Williamson (1988)

Williamson in his article, “Corporate Finance and Corporate Governance”, analyzed the effects of tangible assets and probability of bankruptcy on the relationship between capital structure, leverage, and asset liquidity. He predicted that asset liquidity will increase optimal leverage, which means he concluded positive relationship between asset liquidity and capital structure.

Shleifer and Vishny (1992)

Shleifer and Vishny (1992) in their article, “Liquidation Values and Debt Capacity: A Market Equilibrium Approach”, discussed about asset liquidity and optimal leverage. They argue that in costs of financial distresses, asset liquidity plays an important role as a determinant. Their paper is focused on industry and economy wide determinants of liquidity.

They believe asset liquidation either through an auction or other sales will not be exactly appointed to the highest price and value users. During an industry or an economy wide recession selling assets which has just one usage can bring forth prices less than the value in best use or when buyers are prevented from bidding by rules.

They say asset liquidity limits optimal leverage levels. Holding cash flow volatility in different status like constant, cyclical and growth assets will have optimal level of debt finance and leverage in lower position. Multi department firms and specially conglomerates have higher status of optimal leverage level at the same level of cash flow.

In same industry firms are related to each other in debt level, which means a firm optimal leverage depends on the level of the leverage of the same industry firms. Even when an individual firm in an industry does not have an optimal leverage capacity, the industry might have itself. They also believe that optimal leverage levels and asset liquidity change over time. In their paper, “Liquidation Values and Debt Capacity: A Market Equilibrium Approach”, they predict that asset liquidity increases optimal leverage by analyzing the industry environment through different common ways to sell a firm assets and market equilibrium approach.

Rajan and Zingales (1995)

Rajan and Zingales (1995) analyzed Germany market to explain relationship between capital structure and its components. Their result can be an explanation of the empirical finding which firm size is negatively related to leverage in Germany. This negative effect is for German capital markets which are less developed and just large firms are traded in public.

Myers and Rajan (1998)

Myers and Rajan (1998) in their paper “The paradox of liquidity” argue that effect of asset liquidity on capital structure is negative or curvilinear. They believe a company with more liquid assets has greater value in short notice liquidity. If other components considered equal, asset liquidity are commonly seemed as increasing leverage capacity. This article is focused on the specific side of liquidity which shows greater liquidity decreases the power of borrowers to commit to their course of action. This paper examines the effects of asset liquidity fluctuation on debt level. Myers and Rajan (1998) “suggest an alternative theory of financial intermediation and disintermediation”.

They define asset liquidity the ease of selling or trading assets in the market. They believe a company with more liquid assets has greater value in short notice liquidity. If other components considered equal, asset liquidity are commonly seemed as increasing leverage capacity and in some contexts not liquid have meaningfully less value than readily tradable ones.

Myers and Rajan (1998) say that “asset liquidity is almost always a plus for nonfinancial corporations or individual investors”. However increased liquidity can be negative point for financial institutions. Although assets with more liquidity increase the ability of companies to increase cash on short notice, this also decrease the ability of management to commit reasonably to an investment and financing strategy which will protect the company’s creditors. When the company is making trading or markets for itself, this problem will become more serious.

They bring an example to show this paradox in liquidity. Consider a firm is making markets in government and corporate bonds. The firm will start activity with treasury inventory. The firm will finance its inventory with full leverage, if the securities and bonds could be unchangeably identified as collateral. Then a difficulty will come, which is unemployed inventory for trading because it is locked up.

Such a firm like this cannot perform not to sell so therefore cannot lock up the assets as collateral, because of doubt about due and default risk which is built inside the business and therefore any securities and bonds position as collateral has limitation. As a result, a nonfinancial institute, that does not need the treasuries as assets, could catch them and bring much more against them.

Companies which invest mainly on illiquid assets like financial institutes will find long-term financing and investment easier to enhance. Illiquidity will give less to creditors if they hold the assets, so it also gives more time to them to estimate interest rate and credit risk. They believe that “today’s risks would change slowly – – illiquid portfolios do not change overnight”.

