Investment,leverage and political risk: Evidence from project-level FDI

Does capital structure influence firms' FDI capital expenditure decisions into countries with varying degrees of political risk? We explore this question using a novel dataset that matches 10,000 unique outward foreign direct investment (OFDI) projects with 1135 distinct U.S. firms over the period 2003–2014. We find that capital expenditures allocated to FDI projects are significantly lower for highly leveraged firms, in particular for firms with low growth opportunities. Firms also commit lower capital amounts to investments located in countries characterized by higher political risk. Furthermore, leverage and political risk interact with one another in determining the financial commitment of the FDI, with leverage exerting a significantly stronger negative effect on capital expenditures in countries where political risk is elevated. Our findings are consistent with the monitoring role of debt in curbing exposure to political risk in multinational firms' foreign operations, and corroborate the disciplinary role of leverage on firms' investment decisions.     

Collateral,Risk Management,and the Distribution of Debt Capacity

Collateral constraints imply that financing and risk management are fundamentally linked. The opportunity cost of engaging in risk management and conserving debt capacity to hedge future financing needs is forgone current investment, and is higher for more productive and less well‐capitalized firms. More constrained firms engage in less risk management and may exhaust their debt capacity and abstain from risk management, consistent with empirical evidence and in contrast to received theory. When cash flows are low, such firms may be unable to seize investment opportunities and be forced to downsize. Consequently, capital may be less productively deployed in downturns.     

Hedging,financing, and investment decisions: Theory and empirical tests

In this paper we theoretically and empirically examine the interaction between hedging, financing, and investment decisions. A simple equilibrium model with costly financial distress suggests that as firms become more efficient at risky investments vis a vis low risk investments, they will borrow less, invest more in risky assets, and hedge more. The model also predicts a positive relationship between hedging and leverage – a result consistent with debt capacity arguments. We test the model empirically using a simultaneous equations framework to investigate the determinants of firm-level hedging, financing and investing decisions. The results strongly support the hypothesis that the hedging, financing and investment decisions are jointly determined. In addition, we find strong support for the central hypothesis that firms more efficient investing in risky technologies more aggressively hedge and use less debt financing in order to maximize their comparative advantage.     

Managerial conservatism and corporate policies

This paper investigates how conservative managers make corporate decisions. Motivated by psychology research, we use handwritten signatures (i.e., emotionally restraint disclosure styles) as a proxy for CEO conservatism. We find that firms with conservative CEOs engage more with safer investments (capital expenditures), engage less with risky policies (Research & Development expenses and debt financing), hold more cash, are less likely to pay cash dividends, and more likely to use stock repurchase schemes. We use the same proxy for CFO conservatism. We find that CFO conservatism is a better determinant than CEO conservatism for cash holding and financing policies, but the reverse is true for investment policies. Conservative CFOs prefer long-term debt to short-term debt.     

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.     

Capital structure and large investment projects

This paper provides empirical evidence that lumpy investment projects provide firms with the opportunity to adjust leverage at low marginal cost. Consistent with a theoretical model, I find that 1) firms sequence equity before debt during the financing period of their investment projects, and 2) that firms adjust their leverage ratios toward their target leverage during these investment periods. I also show that proactive increases in leverage observed in other studies can be explained by the evolution of firms' target leverage ratios over the financing period of a project. My results are consistent with trade-off theory and imply that firms move toward their target capital structures when they invest.     

Shareholders' control rights,family ownership and the firm's leverage decisions

We investigate the association between controlling shareholders' ownership (CS_Own) and firms' leverage decisions in the Singaporean context. We examine whether the impact of ownership concentration on leverage differs across excess and lower control. We report that shareholders with excess control prefer leverage financing for an optimal capital structure and focus on value maximisation rather using leverage as a tool of minority shareholders' expropriation. Our analysis shows that firms capital structure significantly influences by the coalition of shareholders particularly decisions about leverage financing in addition to the firms' specific characteristics and institutional arrangements. Our empirical evidence shows that controlling shareholders with a lower fraction of equity are more concerned about limited holding thus prefer leverage over equity financing to inflate their equity stake to protect them from the potential takeovers and mergers. We report that capital structure decisions in Singapore are linked with the trade-off between the controlling shareholders' target of mitigating firm risk and their non-dilution entrenchment needs. Further, we found an inverted U-shaped association between control ownership and leverage financing. In terms of moderating effect of family-controlled ownership, our findings exhibit that leverage financing is less pronounced for family firms in Singapore due to the under-diversified investment portfolio.     

