Hot debt market - Adverse selection costs as a debt issue driver

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School of Economics | Master's thesis
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PURPOSE OF THE STUDY The purpose of this thesis is to examine the role of adverse selection costs in times of high debt issue volume, or the hot debt market. Following the pecking order theory of capital structure, I hypothesize that high information asymmetry between investors and managers hinders companies from issuing equity and, instead, prompts firms to time their debt issues to that point of time. I also examine whether the phenomenon is more pronounced for the private debt market and whether evidence of timing attempt can be found in the issue size and use of proceeds of hot debt issues. DATA The empirical analysis conducted in this study is based on comprehensive data of debt issues by listed non-financial companies in the U.S. market in 1999-2009. The data are collected from SDC Platinum. The final sample of debt issues consists of 1,527 public debt issues, 814 private debt issues and 4,408 issues of syndicated loans. I also utilize Thomson ONE Banker for issuers’ financial and stock price data, I/B/E/S for analyst forecast data and DataStream for macroeconomic variables. RESULTS The results from the empirical analysis, based on ordinary least squares regressions method, lead to a conclusion that, in aggregate, adverse selection costs are one factor behind the hot debt market. I also find that the three examined debt markets have behaved in a remarkably divergent way, and while high adverse selection costs are found to drive the debt issue waves of syndicated loans, information asymmetry appears to reduce private debt issuance. Based on larger issue size and changes in balance sheet items of hot debt issuers, I conclude that the behavior of hot debt issuers shows some evidence of market timing. However, the impact of adverse selection costs in issue size and use of proceeds is varying and in many cases statistically weak.
debt issuance, market timing, information asymmetry, capital structure, syndicated loans
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