Trade credit and supplier competition

This paper examines how competition among suppliers affects their willingness to provide trade credit financing. Trade credit extended by a supplier to a cash constrained retailer allows the latter to increase cash purchases from its other suppliers, leading to a free rider problem. A supplier that represents a smaller share of the retailer’s purchases internalizes a smaller part of the benefit from increased spending by the retailer and, as a result, extends less trade credit relative to its sales. In consequence, retailers with dispersed suppliers obtain less trade credit than those whose suppliers are more concentrated. The free rider problem is especially detrimental to a trade creditor when the free-riding suppliers are its product market competitors, leading to a negative relation between product substitutability among suppliers to a given retailer and trade credit that the former provide to the latter. We test the model using both simulated and real data. The estimated relations are consistent with the model’s predictions and are statistically and economically significant.     

Strategic Cost of Diversification

This article proposes a new explanation for the large cross-sectionalvariation in the excess values of diversified firms. The modelapplies the idea of shareholders' limited liability affectingfirms' output market strategies to the analysis of financialand operating choices of conglomerates. The inability of conglomeratesto commit to unconstrained optimal operating strategies, followingfrom the lack of flexibility in choosing their divisions' capitalstructures, reduces their value. Thus, the model highlightsa new type of inefficiency of the conglomerate organizationalstructure, which is suboptimal financing. The predictions ofthe model are generally supported by the data.     

Strategic IPOs and product market competition

We examine firms' incentives to go public in the presence of product market competition. As a result of their greater ability to diversify idiosyncratic risk in the capital market, public firms' owners tolerate higher profit variability than owners of private firms. Consequently, public firms adopt riskier and more aggressive output market strategies than private firms, which improves the competitive position of the former vis-à-vis the latter. This strategic benefit of being public, and thus, the proportion of public firms in an industry, is shown to be positively related to the degree of competitive interaction among firms in the output market, to demand uncertainty, and to the idiosyncratic portion of this uncertainty. Additional empirical predictions concern the effect of a firm's initial public offering on its market share and on its rivals' valuations. We test the model's predictions and find empirical support for most of them.     

Target leverage and the costs of issuing seasoned equity

In this paper, I examine the relation between the direct costs of issuing seasoned equity (SEO gross spreads) and the change in deviation of firms’ leverage ratios from their estimated targets following SEOs. If underwriters have bargaining power vis-a-vis issuing firms in setting SEO fees and if the tradeoff theory of capital structure holds, then SEO fees should be negatively related to the post-SEO change in absolute deviation of firms’ leverage ratios from targets. I find that this relation is indeed negative and economically and statistically significant, especially in cases in which underwriters have relatively high bargaining power, suggesting that one of the important determinants of SEO fees is the change in firms’ absolute deviations from their target leverage as a result of issuing seasoned equity, and that underwriters are able to capture part of the value created by firms moving towards their leverage targets.     

Investment opportunities and bankruptcy prediction

A firm's mix of growth options and assets in place is an important determinant of its optimal default strategy. Our simple model shows that shareholders of a firm with valuable investment opportunities would be able/willing to wait longer before defaulting on their contractual debt obligations than shareholders of an otherwise identical firm without such opportunities. More importantly, we show empirically using a dataset of recent corporate bankruptcies that measures of investment opportunities are significantly related to the likelihood of bankruptcy. Augmenting existing bankruptcy prediction models by these measures improves their out-of-sample forecasting ability.     

Accelerated investment effect of risky debt

In this paper we examine a new effect of risky debt on a firm’s investment strategy. We call this effect “accelerated investment”. It stems from a potential loss of investment option in the event of default. The possibility of default reduces the value of the option to wait and provides equity holders with an incentive to speed up investment. As a result, in the absence of wealth expropriation by a levered firm’s debt holders, its shareholders exercise their investment option earlier than the shareholders of an otherwise identical all-equity firm. This result is at odds with the generally accepted intuition that in the absence of potential wealth transfers and taxes the shareholders of a levered firm would follow the same investment policy as that of an unlevered firm. In addition to providing various illustrations of the accelerated investment effect, we relate its magnitude to the presence of competition for investment opportunities.     

Understanding Investor Sentiment: The Case of Soccer

We examine the extent to which the stock market's inefficient responses to resolutions of uncertainty depend on investors’ biased ex ante beliefs regarding the probability distribution of future event outcomes or their ex post irrational reactions to these outcomes. We use a sample of publicly traded European soccer clubs and analyze their returns around important matches. Using a novel proxy for investors’ expectations based on contracts traded on betting exchanges (prediction markets), we find that within our sample, investor sentiment is attributable, in part, to a systematic bias in investors’ ex ante expectations. Investors are overly optimistic about their teams’ prospects ex ante and, on average, end up disappointed ex post, leading to negative postgame abnormal returns. Our evidence may have important implications for firms’ investment decisions and corporate control transactions.     

Costly external financing, investment timing, and investment–cash flow sensitivity

This paper examines the effects of costly external financing on the optimal timing of a firm's investment. By altering the optimal investment timing, costly financing affects current investment and the sensitivity of investment to internal cash flow. Importantly, the relation between the cost of external funds and investment–cash flow sensitivity is non-monotonic. Investment–cash flow sensitivity is decreasing in the cost of external financing when it is relatively low and is increasing in the financing cost when it is high. Empirical tests examining investment–cash flow sensitivities within groups of firms classified by proxies for their costs of external funds provide evidence consistent with the model. The model and the empirical results complement recent studies by Cleary, Povel and Raith [Cleary, S., Povel, P. and Raith, M., 2007. The U-shaped investment curve: theory and evidence, Journal of Financial and Quantitative Analysis 42, 1–39.] and Almeida and Campello [Almeida, H. and Campello, M., in press, Financial constraints, asset tangibility and corporate investment, Review of Financial Studies.] that show a non-monotonic relation between firms' investment and the availability of internal funds.