Corporate capital structure and the characteristics of suppliers and customers

We investigate the link between a firm's leverage and the characteristics of its suppliers and customers. Specifically, we examine whether firms use decreased leverage as a commitment mechanism to induce suppliers/customers to undertake relationship-specific investments. We find that the firm's leverage is negatively related to the R&D intensities of its suppliers and customers. We also find lower debt levels for firms operating in industries in which strategic alliances and joint ventures with firms in supplier and customer industries are more prevalent. Consistent with a bargaining role for debt, we find a positive relation between firm debt level and the degree of concentration in supplier/customer industries.     

Conditional conservatism and trade credit during the global financial crisis

We investigate conditional conservatism and firms’ access to trade credit during the 2007–2008 global financial crisis. Previous studies argue that suppliers prefer conservative customers because of information asymmetry in production networks; we extend this line of research by focusing on trade credit during the 2007–2008 global financial crisis, a period that was characterized by a credit supply shock. We first document a positive association between conditional conservatism and firms’ access to trade credit both before and after the onset of the crisis, which indicates suppliers’ demand for conditional conservatism. Meanwhile, the association between conditional conservatism and trade credit experienced a significant decline following the onset of the crisis, and this only held when suppliers and customers had frequent transactions or were in close proximity, when transacted goods were standardized rather than differentiated, when customers were financially constrained and had high bargaining power, and when suppliers had sufficient liquidity. It implies that, when information asymmetry along the supply chain was low and customers had strong bargaining power, liquid suppliers increased their tolerance to less conservative customers, and they were even willing to grant trade credit to the less conservative customers that were financially constrained. Overall, this study adds to previous literature by demonstrating suppliers’ multifaceted demand for conditional conservatism.     

Bargaining power and trade credit

This paper investigates how the supplier's bargaining power affects trade credit supply. We use a novel firm-level database of Chinese firms with unique information on the amount, terms, and payment history of trade credit extended to customers and detailed information on product market structure and clients-supplier relationships. We document that suppliers with weak bargaining power towards their customers are more likely to extend trade credit, have a larger share of goods sold on credit, and offer a longer payment period before imposing penalties. Important customers extend the payment period beyond what has been offered by their supplier and generate overdue payments. Furthermore, weak bargaining power suppliers are less likely to offer trade credit when credit-constrained by banks. Our findings suggest that suppliers use trade credit as a competitive device in the product market.     

Corporate Lobbying,Visibility and Accounting Conservatism

In this study, we examine the relationship between a firm's lobbying activities and financial reporting quality using a US setting where public scrutiny of corporate political activities is high. More importantly, we examine whether and how a firm's visibility shapes the relationship between its corporate lobbying activities and accounting conservatism. Adopting annual lobbying expenditure data to measure firms’ lobbying activities, and using a propensity‐score‐matching methodology to control for differences in firm characteristics between lobbying and non‐lobbying firms, we find a positive relationship between a firm's lobbying intensity and the degree of accounting conservatism in its financial reporting. We further find this positive relationship to be more pronounced in lobbying firms with a higher level of visibility. These results are robust after controlling for a firm's political connections, across various conditional conservatism measures, and across a number of visibility measures including firm size, the number of analysts following the firm, the age of the firm, the number of foreign stock exchanges that the firm is cross‐listed in, and the level of the firm's media coverage. Together, our findings add to the literature on how firms’ political activities shape their accounting practices in general, and accounting conservatism in particular. More importantly, our findings suggest that the heightened public attention paid to political activities in the US yields incentives for firms to be more conservative in their accounting practices.     

Internal control quality and relationship‐specific investments by suppliers and customers

This paper investigates the association between the quality of internal control over financial reporting (ICOFR) and relationship‐specific investments by suppliers/customers. I find a significant negative association between the disclosure of a material weakness (MW) in ICOFR and changes in the relationship‐specific investments of suppliers/customers. Relationship‐specific investments of suppliers/customers have a stronger negative association with inventory‐related MW. The negative association between MW disclosures and the relationship‐specific investments of suppliers/customers is stronger when economic dependence between the firms and the suppliers/customers is more important and when the suppliers/customers have greater bargaining power. Also, suppliers/customers significantly increase their relationship‐specific investments following the remediation of ineffective ICOFR. Overall, my findings show that a firm's quality of ICOFR affects the relationship‐specific investment decisions of suppliers/customers.     

Do firms' relationships with principal customers/suppliers affect shareholders' income?

In this paper, we examine whether a firm's relationship with its principal customers/suppliers affects its payout policies. A firm has customer–supplier relationships when its business depends on a small number of major customers/suppliers. The extant literature indicates two channels through which customer–supplier relationships might negatively affect a firm's dividend payments: 1) the high financial distress costs associated with relationship-specific investments and 2) the information certification effect of the principle customer. Consistent with expectations, our study reveals a negative relationship between a firm's dependence on customer–supplier relationships and its dividend payments. This result is robust to various model specifications and consistent with evidence regarding the time-series properties of dividends. Moreover, we find that high financial distress costs associated with relationship-specific investments are the key channel through which a firm's customer–supplier relationship affects its dividend payments. Overall, our results suggest that a firm's relationship with its non-financial stakeholders, such as principal customers/suppliers, is an important determinant of its shareholders' income.     

