Assignment EMF part II deadline November 25, 2015

The purpose of this assignment is to make you familiar with standard methods of conducting
empirical research. Some parts of the assignment relate to the paper: DeAngelo and Roll: How
Stable Are Corporate Capital Structures?, Journal of Finance, forthcoming (DAR), a link to this
study is provided on Blackboard. You are expected to complete the assignment using STATA and
WRDS.

To get started, please go to WRDS and then CRSP Annual Update CRSP/Compustat Merged
Fundamentals Annual. To keep the dataset manageable, please only include data for the range of
January 1, 1990 to December 31, 2013 (by Data Date). Please only use firms with total sales
(variable name SALE) greater than $8 billion.1 Please eliminate banks (SICH codes 6000 to 6999)
from this set before conducting your tests. Also, eliminate all companies not incorporated in the USA
(use the FIC code to identify such firms). Please do not make changes in Step 2 in the data download
in WRDS, except for making sure you search the entire database, and please do not make changes
to the Link Type selection in Step 3.

As a definition of book debt, you can use:

Total Book Debt = Long-Term Debt + Current Portion of Long-Term Debt,
where Long-Term Debt is Compustat item (DLTT), and the Current Portion of Long-Term Debt is
Compustat item (DLC). Other definitions:
Total Assets is Compustat item (AT).
Book Leverage = Total Book Debt / Total Assets
Market Value of Equity = Price (PRCC_C) * Shares Outstanding (CSHO)
Market Leverage = Total Book Debt / (Total Book Debt + Market Value of Equity)
Please drop observations with missing values for SICH codes, sales, book leverage, or market
leverage from your dataset.

You may want to use the compustat manual to look up the scale of variables (in this case SALE) available in
WRDS > CompuStat > Manuals and Overviews

Tasks:
(1) Generate a Table of summary statistics. The table should include for each variable in your
dataset the mean, median, standard deviation, minimum, maximum, and the number of
observations. Please provide the years covered by your observations in the caption.
a. Please have a careful look at your dataset before you start your analysis. If something
needs fixing, please fix it before you start with the analysis. In case you make any changes to
your dataset at this point, please briefly mention them in your write-up.
b. Please have a careful look at your summary statistics. Does something need fixing? If so,
please mention it briefly and fix it.

(2) What is the largest firm in terms of the Market Value of Equity in your dataset? Please
replicate Figure 1 in DAR for that firm. Describe briefly what you observe and whether that
fits well with the stylized fact of stable capital structures.

Please produce the plot in STATA. A simple annotated line plot is ok, i.e. you do not have to
match the plot layout exactly. [Hint: you might find the plot programs we used in the Data
handling session useful.]
(3) Replicate Figure 2, Panel A in DAR, for your dataset.

(4) Suppose you want to examine the hypothesis that larger firms have lower leverage ratios.
To do this you want to start by sorting your data into quintiles by Book Leverage. Then, for
each quintile, you want to present the average of total sales for all firms in that quintile.

a. Please produce the sorting table. Show both the average total sales and the average book
leverage for each quintile

b. How do you interpret the results?

c. How can you use an OLS regression to check if the size of firms in group 1 (low leverage
firms) is statistically significantly different than the size of firms in group 5 (high leverage
firms)? Explain briefly how you conduct the test. Then please run it and discuss the results.

(5) Run three OLS regressions. In each regression, use Book Leverage as the dependent
variable and the logarithm of total sales as an explanatory variable. The following
specifications should be run:

a. Specification (1): include no fixed effects and simply regress leverage on size.

b. Specification (2): same as specification (1), but include year fixed effects. Please discuss
the effect of including the year effects. How does it change your results and what do we
learn from the change?

c. Specification (3): same as specification (1), but include year-times-industry fixed effects
(i.e., one dummy for each industry-year combination). Please use 1-digit sic codes, obtained
by the command: g sic1dig=floor(sich/1000). And please use the areg command in STATA.
Please, discuss the differences in results between specification (2) and specification (3)
(6) Comment on the economic and statistical significance of the size variable in the above
regressions. Would you conclude that size has a causal impact on leverage? If so, why? If
not, why not?

