Ratings,Commercial Paper,and Equity Returns

We present the first evidence that initial ratings of commercial paper influence common stock returns. Highly-rated industrial issues of commercial paper, unaccompanied by bank letters of credit, are associated with significantly positive abnormal returns; lower-rated issues are not. The stock price effects of changes in commercial paper ratings also demonstrate the relevance of ratings to the financing of firms. Rating downgrades, especially those that imply an exit from the commercial paper market, produce significantly negative abnormal returns; upgrades have no effects. Initial commercial paper ratings and subsequent reratings appear to help investors sort firms by their future prospects.     

Firms' Off-Balance Sheet and Hybrid Debt Financing: Evidence from Their Book-Tax Reporting Differences

We match large U.S. corporations' tax returns during 1989–2001 to their financial statements to construct a firm‐level proxy of firms' use of off‐balance sheet and hybrid debt financing. We find that firms with less favorable prior‐period Standard & Poor's (S&P) bond ratings or higher leverage ratios in comparison to their industry report greater amounts of interest expense on their tax returns than to investors and creditors on their financial statements. These between‐firm results are consistent with credit‐constrained firms using more structured financing arrangements. Our within‐firm tests also suggest that firms use more structured financing arrangements when they enter into contractual loan agreements that provide incentives to manage debt ratings. Specifically, we find that after controlling for S&P bond rating and industry‐adjusted leverage, our sample firms report greater amounts of interest expenses for tax than for financial statement purposes when they enter into performance pricing contracts that use senior debt rating covenants to set interest rates. Furthermore, we find that the greatest book‐tax reporting changes occur when firms become closer to violating these debt rating covenants. These latter findings are consistent with firms' contractual debt covenants influencing their use of off‐balance sheet and hybrid debt financing.     

The Shareholder Wealth Effects of Insurance Securitization: Preliminary Evidence from the Catastrophe Bond Market

Insurance securitization has long been hailed as an important tool to increase the underwriting capacity for companies exposed to catastrophe-related risks. However, global volumes of insurance securitization have remained surprisingly low to date which raises questions over its benefits. In this paper, we examine changes in the market value of insurance and reinsurance firms which announce their engagement in insurance securitization by issuing catastrophe (Cat) bonds. Consistent with the hitherto underwhelming contribution of Cat bonds to global catastrophe coverage, we do not find evidence that Cat bonds lead to strong wealth gains for shareholders in the issuing firm. More importantly, we report large variations in the distribution of wealth effects in response to the issue announcement. We show that the wealth effects for shareholders in firms which issue Cat bonds appear to be driven by explanations according to which Cat bonds offer cost savings relative to other forms of catastrophe risk management (and less by the potential of Cat bonds to hedge catastrophe risk). Thus, abnormal returns are particularly large for issues by firms which face low levels of loss uncertainty (which reduces the information acquisition costs in financial markets) as well as for issues during periods when prices for catastrophe coverage (including Cat bonds) are low.     

Shareholder Returns from Supplying Trade Credit

We examine shareholder wealth implications of supplying financing to customers. Robust results suggest that excess returns and changes in trade receivables are directly and significantly related. Further evidence indicates the value of receivables is higher for suppliers with stronger motives relating to operating and contracting costs. The results also suggest a discounted value of receivables for financially unconstrained firms. Overall, we conclude that investors recognize trade credit as an effective instrument in mitigating frictions hindering sales growth. Thus, certain suppliers are positioned to derive increased strategic benefits from credit policy.     

Corporate investment and financing under asymmetric information

We develop a dynamic model of corporate investment and financing decisions in which corporate insiders have superior information about the firm's growth prospects. We show that firms with positive private information can credibly signal their type to outside investors using the timing of corporate actions and their debt-equity mix. Using this result, we show that asymmetric information induces firms with good prospects to speed up investment, leading to a significant erosion of the option value of waiting to invest. Additionally, we demonstrate that informational asymmetries may not translate into a financing hierarchy or pecking order over securities. Finally, we generate a rich set of testable implications relating firms’ investment and financing strategies, abnormal announcement returns, and external financing costs to a number of managerial, firm, and industry characteristics.     

How Do Firms Choose Between Intermediary and Supplier Finance?

This paper examines firms’ short‐term financing choices between intermediated loans and trade credit. I test two sets of empirical hypotheses: 1) hypotheses concerning the cross‐sectional differences in the level of intermediary finance for firms that use different levels of trade credit and 2) hypotheses concerning the dynamics of trade credit growth. I find strong evidence that for firms with high agency costs, the use of trade credit facilitates access to conventional bank loans. The evidence is consistent with theories based on the signaling role of trade credit provision and suppliers’ liquidation advantage.     

