Investor protection and convertible debt design

An important issue that firms consider when designing convertible debt is to specify security features such as conversion ratio, maturity date and call period. Following Lewis et al. [Lewis, M., Rogalski, R., Seward, J., 2003. Industry conditions, growth opportunities and market reactions to convertible debt financing decisions. Journal of Banking and Finance 27, 153–181], we employ a single measure that simultaneously considers all of these features: the expected probability (measured at issue date) that the convertible will be converted to equity at maturity. We find that firms in countries with stronger shareholder rights issue convertible debt with a higher expected probability of converting to equity. The positive association between the expected probability of conversion and shareholder rights is less pronounced in firms for which ownership structures create potentially high managerial agency costs. Specifically, in countries with stronger shareholder rights, firms with higher separation of control rights and cash flow rights tend to issue convertibles with lower probability of conversion. Furthermore, we find that large non-management block ownership strengthens the likelihood of issuing convertible debt with higher probability of conversion in countries with stronger shareholder rights. In contrast, firms in countries with stronger creditor rights issue convertibles with lower probability of conversion. We also document that the negative association between creditor rights and probability of conversion is more pronounced in firms with higher separation of control rights and cash flow rights.     

Control/ownership structure,creditor rights protection,and the cost of debt financing: International evidence

We explore the effect of governance on bond yield-spreads and ratings in a multinational sample of firms. We find strong evidence that ultimate ownership (i.e., the voting/cash-flow rights wedge) and family control have a positive and significant effect on bond yield-spreads, and a negative and significant effect on bond ratings. Control in the hands of widely held financial firms has a positive effect on bond ratings only, while State control has no effect on either bond yield-spreads or ratings. We also find that a higher protection of debtholders’ rights generally reduces bond yield-spreads and increases bond ratings. Our results additionally show that, for both bondholders and rating agencies, the enforcement of debt laws is crucially important. Finally, we document a negative effect of debt covenants on debt costs when there is a high expropriation risk and poor creditor rights protection.     

Creditor rights and capital structure: Evidence from international data

For a large sample of 48 countries, we find robust evidence that strong creditor rights are associated with low long-term leverage across countries. We further find that strong creditor protection lowers long-term debt issuance, the extent to which investments are financed with long-term debt, and target leverage ratios. Finally, we find that firm and country characteristics influence the link between creditor protection and long-term leverage. Our results support the demand-side view that strong creditor protection discourages firms from making long-term cash flow commitments to service debt because managers and shareholders avoid the risk of losing control in the case of financial distress.     

The effect of state antitakeover laws on the firm's bondholders

We examine how state antitakeover laws affect bondholders and the cost of debt, and report four findings. First, bonds issued by firms incorporated in takeover-friendly states have significantly higher at-issue yield spreads than bonds issued by firms in states with restrictive antitakeover laws. Second, firms in takeover friendly states have significantly higher leverage than their counterparts in restrictive law states. Third, bond issues are associated with negative average stock price reactions among firms in takeover-friendly states, but positive stock price reactions among firms in restrictive law states. Fourth, existing bond values increase, on average, upon the introduction of Business Combination antitakeover law. These results indicate that state antitakeover laws tend to decrease bond yields and increase bond values, which is the opposite of their effect on equity values. This, in turn, implies that state laws help mitigate the agency cost of debt by shielding bondholders from expropriation in takeovers. Overall, the empirical evidence suggests that the effect of antitakeover provisions on firm value must take into account the impacts of both bondholders and stockholders.     

Short‐Term Corporate Debt around the World

Short‐term corporate debt as a proportion of total debt issued by public firms varies greatly across countries, between 28% in the United States and 78% in China. This paper argues that the interaction between information asymmetry and legal protection of creditors is an important determinant of debt maturity. When short‐term debt plays a dual role as signaling and commitment devices, a reduction in information asymmetry has a larger impact on debt maturity when creditor rights are weaker. We find empirical support for this prediction using firm‐level data from 45 countries around the world.     

