Debt financing: Does it boost or hurt firm performance in product markets?

Previous research seeks to establish whether debt boosts or hurts a firm's product market performance. This paper proposes that both of these outcomes can be observed: debt can boost and hurt performance. I first model a nonmonotonic relation between debt-like finance and competitive conduct. I then empirically examine the within-industry relation between leverage and sales performance using data from 115 industries over 30 years. My tests deal with the endogeneity of debt in a novel fashion: I use creditors’ valuation of assets in liquidation to identify financial leverage. I find that moderate debt taking is associated with relative-to-rival sales gains; high indebtedness, however, leads to product market underperformance.     

Corporate financing decisions, managerial market timing, and real investment

Both market timing and investment-based theories of corporate financing predict under-performance after firms raise capital, but only market timing predicts that the composition of financing (equity compared with debt) should also forecast returns. In cross-sectional tests, we find that the amount of net financing is more important than its composition in explaining future stock returns. In the time series, investment-based factor models explain abnormal stock performance following a variety of corporate financing events that previous studies link to market timing. At the aggregate level, the amount of new financing is also more important for future market returns than its composition. Overall, our joint tests reveal that measures of real investment are correlated with future returns and measures of managerial market timing are not.     

Creditor control rights and firm investment policy

We present novel empirical evidence that conflicts of interest between creditors and their borrowers have a significant impact on firm investment policy. We examine a large sample of private credit agreements between banks and public firms and find that 32% of the agreements contain an explicit restriction on the firm's capital expenditures. Creditors are more likely to impose a capital expenditure restriction as a borrower's credit quality deteriorates, and the use of a restriction appears at least as sensitive to borrower credit quality as other contractual terms, such as interest rates, collateral requirements, or the use of financial covenants. We find that capital expenditure restrictions cause a reduction in firm investment and that firms obtaining contracts with a new restriction experience subsequent increases in their market value and operating performance.     

Tournament incentives, firm risk, and corporate policies

This paper tests the proposition that higher tournament incentives will result in greater risk-taking by senior managers in order to increase their chance of promotion to the rank of CEO. Measuring tournament incentives as the pay gap between the CEO and the next layer of senior managers, we find a significantly positive relation between firm risk and tournament incentives. Further, we find that greater tournament incentives lead to higher R&D intensity, firm focus, and leverage, but lower capital expenditures intensity. Our results support the hypothesis that option-like features of intra-organizational CEO promotion tournaments provide incentives to senior executives to increase firm risk by following riskier policies. Finally, the compensation levels and structures of executives of financial institutions have received a great deal of scrutiny after the financial crisis. In a separate examination of financial firms, we again find a significantly positive relation between firm risk and tournament incentives.     

Financial development,government ownership of banks and firm innovation

Using a newly-available World Bank survey of over 28,000 firms from 46 countries, we examine how financial development affects firm innovation around the world. We find that while stock market development significantly enhances firm innovation, banking sector development has mixed effects. We show that the latter result can be explained by different levels of government ownership of banks. Specifically, in countries with lower government ownership of banks, banking sector development significantly enhances firm innovation; while in countries with higher government ownership of banks, banking sector development has no significant or sometimes even significantly negative effects on firm innovation. Such negative effects are significantly stronger for smaller firms. The results are robust to various controls such as firms’ human capital and ownership structure, to estimations using instrumental variable techniques and alternative measures of firm innovation.     

Corporate trade credit and inventories: New evidence of a trade-off from accounts payable and receivable

Trade credit is an important source of finance for firms and has been well researched, but the focus has been on financial trade-offs. In this paper, we consider the trade-offs with inventories and develop a simple model that recognizes the incentives a firm faces to offer and receive trade credit. Our model identifies the response of accounts payable and accounts receivable to changes in the cost of inventories, profitability, risk and liquidity, and importantly, this influence operates through a production channel. Our results support the model and complement many existing studies focused on explaining the financial terms of trade credit.     

Trade credit,cash holdings,and financial deepening: Evidence from a transitional economy

This paper investigates the effect of financial deepening on the relationship between trade credit and cash holdings among Chinese listed firms. We first document an asymmetric effect of trade payables and receivables on cash holdings, in that firms hold an additional $0.71 of cash for every $1 of credit payable but use $1 of receivables as a substitute for only $0.15 of cash. We then find that firms in regions with higher levels of financial deepening hold less cash for payables while substituting more receivables for cash. A more highly developed financial sector helps firms to better use trade credit as a short-term financing instrument. Finally, we find that the ratio at which receivables are substituted for cash increased following the implementation of the new receivables pledge policy in 2007, which allowed firms to use receivables as security for loans. This policy event represents an exogenous shock that mitigates the endogeneity concern.     

