The Growth Opportunity And The Choice Of Debt Policy

Before deciding the ultimate financial arrangements, a enterprise will take both internal and external environmental factors into consideration, which determine the form of debt structure jointly. This paper aims to discuss the impact of the company’s investment environment on the structure of its debt, which includes the following three aspects:leverage, debt maturity, and covenants. Covenants design is the key point of this paper, and research correlate with other factors are expanded from covenants. The reason focusing on the design of covenants is out of the following consideration:one of the important functions of protective covenant is raising the credit rate of certain bond to a level higher than the overall credit rate of the company. Adding protective covenants to a bond will be a very convenient method for the issuer to highlight itself (if the function of covenants are widely accepted by investors). What’s more, certain kinds of covenants can overcome the disadvantages of corporate bonds, such as have no flexibility in issue procedure, need to attract enough investors in a quite short term and generally have long maturity.Our sample is a long-term corporate bond issue from 2005-2015, eliminating issued by government or financial institutions. Bond covenants information is collected handily, which come from the prospectus, the public announcement, and the company’s annual financial statements are from RESSET financial database. By establishing contact between debt issue and the financial environment, we can get answers to following questions:what’s play a key role during the determination of debt covenants, and a reasonable explanation to the correlation among leverage, debt maturity, covenants and their correlation with the development potential of the whole company.The GMM (generalized method of moments) method is used to estimate the parameters. Generalized method of moments (GMM) estimation for linear and non-linear models with applications in economics and finance. GMM estimation was formalized by Hansen (1982), and since has become one of the most widely used methods of estimation for models in economics and finance. Unlike maximum likelihood estimation (MLE), GMM does not require complete knowledge of the distribution of the data. In models for which there are more moment conditions than model parameters, GMM estimation provides a straightforward way to test the specification of the proposed model. This is an important feature that is unique to GMM estimation. According to the two-equation system of Barclay, Michael J. (2003) and the three-equation system established by Billett, King and Mauer (2007), which are a version of expansion of the two-equation system. Based on the estimation that we draw form the system, we find that covenant protection is increasing in debt maturity and leverage, as well as increasing in growth opportunities. We also document that the negative relation between leverage and growth opportunities is significantly attenuated or even reversed by covenant protection, suggesting that covenants can mitigate the agency costs of debt for high growth firms.On the basis of the results from former research, this paper take leverage, debt maturity, and covenants into one system for the first time, hoping provide some reference for the development of the securities market in China. But it should be pointed out that, due to the limitation of time, resources and personal ability, this study also has some shortcomings, such as the automatically lock the sample into high level enterprises, or which limit the application of the results; or the shortage in collecting debt covenants may underestimate the covenants’influence.