Trading company creditors, with mostly liquid assets, have not any way to estimate or predict risk or values for the next step, month or year. The company will end up so liquid for its creditors when keeping assets flexible over its disposition is necessary.

Myers and Rajan (1998) believe “liquid assets give creditors greater value in liquidation, but they also give borrowers more freedom to act at creditors’ expense. While both issues have been separately recognized, their interactions arc largely unexplored”.

They show in their paper that a company with initial use of liquid core assets will be able to have a total advantage in earning external finances for projects with lower liquidity. The increasing debt level which the company will generate by accepting the less liquid project will exceed the level and capacity of the project itself. In contrast with, two company or projects which are less liquid could have less debt level and capacity combined in comparison to its stand-alone status.

They also prove that company unusually core businesses liquidity, are suitable to refer financing to other company in the industry. This will lead us to a theory of financial intermediation that is reliable with the banks rise origin. Their theory also explains why disintermediation has increased currently, and why the concentration of banks has been increased on illiquid part of the loan and borrowing.

Myers and Rajan (1998) examine the adverse shock impact on companies excessively asset liquidity. Such these firms have this ability to transform assets which this possibility leads to responds by creditors than firms with less liquid assets. A rational company will sell an asset which its liquidity is temporarily pressed down, even though its liquidity is expected to recover, and even the company asset is higher current liquidity.

Weiss and Wruck (1998)

Weiss and Wruck (1998) believe in their paper “Information problems, conflicts of interest, and asset stripping” that relationship between asset liquidity and leverage is negative. They say that distressed companies selling assets are probably to face a less liquid or illiquid market because their industry companions are also distressed. Thus companies can sell assets only at minimum price which is “fire sale”. They find that this illiquidity will decrease a company’s leverage level or debt capacity. As it is mentioned in Eastern’s case definition of asset liquidity will be “what allows value-destroying asset stripping to occur”. Less liquid assets would provide creditors with defense of such operations. “Unless a credible promise can be made not to engage in asset stripping, asset liquidity will reduce, not increase, a firm’s ability to issue debt securities”. They say that if development of capital market is continuing and provision of liquidity is increasing in a sort of asset markets, the asset stripping problem will importantly increase.

Alan A. Bevan and Jo Danbolt (2000)

The research on capital structure and leverage by Rajan and Zingales (1995) suggested that the leverage level in UK firms is positively related to firm size and tangible assets, and relation between leverage level with profitability and the growth opportunities level is negative. However, as explained by Harris and Raviv (1991), “The interpretation of results must be tempered by an awareness of the difficulties involved in measuring both leverage and the explanatory variables of interest”. In their paper, “Capital Structure and its Determinants in the UK – A Decompositional Analysis”, Alan A. Bevan and Jo Danbolt (2000) focus on the measuring leverage difficulties, and testing the Rajan and Zingales’ results sensitivity to deviations in leverage levels. They perform analysis on 822 UK firms capital structure and leverage level and find that result of Rajan and Zingales’ research to be highly dependent in definition. The determinants of leverage seem to fluctuate meaningfully, which would be depend on what component of debt is analyzed. Especially they find significant differences in the long term and short term debt determinants. On the assumption that equivalent and trade credit be on average, the results are specifically responsive to whether during measurement of leverage such debt and liability is included or not. They argue that capital structure analysis will not be complete without an examination of different forms of debt in detail.

Morellec (2001)

Morellec (2001) argue in his paper, “Asset liquidity, Capital structure and Secured debt“, that affect of asset liquidity on capital structure is negative or curvilinear. This paper investigates the effect that asset liquidity has on securities valuation and the company’s financial decision makings. Morellec (2001) shows in his paper that asset liquidity will have positive relation with debt capacity only when bond conditions limit the nature of assets. He demonstrates that, using unsecured debt with greater asset l