The Perverse Effect of Debt Tax Benefits on Firm Investment Decisions

In this paper we question the idea that the deduction of debt interest is always an effective policy instrument to spur firm investment. We analyse the investment decision in presence of a borrowing constraint on the amount of debt that the firm can raise. We show that if the debt interest rate is decreasing in the firm's capital accumulation and another financial resource more expensive than debt is available (at least for levels of debt lower than the upper bound), then the deduction of the debt interest from taxes on capital income may reduce firm investment. This theoretical result is relevant for economic policy decisions when financial intermediaries are not willing to finance beyond a certain threshold but firms have access to other sources of finance.     

中国上市公司融资偏好问题的重新审视

基于对中国上市公司股本融资偏好问题的重新审视,我们发现:(1)如果将短期债务考虑在内并剔除首次公开募股的影响,股本融资偏好就不复存在;(2)在企业债务比率的调整过程中,融资缺口所起的作用超过了传统的企业特征因素,这意味着顺序偏好理论能在一定程度上解释企业的融资行为;(3)股票市场状况和政府管制政策会对企业外部融资的构成产生一定的影响。以上经验证据表明,中国上市公司的融资行为并不像原先所想的那样独特,主流的资本结构理论对企业的债务政策具有相当的解释能力。     

R&D financing and growth

ABSTRACT

R&D investment are an important engine of growth and development. Yet economists have often claimed underinvestment, based on the consideration that these projects are more costly to finance, especially, due to the asymmetric information between inside and outside investors. Coherently, a recent empirical evidence has shown that firms intensively active in R&D are less leveraged and rely more heavily on internal finance. Motivated by this evidence, we study the effects of asymmetric information and financial frictions within a GE economy of Schumpeterian tradition. The model and equilibrium concept are rich enough to represent investment and innovation decisions, technology adoption/diffusion through patent licensing and, most importantly, firms' financial decisions. In this representation, R&D-intensive firms might effectively rely more on internal sources and equity than on debt financing, relative to what would happen in frictionless markets. Further, financial decisions affect aggregate investment and income dynamics.     

Financial globalization and debt maturity in emerging economies

This paper studies how financial globalization affects debt structure in emerging economies. We find that by accessing international markets, firms increase their long-term debt and extend their debt maturity. In contrast, with financial liberalization, long-term debt decreases and the maturity structure shifts to the short term for the average firm. These effects are stronger in economies with less developed domestic financial systems. The evidence is consistent with financial integration having opposite effects on the firms that are able to integrate with world markets and obtain financing globally, relative to the firms that rely on domestic financing only.     

Financing constraints and investment efficiency: evidence from a panel of Canadian forest firms

This article examines the financial constraint of 18 listed Canadian forest firms between 2000 and 2014 following the stochastic frontier approach. Empirical results support the observation that Canadian forest firms have a strong dependence of using both equity financing and debt financing as the coefficients of both equity and debt financing mean functions are significant at 1% level. The distribution of investment efficiency index (IEI) of all 18 firms demonstrates a loss of around 40% of the rate of investment due to financing constraints. Regional analysis demonstrates that the time-varying patters of IEI of three provinces are significantly different.     

What can Islamic financing tell us about macro-prudential policies?

Macro-prudential policies are theoretically effective at mitigating a debt deflation crisis by forcing individuals to internalize their impact on aggregate prices reducing systemic risk caused by pecuniary externalities. To better understand the potential effectiveness of a macro-prudential time varying tax/subsidy on debt/dividends, we empirically estimate the impact of an Islamic financing presence on financial crises. Adherence to Islamic financing principles for a nontrivial portion of a country’s population has similar impacts to a macro-prudential policy in that these limited asset holders are likely to hold less debt or use debt-like instruments rather than conventional debt, driving down their marginal rate of substitution and the price of equity in equilibrium. To empirically estimate the effects of this policy, we interact an Islamic financing variable with debt in an otherwise standard model of financial crises. The results show that this macro-prudential-like policy decreases the likelihood of a banking crisis by 50%. The contribution of the article is twofold. First, we show that an Islamic finance presence encourages precautionary savings like a macro-prudential policy. Second, using an Islamic finance presence to capture macro-prudential potential effects, we find empirically that the likelihood of banking crises are cut roughly by half when such policies are in effect.     