(7) Run the regression of leverage on the logarithm of sales once more as in specification (1),
but this time include firm fixed effects. Call the regression: specification (4). Compare your
results of specification (4) to the results you obtained using the industry-times-year fixed
effects in specification (3). What is the conceptual difference between the two regressions?
Is one of them more appropriate than the other (if so, which and why)?

Guidelines
In your write-up, please adhere to the following guidelines. (Failure to do so will result in
point deductions!):
a. Please produce one table with specifications (1) to (5). You can base the table layout (but
obviously not the content of the table) on Table 5, Panel A in the KPS paper discussed in
class.
b. Please round numbers sensibly. For example, if we are talking about millions of dollars,
writing $1.2 million is in most cases much easier for the reader to understand than
$1.1984232 million. Reporting a coefficient as 1.34 is much better than reporting
1.34123923745.
c. Please produce figures as requested in the questions above. You can base the figure
layouts on DAR.
d. Please use separate A4 pages for each table and figure you produce. No table or figure
should extend across two pages.
e. Every table and figure should have a title and a caption. The caption should contain all
information usually presented in captions in academic papers. Your tables should be
formatted so that they would be ready to be included in an academic publication.
f. In addition, your final write-up should contain answers to the questions above. The page
limit for these answers is two (2) A4 pages in total (so you should be very concise).
g. The minimum font size for text (the text for the questions; not the text in tables) is 12.
h. Provide an appendix in which you show your complete STATA code (max. 10 pages but
ideally you would need much less). This code must be accessible to an outside reader, i.e. it
should be written in a way that allows the outside reader to understand the basic steps
carried out in the code. (As a reference on the level of detail, you may use the programs
provided in class.) Code that is incomprehensible, not complete etc. will lead to point
deductions.
i. There is no need to hand in programs or datasets, initially. However, we reserve the right
to ask for data or code after the hand in date. If you are not able to send programs or
datasets if asked to do so, you risk getting zero points on the assignment. Hence, please
make sure to store your programs and datasets used for this assignment in a safe place.
Please provide a contact email address with your write-up.

j. You are allowed to work in groups of up to 3 (three!) students. Smaller groups are allowed,
but larger groups will not be accepted.
k. Please provide ANRs along with your names on the write-up.
l. The (strict!) deadline for handing in your work is Wednesday, November 25, 2015 before
the university closes. Location: Letter box in front of West elevators on floor 9 of the
Koopmans building (Finance Dept) marked EMF assignment.

Additional Hints
(1) Please see the document on useful STATA commands on Blackboard (Data & Programs
folder) for some STATA essentials.
(2) You may also find the STATA tutorial videos on Blackboard useful.
(3) The programs we used in class as well as the slides should help you figure out the answer
to most questions. Have a close look at them again.
(4) Note that the gvkey variable in Compustat comes in a string format (written in red
when you look at your data in the browser in STATA). You might want to transform this into
a numerical value using the destring command in order to work with it easily.

Academic dishonesty
Cheating will not be tolerated and students caught cheating will be punished to the
maximum extent possible under the rules and regulations of Tilburg University. Students
suspected of cheating will be reported to the Examination Committee. In particular I will
regard as cheating if two or more groups collaborate, or if material or solutions are copied
from any source without proper reference. I reserve the right to make and retain copies of
write-ups and to use plagiarism software to detect dishonest behavior. Students are not
allowed to pass on their write-ups to students not in this course, or to consult write-ups
from prior students of this course or other sources. At the very least, students caught
plagiarizing will receive zero points for their write-up, but the Examination Committee has in
the past routinely excluded students from all exams for a period of one year in proven cases

of plagiarism and academic dishonesty. For more information on cheating, plagiarism

software,

and

possible

consequences

at

http://www.tilburguniversity.edu/students/study/fraud/

Tilburg

University

see