Effects of air pollution on accounting conservatism

We examine the impact of air pollution on a firm's accounting policy conservatism. We hypothesize that, in response to risks associated with increased air pollution, firms apply more conservative accounting practices and utilize more conservative estimates in their reporting. Using a sample of Chinese firms, accounting conservatism measures, and a satellite-based air pollution metric, we confirm the validity of our hypothesis. Additional analysis suggests that the impact of air pollution on accounting policy conservatism is more salient for firms in high-pollution industries, firms under severe financial constraint, firms with higher environmental risk, and firms that receive high media coverage. Further, we document that air pollution does not significantly affect a firm's return on assets, year-on-year sales growth, or Tobin's Q measure. Hence, it is management's risk perception, not objective performance concern, that is driving accounting conservatism. Finally, specifically investigating accounting conservatism, we discover that, for firms with higher pollution levels, selling general and administrative expenses, liabilities provision, accrued expenses, and asset impairment loss are significantly higher.     

Distance produces the fear of loss: Customer geographic proximity and corporate cash holdings

Suppliers usually worry about losing important customers far away. This study examines the effect of long-distance customers on the supplier's cash holdings in China. We find that firms with long-distance major customers tend to hold more cash holdings, and the exogenous opening of the high-speed rail can reduce the effects of distant customers. Our results still hold when considering the endogeneity concerns. The cross-sectional tests suggest that the impact of long-distance customers is more pronounced for firms that have fewer accounts receivables and a larger customer concentration. Furthermore, we document that suppliers with a long-distance supply chain relationship hold more cash mainly due to the precautionary motive. Overall, we highlight that the distance between suppliers and customers is an important factor that affects a firm's cash holdings policy, and we also provide some suggestions for both suppliers and policymakers.     

Accounting conservatism and corporate social responsibility

In this paper, we examine whether a firm's stakeholder orientation, as manifested by its social responsibility endeavors, matters for its choice of accounting conservatism. We find that the level of conservatism in financial reporting significantly increases with socially responsible activities. This result is robust to several conservatism aspects, including market-based conservatism measure, the aggregate of R&D reserves, advertising reserves, and LIFO reserves, and accrual-based conservatism construct. Moreover, our two-stage regression results validate that conservatism is more pronounced for firms that devote more resources to social responsibility programs. Consistent with stakeholder theory, these findings indicate that CSR-oriented firms are more likely to use accounting conservatism to credibly commit to acting in the interests of stakeholders. As a whole, our results provide a novel implication that the extent of accounting conservatism can be entailed by a firm's efforts to enhance stakeholder relations.     

Trade Credit Risk Management: The Role of Executive Risk‐Taking Incentives

In this study we investigate how executive equity incentives affect companies’ risk‐taking behavior in relationships with their customers. We hypothesize and find that executive risk‐taking incentives provided by options are positively related to the degree of trade credit riskiness measured both as the amount of total trade credit a firm extends to all its customers and as the amount of trade credit a firm extends to customers with a high probability of default. We also find that the measures of trade credit riskiness are positively related to the firm's future stock return volatility, suggesting that the customer default risk inherent in customer‐supplier trade credit relationships represents an important economic source of the overall supplier‐firm riskiness. The findings of the study provide insights into why firms facing financial difficulties are not denied trade credit.     

As told by the supplier: Trade credit and the cross section of stock returns

With superior information about their customers’ prospects, suppliers extend trade credit to capture future profitable business. We show that this information advantage generates significant return predictability. After controlling for major firm characteristics, firms that rely more on trade credit relative to debt financing have higher subsequent stock returns. The return predictability by trade credit is stronger among firms with lower borrowing capacity or profitability, and is more significant for firms with a higher degree of information asymmetry. Our findings suggest that trade credit extension reveals suppliers’ information that diffuses gradually across the investing public.     

Employee firing costs and accounting conservatism: Evidence from wrongful discharge laws

This paper identifies the causal effect of a firm's employee firing costs on its conditional conservatism, using the staggered adoption of US state wrongful discharge laws (WDLs) that increase a firm's cost of firing employees. We find that the adoption of WDLs leads to a significant increase in conditional conservatism. This result is greater for firms that are more labor-intensive, have higher propensities to fire employees, make more firm-specific investments and have greater risk. Overall, our findings support the view that higher firing costs lead to greater demand for conditional conservatism to decrease investment inefficiencies because higher firing costs make inefficient investments (including overinvestment in negative-net present value (NPV) projects and delays in disinvesting poorly performing projects) costlier for the firm.     

