Local Crowding-Out in China

In China, between 2006 and 2013, local public debt crowded out the investment of private firms by tightening their funding constraints while leaving state-owned firms' investment unaffected. We establish this result using a purpose-built data set for Chinese local public debt. Private firms invest less in cities with more public debt, with the reduction in investment larger for firms located farther from banks in other cities or more dependent on external funding. Moreover, in cities where public debt is high, private firms' investment is more sensitive to internal cash flow.     

Investment Policy and Exit-Exchange Offers Within Financially Distressed Firms

This article examines the conflict of interest between shareholders and bondholders in a setting in which firms can renegotiate the terms of existing debt with public debtholders. In particular, we consider one of the most common types of debt restructuring: the exit-exchange offer. Our analysis explores the relation between exit-exchange offers and investment choice by the manager, and it concludes that managers, acting strategically on behalf of shareholders, may select inefficient investment projects in order to enhance their bargaining position vis-a-vis creditors. Holding the upside potential of an investment project fixed, managers/shareholders prefer projects with lower payoffs in states of bankruptcy because it induces individual bondholders to accept poorer terms in a debt-for-debt exit-exchange offer, thus generating a greater residual for shareholders in states of solvency. Additionally, we show how the investment inefficiencies in our analysis depend on (i) the inability of bondholders to coordinate their actions; (ii) the ability of managers to commit to suboptimal investment projects; and (iii) the coupling of an individual bondholder's decision to tender and her decision to consent to allow the firm to strip fiduciary covenants. We suggest conditions under which a ban on coupled exit-exchange offers—or alternatively, constraints on “debt-for-debt” exchanges—would be efficiency-enhancing.     

Bank Debt,Flexibility, and the Use of Proceeds from Asset Sales

In the theory of financial intermediation, bank debt is often characterized as being more readily renegotiable than public debt. Banks are also conjectured to gain valuable non-public information through closer monitoring. Given these features, bank debt can theoretically be more flexible than public debt and can lead to better investment/liquidation decisions. We investigate this possibility using a sample of firms facing the important decision of whether to reinvest the proceeds from asset sales or whether to distribute the proceeds to debtholders. While higher levels of leverage are associated with an increased probability of distributing proceeds to creditors, this relationship is significantly muted for bank debt as opposed to public debt. This finding is consistent with the conjecture that bank debt provides enhanced flexibility when compared to public debt. Further we find that asset sale announcement period abnormal stock returns are increasing in firms’ use of bank debt, but not public debt. This suggests that market participants believe that banking relationships are leading to better decision making for this particular type of investment/liquidation decision. We find no significantly different effects of bank vs. public debt on the initial decision to undertake an asset sale in the first place. Thus, in the context of asset sales, the main observable difference arises in the use of proceeds decision, rather than the initial asset sale decision.     

A multilevel index of heterogeneous short-term and long-term debt dynamics

We have created a novel index that classifies U.S. public firms by their leverage choice. Our statistical approach to the construction of this index considers the interaction of all firm characteristics and unpredictable events that shapes the observed leverage choices. We have subsequently associated our estimates of the degree and persistence of short-term and long-term debt fluctuations with pecking-order, market-timing, and static and dynamic trade-off theories. Our index reveals that: (i) one-third of firms have a stationary leverage target, (ii) adjustments to targets are faster for short-term debt, and (iii) the persistence of long-term debt ratios is driven by investment constraints and market conditions.     

On the value of restrictive covenants: Empirical investigation of public bond issues

Are restrictive covenants effective mechanisms in mitigating agency problems? Is the magnitude of the increase in the cost of debt due to agency problems non-trivial? We tackle these questions using a large dataset of public bonds. Contrary to the view that restrictive covenants in public bond contracts are standard boilerplates that serve little purpose, we find significant benefits in terms of reduction in the cost of debt associated with covenants. Restrictions on investment activities or issuance of higher priority claims reduce the cost of debt by about 35–75 basis points. These findings suggest that investors view bond covenants as important instruments in mitigating agency problems, and an increase in the cost of debt due to agency problems could be substantial. Additionally, we find that high growth firms and firms with low probability of default are less likely to include covenants suggesting that the costs of covenants outweigh benefits for these types of firms.     