Dividend policy,creditor rights,and the agency costs of debt

We show that country-level creditor rights influence dividend policies around the world by establishing the balance of power between debt and equity claimants. Creditors demand and managers consent to a more restrictive payout policy as a substitute for weak creditor rights in an effort to minimize the firm's agency costs of debt. Using a sample of 120,507 firm-years from 52 countries, we find that both the probability and amount of dividend payouts are significantly lower in countries with poor creditor rights. A reduction in the creditor rights index from its highest value to its lowest value implies a 41% reduction in the probability of paying a dividend, and a 60% reduction in dividend payout ratios. These results are robust to numerous control variables, sample variations, model specifications, and alternative hypotheses. We also show that the agency costs of debt play a more decisive role in determining dividend policies than the previously documented agency costs of equity. Overall, our findings contribute to the growing literature arguing that creditors exert significant influence over corporate decision-making outside of bankruptcy.     

Creditor rights and corporate risk-taking

We propose that stronger creditor rights in bankruptcy affect corporate investment choice by reducing corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions that are value-reducing, to acquire targets whose assets have high recovery value in default, and to lower cash-flow risk. Also, corporate leverage declines when creditor rights are stronger. These relations are usually strongest in countries where management is dismissed in reorganization and are also observed over time following changes in creditor rights. Our results thus identify a potentially adverse consequence of strong creditor rights.     

How creditor rights affect the value of cash: A cross-country study

We examine how legal protection of creditors affects the value of cash across countries. We find that the marginal value of cash is considerably higher in countries with weak creditor rights. Creditor rights are at least as relevant as shareholder rights, which other studies have found to be an important factor affecting various corporate policies. In addition, we find that marginal investment is more valuable for firms in countries with weak creditor rights. This combines the findings of previous studies that weak creditor protection makes firms financially constrained and that cash is more valuable for financially constrained firms. Subsample analysis suggests that financial constraints generated by weak creditor rights create underinvestment among cash starved firms but alleviate agency conflicts among cash rich firms. Further analysis reveals that good country governance complements laws protecting creditors in cash valuation.     

The cost of private debt over the credit cycle

We identify global and regional fluctuations in international private debt flows to emerging and developing countries using data on cross-border loans and international bond issuance over 1993–2009. We use micro-level data on syndicated cross-border loans and international bond placements to estimate the effects of individual borrower characteristics as well as macroeconomic conditions on the cost of foreign borrowing and test whether these effects differ across phases of the lending cycle. First, we find that borrower characteristics associated with lower loan spreads are not necessarily associated with lower bond spreads. Second, we find differential effects of borrower characteristics between cycle phases for loans and bonds separately. Third, we find strong reductions in the cost of debt finance during periods when international debt flows are more than one standard deviation above their mean, but not for expansionary periods, when the growth rate of debt flows is increasing. We also find that higher trade ratios in the borrower's home country raise loan spreads more in periods of high credit flows but have no effect on bond spreads. At the same time, borrowers residing in countries with high investment ratios pay lower spreads on bond issuance particularly during periods of high credit flows, but we find no similar effect for loan spreads. Inflation rates, real exchange rates and previous banking crises have small impacts on loan and bond spreads.     

Cooking the books: Recipes and costs of falsified financial statements in China

We examine the causes and consequences of falsified financial statements in China. Using bivariate probit regression analysis, we find that firms with high debt and that plan to make equity issues are more likely to manipulate their earnings and thus have to restate their financial reports in subsequent years. We also find that corporate governance structures have an effect on the occurrence and detection of financial fraud. There are significant negative consequences to fraudulent financial statements. Restating firms suffer negative abnormal stock returns, increases in their cost of capital, wider bid-ask spreads, a greater frequency of modified audit opinions, and greater CEO turnover. We also find that firms located in highly developed regions suffer more severe consequences when they manipulate their accounts.     

Directors' and officers' liability insurance and loan spreads

We analyze the effect of directors' and officers' liability insurance (D&O insurance) on the spreads charged on bank loans. We find that higher levels of D&O insurance coverage are associated with higher loan spreads and that this relation depends on loan characteristics in economically sensible ways and is attenuated by monitoring mechanisms. This association between loan spreads and D&O insurance coverage is robust to controlling for endogeneity (because both could be related to firm risk). Our evidence suggests that lenders view D&O insurance coverage as increasing credit risk (potentially via moral hazard or information asymmetry). Further analyses show that higher levels of D&O insurance coverage are associated with greater risk taking and higher probabilities of financial restatement due to aggressive financial reporting. While greater use of D&O insurance increases the cost of debt, we find some evidence that D&O insurance coverage appears to improve the value of large increases in capital expenditure for firms with better internal and external governance.     