Long-Term Financing Decisions: Views and Practices of Financial Managers of NYSE Firms

This paper reports the findings of a 1990 survey of a sample of NYSE firms conducted to learn about the managerial opinions and practices with respect to longterm financing decisions. Relying on a hierarchy of financing sources is discovered to be a far more common practice among the sample firms than maintaining a target capital structure. The risk-return dimensions of the investment being financed are found to be the most important inputs in determining financing decisions. In spite of the perceived lack of fairness in the market pricing of their securities, the sample firms do not report making financing decisions to signal a need for reevaluation of their securities. Financial managers display a much greater flexibility with capital structure decisions than with either dividend policy decisions or investment decisions. The firms which attempt to maintain target capital structures are found to perceive the average debt ratios in their respective industries to be important determinants of their own debt ratios. The firms which follow financing hierarchies on the other hand, are found to view their firms' past profits and past growth to be important determinants of their debt ratios.     

Investment financing: evidence from Korea

This study examines the relative importance of various forms of capital in financing investments by Korean firms. Our results from the seemingly unrelated regression (SUR) method indicate that, unlike U.S. firms, Korean firms rely substantially on cash holdings to finance investments. These results also suggest that Korean firms use long‐term debt more actively than equity issuance to finance investments. Subgroup analyses show that large firms and Chaebol‐affiliated firms use more long‐term debt but less equity issuance than comparison firms do, suggesting that debt capacity allows firms to reduce the use of equity issuance. However, there is little evidence that financing decisions are driven by information asymmetry. The results from the quantile regression (QR) method suggest that Korean firms tend to use debt capital more than they do equity capital at low and medium levels of investments, while their reliance on equity capital increases at high levels of investments.     

How do firms finance their investments?: The relative importance of equity issuance and debt contracting costs

This paper examines the financing decisions of firms in response to changes in investments and profits. We find that information frictions play important roles in firms' financing decisions. However, we find no evidence that asymmetric information about the value of a firm's assets causes equity to be used only as a last resort. Indeed equity is the predominant source of finance in situations, such as profit shortfalls, investment in intangible assets, and internally generated growth opportunities, where informational asymmetries and agency costs are likely to be high. We also find that firms respond asymmetrically to positive and negative profit shocks. In financing fixed assets, high asymmetric information firms use more short-term debt and less long-term debt, whereas firms with high potential agency problems use significantly more equity and less long-term debt and cash.     

The Effects of Public Venture Capital Investments on Corporate Governance: Evidence From IPO Firms in Emerging Markets

This study examines the impact of public venture capital (hereafter PVC) investments on corporate governance of initial public offering (hereafter IPO) firms in emerging markets. Using data collected from Taiwan PVC investments during 1996–2005, we analyse three corporate governance features in IPO firms: earnings management, board characteristics, and excess control by controlling shareholders. We find that PVC‐backed firms use fewer accounting accruals in their IPO financial statements than non‐PVC‐backed firms. This result suggests that PVC‐backed IPO firms engage in less earnings management than non‐PVC‐backed IPO firms. We also find PVC‐backed firms tend to set up their boards with fewer non‐independent directors and supervisors at IPO. This result indicates that PVC‐backed IPO firms have better board structures than non‐PVC‐backed IPO firms. Finally, we find that controlling shareholders are less likely to exert excess control in PVC‐backed firms than in non‐PVC‐backed firms. Overall, our results indicate that PVC investments add value to new IPO firms not only in financing their capital needs but also in creating better corporate governance structures in emerging markets.     

Debt Maturity Structure and Accounting Conservatism

This study examines the association between debt maturity structure and accounting conservatism. Short‐maturity debt can mitigate agency costs of debt arising from information asymmetry and suboptimal investment problems inherent in debt financing. As such, debt‐contracting demand for accounting conservatism is expected to be lower in the presence of more short‐maturity debt. We find that short‐maturity debt is negatively associated with accounting conservatism. As firms could commit to more accounting conservatism to gain access to long‐maturity debt, we conduct lead‐lag tests of the direction of causality, and the results suggest that more short‐maturity debt leads to less conservative reporting, rather than the reverse. We also find the negative relation between short‐maturity debt and accounting conservatism is more pronounced among financially distressed firms, where ex ante severity of agency costs of debt are higher. Collectively, our results contribute to our understanding of the role of accounting conservatism in debt contracting and show how debt maturity, a key and pervasive feature of creditor protection in debt contracting, affects accounting conservatism.     

Real Estate Risk,Corporate Investment and Financing Choice

This paper empirically examines how real estate risk impacts corporate investment and financing decisions. Using a panel of United States firms from 1985 to 2013, we document that real estate risk is negatively associated with firms’ long-term investments and long-term external financing in equity and debt. The results are robust to different risk measurements and in particular salient during the financial crisis period when the endogeneity between risk and investment is less of a concern. The effect on firm leverage, however, depends on risk measures. Overall, in contrast to previously documented positive effects of the real estate value, real estate risk exposure exhibits mostly the opposite effects on investment, financing and capital structure. This difference is consistent with option value determinants. Findings in this paper shed new lights on the impact of real estate holding on corporate decisions, offer a new explanation for the underperformance of hedge funds’ real estate strategies, and confirm the theoretical predictions in Deng et al. (2015).     

