Political connections and corporate financial decision making

Review of Quantitative Finance and Accounting - This paper investigates whether and how political connections influence managerial financial decisions. Our study reveals that those firms that have...     

Bank connections,corporate investment and crisis

Against the backdrop of a severe financial crisis and extensive restructuring of the financial sector, we investigate the evolution and determinants of connections between firms and banks, and the impact of bank connections on corporate investment. Our study examines Thai non-financial companies during 1995–2000, a period straddling the East Asian Financial Crisis of 1997–1998. Before the crisis, bank-connections are common and associated with significantly lower sensitivity of corporate investment to internal cash flow. After the crisis, and following substantial changes in bank ownership and governance due to financial-sector reforms and restructuring, far fewer firms are bank-connected and connections no longer affect investment–cash flow sensitivity.     

Financing constraints, cash-flow risk, and corporate investment

Using an analytically tractable two-period model of a financially constrained firm, we derive an investment threshold that is U-shaped in cash holdings. We show analytically the relevant trade-offs leading to the U-shape: the firm balances financing costs for present and future investment, respectively. Our main argument is that financing costs today are more important than the risk of future financing costs. The empirically testable implications are that low-cash firms facing financing costs today are more reluctant to invest if they have less cash, or if their future cash flows are more risky. On the other hand, cash-rich firms facing no financing costs today invest in less favorable projects (i.e., forgo their real option to wait) if they have less cash, or if their future cash flows are more risky. The magnitude of these effects is amplified by the degree of market frictions that the firms are facing.     

Time-inconsistent investment,financial constraints,and cash flow hedging

This paper studies the interplay between firm investment and cash flow hedging decisions when the decision-maker has time-inconsistent preferences. We show that cash flow hedging acts as a double-edged sword. In some cases, cash flow hedging enhances firm value because the firm can thus invest at the firm-value-maximizing timing. In other cases, however, cash flow hedging may adversely affect firm value because it loosens the financial constraint that works as a commitment device to mitigate premature investment. Our results thus highlight one unexplored potential dark side of hedging and suggest that the optimal hedging decision is the result of a trade-off between flexibility and commitment.     

Internal financial constraints,external financial constraints,and investment choice: Evidence from a panel of UK firms

This paper uses a panel of 24,184 UK firms over the period 1993–2003 to study the extent to which the sensitivity of investment to cash flow differs at firms facing different degrees of internal and external financial constraints. Our results suggest that when the sample is split on the basis of the level of internal funds available to the firms, the relationship between investment and cash flow is U-shaped. On the other hand, the sensitivity of investment to cash flow tends to increase monotonically with the degree of external financial constraints faced by firms. Combining the internal with the external financial constraints, we find that the dependence of investment on cash flow is strongest for those externally financially constrained firms that have a relatively high level of internal funds.     

The effect of financial constraints,investment policy,product market competition and corporate governance on the value of cash holdings

This study empirically investigates the value shareholders place on excess cash holdings and how shareholders’ valuation of cash holdings is associated with financial constraints, firm growth, cash‐flow uncertainty and product market competition for Australian firms from 1990 to 2007. Our results indicate that the marginal value of cash holdings to shareholders declines with larger cash holdings and higher leverage. However, firms that are more financially constrained, that have higher growth rates and that face greater uncertainty exhibit a higher marginal value of cash holdings. These findings are consistent with the explanation that excess cash holdings are not necessarily detrimental to firm value. Firms with costly external financing and that also save more cash for current operating and future investing needs find that the market values these cash hoarding policies favourably. Finally, there is limited evidence of an association between various corporate governance measures and the value of cash holdings for a shorter sample period.     

Cash flow uncertainty,financial constraints and R&D investment

Based on the data from Chinese listed companies of Shanghai and Shenzhen stock markets between 2005 and 2016, we systematically examine the relationship between cash flow uncertainty and R&D investment, and further research the moderating effect of financial constraints on the association between the two. Our empirical results find that R&D investment decisions tend to be more conservative and cautious due to cash flow uncertainty, which is not conducive to innovation efficiency. Firms with higher cash flow uncertainty invest more cautiously in R&D innovation, whereas firms with lower cash flow invest more boldly in R&D innovation. Financial friction may exacerbate the negative impact of cash flow uncertainty on innovation activities. Strategic cash holding can help firms better deal with the risks caused by cash flow uncertainty. In provinces with high marketization, the market competition intensifies, resulting in more significant cash flow uncertainty.     