Ownership structure and the cost of corporate borrowing

This article identifies an important channel through which excess control rights affect firm value. Using a new, hand-collected data set on corporate ownership and control of 3,468 firms in 22 countries during the 1996–2008 period, we find that the cost of debt financing is significantly higher for companies with a wider divergence between the largest ultimate owner’s control rights and cash-flow rights and investigate factors that affect this relation. Our results suggest that potential tunneling and other moral hazard activities by large shareholders are facilitated by their excess control rights. These activities increase the monitoring costs and the credit risk faced by banks and, in turn, raise the cost of debt for the borrower.     

Earnings Management Surrounding New Debt Issues

We examine whether firms manage earnings before issuing bonds to achieve a lower cost of borrowing. We find significant income‐increasing earnings management prior to bond offerings. We also find that firms that manage earnings upward issue debt at a lower cost, after controlling for various bond issuer and issue characteristics. Our results are consistent with studies that report earnings management around equity issuance. The results indicate that, like equity holders, bondholders fail to see through the inflated earnings numbers in pricing new debt.     

Analyst forecast characteristics and the cost of debt

We examine the relation between analyst forecast characteristics and the cost of debt financing. Consistent with the view that the information contained in analysts’ forecasts is economically significant across asset classes, we find that analyst activity reduces bond yield spreads. We also find that the economic impact of analysts is most pronounced when uncertainty about firm value is highest (that is, when firms have high idiosyncratic risk). Our findings are robust to controls for private information in equity prices and level of corporate disclosures. Overall, the results indicate that the information contained in analyst forecasts is valued outside the equity market and provide an additional channel in which better information is associated with a lower cost of capital.     

Corporate ownership structure and the choice between bank debt and public debt

This article examines the relation between a borrowing firm's ownership structure and its choice of debt source using a novel data set on corporate ownership, control, and debt structures for 9,831 firms in 20 countries from 2001 to 2010. We find that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant negative impact on the firm's reliance on bank debt financing. In addition, we show that the control-ownership divergence affects other aspects of debt structure including debt maturity and security. Our results indicate that firms controlled by large shareholders with excess control rights may choose public debt financing over bank debt as a way of avoiding scrutiny and insulating themselves from bank monitoring.     

Has the CDS market lowered the cost of corporate debt?

Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.     

Political rights and equity pricing

We examine the influence of political rights on the implied cost of equity capital using a sample of firms from 44 countries. We find that firms' equity financing costs are lower when political rights are stronger. We further find that political institutions' direct impact on the cost of equity capital is incremental to that of legal institutions. Economically, our results imply that a one standard deviation increase in political rights is associated with a 38 basis point decrease in corporate cost of equity capital. In additional analyses, we find that the effect of political rights on equity pricing is more pronounced in countries with weak legal institutions.     

Creditor rights and debt allocation within multinationals

We analyze the optimal debt structure of multinational corporations choosing between centralized or decentralized borrowing. We identify how this choice is affected by creditor rights and bankruptcy costs, taking into account managerial incentives and coinsurance considerations. We find that partially centralized borrowing structures are optimal with either weak or strong creditor rights. For intermediate levels of creditor rights fully decentralized (centralized) borrowing structures are optimal if managers have strong (weak) empire-building tendencies. Decentralized borrowing is more attractive for companies focussing on short-term profitability. Credits are rather taken in countries with better creditor rights and more efficient insolvency systems.     

Access to Collateral and Corporate Debt Structure: Evidence from a Natural Experiment

We investigate how firms respond to strengthening of creditor rights by examining their financial decisions following a securitization reform in India. We find that the reform led to a reduction in secured debt, total debt, debt maturity, and asset growth, and an increase in liquidity hoarding by firms. Moreover, the effects are more pronounced for firms that have a higher proportion of tangible assets because these firms are more affected by the secured transactions law. These results suggest that strengthening of creditor rights introduces a liquidation bias and documents how firms alter their debt structures to contract around it.     

Beauty is in the eye of the beholder: The effect of corporate tax avoidance on the cost of bank loans

We find that firms with greater tax avoidance incur higher spreads when obtaining bank loans. This finding is robust in a battery of sensitivity analyses and in two quasi-experimental settings including the implementation of Financial Accounting Standards Board Interpretation No. 48 and the revelation of past tax sheltering activity. Firms with greater tax avoidance also incur more stringent nonprice loan terms, incur higher at-issue bond spreads, and prefer bank loans over public bonds when obtaining debt financing. Overall, these findings indicate that banks perceive tax avoidance as engendering significant risks.