Investment Horizons and Information

We examine the relation between institutions' investment horizons on firms' financing and investment decisions. Firms with larger short‐term institutional ownership use less debt financing and invest more in corporate liquidity. In contrast, firms with larger long‐term institutional ownership use more internal funds, less external equity financing, and preserve investments in long‐term assets. These results are primarily driven by the variation in informational preferences of different institutions. We argue that short‐term (long‐term) institutions collect and use value‐neutral (value‐enhancing) information.     

Sources of Financing,Profitability and Productivity: First Evidence from Matched Firms

This paper contributes to the literature on capital structure and firm performance. Using firm‐level data covering over 11,000 firms from 47 countries over a recent period of 1997‐2007, we address the effect of different sources of financing on corporate performance, employing a matching process, which allows an adequate `like‐for‐like’ comparison between high and low level of financing by firms. Robust to different matching estimators, the main findings are consistent with the theories of capital structure, in that firms with high debt‐to‐equity ratio tend to have lower returns to shareholders (profitability) and lower internal efficiency (productivity). The results become more robust when we separate the firms into advanced and emerging country‐groups or countries with high/low levels of financial development. Given the lower level of leverage below 50% on average in emerging markets (or in countries with lower level of financial reforms), firms in these economies face lower risk of financial distress and thereby less adverse effect on firm profitability and productivity, relative to their counterparts in advanced economies. We also find that retained earnings and equity financing improve performance, while debt financing by firms particularly in the form of bank loans leads to lower performance, although not so in the case of debt raised through issuing bonds.     

Dynamic Models of Investment Distortions

This paper studies the interaction between corporate financing decisions and investment decisions in a dynamic framework. When the production decision involves an expansion option, the firm trades off tax benefits of debt against two costs of debt financing, namely the investment distortion related to exercise of the expansion option and the loss of a valuable expansion opportunity if the firm defaults. The optimal capital structure is all equity for firms with more value in growth options (or intangible assets) and tends to involve debt financing for firms with more value in tangible assets. JEL Classification: D81, G13, G31, G32     

The Effects of Ownership Structure and Intragroup Loans on Leverage: Evidence from Family Firms in Chile

This article examines the effects of family control and pyramidal ownership on firms’ capital structure decisions. After studying a sample of listed family and nonfamily firms in Chile, we find that families take a conservative approach to debt and financial risk exposure. We test the hypothesis that family firms restrict the use of debt in order to avoid the monitoring role of creditors, which could limit their enjoyment of the private benefits of control. In keeping with this hypothesis, we find a U-shaped relationship between leverage and the degree of pyramidal ownership that is more pronounced among family firms than nonfamily firms. We do not find any evidence that is consistent with the hypothesis that family-controlled firms have low leverage ratios due to their access to internal capital markets. In fact, conversely, we find that listed family firms provide more loans to related companies than comparable nonfamily firms.     

Investment policy in family controlled firms

We explore the relation between family ownership and corporate investment policy. Our analysis centers on two incentives, risk aversion and extended investment horizons, which potentially influence the level and type of investments that family firms undertake. We find that family firms devote less capital to long-term investments than firms with diffuse ownership structures. When dividing long-term investment into its two components of R&D and capital expenditures, we note that family firms, relative to nonfamily firms, prefer investing in physical assets relative to riskier R&D projects. Additional tests indicate that family firms receive fewer patent citations per dollar of R&D investment relative to nonfamily firms. Overall, all empirical results indicate that family preferences for lower firm risk, across all family sub-types, affects corporate R&D spending and capital expenditures.     

A Unified Theory of Tobin's q,Corporate Investment,Financing, and Risk Management

We propose a model of dynamic investment, financing, and risk management for financially constrained firms. The model highlights the central importance of the endogenous marginal value of liquidity (cash and credit line) for corporate decisions. Our three main results are: (1) investment depends on the ratio of marginal q to the marginal value of liquidity, and the relation between investment and marginal q changes with the marginal source of funding; (2) optimal external financing and payout are characterized by an endogenous double‐barrier policy for the firm's cash‐capital ratio; and (3) liquidity management and derivatives hedging are complementary risk management tools.     

Corporate Governance and Corporate Financing and Investment during the 2007‐2008 Financial Crisis

We examine the impact of the 2007‐2008 financial crisis on nonfinancial firms’ financing and investment activities and the role of corporate governance in alleviating the adverse consequences of the external capital supply shock. Employing a difference‐in‐differences research design, we find that better governance mitigates the disruption caused by the bank credit supply shock to firms’ financing and investment activities. A variety of robustness tests suggest that our findings are unlikely to be driven by an endogeneity problem. We obtain similar results when we extend the sample period to include the delayed spillover from the banking sector to other capital market sectors.