Financial flexibility,corporate investment and performance: evidence from financial crises

This study examines the impact of financial flexibility on the investment and performance of East Asian firms over the period 1994–2009. We employ a sample of 1,068 firms and place particular emphasis on the periods of the Asian crisis (1997–1998) and the recent credit crisis (2007–2009). The results show that firms can attain financial flexibility, primarily through conservative leverage policies and less commonly by holding large cash balances. Financial flexibility appears to be an important determinant of investment and performance, mainly during the Asian 1997–1998 crisis. In particular, firms that are financially flexible prior to this crisis (1) have a greater ability to take investment opportunities, (2) rely much less on the availability of internal funds to invest, and (3) perform better than less flexible firms during the crisis. Our analysis covering the credit crisis period of 2007–2009 suggests that some of the advantages of flexible firms towards investing persist but are significantly less pronounced over that period. We also find that the value of financial flexibility is region/country specific, which may be explained by the fact that different regions/countries often adopt different macroeconomic policies and operate in diverse economic/legal environments.     

International corporate investment and the relationships between financial constraint measures

This paper uses international panel data to examine the interrelationships among some commonly used measures of financial constraint. The analysis reveals the following insights: (1) firms with stronger financial positions are more investment-cash flow sensitive than firms with weaker financial positions even after controlling for size and dividend payout and (2) higher payout firms are more investment-cash flow sensitive than lower payout firms even after controlling for size and financial strength. Evidence regarding the impact of firm size that is documented originally becomes much weaker once financial health and dividend payout behavior are controlled for. Finally, additional analysis reveals that many of these results may be driven by the fact that firms possessing high cash flow volatility display lower investment-cash flow sensitivities.     

Political uncertainty and corporate investment: Evidence from China

Using hand-collected data on changes of government officials in 277 Chinese cities, we examine how political turnover affects corporate investment in a transitional economy. We find that political turnover leads firms to significantly reduce corporate investment, particularly when the new official is an outsider appointed by a higher level government. The effect of political turnover on corporate investment is stronger for state-owned enterprises, capital intensive firms, and firms deemed locally important. Overall, the volatility of corporate investment increases with political turnover. Finally, the investment decline due to political turnover has significantly negative impact on the profitability of private firms, but not state-owned firms.     

Effects of financial constraints on corporate policies in Australia

We jointly study the impact of financial constraints on Australian companies’ investment decisions and demand for liquidity. By examining a large sample of Australian firms over the period 1990–2003, we find that financial constraints not only reduce the sensitivity of investment to the availability of internal funds, but also increase the responsiveness of cash holdings to internally generated cash flows. Further analysis shows that the impact of financial constraints varies across different cash flow states; that is, financial constraints have a small effect on corporate investment and cash policies when cash flows are positive. In contrast, the severity of constraints is high in negative cash flow years in which the cost disadvantage of external finance coincides with deteriorating operating performance.     

Bank concentration and financial constraints on firm-level investment in Europe

This study examines the effect of bank concentration on financing constraints of non-financial firms in 14 European countries between 1992 and 2005. Using firm-level data we analyze financial constraints with the Euler equation derived from the dynamic investment model. We find that with a highly concentrated banking sector firms are less financially constrained. This result is robust to consideration of firm opacity, firm size, and business cycle. Relaxation of financial constraint while greater for firms in less opaque industries also accrues for firms in more opaque industries. Greater bank concentration is associated with less tight financial constraint during both expansions and recessions. Results overall are consistent with an information-based hypothesis that more market power increases banks’ incentives to produce information on potential borrowers. Findings are robust to consideration of country specific institutional factors.     

Corporate liquidity,investment and financial constraints: Implications from a multi-period model

In single period models, financially constrained firms invest more in response to increases in their net worth or interest rate cuts. We examine whether or not these results necessarily hold in a multi-period setting. We present a multi-period version of the Holmstrom and Tirole moral hazard model and show that the probability of investment (or the hurdle rate for investment) in the first period of a two-period model is non-monotonic in the level of liquid balances [Holmstrom, B., Tirole, J., 1997. Financial intermediation, loanable funds, and the real sector. Quart. J. Econ. 112 (3), 663–691. August; Holmstrom, B., Tirole, J., 1998. Private and public supply of liquidity. J. Polit. Economy 106 (1), 1–40. February; Holmstrom, B., Tirole, J., 2000. Liquidity and risk management. J. Money, Credit, Banking 32 (3), 295–319. August]. When a risk-free interest rate is introduced in the model, we show that a lower interest rate (or a downward shift or the yield curve) can lead to less current investment due to the interaction of future financial constraints and discounting of cash flows. Our results have implications for the effect of monetary policy on investment by financially constrained firms. They also address several recent empirical debates, such as the relationship between liquidity and the cash-flow sensitivity of investment, and whether or not accumulation of cash balances by Japanese firms can be consistent with the existence of financial constraints affecting investment.     

Political connection,market frictions and financial constraints: evidence from China

This paper studies the relationship between market frictions and political connections in determining financial constraints. We develop a novel index to measure the depth of political connections (PC) at the firm level and provide robust empirical evidence that firms in China actively build PC to alleviate the costs of market frictions. Specifically, we find that firms facing severe market frictions are not as financially constrained as expected. This is because these firms also possess strong PC, which alleviate the costs of market frictions. We find that market frictions can significantly affect financial constraints in Chinese firms, but only for those firms with modest levels of PC.     