The information content of trade credit

During 1992–2007, suppliers financed almost 10% of the total assets of US listed firms. This intensive usage of trade credit is puzzling in the light of its high (implicit) costs. By arguing that trade credit use provides valuable information to outside investors, we first derive a theoretical model that predicts a positive correlation between trade credit use and the quality of the firm’s investments. Then, using several proxies for firm’s investment quality (Z-score, return on assets, and long-run abnormal returns), we show that this prediction receives strong support from a large sample of US firms.     

Short‐Term Debt as Bridge Financing: Evidence from the Commercial Paper Market

We analyze why firms use nonintermediated short‐term debt by studying the commercial paper (CP) market. Using a comprehensive database of CP issuers and issuance activity, we show that firms use CP to provide start‐up financing for capital investment. Firms’ CP issuance is driven by a desire to minimize transaction costs associated with raising capital for new investment. We show that firms with high rollover risk are less likely to enter the CP market, borrow less CP, and borrow more from bank credit lines. Further, CP is often refinanced with long‐term bond issuance to reduce rollover risk.     

Stock vs. stock-warrant units: evidence from seasoned offerings

Recent theories based on sequential financing and information signaling reveal a special role for warrants. Data from initial public offerings (IPOs) of stock-warrant units have been used to test the theories, and we extend the analysis to seasoned offerings. Consistent with predictions from both families of theories, we find that issues made by smaller and younger firms are more likely to involve stock-warrant units, and firms with greater stock price volatility are more likely to issue units in seasoned offerings. Moreover, firms with relatively high levels of long-term debt, and those whose issues are underwritten by less prestigious underwriters are more likely to employ stock-warrant unit financing. Consistent with information signaling, we find that firms with high managerial ownership are more likely to issue units. Firms that include warrants in their stock offerings are predicted to have experienced higher abnormal stock returns than if they had issued shares alone. Thus, consistent with both theoretical explanations, some firms can reduce capital costs by adding warrants to shares in seasoned offerings.     

Life-cycle effects in small business finance

This paper studies the life-cycle profiles of small firms’ cost and use of credit using a panel of Finnish firms. The choice of method matters for the conclusions drawn about the relationship between firm age and financing costs; the cross-sectional age profiles of financing costs are hump-shaped and consistent with hold-up theories, whereas methods that control for cohort fixed effects demonstrate that the financing costs decrease monotonically as the firms mature. The life-cycle profiles of the use of credit also indicate that firms are more dependent on financial intermediaries in the early periods of their lives. Furthermore, the cohorts born during recessions pay higher financing costs and use smaller amounts of bank loans, even after their creditworthiness is controlled for. The recession cohort effect appears to be more related to the experience of starting-up the firm in the recession than to the CEOs growing up in a recession during their early adulthood.     

Corporate liquidity and the contingent nature of bank credit lines: Evidence on the costs and consequences of bank default

I study the impact of Lehman Brothers' bankruptcy and resultant inability to honor its obligations as a lender under committed credit lines. Firms that lost access to a credit line committed by Lehman Brothers experienced abnormal stock returns of − 3%, on average, on the day of and day after Lehman's bankruptcy filing, amounting to roughly $5.7 billion in aggregate, risk-adjusted losses. These losses were significantly larger for firms that were more financially constrained, firms with less cash, firms for whom Lehman was a lead-bank, and firms that lost access to larger amounts of committed credit. During the four quarters immediately following Lehman's collapse, firms that lost access to a credit line cut their investment spending significantly while simultaneously hoarding more cash than comparable firms. Overall, these findings indicate that firms that lost access to a credit line incurred economically significant costs and real-side consequences as a result of Lehman's default on its loan commitments.     

Information Transfer Effects of Bond Rating Downgrades

This paper investigates information transfer effects of bond rating downgrades measured by equity abnormal returns for industry portfolios. Industry rivals can be subject to two opposing effects, the contagion effect and the competition effect. We find that the net effect is strongly dependent on the original bond rating of the downgraded firm. For investment‐grade (speculative‐grade) firms, industry abnormal equity returns are negative (positive), which implies a predominant contagion (competition) effect. The analysis reveals a rich pattern of positive and negative correlations across negative credit events, which can be used to improve our understanding of portfolio credit risk models.     

The Initial Public Offerings of Listed Firms

A number of firms in the United Kingdom list without issuing equity and then issue equity shortly thereafter. We argue that this two‐stage offering strategy is less costly than an initial public offering (IPO) because trading reduces the valuation uncertainty of these firms before they issue equity. We find that initial returns are 10% to 30% lower for these firms than for comparable IPOs, and we provide evidence that the market in the firm's shares lowers financing costs. We also show that these firms time the market both when they list and when they issue equity.     