Is cash negative debt? A hedging perspective on corporate financial policies

We show theoretically that while cash allows financially constrained firms to hedge future investment against income shortfalls, reducing current debt is a more effective way to boost investment in future high cash flow states. Thus, constrained firms prefer higher cash to lower debt if their hedging needs are high, but lower debt to higher cash if their hedging needs are low. We provide empirical evidence that supports our theory. Our analysis points to an important hedging motive behind cash and debt management policies. It suggests that cash should not be viewed as negative debt in the presence of financing frictions.     

Financial Shocks and Corporate Investment in Emerging Markets

We examine how cross-firm and cross-country heterogeneity shapes the responses of corporate investment in emerging markets to changes in U.S. monetary policy and financial-market volatility, the latter proxying for uncertainty. We find that in response to increases in U.S monetary policy rates or financial-market volatility, financially weaker firms reduce investment by more than financially strong firms. We also show that firms with stronger balance sheets delay investment voluntarily when faced with higher uncertainty. Finally, we find that stronger macroeconomic fundamentals (lower public debt or higher international reserves) help to buffer corporate investment from increases in U.S. monetary policy rates.     

An empirical analysis of corporate debt maturity structure

This paper provides an empirical investigation of the maturity structure of corporate debt. A dynamic model is estimated by GMM estimation procedure using data for an unbalanced panel of 429 non-financial UK firms over the period of 1983–96. The evidence provides strong support for the hypotheses that firms with more growth opportunities in their investment sets tend to have more shorter-term debt and firm size exerts a negative impact on debt maturity structure. The results also support the maturity-matching hypothesis that firms match the maturity structure of their debt to the maturity of their assets. There is less support for the view that firms use their debt maturity structure to signal information to the market. We do not find evidence for a negative correlation between taxes and debt maturity. Our results also suggest that firms have long-term target ratios and they adjust to the target ratio relatively fast, which might indicate that the costs of being away from target ratios are significant for firms.     

Debt Issues around Mergers & Acquisitions

We investigate firms’ debt financing choices among bank loans, public bonds and privately placed debt around mergers and acquisitions (M&As). We find that prior to M&As, firms with above-optimal leverage tend to pursue arm’s-length debt financing in lieu of bank debt. We find that three-day CARs for highly levered firms and acquirer’s long-run performance are negatively associated with non-bank financing. This supports a monitoring avoidance hypothesis for highly levered firms’ non-bank debt financing decisions in M&As. As a falsification test, we do not find the same debt financing considerations of acquirer firms during their post-M&A period.     

The impact of assets-in-place on corporate financing and investment decisions

In a dynamic setting with asymmetric information we consider firms’ debt-equity choice and investment timing. We extend recent research by adding an abandonment option and assets-in-place and we show that these extensions make debt more attractive. This implies, e.g., that mature firms (with larger assets-in-place) mainly use debt financing, whereas young high-growth firms (without assets-in-place) frequently use equity financing and signal their type by early investment. Simulation analyses confirm this and our model is thus able to explain empirical patterns which contradict the static pecking order theory.     

The deregulation of capital markets in France

This paper investigates how the deregulation of French capital markets affected corporate investment in the 1980s. Access to public financial markets may be less important in countries that have traditionally relied on institutional investors to finance their corporate investment projects. This should be true for France where, contrary to the US, banks and government agencies have always been involved in firms’ long term activities. In this study, French firms are categorized based on their ownership structure and trading characteristics. Two investment models are augmented with measures of corporate liquidity in order to test the role of internal funds on investment. Empirical results show that only small French firms trading on the secondary stock market have to rely on liquid assets to finance their capital expenditures. French firms with strong bank ties avoid this constraint since they are allowed to maintain higher debt levels.     

Growth Opportunities and the Choice of Leverage, Debt Maturity, and Covenants

We investigate the effect of growth opportunities in a firm's investment opportunity set on its joint choice of leverage, debt maturity, and covenants. Using a database that contains detailed debt covenant information, we provide large‐sample evidence of the incidence of covenants in public debt and construct firm‐level indices of bondholder covenant protection. We find that covenant protection is increasing in growth opportunities, debt maturity, and leverage. We also document that the negative relation between leverage and growth opportunities is significantly attenuated by covenant protection, suggesting that covenants can mitigate the agency costs of debt for high growth firms.     

