Permanent sales increase and investment

When firms experience increases in sales that they consider to be permanent, the present value of expected profits also increases, leading to increases in the firms' investments. Our study investigates the permanent sales hypothesis (PSH) of firms' investment; it examines whether investment decisions are influenced by changes in the permanent, in contrast to transitory, component of sales income increases. Using the co-integration test and the structural vector auto-regression (SVAR) framework, our paper finds strong support for the hypothesis that investment behavior is primarily explained by permanent changes in sales income. Empirical multiple time series regression results also confirm that investments are a function of a number of past yearly sales changes. Our results show that larger, more liquid, and lower debt ratio firms follow PSH more closely than smaller, less liquid, higher debt ratio firms. Recent studies on corporate investment (i.e., Fazzari, Hubbard, and Petersen, 1988) have argued that the higher the dependence on the internal source of funding of the investment, the stronger the severity of financing constraints. Our study shows that the more dependent on the permanent cumulative increase of internal source of funding a firm's funding on investment, the less financially constrained firms.     

Financial constraints and stock returns — Evidence from Australia

Using multiple discriminant analysis, we construct an index that measures firms' external financial constraints in an Australian setting. We form portfolios of firms based on our financial constraints index and find that financially constrained firms earn lower return than their unconstrained counterparts. Moreover, stock returns of financially constrained firms are found to move together, indicating the potential existence of a financial constraints factor. Neither the variation nor the mean return of the constraints factor are well explained by existing asset pricing models, suggesting an independent role for our financial constraints factor in affecting stock returns.     

Supply of capital and capital structure: The role of financial development

We explore the effect of financial development on corporate capital structure and the tightness of financial constraints that firms face. We employ an econometric technique that allows us to explicitly test for convergence in capital structure. This technique increases the power of our statistical tests. In doing so, we identify a group of convergent firms. The driving force of convergence is financial development, which positively affects the firms' leverage ratio. We also identify a group of firms, whose leverage is not affected by financial development, because they are financially constrained.     

Investor sentiment and firm capital structure

We provide novel evidence of the role of investor sentiment in determining firms' capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms' debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is slower in low sentiment periods, indicating higher costs of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms' financing decisions and stock returns.     

The determinants of corporate cash management policies: Evidence from around the world

We examine the determinants of corporate cash management policies across a broad sample of international firms. We document that firms in countries with strong legal protection of minority investors are more likely to decrease their cash holdings in response to an increase in cash flow than are firms in countries with weak legal protection. This relationship is most pronounced for firms that are financially constrained and those with high hedging needs. More importantly, we do not find evidence that financial development plays an incremental impact on the cash flow sensitivity of cash, after controlling for the effect of legal protection. Therefore, we argue that the legal protection of investors (rather than financial development) represents the first-order effect in influencing international firms' cash management policies. The results are robust to alternative specifications. In general, our findings reinforce the importance of country-level legal protection of investors in mitigating the effects of firm-level financial constraints and hedging needs on corporate cash management policies.     

The Cash Flow Sensitivity of Cash

We model a firm's demand for liquidity to develop a new test of the effect of financial constraints on corporate policies. The effect of financial constraints is captured by the firm's propensity to save cash out of cash flows (the cash flow sensitivity of cash). We hypothesize that constrained firms should have a positive cash flow sensitivity of cash, while unconstrained firms' cash savings should not be systematically related to cash flows. We empirically estimate the cash flow sensitivity of cash using a large sample of manufacturing firms over the 1971 to 2000 period and find robust support for our theory.     

Do personal taxes affect capital structure? Evidence from the 2003 tax cut

Because the personal tax treatments of interest and dividend income likely affect the relative cost of debt and equity financing, a sharp change in tax treatment could affect firms' optimal leverage. This paper examines the effect of the 2003 equity income tax cut on firms' debt usage. Because this tax cut affected only individual investors, we can use a difference-in-differences method to identify the effect of personal tax on firms' leverage. Previous research has found that the 2003 tax cut encouraged dividend payouts and reduced the cost of equity, but it provides no link to equilibrium leverage ratios. We estimate that the tax cut causes the affected firms' leverage to decrease by about 5 percentage points. Furthermore, we show that the effects of the tax cut are stronger for firms with lower marginal corporate tax rates and for firms that are not financially constrained, consistent with our theoretical predictions. Overall, we find strong evidence that personal tax is an important determinant of firms' optimal leverage.     

