measuring the cost of debt
– Yield spread weighted yield to maturity less its duration equivalent Treasury yield

Measuring state law and antitakeover variables
–
–
Payout restrictions (the minimum asset/debt ratio (0, 1,
1.25)) as in Wald and Long (2005)
Antitakeover laws as in Bebchuk and Cohen (2003)
–
GIndex as in Gompers et al. (2003) or a subset based on
Bebchuk et al. (2005).

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
Firm Specific
–
–
–
–
Size, Leverage, MTB
Profitability
Intangibles
Firm Risk

Debt Covenants
–
–
–
Event Risk
Payout
Financing

Security Specific
–
–
–
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Credit Ratings
Duration
Convexity
Debt Age
•
Governance
–
–
Inside Ownership
Inst. Ownership

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State of
Incorporation
Delaware
New York
Ohio
New Jersey
Pennsylvania
Virginia
Texas
California
Other States
Frequency
4,678
396
350
253
205
182
178
115
830
Percent
54.84
4.64
4.10
2.97
2.40
2.13
2.09
1.35
9.73
Cumulative
54.84
59.48
63.58
66.55
68.95
71.08
73.17
83.32
100.00
Total Asset
Constraint
0.00
1.00
1.00
1.00
1.00
1.00
1.00
1.25
0 or 1 or 1.25

22

Most of the firms in the sample are incorporated in Delaware (about 55%)

This is because Delaware firms are more likely to use debt financing.

Most of the firms in the sample have TA constraint variable of 1.0. Exception is
Delaware (TA=0) and California (TA=1.25)

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Variable
Spread
Antitakeover Index
GIndex
Size
Leverage
ROA
FirmRisk
Ratings
Duration
Convexity
Age
Payout Covenants
Fin. Covenants
Event Risk Cov.
Insider
Inst-Own
Firm-Year Obs.
Mean
438.489
0.955
9.553
7.531
0.626
0.127
0.435
BB+
5.682
0.524
2.519
0.495
2.070
1.359
0.028
0.534
Delaware Firms
(TA Constraint = 0)
Median
273.067
1.000
10.000
7.490
0.562
0.128
0.139
BB+
5.510
0.389
2.827
0.000
2.000
1.000
0.005
0.569
StDev
679.707
0.298
2.894
1.454
0.286
0.096
1.289
A/B
2.057
0.439
2.775
0.566
1.424
0.754
0.070
0.215
4,764 4,764 4,764
Mean
269.226
3.593
10.029
7.688
0.533
0.140
0.360
BBB+
6.183
0.652
3.548
0.370
1.782
0.977
0.025
0.531
Non-Delaware Firms
(TA Constraint = 1)
Median
155.430
4.000
10.000
7.627
0.481
0.133
0.089
BBB+
6.086
0.507
3.762
0.000
2.000
1.000
0.004
0.552
StDev
393.228
1.560
2.475
1.399
0.201
0.074
1.354
AA-/BB
2.262
0.494
2.978
0.530
1.203
0.780
0.069
0.199
3,647 3,647 3,647

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Log
(spread)
TA Constraint -0.236
Antit. Index
Covenant
-0.157
0.402
Size
Rating
FirmRisk
Insider
Inst-own
-0.418
-0.784
0.026
0.144
-0.232
TA
Constraint
0.728
-0.125
0.068
0.286
-0.033
-0.018
-0.015
Antit.
Index
-0.087
0.068
0.199
-0.001
-0.036
0.053
Covenants
-0.340
-0.482
-0.022
0.163
-0.165
Firm
Size
0.523
-0.033
-0.201
0.370
Debt
Rating
-0.025
-0.210
0.250
-0.009
-0.029
Firm
Risk
-0.207
Insider

25

We examine the relation between state laws and antitakeover measures and credit ratings/cost of debt and various controls for firm specific variables

We control for clustering and heteroskedasticity as in Peterson (2006)

26
TA Constraint
Antitakeover
Index
GIndex
Leveragesq
FirmRisksq
Insider
Insidersq
Inst-own
Adj. R-Squared
Obs.
Primary
Specification
(1)
0.552
b
(2.071)
0.031
(0.400)
0.672
6,979
GIndex
(2)
0.377
b
(2.237)
0.114
c
(3.611)
0.644
4,515
Non-Linear
Leverage
(3)
0.397
b
(2.349)
0.114
c
(3.649)
2.836
c
(4.275)
0.649
4,515
Non-Linear
Volatility
(4)
0.378
b
(2.243)
0.116
c
(3.676)
-0.018
(-2.260) b
0.645
4,515
Ownership
Variables
(5)
0.334
a
(1.898)
0.068
a
(1.925)
-4.698
a
(-1.867)
2.423
(0.436)
-1.062
(-1.810)
0.624
3,440 a

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
In all specifications, a larger (more strict) TA constraint is associated with a significantly higher credit ratings

For Model 1, a TA constraint of 1 is associated with a ratings increase of 0.552, more than half a rating step

Changes between models due mainly to smaller sample sizes

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TA Constraint
TA Constraint = 1
TA Constraint = 1.25
Antitakeover Index
GIndex
Firm risk
Adjusted R-Squared
Observations
Cross-sect
Time
Series
(1)
-0.215
c
(-11.918)
0.002
(0.370)
0.756
8,531
State
Anti-takeover
Laws
(2)
Dummies for
Payout
Restriction
(3)
-0.231
c
(-9.297)
-0.218
(-11.979)
-0.202
c c
(-3.312)
0.006
(1.044)
0.002
(0.377)
0.756
8,531
0.002
(0.365)
0.756
8,531
GIndex
(4)
-0.076
c
(-4.005)
-0.017
c
(-4.472)
0.011
a
(1.775)
0.786
4,007
Fama
MacBeth
(5)
-0.080
c
(-5.715)
-0.019
c
(-9.954)
0.012
b
(2.548)
0.840
4,007

29

Results suggest that the overall total asset constraint variable is negatively related to the cost of debt financing

The index of antitakeover laws variable has no significant impact on bond yields

30
TA Constraint
Gindex
Insider
Insidersq
Inst-own
Event Risk Cov.
Payout Cov.
Financing Cov.
Pay & Fin Cov.
Adj. R-Squared
Firm-Year Obs.
Ownership
Variables
(1)
-0.064
c
(-3.083)
-0.014
c
(-3.496)
-0.360
(-1.146)
0.316
(0.585)
-0.139
b
(-2.098)
0.783
3,047
0.756
1,692
Non-
Delaware
(2)
-0.271
c
(-2.580)
0.000

(0.000)
Dependent Variable = Yield Spread
Covenant Covenant
Controls
(3)
-0.184
c
(-5.370)
Controls
(4)
-0.184
c
(-5.497)
Investment
Grade
(5)
-0.062
c
(-3.040)
-0.017
c
(-4.315)
0.000
(-0.014)
0.021
(0.595)
0.026
a
(1.717)
0.740
2,232
0.025
b
(2.556)
0.740
2,232
0.672
2,746
Non-Invest
Grade
(6)
-0.099
c
(-2.902)
-0.018
c
(-2.634)
0.627
1,261

31

We provide evidence that more stringent payout constraints in state laws have a negative impact on bond yield spreads

State laws that restrict firm payouts can reduce the firm’s cost of debt

These restrictions function similar to how Smith and
Warner (1979) describe the function of debt covenants

The impact of antitakeover laws on bond yields is insignificant