Catering Theory Essay
Extant literature of the catering theory proposes different theories for how firms cater to investors. Companies need more funds to expand the size of the company. External financing sources of funding target are the company’s stockholders and bondholders. Therefore, the company's managers may cater the expectations of the stockholders or bondholders. Baker and Wurgler (2004a) proposed a catering theory of dividends. They argue that investor demand for dividend-paying stocks is time-varying, thereby causing the relative prices of dividend-paying and non-dividend-paying stocks to fluctuate. Therefore, the company's cash dividend decision is due to investor demand. The main purpose for doing so is to generalize the catering theory so that it …show more content…
Companies that use long-term debt tend to avoid dividend payments. Generally, the cost of debt financing is lower than equity financing. Moreover, debt financing has tax shield effect. Managers avoid excessive debt ratio to stabilize their job and personal wealth. It is also possible that corporate financing decision is a signal to convey information to investors about the company's business risk and profitability. Jensen and Meckling (1976) show due to equity’s limited liability, shareholders and the managers that act in their interests are encouraged to approve projects that are riskier than the ones initially proposed before the debt was underwritten. Therefore, shareholders of indebted firms can obtain most of the benefits inherent in a risky project when it is successful and can avoid sharing the costs of unsuccessful projects with bondholders thanks to their limited liability. In this case, the debt’s market value would decrease and the bondholders’ loss would be the shareholders’ gain. Bondholders may want the company to reduce the size of investments to protect their own interests. Hence, companies that cater to bondholders will tend to be underinvested. The purpose of this study is to explore whether the company caters to the abnormal investment behavior of corporate debt …show more content…
Data source
SEO and corporate bond samples are taken from Security Data Corporation’s (SDC) New-issues Database. The financial statement data is from the Compustat Annual Database. Board data is from the BoardEX.
3.Sample selection
The research samples are common shares of listed companies from NYSE, AMEX and NASDAQ's. SEOs of listed company and the issuance of corporate bonds are from 1999 to 2012. We select the sample event of 2012 to observe the investment behavior of sample companies from 2013 to 2015.
Fu (2010) find that subsequent to the offering companies used SEO's cash for investment. Therefore, the company's cash flow increases while changing investment decisions after SEO. At this point, the over-investment situation may occur. We believe that, in order to cater the stock investors, the company that engaging SEO will have a positive abnormal investment. Jensen（1986）believes that issue bonds solve the problem of overinvestment. In this sense, the problem of underinvestment is likely to occur. Therefore, we believe that the issuance of corporate bonds will cause an underinvestment
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