Financial Contracting and Leverage Induced Over- and Under-Investment Incentives

This paper investigates the effects of seniority rules and restrictive dividend convenants on the over- and under-investment incentives associated with risky debt. We show that increasing seniority of new debt decreases the incidence of under-investment but increases over-investment, and vice versa. Under symmetric information, the optimal seniority rule is to give new debtholders first claim on a new project without recourse to existing assets (i.e., project financing). Under asymmetric information, the optimal debt contract requires equating the expected return to new debtholders in the default state to the new project's cash flow in the same rate. If this is not possible, the optimal seniority rule calls for strict subordination of new debt if the expected cash flow in default is small and full seniority if it is large. With regard to dividend convenants, we show that their effect depends on whether or not dividend payments are conditioned on future investments. When they are unconditioned, allowing more dividends increases the under-investment incentive. In contrast, conditional dividends decrease the underinvestment incentive and increase the over-investment incentive.     

Capital Structure as a Strategic Variable: Evidence from Collective Bargaining

I analyze the strategic use of debt financing to improve a firm's bargaining position with an important supplier—organized labor. Because maintaining high levels of corporate liquidity can encourage workers to raise their wage demands, a firm with external finance constraints has an incentive to use the cash flow demands of debt service to improve its bargaining position with workers. Using both firm‐level collective bargaining coverage and state changes in labor laws to identify changes in union bargaining power, I show that strategic incentives from union bargaining appear to have a substantial impact on corporate financing decisions.     

Are banks happy when managers go long? The information content of managers’ vested option holdings for loan pricing

While traditional finance theory holds that managers with option-laden incentive contracts may favor equity at the expense of debt, a risk-averse manager may be more likely to retain vested in-the-money options if the manager has private information that the firm's risk-adjusted performance will be better. It follows that vested option holdings should be positively associated with credit quality. In support of this, we find that vested option holdings have a strong negative association with loan pricing, especially for informationally sensitive loans, and also predict higher cash flows and credit ratings, a greater distance to default, and lower equity volatility.     

Monetary policy and regional availability of debt financing

The relative availability of bond and bank financing should affect the firm's external financing and investment decisions. We define a measure that proxies for the regional borrowing inflexibility to substitute between bank and bond financing: “debt inflexibility”. Debt inflexibility tilts the firm's financial structure towards equity and reduces investment. The impact is stronger during the period of tight monetary policy, particularly for smaller firms and firms without banking relationships. Debt inflexibility increases the sensitivity of cash holdings to cash flows, reduces the likelihood of dividend payment and makes the firm more likely to pay equity in mergers and acquisitions.     

Financial constraints on credit ratings and cash-flow sensitivity

This study investigates whether financial constraints, as measured by the level of credit ratings and their migrations would affect the firm's cash flow allocation policies and reflect the main financial constraints on a firm's cash flow sensitivity of cash. For a given credit quality shock, control for firm-level characteristics and endogeneity of cash flow allocation, our results suggest that firms with higher credit financial constraints have significantly higher cash flow sensitivities on cash holding, investment, and debt financing activities. Our results provide evidence that credit rating risk has a larger impact on cash flow allocation and drives the financial constraints on cash flow sensitivity for various reasons, including precautionary motivation and restricted access to external financing.     

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.     

MORGAN STANLEY ROUNDTABLE ON Capital Structure and Payout Policy

A group of distinguished finance academics and practitioners discuss a number of topical issues in corporate financial management: Is there such a thing as an optimal, or value‐maximizing, capital structure for a given company? What proportion of a firm's current earnings should be distributed to the firm's shareholders? And under what circumstances should such distributions take the form of stock repurchases rather than dividends? The consensus that emerges is that a company's financing and payout policies should be designed to support its business strategy. For growth companies, the emphasis is on preserving financial flexibility to carry out the business plan, which means heavy reliance on equity financing and limited payouts. But for companies in mature industries with few major investment opportunities, more aggressive use of debt and higher payouts can add value both by reducing taxes and controlling the corporate free cash flow problem. In such cases, both leveraged financing and cash distributions through dividends and stock buybacks signal management's commitment to its shareholders that the firm's excess cash will not be wasted on projects that produce low‐return growth that comes at the expense of profitability. As for the choice between dividends and stock repurchases, dividends provide a stronger commitment to pay out excess cash than open market repurchase programs. Stock buybacks, at least of the open market variety, preserve more flexibility for companies that want to be able to capitalize on unpredictable investment opportunities. But, as with the debt‐equity decision, there is an optimal level of financial flexibility: too little can mean lost investment opportunities, but too much can lead to overinvestment.     