R&D investment and distress risk

This paper proposes that besides volatility, R&D can increase firms' distress risk through another channel. Unlike capital investment, R&D is more inflexible and subject to high adjustment costs. Moreover, R&D intensive firms face severe financial constraints and are more likely to suspend/discontinue R&D projects. Therefore, firms' distress risk increases with their R&D intensity. Using a large panel of US companies over the 1980 to 2011 period, I find a robust empirical relation between R&D and distress risk, primarily among financially constrained firms. Moreover, the effect of R&D on distress risk is magnified during economic downturns. I also find that firms that have been previously successful in R&D or firms with high analyst coverage can mitigate the relationship between R&D and distress risk.     

Demand collapse or credit crunch to firms? Evidence from the World Bank's financial crisis survey in Eastern Europe

This paper assesses whether the primary effect of the global crisis on Eastern European firms took the form of an adverse demand shock or a credit crunch. Using a unique firm survey conducted by the World Bank in six Eastern European countries during the 2008–2009 financial crisis, the paper shows that the drop in demand for firms' products and services was overwhelmingly reported as the most damaging adverse effect of the crisis. Other “usual suspects”, such as rising debt or reduced access to credit, were reported as minor. The paper also finds that the changes in firms' sales and installed capacity are significantly and robustly correlated with different demand sensitivity measures of the sector in which the firms operate. However, they are not robustly correlated with various proxies for firms' credit needs.     

Do corporate tax cuts increase investments?

This paper studies the effect of corporate taxes on investment. Since firms with a foreign parent have more cross-country profit shifting opportunities than domestically owned firms do, their effective tax rate and, consequently, their tax-induced costs to investment are lower. We therefore expect capital investment responses to a corporate tax cut to be heterogeneous across firms. Using firm-level data on German corporations, we exploit the 2008 tax reform, which substantially cut corporate taxes as an exogenous policy shock and expect domestically owned firms' investments to be more responsive to the reform. We show exactly this in a difference-in-differences setting. We find that the reduction in corporate tax payments led to a one-to-one increase in the real investments of domestic firms. The effect is stronger for domestic firms relying more on internal funds. Correspondingly, labor investment increased more for domestic firms, ensuring a constant mix of input factors. In addition, we show that domestic firms' sales grew faster after the tax cut than the sales of foreign-owned firms. Our results imply that corporate tax changes can increase corporate investment but that domestic firms benefit more than foreign-owned firms from a tax cut through higher investment responses resulting in greater sales growth.     

Government intervention and firm investment: Evidence from international micro-data

Building on the important study by Beck et al. (2005), we examine how government intervention in firms' decision-making is related to their investment and sales growth. Using the unique World Bank dataset (WBES) covering 6500 firms in 70 countries, we find strong evidence that the extent of government intervention in firms' investment, employment, sales, pricing, dividend, and merger and acquisition decisions is negatively related to their investment and sales growth, with the effect being more profound in foreign owned firms and less significant in state-owned firms. The empirical results are robust to a series of robustness tests and instrumental variable regressions.     

The regulatory environment and financial constraints of private firms in the European Union

This study analyzes the influence of the institutional environment on firms' capital structure in the European Union (EU). Unlike other research, we focus on private firms and include data from all EU countries from 2010 to 2018. We split the sample into groups of small and large firms, which we consider financially constrained and unconstrained, respectively. Throughout the study, we posit that institutional effects on financing policies vary with size, with the effects being greater for constrained firms as they face more financing frictions. We also run regression models controlling for firm-level characteristics and relevant macroeconomic factors. Our findings reveal that a high-quality regulatory environment negatively affects firms' leverage, whereas social corruption has the opposite effect. Moreover, the efficiency of enforcing commercial contracts and developing the financial system positively influences firms' leverage.     

Emerging market corporate leverage and global financial conditions

This paper explores how global financial conditions influence corporate leverage growth in emerging markets (EMs). Using a sample of 800,000 listed and non-listed firms across 28 EMs, we find that accommodative global financial conditions—initially proxied with a measure of U.S. monetary policy—are associated with faster leverage growth. The impact is more pronounced for financially constrained firms, such as small- and medium-sized enterprises (SMEs), and for EMs whose domestic monetary policy is more aligned with that of the United States. The findings suggest that global financial conditions affect EM firms' leverage growth by influencing domestic interest rates and by relaxing corporate borrowing constraints. Finally, leverage increases disproportionately more for firms that are either relatively less profitable or less solvent when global financial conditions become looser.     