Bond market access and acquisitions: empirical evidence from the European market

We investigate whether access to bond markets affects acquisition activity of the European firms between 1999 and 2014. Our study provides insight into the effect that the growing European bond market has on corporate investment activity. We find that access to the bond markets, measured by the existence of a credit rating, has a significant effect on the tendency of firms to make acquisitions. The effect is strongest in Continental Europe and during times of high acquisition activity. We further find that consistent with prior U.S. evidence, bond market access has an inverse effect on abnormal returns generated by the acquisitions. That finding suggests that firms with superior access to financing pursue targets of lesser quality.     

The Impact of Bank Consolidation on Commercial Borrower Welfare

We estimate the impact of bank merger announcements on borrowers' stock prices for publicly traded Norwegian firms. Borrowers of target banks lose about 0.8% in equity value, while borrowers of acquiring banks earn positive abnormal returns, suggesting that borrower welfare is influenced by a strategic focus favoring acquiring borrowers. Bank mergers lead to higher relationship exit rates among borrowers of target banks. Larger merger‐induced increases in relationship termination rates are associated with less negative abnormal returns, suggesting that firms with low switching costs switch banks, while similar firms with high switching costs are locked into their current relationship.     

The impact of securitization on credit rationing: Empirical evidence

We study whether banks’ involvement into different types of securitization activity – asset backed securities (ABS) and covered bonds – in Spain influences credit supply before and during the financial crisis. While both ABS and covered bonds were hit by the crisis, the former were hit more severely. Employing a disequilibrium model to identify credit rationing, we find that firms with banks that were more involved in securitization see their credit constraints more relaxed in normal periods. In contrast, only greater covered bonds issuance reduces credit rationing during crisis periods whereas ABS aggravates these firms’ credit rationing in crisis periods. Our results are in line with the theoretical predictions that a securitization instrument that retains risk (covered bond) may induce a more prudent risk behavior of banks than an instrument that provides risk transferring (ABS).     

Asset financing with credit risk

This paper develops a model for the unified valuation of all forms of real asset financing, such as bank loans, leases, securitization vehicles, and credit guarantees, secured by assets that generate a stochastic service flow to the operator, or a rental stream to the lessor, and depreciate over a finite economic life to their scrap value. Examples include mobile equipment, such as aircraft, railroad equipment, ships, trucks and trailers, as well as energy generation assets, heavy factory equipment and construction equipment. In the event of obligor default, after a repossession delay and incurring costs of repossession, maintenance, re-marketing and re-deployment, the lender repossesses the asset and sells it on the secondary market and is, thus, subject to the risk of decline in the market value of the asset. The model we develop in this paper treats all forms of asset financing in a unified fashion as contingent claims on the collateral asset and the credit of the borrower. As an application, we estimate the collateral asset model on historical secondary market data for aircraft values and calibrate the financing model to the Enhanced Equipment Trust Certificates (EETCs) issued in 2007 by Continental Airlines and secured by a fleet of new aircraft. We then apply the calibrated model to value private market financing, including bank loans, leases, and credit guarantees, consistently with the capital market financing, and assess the impact of repossession delays on credit spreads. This analysis leads to a policy insight suggesting that bankruptcy laws limiting asset repossession delays lead to lower costs of asset financing.     

Information Asymmetry and Valuation Effects of Debt Financing

This study demonstrates that under conditions of information asymmetry, shareholders earn positive returns around the shelf registration date of straight debt. The results provide evidence to support Miller and Rock's conclusion that new expected financing by firms can result in positive returns to shareholders and Blazenko's contention that positive returns around the announcement date of straight debt issuance may be found by studying firms with asymmetric information. Firms with reported research and development expenses are assumed to have a higher level of asymmetric information and a greater chance of requiring new outside financing. Research and development expense intensity and abnormal earnings in future periods are found to be significant in a cross-sectional regression explaining abnormal returns for days surrounding the announcement period.     

Did the securitization market freeze affect bank lending during the financial crisis? Evidence from a credit register

Using data from the Italian Credit Register we identify the adverse effect of the freeze of the securitization market on bank lending during the crisis of 2007–2008. Applying a differences-in-differences estimation to data on firms that borrow from multiple banks, we single out credit supply by including firm fixed effects. Our results show that the degree to which banks tightened credit supply to nonfinancial firms is positively related to the share of loans they securitized before the crisis. The tightening translated into lower credit growth, higher interest rates, lower probability of accepting loan applications and higher probability of relationship termination. Firms were unable to fully compensate the negative credit supply shock, which suggests that the securitization freeze played a role in reducing aggregate credit availability.     

As told by the supplier: Trade credit and the cross section of stock returns

With superior information about their customers’ prospects, suppliers extend trade credit to capture future profitable business. We show that this information advantage generates significant return predictability. After controlling for major firm characteristics, firms that rely more on trade credit relative to debt financing have higher subsequent stock returns. The return predictability by trade credit is stronger among firms with lower borrowing capacity or profitability, and is more significant for firms with a higher degree of information asymmetry. Our findings suggest that trade credit extension reveals suppliers’ information that diffuses gradually across the investing public.