Does issuing equity help R&D activity? Evidence from unlisted Italian high-tech manufacturing firms

This paper evaluates the causal effect of issuing equities on the probability that a firm engages in R&D activity. Equity is a better source of external finance than debt for innovation. It does not require collateral, does not exacerbate moral hazard problems connected with the substitution of high-risk for low-risk projects, quite common when using debt, and, unlike debt, does not increase the probability of bankruptcy; equity also allows investors to reap the entire benefit of the returns of successful innovative projects. This paper focuses on high-tech firms for which asymmetric information problems are more pervasive. Implementing an instrumental variable estimation, we find that issuing equity increases the probability that the firm has R&D expenditures by 30–40%. We detect considerable heterogeneity in this effect: the impact of issuing equity is significant only for small, young and more highly leveraged high-tech firms. We also find interesting evidence that issuing equity increases R&D expenditures in relation to sales.     

Political uncertainty and corporate debt financing: empirical evidence from China

We examine the influence of political uncertainty on corporate debt financing under the Chinese highly specialized political system. A new reasonable and effective alternative indicator, official turnover reason, is constructed to measure different political uncertainty level. Robust results suggest that listed companies will keep low debt financing level and smooth debt financing volatility under political uncertainty, which will be weakened during the global financial crisis. We also find that the listed company will raise equity financing level while overall financing is significantly reduced. In addition, SOEs are more sensitive to political uncertainty than non-SOEs, as they have stronger political connections with government officials.     

Is executive compensation a substitute governance mechanism to debt financing and leasing?

This study examines whether and how CEO equity incentives relate to financing choices (i.e., debt and leases). Using manually collected CEO compensation and lease data for a sample of large UK firms, we found evidence of a negative relationship between CEO equity incentives and firm leverage. We also found that CEO equity incentives and leases are negatively related. The results are consistent with the theory introduced in this study on the substitutability of executive compensation and firm’s debt/lease financing. Our findings represent fresh empirical evidence and renewed interpretation regarding the relationship between executive equity-based incentives and firm’s financing choices. The substitutability theory we introduced here suggests that firms with greater use of debt and/or leases will implement less equity-based compensation in mitigating the agency cost of equity.     

(NON‐)RESILIENCY OF FOREIGN DIRECT INVESTMENT IN THE UNITED STATES DURING THE 2007–2009 FINANCIAL CRISIS

We study the contraction of foreign direct investment (FDI) flows in the United States during the recent financial crisis and show their unusual non‐resiliency, which depends in part on the global nature of the economic recession, but also on the increases in the cost of financing FDI in the economies in which the flows originate. To formally study the effects of external financial conditions on FDI in the United States, we exploit the three dimensions of a panel of US inward FDI flows organized by recipient US industries, source countries and years for the recorded flows. Changes in the cost of finance in the source countries have little or no effect on total inward flows (the sum of equity, debt and reinvested earnings) over the 2006–2010 period. However, US industries characterized by more financial vulnerability experience statistically significant variations in the debt and equity components of inward FDI flows in response to the changes in the cost of capital that occurred in the source countries during the crisis.     

Monetary–fiscal interactions with endogenous liquidity frictions

I develop a tractable macro model with endogenous asset liquidity to understand monetary–fiscal interactions with liquidity frictions. Agents face idiosyncratic investment risks and meet financial intermediaries in competitive search markets. Asset liquidity is determined by the search friction and the cost of operating the financial intermediaries, and it drives the financing constraints of entrepreneurs (those who have investment projects) and their ability to invest. In contrast to private assets, government bonds are fully liquid and can be accumulated in anticipation of future opportunities to invest. A higher level of real government debt enhances the liquidity of entrepreneurs׳ portfolios and raises investment. However, the issuance of debt also raises the cost of financing government expenditures: a higher level of distortionary taxation and/or a higher real interest rate. A long-run optimal supply of government debt emerges. I also show that a proper mix of monetary and fiscal policies can avoid a deep financial recession.     

Portfolio Implications of an Equity Rain in Australia*

In the next decade Australia will experience a substantial privatization program. This represents a switch away from public debt financing towards public equity financing. In this paper, estimates of the likely effect of the government's privatization program on corporate financing are provided. The main result of an increase in the supply of equities along with a commensurate reduction in the supply of government debt is to cause a significant increase in the relative cost of equity, thereby creating incentives for corporate financiers to emphasize reliance on debt financing relative to equity financing. The estimated effect on the weighted cost of finance in the economy, while positive, is small     

What impact do differences in financial structure have on the macro effects of bank capital requirements in the United States and Australia?

