Thus, a negative relationship between APAR and DEBT is expected.
Since ERCs with stronger protection are expected to have a more positive impact on firm value, a negative relationship between APAR and RANKING is hypothesized.
We expect a positive relationship between free cash flow to total assets, FCF, and APAR and a negative relationship between degree of insider ownership, INS, and APAR.
Since the variables FCF and INS may not measure the relationship between the agency costs of equity and APAR associated with the issuance of debt with or without ERCs, the interactive variable must be included in the regressions.
Two measures of the agency costs of debt, bond callability, CALL, and cumulative profitability, CP, are used.(13) A positive relationship between CALL and APAR and between CP and APAR is expected.
Therefore, a positive relationship is expected between CALL x COV and APAR, and a negative relationship is expected between CP x COV and APAR.
A summary of definitions and measures of variables and their expected relationships to APAR is presented in Table 4.
Regressions 1 and 2 take COV and RANKING as the sole independent variable to measure the effect of ERCs on APAR. Regressions 3 and 4 take FCF and INS as the measure of agency costs of equity.
The magnitude (0.7%) and t-statistic (2.16) for the estimated coefficient for COV are consistent with the results associated with the two-day APAR reported in Table 3.
Since these two interactive variables measure the differential effect of the agency costs of debt on stockholder wealth for protected bonds over nonprotected bonds, the significantly positive relationship between CALL x COV and APAR strongly suggests that the presence of ERCs provides a net positive benefit to stockholders by further lowering the agency costs of debt.