Price uncertainty and corporate value

This study examines the sensitivity of equity values of oil producers to changes in the uncertainty of future oil prices. We document that this sensitivity is negatively correlated with a firm's debt ratio and its production costs. These results indicate that companies that are more likely to experience financial distress or underinvestment from low cash flows are adversely affected by increases in the uncertainty of future cash flows. We conclude that corporate risk management can increase shareholder value by reducing the expected costs of financial distress and underinvestment.     

Morgan Stanley Roundtable on Capital Structure and Payout Policy

A group of finance academics and practitioners discusses a number of topical issues in corporate financial management: Is there such a thing as an optimal, or value‐maximizing, capital structure for a given company? What proportion of a firm's current earnings should be distributed to the firm's shareholders? And under what circumstances should such distributions take the form of stock repurchases rather than dividends? The consensus that emerged was that a company's financing and payout policies should be designed to support its business strategy. For growth companies, the emphasis is on preserving financial fl exibility to carry out the business plan, which means heavy reliance on equity financing and limited payouts. But for companies in mature industries with few major investment opportunities, more aggressive use of debt and higher payouts can add value by reducing taxes and controlling the corporate “free cash flow problem.” Both leveraged financing and cash distributions through dividends and stock buybacks represent a commitment by management to shareholders that the firm's excess cash will not be wasted on projects that produce growth at the expense of profitability. As for the choice between dividends and stock repurchases, dividends appear to provide a stronger commitment to pay out excess cash than open market repurchase programs. Stock buybacks, at least of the open market variety, preserve a higher degree of managerial fl exibility for companies that want to be able to capitalize on unpredictable investment opportunities. But, as with the debt‐equity decision, there is an optimal level of financial fl exibility; too little can mean lost investment opportunities but too much can lead to overinvestment.     

Sources of Corporate Financing and Operating Performance: The effects of strategic ownership and financial restatements

Using a sample from European markets this study documents that changes in external financing, both in the form of equity and debt, can predict future operating performance (profitability and cash flows). In terms of future profitability, increases in equity (debt) financing particularly benefit large-size growth firms (large-size value firms). It is notable that a firm environment of low information quality, indicated by the presence of accounting restatements, intensifies the association between external financing and operating performance, due to the heightened scrutiny investors/lenders apply to firms that have recently restated their financials. In addition, strategic ownership in the firm has no significant effect on the financing – operating profitability association but may amplify the positive effects of equity financing on future operating cash flows. Moreover, financial analysts' forecasts of operating profitability and operating cash flows reflect the impact of external financing changes on future operating performance but exhibit a financing-related systematic inefficiency particularly for firms that have recently announced a material restatement of their prior financial results. Finally, controlling for information contained in analyst forecast surprises, the market is efficient overall and incorporates the effects of equity and debt financing changes into stock prices.     

Do Firms Adjust Their Timely Loss Recognition in Response to Changes in the Banking Industry?

This paper investigates the impact of changes in the banking sector on firms’ timely recognition of economic losses. In particular, we focus on the entry of foreign banks into India during the 1990s, which likely causes an exogenous increase in lender demand for timely loss recognition. Analyzing variation in both the timing and the location of the new foreign banks’ entries, we find that foreign bank entry is associated with more timely loss recognition and this increase is positively related to a firm's subsequent debt levels. The change appears driven by a shift in firms’ incentives to supply additional information to lenders and lenders seem to value this information. The increase in timely loss recognition is also concentrated among firms more dependent on external financing: private firms, smaller firms, and nongroup firms. Overall, our evidence suggests that a firm's accounting choices respond to changes in the banking industry.     

What determines the composition of a firm's cash reserves?

We investigate what determines variation in the composition of the financial assets that constitute corporate cash reserves and how this variation relates to other key liquidity management practices. The degree to which a firm invests its cash reserves in less liquid, longer-maturity financial assets that earn a higher yield is explained by financial constraints, the ability to accurately forecast short-term liquidity needs, and the firm's likelihood of defaulting on its debt. During years when a firm's cash reserves are required to fund increases in investment or operating expenses the firm transfers funds from less liquid to more liquid financial assets. A firm's decisions relating to the composition of its cash reserves interacts with other key liquidity management practices, such as relying on credit lines for liquidity, extending trade credit or using it as a source of financing, and holding large amounts of inventories. Our findings provide insights on an important component of corporate liquidity management decisions.     