The response of the external finance premium in Asian corporate bond markets to financial characteristics,financial constraints and two financial crises

Empirical investigation of the external finance premium has been conducted on the margin between internal finance and bank borrowing or equities but little attention has been given to corporate bonds, especially for the emerging Asian market. In this paper, we hypothesize that balance sheet indicators of creditworthiness could affect the external finance premium for bonds as they do for premia in other markets. Using bond-specific and firm-specific data for China, Hong Kong, Indonesia, Korea, Philippines, Singapore and Thailand during 1995–2009 we find that firms with better financial health face lower external finance premia in all countries. When we introduce firm-level heterogeneity, we show that financial variables appear to be both statistically and quantitatively more important for financially constrained firms. Finally, when we examine the effects of the 1997–1998 Asian crisis and the 2007–2009 global financial crisis, we find that the sensitivity of the premium is greater for constrained firms during the Asian crisis compared to other times.     

State-ownership and financial constraints on investment of Chinese-listed firms: new evidence

We examine how state-ownership affects financial constraints on investment of Chinese-listed firms during 1999–2008. We find that although an average sample firm experiences some degree of financial constraints, state-ownership does not necessarily help in reducing the firm's financial constraints on investment. Further evidence shows that state-ownership does not lead to more borrowing from the Chinese banking sector, implying that state-ownership does not necessarily reduce the firm's financial constraints via the state-controlled banking sector. We consider not only the standard factors in the investment equation, but also the firm's equity financing behaviour explicitly. The result is robust to both the conventional proxy for financial constraints, i.e. the investment–cash-flow sensitivity, and a recently developed proxy for financial constraints, i.e. the KZ index. Our results suggest that China's corporatisation movement is effective in that soft budget constraints once enjoyed by former state-owned enterprises have been removed along with the progress of corporatisation. These firms, although still state-involved, can be seen as modern corporations operating in a market environment.     

The effectiveness of chief financial officer board membership in improving corporate investment efficiency

The key roles of the Chief Financial Officer (CFO) in firm operating performance, corporate strategic choices, and corporate governance have been increasingly emphasized in recent decades. In this study, we empirically investigate the relation between CFO board membership and corporate investment efficiency to determine whether CFO presence on the board reduces firms’ propensity to over- or underinvest. We find that CFO board membership is significantly associated with a decreased level of corporate over- and underinvestment. Further, the positive effects of CFO board membership on corporate investment efficiency are greater for firms with greater information asymmetries. Last but not least, we find that the improved investment efficiency experienced by firms with CFOs on their boards has a positive effect on the firms’ future performance. Overall, we find that CFO board membership is associated with improved investment efficiency and firms’ future profitability. By documenting the real business impact of CFO board membership on investment efficiency and firms’ future performance, we add bricks to the literature on board composition and how it influences firms’ strategic choices and performance. Our findings suggest that having CFOs on boards could benefit firms’ investment practices, which directly relate to corporate strategic performance.

     

Political connections,auditor choice and corporate accounting transparency: evidence from private sector firms in China

This article investigates the way in which political connections impact auditor choice. Using a political connection index constructed based on the bureaucratic ranks of executive managers and board members in Chinese private sector firms, we find that for firms with weak political connections, the likelihood of hiring high‐quality auditors increases with the degree of political connectedness, while it decreases with political connectedness for firms with strong political connections. This inverse U‐shaped relationship is particularly pronounced for firms with ownership structures that intensify agency problems. Finally, we find that political connections and accounting transparency also have an inverse U‐shaped relationship.     

Loan collateral,corporate investment,and business cycle

Collateral and loan rates are observed to be highly cyclical in their use for bank lending. The effects of such cyclicality on corporate investment are analyzed in this paper using a dynamic model. We find that more collateral causes firms to select riskier (/safer) projects if the loan rate rises above (/falls below) the expected investment return. We show that the incentive effect of loan rates becomes stronger with greater collateral, with the two credit terms having larger incentive effects on lower-quality firms. These results offer a new explanation for why lenient collateral policies are associated with rising loan rates in economic upturns but stricter collateral requirements come with falling loan rates during downturns.     

Investor sentiment,executive compensation,and corporate investment

We develop a model that predicts corporate investment level increases with investors’ optimism and that the relationship between investment level and executive compensation depends on investor sentiment and other parameters. The empirical test shows that optimism is significantly and positively related to the level of investment and that executive compensation is insignificantly related to the level of investment. The managerial share ownership is positively related to the level of investment, conditional on the degree of optimism. The empirical results suggest that executives make investment decisions that not only cater to investor sentiment but also reflect their own interest in the company.