We investigate the influence of jurisdictional differences in financial structure on the economic consequences of bank capital regulation. We use two disaggregated financial computable general equilibrium models to compare the impacts of identical increases in bank capital adequacy ratios in the U.S. and Australia. In both models, this raises bank equity financing shares, and lowers banks’ risk-weighted asset holdings. Thereafter however, differences in financial structure drive contrasting outcomes: in the U.S., average costs of capital fall, stimulating real investment, while we find the opposite outcome for Australia. We attribute this to differences in the structure of bank assets (U.S. banks hold more risk-free assets) and the importance of banks as intermediaries (bank finance is more important to capital formation in Australia). This may explain why capital regulations encompass non-banks in the U.S. but not Australia.     

Why is the corporate tax rate lower than the personal tax rate?: The role of new firms

In many OECD countries, statutory corporate tax rates are lower than personal income tax rates. This tax rate difference is often particularly large for small firms. The present paper argues that a reduction of the corporate tax rate below the personal tax rate is an optimal tax policy if there are problems of asymmetric information between investors and firms in the capital market. The reduction of the corporate tax rate below the personal tax rate encourages equity financing and thus mitigates the excessive use of debt financing induced by asymmetric information. Our main theoretical result stands in marked contrast to the traditional view of corporate taxation and corporate finance theory, according to which there is a tax disadvantage to equity financing. More recent empirical evidence on this issue, however, is in line with our result.     

Determinants of capital flows to emerging and advanced economies between 1990 and 2011

The previous and latest crises confirmed that stability of external financing of the economy is determined not only by the volume of capital inflow but also by its structure. It is established that a bias in gross external liabilities towards debt, especially short-term, may rise vulnerability to financial crises. Greater share of equity capital, mainly direct investment is not found to bear such financial risk. The results of Bayesian Model Averaging (BMA) show that influence of variables inherent in macroeconomic and portfolio approaches varies depending on the type of capital inflow and the group of countries. We also find some arguments that equity investment is a more desirable form of foreign capital because debt inflows are more responsive to global factors and therefore more volatile. As a word of caution, we highlight the need for diversification and careful monitoring of external financing sources and forms.     

Labour unions and leverage: evidence from firm-level union data

ABSTRACT

Using firm-level labour union data from Japan, this paper investigates the effect of labour unions on firm leverage. We find that as union coverage increases, both the level of and extent of change in leverage decreases. These relations remain robust when a firm falls into deficit. We also find that firms with higher union coverage have a higher interest coverage ratio. In addition, we find that firms with higher union coverage are less likely to choose issuing debt compared to issuing equity when they face financial distress. Our results imply that significant employee influence enhanced by labour unions increases fixed costs, crowds out the firm’s debt capacity and consequently reduces the firm’s leverage.     

Government debt and private leverage: An extension of the Miller theorem

This paper shows how government financing decisions can influence the corporate decision to use debt or equity finance. In particular, it is shown that an increase in the stock of taxable government debt reduces the equilibrium quantity of corporate debt, and that an increase in the stock of tax-free government debt reduces the equilibrium quantity of corporate equity. The effects of inflation rate and tax rate changes are also considered.     

Financial Development, Financing Choice and Economic Growth

In an overlapping generations economy, households (lenders) fund risky investment projects of firms (borrowers) by drawing up loan contracts on the basis of asymmetric information. An optimal contract entails either the issue of only debt or the issue of both debt and equity according to whether a household faces a single or double enforcement problem as a result of its own decision about whether or not to undertake costly information acquisition. The equilibrium choice of contract depends on the state of the economy which, in turn, depends on the contracting regime. Based on this analysis, the paper provides a theory of the joint determination of real and financial development, with the ability to explain both the endogenous emergence of stock markets and the complementarity between debt finance and equity finance.     

Distress cost and corporate financing policy: evidence from the equity options market

This study examines the link between distress cost and corporate financing policy through the lens of the equity options market. Four features stand out. First, the cost of distress is comparable to the tax shield from debt financing. Second, the results provide evidence that ordinary least-squares estimates understate the impact of market leverage on default risk. Third, consistent with the information models of debt maturity, firms with higher default probability use more long-term debt. Finally, more distressed firms rely on secured debt to a greater extent. Overall, the results support the trade-off theory of capital structure.     

Is the use of bank debt as a governance mechanism conditioned by the financial system? The cases of Chile and Spain

We test whether the use of bank debt as a governance mechanism is conditioned by the financial system in which firms operate. Our results indicate that the legal and institutional environment determines the use of bank debt to finance growth opportunities. Firms use bank debt to finance their growth opportunities when the country's banking system contributes to solving agency and asymmetric information problems and avoiding information monopoly costs. The evolutionary process of the financial systems in each country means that market imperfections such as information asymmetry or agency costs can have a diverse influence on firms’ bank debt decisions.