Collateral,debt capacity,and corporate investment: Evidence from a natural experiment

This paper examines how a shock to collateral value influences firms’ debt capacities and investments. Using a source of exogenous variation in collateral value provided by the land market collapse in Japan, I find that collateral has a statistically and economically significant impact on corporate investments. I also provide direct evidence on the workings of such a collateral channel. Exploiting a unique dataset of matched bank-firm lending, I show that firms with greater collateral losses are less likely to sustain their banking relationships and tend to obtain a smaller amount of bank credit.     

Corporate governance and firm cash holdings in the US

Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures actually have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions. Firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is only limited evidence that the presence of excess cash alters the overall relation between governance and profitability. In the US, weakly controlled managers choose to spend cash quickly on acquisitions and capital expenditures, rather than hoard it.     

Early-stage financing and firm growth in new industries

This paper shows that active investors, such as venture capitalists, can affect the speed at which new ventures grow. In the absence of product market competition, new ventures financed by active investors grow faster initially, though in the long run those financed by passive investors are able to catch up. By contrast, in a competitive product market, new ventures financed by active investors may prey on rivals that are financed by passive investors by “strategically overinvesting” early on, resulting in long-run differences in investment, profits, and firm growth. The value of active investors is greater in highly competitive industries as well as in industries with learning curves, economies of scope, and network effects, as is typical for many “new economy” industries. For such industries, our model predicts that start-ups with access to venture capital may dominate their industry peers in the long run.     

Shareholder governance, bondholder governance, and managerial risk-taking

We examine the relation between the overall corporate governance structure and managerial risk-taking behavior. We find that the overall governance structure has a significant impact on how managers make decisions on investment policy: strong bondholder governance motivates more low-risk investments such as capital expenditure and lower high-risk investments such as R&D expenditures, whereas weak shareholder governance (entrenched managers) leads to more R&D expenditures. Moreover, we find that the effects of governance on investment policy differ significantly between speculative and investment-grade firms. For speculative firms, strong bondholder or shareholder governance leads to more capital expenditures and low R&D investments. For investment-grade firms, strong bondholder or shareholder governance leads to low capital expenditures and an insignificant impact on R&D investments. Furthermore, financing and investment covenants exhibit strong binding power to deter risky investments. Finally, a more dependent (or a less independent) board is associated with low capital expenditures and high R&D investments.     

Geographic diversification and firm value in the financial services industry

This paper investigates whether geographic diversification is value-enhancing or value-destroying in the financial services sector, broadly defined. Our dataset comprises approximately 3579 observations over the period from 1985 to 2004 and covers the entire range of U.S. financial intermediaries — commercial banks, investment banks, insurance companies, asset managers, and financial infrastructure services firms. We use two alternative measures of geographic diversification: (1) a dummy variable whether the firm reports more than one geographic segment and (2) the percentage of sales from non-domestic operations. Our results indicate that geographic diversification is not associated with a significant valuation discount in financial intermediaries. However, when accounting for the firms' main activity-areas, we find evidence of a significant discount associated with geographic diversification in securities firms and a premium in credit intermediaries and insurance companies. All these results are robust after taking into account functional diversification of the firms, a potential endogeneity of both functional and geographic diversification, and a potential value transfer from equity to debt holders by using estimates of the market value of debt.     

Access to capital,investment, and the financial crisis

During the recent financial crisis, corporate borrowing and capital expenditures fall sharply. Most existing research links the two phenomena by arguing that a shock to bank lending (or, more generally, to the corporate credit supply) caused a reduction in capital expenditures. The economic significance of this causal link is tenuous, as we find that (1) bank-dependent firms do not decrease capital expenditures more than matching firms in the first year of the crisis or in the two quarters after Lehman Brother's bankruptcy; (2) firms that are unlevered before the crisis decrease capital expenditures during the crisis as much as matching firms and, proportionately, more than highly levered firms; (3) the decrease in net debt issuance for bank-dependent firms is not greater than for matching firms; (4) the average cumulative decrease in net equity issuance is more than twice the average decrease in net debt issuance from the start of the crisis through March 2009; and (5) bank-dependent firms hoard cash during the crisis compared with unlevered firms.     