Leverage and investment in diversified firms

Within diversified firms, the negative impact of leverage on investment is significantly greater for high q than for low q segments and significantly greater for non-core than for core segments. This differs substantially from focused firms and is consistent with the view that diversified firms allocate a disproportionate share of their debt service burden to their higher q and non-core segments. We also find that, among low-growth firms, the positive relation between leverage and firm value is significantly weaker in diversified firms than in focused firms. We conclude that the disciplinary benefits of debt are partially offset by the additional managerial discretion in allocating debt service that is provided by the diversified organizational structure.     

MANAGING FOR RATINGS: REAL EFFECTS OF A CORPORATE RATINGS CRITERIA CHANGE

We exploit a criteria change by Standard & Poor's (S&P) to examine the real effects of a credit ratings change. Using a recalibration by S&P, unrelated to firms’ fundamentals, as a quasi-natural experiment we analyze the impact of a ratings upgrade on the issuance activity, investment, cash holdings, and payout policy of companies. Our findings suggest upgraded firms subsequently issue more debt relative to equity, enjoy lower debt yields, and increase their investment rate and share repurchases. We find limited evidence that upgraded firms decrease their cash holdings. Our results support the view that credit ratings have a real effect on corporations.     

Debt enforcement,investment, and risk taking across countries

We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder–debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms’ investment and risk depends on the firm-specific probability of default. A differences-in-differences analysis of firms’ investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.     

Compliance with pension‐related mandatory disclosures and debt financing

Using hand‐collected data on the level of pension‐related mandatory disclosures required by International Accounting Standard 19 Employee Benefits, we test whether compliance levels with these disclosures convey information that affects firms’ access to the public instead of the private debt market, as well as the cost of their new debt issues. We document a higher tendency to access the public debt market for firms with higher levels of pension‐related disclosure. Furthermore, we find that firms with higher levels of pension‐related disclosure enjoy a lower cost in terms of issuance of public debt, but not a lower cost for private debt issues. Thus, the benefits of disclosure in reducing information risk are only realisable when creditors rely heavily on financial statements in their decision making, due to the limited access to private information. Additional tests reveal that high compliance levels effectively mitigate the negative effect of pension deficits on the cost of public debt. These findings provide novel evidence in the extant literature on the role of mandatory (and, in particular, pension‐related) disclosures on firms’ debt financing. They also have important policy implications.     

Debt Maturity Structure and Firm Investment

This study shows that the maturity structure of a firm's debt has a significant impact on its investment decisions. We show, after controlling for the effect of the overall level of leverage, that a higher percentage of long-term debt in total debt significantly reduces investment for firms with high growth opportunities. In contrast, the correlation between debt maturity and investment is not significant for firms with low growth opportunities. The results are strong at the firm level and at the business segment level. These results hold even after controlling for the endogeneity problem inherent in the relationship between total leverage, the maturity composition of leverage, and investment.     

Debt Financing and Voluntary Adoption of the International Financial Reporting Standards: Evidence from Korean Unlisted Firms

We investigate the effect of debt financing on the voluntary adoption of the International Financial Reporting Standards (IFRS) by unlisted firms and such adoption’s effect on bond credit rating. We find that unlisted firms with public debts are more likely to voluntarily adopt IFRS. Subsequent to the voluntary application of IFRS, the unlisted firms exhibit, on average, enhanced credit ratings. These findings suggest that the public debt market’s demand for high-quality financial reporting may drive those unlisted firms to voluntarily adopt IFRS. Furthermore, rating agencies seem to reward such firms by elevating their bond credit ratings.     

Firm listing status and the investment home bias

Are public firm investment rates more sensitive than private firm rates to new investment opportunities? We offer a new explanation for differences in public and private firm investment sensitivities: investment sensitivities differ because the type of investments favored by firms varies with their listing status. Specifically, we consider the geography of investment opportunities and find that private firms have a much stronger investment home-bias than similar public firms which makes their investment decisions more sensitive to local investment opportunities than public firms. Controlling for local investment opportunities explains four-fifths of the differential sensitivity between public and private firms not explained by more traditional measures of investment opportunities.     

Capital structure and product market behavior: an examination of plant exit and investment decisions.

We examine whether sharp debt increases through leveraged buyoutsand recapitalizations interact with market structure to influenceplant closing and investment decisions of recapitalizing firmsand their rivals. We take into account the fact that recapitalizationsand investment decisions are both endogenous and may be simultaneouslyinfluenced by the same exogenous events. Following their recapitalizations,firms in industries with high concentration are more likelyto close plants and less likely to invest. Rival firms are lesslikely to close plants and more likely to invest when the marketshare of leveraged firms is higher.