The Issue Decision of Manager-Owners under Information Asymmetry

A firm must issue common stock in order to undertake a new investment, and the firm's manager-owners can value the firm more accurately than the market. The ability of the manager-owners to trade in the firm's shares during the issue (a) reduces the investments that are foregone because of the market's mispricing the firm's shares, (b) changes the size and direction of the stock price change when the firm announces a new stock issue, and (c) changes the market value of the firm before and after the issue announcement, whether or not it decides to issue.     

DETERMINANTS OF CAPITAL STRUCTURE IN BUSINESS START‐UPS: THE ROLE OF NONFINANCIAL STAKEHOLDER RELATIONSHIP COSTS

According to the finance literature, nonfinancial stakeholders (NFS), such as customers, suppliers, and employees, take into account their expected liquidation costs when dealing with a firm. In this framework, firms can influence their probability of liquidation by choosing an appropriate capital structure. Also, the literature suggests NFS bargaining power may affect firm financing decisions. In the current article we investigate these ideas for initial financing decisions by business start‐ups, where ex ante failure risk is high and NFS must decide whether to make relationship‐specific investments. We find that start‐ups imposing larger costs on their NFS following liquidation significantly reduce leverage. This effect is strengthened when suppliers have greater bargaining power. We also document a marginally negative effect of NFS liquidation costs on the proportion of bank loans. Finally, business start‐ups rely less on bank loans when customers and suppliers are in a powerful bargaining position.     

The effect of leverage on bargaining with a corporation

This paper shows that the choice of a capital structure by a firm affects the bargaining posture of its shareholders vis-a-vis its suppliers of specialized production factors. The pricing of the firm's securities and the choice of a capital structure are analyzed in light of this effect of debt financing.     

Earnings‐based Delisting Regulations and Government Subsidies

This paper examines who receives government subsidies when a firm faces delisting risk and how subsidies affect such a firm's performance in China. It focuses on the accounting‐based delisting rule issued in 1998 that relies heavily on the profitability of firms. Using the probit model, this study finds that subsidies are less likely to be granted to a firm that has a higher risk of being delisted than a healthy firm, but are more likely to be granted to such a firm if it is state‐owned. It is also found that having a political connection increases a firm's chance of receiving subsidies, but such an effect disappears when a firm faces a delisting risk. In assessing the impact of a subsidy on firm performance, this study shows that a subsidy increases a firm's valuation and profitability for firms at delisting risk.     

Reliability-Relevance Trade-Offs and the Efficiency of Aggregation

This paper studies how an accountant's method of aggregating information in a financial report is affected by differences in the reliability and relevance of components of the report. We study a firm that hires an accountant to produce a report that reveals information to investors regarding the returns to the firm's past investments. In constructing the report, the accountant must combine information elicited from the firm's manager with other information directly observable to the accountant. The manager's information is assumed to be directly observable only by the manager and to be of superior quality to the other information available to the accountant. Reliability‐relevance trade‐offs arise because as the accountant places more weight on the manager's report, potentially more useful information gets included in the report, at the cost of encouraging the manager to distort his or her information to a greater extent. Capital market participants anticipate this behavior and price the firm accordingly. We show how the market's price response to the release of the firm's aggregate report, the efficiency of the firm's investment decisions, and the manager's incentives to manipulate the soft information under his or her control are all affected by—and affect—the aggregation procedure the accountant adopts. In addition, we identify a broad range of circumstances under which aggregated reports are strictly more efficient than disaggregated reports because aggregation tempers the manager's misreporting incentives. We also demonstrate that, as any given component of the aggregated accounting report becomes softer, the equilibrium level of the firm's investment diminishes and the market places greater weight on the remaining components of the report.     

Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism

A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political, and institutional variables. Studies typically assume the Basu [1997] asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise‐linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure's validity, in the context of a model with accounting income incorporating different types of information with different lags, and with noise. We demonstrate that the asymmetric timeliness coefficient varies with firm characteristics affecting their information environments, such as the length of the firm's operating and investment cycles, and its degree of diversification. We particularly examine one characteristic, the extent to which “unbooked” information (such as revised expectations about rents and growth options) is independent of other information, and discuss the conditions under which a proxy for this characteristic is the market‐to‐book ratio. We also conclude that much criticism of the Basu regression misconstrues researchers’ objectives.     

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.     

Do firms follow GAAP when they record share repurchases?

This paper examines U.S. firms' accounting for share repurchases and the accounting choice provided to Delaware-incorporated firms between the treasury and retirement methods. This accounting choice does not affect income, cash flows, or net assets, but it nevertheless affects financial reporting transparency and the allocation of equity between retained earnings and contributed capital. According to Generally Accepted Accounting Principles (GAAP), the accounting choice to record share repurchases should reflect management's intended disposition of the repurchased shares. We compare characteristics of Delaware-incorporated treasury and retirement firms and find that the choice between the two accounting methods is not always consistent with GAAP, but neither is it random; rather, this choice is related to a number of firm characteristics including firm growth, industry membership, trading exchange, and price–earnings ratio. We also find that a firm's accounting method for share repurchases is associated with a firm's propensity to make future share repurchases.