Distribution of institutional ownership and corporate firm performance

We investigate the association between corporate firm performance and the level and stability of institutional ownership within a simultaneous equation model. Our main ownership stability measures include ownership persistence and the time-lengths over which investors hold non-zero shares or maintain their shareholding. We find that there is a positive relationship between firm performance and institutional ownership stability, accounting for the shareholding proportion. This relationship is robust to the employment of ownership turnover measures used in the literature and consistent with the view that stable institutional investors play an effective role in monitoring. When we disaggregate institutional investors into pressure-insensitive and pressure-sensitive categories, we find that stable shareholding of each group has a positive impact on performance, with the first group exerting a larger effect. The channels of the effect include, but are not limited to, decreased information asymmetry and increased incentive-based compensation.     

Dominant institutional owners and firm value

This research analyzes the impact of control by dominant institutional owners (banking institutions and investment funds) on firm value. The analysis considers the level of voting rights in the hands of the dominant institutional owner and other large shareholders. The results reveal a different effect on value depending on whether the dominant institutional investor is a banking institution or an investment fund. Moreover, the results show that the presence of other large shareholders affects firm value when a dominant institutional owner controls the firm.     

Managerial ownership dynamics and firm value

From 1988 to 2003, the average change in managerial ownership is significantly negative every year for American firms. We find that managers are more likely to significantly decrease their ownership when their firms are performing well and more likely to increase their ownership when their firms become financially constrained. When controlling for past stock returns, we find that large increases in managerial ownership increase Tobin's q. This result is driven by increases in shares held by officers, while increases in shares held by directors appear unrelated to changes in firm value. There is no evidence that large decreases in ownership have an adverse impact on firm value. We rely on the dynamics of the managerial ownership/firm value relation to mitigate concerns in the literature about the endogeneity of managerial ownership.     

Debt covenant renegotiations and creditor control rights

Using a large sample of private debt renegotiations from 1996 to 2011, we report that, even in the absence of any covenant violation, debt covenants are frequently renegotiated. These renegotiations primarily relax existing restrictions and result in economically large changes in existing limits. Renegotiations of specific covenants are a response to both the distance the covenant variable is from its contractual limit and the firm?s specific operating conditions and prospects. Moreover, the borrower?s post-renegotiation investment and financial policies are strongly associated with the covenant changes resulting from the renegotiation. Overall, the findings imply that, even outside of default states, creditors have strong control rights over the borrower?s operating and financial policies, and they exercise these rights in a state contingent manner through covenant renegotiations.     

Group affiliation, identity of managers, and the relation between managerial ownership and performance

Two features in Taiwan's companies complicate the ownership-performance relationship. First, the firm's management is usually controlled, either directly or indirectly via equity interlocks, by the controlling family. The shareholding of managers is an access through which the controlling owners can secure control and entrench their private benefits. Second, the management generally consists of individual managers and representatives appointed to top managerial positions by institutions that hold a substantial percentage of shares. The role of corporate managers played by institutions is important in Taiwan's companies. Echoing these two features, empirical results suggest a low inflection point for the nonlinear relation between managerial ownership and performance. Moreover, the impact of managerial ownership on performance varies between different identities of managers and depends on whether the firm is group-affiliated or independent. There is also evidence to show that the relation between individual and institutional managerial ownership is complementary at low levels of ownership and becomes substitutive as ownership gets higher.     

The impact of working capital management on firm profitability in different business cycles: Evidence from Finland

The recent economic downturn of 2007–2008 has brought renewed focus on working capital policies. In this paper we examine the role of business cycles on the working capital–profitability relationship using a sample of Finnish listed companies over an 18-year period. We find the impact of business cycle on the working capital–profitability relationship is more pronounced in economic downturns relative to economic booms. We further show that the significance of efficient inventory management and accounts receivables conversion periods increase during periods of economic downturns. Our results demonstrate that active working capital management matters and, thus, should be included in firms’ financial planning.     

Externalities of public firm presence: Evidence from private firms' investment decisions

Public firms provide a large amount of information through their disclosures. In addition, information intermediaries publicly analyze, discuss, and disseminate these disclosures. Thus, greater public firm presence in an industry should reduce uncertainty in that industry. Following the theoretical prediction of investment under uncertainty, we hypothesize and find that private firms are more responsive to their investment opportunities when they operate in industries with greater public firm presence. Further, we find that the effect of public firm presence is greater in industries with better information quality and in industries characterized by a greater degree of investment irreversibility. Our results suggest that public firms generate positive externalities by reducing industry uncertainty and facilitating more efficient private firm investment.