Second we include the ratio of the market to the book

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Unformatted text preview: d can maintain a stronger bargaining position when renewing the loan contracts (Rajan (1992)). By having the power to withdraw continued 13 financing, banks can influence the firm’s management decisions over investment policy. Also, shorter maturities limit the period over which an opportunistic firm can exploit its creditors without defaulting. In the worse case, with short term debt, banks can pull their capital out at any indication of trouble (Diamond and Rajan (2000)). Following the literature, we include five variables to control for firm specific characteristics. First, we include the natural logarithm of assets (Log (assets) ) as a measure of firm size. According to the financial structure decision literature, size might be positively associated with reputation as well as the level of the firm specific information that is disclosed to public (Diamond (1991b)). Also, larger firms are likely to be more diversified and hence have less chance of going into financial distress than smaller firms. Further, larger firms tend to have easier access to other financial markets and institutions (Demirg¨¸-Kunt and Maksimovic (1999)). uc Accordingly, firm size is likely to be positively correlated with the level of long term debt. Second, we include the ratio of the market to the book value of total assets (M-B ratio ) as a proxy for future investment opportunities. The debt maturity structure literature suggests that firms with high growth prospects are susceptible to under-investment and over investment problems. This under-investment problem arises in firms with debt outstanding (Myers (1977)). Managers tend to pass up their investment opportunities because risky debt captures part of any profitable future investment returns. On the other hand, the over-investment problem arises because of limited liabilities (Jensen and Meckling (1976)). Firms have incentives to invest in risky projects with low or even negative expected payoff because if the projects pay off, they capture most of it, whereas if the projects do not pay off, their losses are bounded by limited liabilities. Short term debt might mitigate this problem since the debt contract comes up for negotiation before completion of the projects. Hence the creditors can monitor the operation and investment decisions of the firms. Thus we predict a negative relation between growth opportunities and long term debt. Third, we also include the ratio of net fixed assets to total assets (Fixed asset ratio ) in the model to capture the effect of collateral on the use of long term loans. Investment in fixed assets is also relatively less difficult to observe and verify by outside investors compared to investment in intangible assets. Hence the information asymmetries are relatively low in firms with a high ratio of fixed assets. Accordingly, a high fixed ratio is expected to be positively related to long term borrowing capacity. The fixed asset ratio can also be used to control for the maturity matching effect on financing structure . Stohs and M...
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