CONVERTIBLE DEBT AND INVESTMENT INCENTIVES

In this paper we examine the effect of convertible debt on the investment incentives facing stockholders. The effect depends critically on the value of existing assets relative to the firm's investment requirements. With a restrictive dividend covenant, convertible debt mitigates the overinvestment incentive associated with risky debt but exacerbates the underinvestment incentive at higher values of existing assets. A less-restrictive dividend covenant exacerbates overinvestment under straight debt financing but reduces the underinvestment incentive induced by the conversion feature. In this context, a convertible debt contract with a less-restrictive dividend covenant maximizes firm value.     

Revenue Recognition in a Multiperiod Agency Setting

This paper examines how various revenue recognition rules affect the incentive properties of accounting information in a stewardship setting. Our analysis demonstrates that if revenues are recognized according to the realization principle, a single performance measure based on aggregated accounting information can be used to provide desirable production and effort incentives to the manager. In contrast, mark-to-market accounting does not provide efficient aggregation of raw information to solve the stewardship problem. Mark-to-market accounting, though sensible from a valuation perspective, fails to provide desirable incentives because it relies on the anticipated, rather than the actual, performance of the manager. We also consider a setting in which the manager can control the timing of the firm's sales. It then becomes desirable to modify the realization principle and apply the lower-of-cost-or-market valuation rule. The desirable accounting thus exhibits a conservative bias.     

Earnings Manipulation and the Cost of Capital

The widespread use of accounting information by investors and financial analysts to help value stocks creates an incentive for managers to manipulate earnings in an attempt to influence short‐term stock price performance. This paper examines the role of earnings management in affecting a firm's cost of capital. Using an agency model with multiple firms whose cash flows are correlated, we demonstrate that the extent of earnings manipulation varies across the business cycle. Depending on a firm's earnings profile, it can have stronger incentives to overstate its performance in good times or in bad times. Because of this dependence on the state of the economy, earnings manipulation can influence a firm's cost of capital despite the forces of diversification.     

Pledgeability,Industry Liquidity,and Financing Cycles

Why do firms choose high debt when they anticipate high valuations, and underperform subsequently? We propose a theory of financing cycles where the importance of creditors’ control rights over cash flows (“pledgeability”) varies with industry liquidity. The market allows firms take on more debt when they anticipate higher future liquidity. However, both high anticipated liquidity and the resulting high debt limit their incentives to enhance pledgeability. This has prolonged adverse effects in a downturn. Because these effects are hard to contract upon, higher anticipated liquidity can also reduce a firm's current access to finance.     

Debt and managerial rents in a real-options model of the firm

We present a theory of capital investment and debt and equity financing in a real-options model of a public corporation. The theory assumes that managers maximize the present value of their future compensation (managerial rents), subject to constraints imposed by outside shareholders’ property rights to the firm's assets. Absent bankruptcy costs, managers follow an optimal debt policy that generates efficient investment and disinvestment. We show how bankruptcy costs can distort both investment and disinvestment. We also show how managers’ personal wealth constraints can lead to delayed investment and increased reliance on debt financing. Changes in cash flow can cause changes in investment by tightening or loosening the wealth constraints. Firms with weaker investor protection adopt higher debt levels.     

会计信息可比性与企业商业信用融资——基于企业市场地位和行业竞争环境的双重考量

不同于传统的基于资本市场情境进行的会计信息可比性经济后果研究,将研究场景拓展至商品市场中企业供应链层面,考察企业会计信息可比性能否影响供应链伙伴的商业信用政策制定,进而反映到企业的商业信用融资水平.研究发现:会计信息可比性越高的企业,其商业信用融资水平也越高;会计信息可比性对商业信用融资的促进作用只在市场地位较低、所处行业竞争程度较高的企业中存在.进一步的拓展研究证实,提高会计信息可比性可以有效缓解我国中小微企业普遍存在的融资难问题.     

Accounting Information, Disclosure, and the Cost of Capital

In this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the Capital Asset Pricing Model and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures affect the firm's assessed covariances with other firms' cash flows, which is nondiversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline in the cost of capital.     

Customers and cash: How relationships affect suppliers' cash holdings

If one customer accounts for a large portion of a supplier's sales, then the loss of that one customer can cripple the supplier's financial health. As a precaution against the additional operating risk induced by being in an important relationship with a customer, I find that suppliers in such relationships hold more cash on average than suppliers that are not in important relationships. Additionally, supplier's cash holdings increase proportionately with the importance of their customer relationships. Being in an important relationship affects cash holdings and leverage differently, indicating that firms manage cash and debt for different purposes. I find that suppliers in relationships primarily accrue cash through issuance of stock as opposed to debt or retained earnings. The results highlight the importance of understanding buyer–supplier relationships when evaluating a firm's financing policy.