The impact of abnormal real earnings management to meet earnings benchmarks on future operating performance

Motivated by agency conflicts of real earnings management (e.g., opportunistic and signalling perspectives), this study investigates the association between firms that manipulate their business operations to meet earnings benchmarks (i.e., zero earnings, last year's earnings) and subsequent operating performance. We examine the effects of the magnitude of real earnings management on firms' future performance for the period 2009 to 2015 for UK firms. Our analysis shows that the manipulation of operating activities such as sales, discretionary expenditures, and production costs to meet earnings benchmarks has a significantly positive consequence for firms' subsequent operating performance and signals firms' good future performance. We also find that firms that manipulate their operating activities in the absence of meeting earnings benchmarks experience a decline in their subsequent operating performance. The findings of this research lend support to our understanding of the process that management follows to evaluate costs and benefits of real earnings management.     

The Effect of Venture Capital Financing on the Sensitivity to Cash Flow of Firm's Investments

This work studies the effect of venture capital (VC) financing on firms' investments in a longitudinal sample of 379 Italian unlisted new‐technology‐based firms (NTBFs) observed over the 10‐year period from 1994 to 2003. We distinguish the effects of VC financing according to the type of investor: independent VC (IVC) funds and corporate VC (CVC) investors. Previous studies argue that NTBFs are the firms most likely to be financially constrained. The technology‐intensive nature of their activity and their lack of a track record increase adverse selection and moral hazard problems. Moreover, most of their assets are firm‐specific or intangible and hence cannot be pledged as collateral. In accordance with this view, we show that the investment rate of NTBFs is strongly positively correlated with their current cash flows. We also find that after receiving VC financing, NTBFs increase their investment rate independently of the type of VC investor. However, the investments of CVC‐backed firms remain sensitive to shocks in cash flows, whereas IVC‐backed firms exhibit a low and statistically not significant investment–cash flow sensitivity that we interpret as a signal of the removal of financial constraints.     

How does credit risk affect cost management strategies? Evidence on the initiation of credit default swap and sticky cost behavior

In this paper, we examine the effect of credit defaults swaps (CDS) initiation on reference firms' cost management strategies. CDS contracts provide insurance protection for creditors, inducing a shift in bargaining power from borrowers to creditors and an excessive incidence of bankruptcy. Anticipating more intransigent creditors in debt renegotiations and higher bankruptcy risk, CDS firms are incentivized to mitigate risk through decreasing cost stickiness after CDS initiation, as cost stickiness lowers liquidity and triggers early covenant violations. We find that, on average, CDS initiation is associated with a decline in reference firms' cost stickiness. This association is more pronounced for less liquid, financially distressed, and lower credit quality firms. We also find that CDS firms with a reduction in cost stickiness will exhibit lower future bankruptcy risk than CDS firms without such as reduction in stickiness. Collectively, our findings suggest that the CDS-induced “empty creditor problem” causes reference firms to undertake more conservative cost management practices to alleviate downside risk.     

The Role of Product-Level Dynamics in Export Growth and Productivity: Evidence from Estonia

Recent empirical studies of international trade have stressed that firm-level decisions about the number of export products or markets are an important margin of adjustment in response to globalization and changes in economic conditions. We investigate how decisions about the export product mix are associated with aggregate export dynamics and productivity of firms. We use detailed data on product and export market levels for the full population of Estonia's firms. Decomposition analysis of trade flows shows that both the relative importance of firms' beginning to export products and the role of product-level churning (firms' adding and dropping of products) in total Estonian export growth increases significantly after accession to the European Union in 2004. We show that concentration on core competence products has a rather different association with productivity of firms in different-size groups. Large firms with a large number of different types of export products gain, on average, in terms of productivity from concentrating their export sales on their core export products. There is no such general regularity in the case of small firms.     

Suppliers' listing status and trade credit provision

We show that public suppliers extend more trade credit than their private counterparts. The impact of stock market listing on accounts receivable is more pronounced among firms that are financially more constrained or more reliant on external finance. Moreover, firms significantly increase their trade credit provision following equity issuances in stock exchanges. These results are consistent with the argument that stock market listing status improves firms' access to external sources of financing, especially equity capital, thus enhancing their ability to offer more trade credit to customers.     

Are Financial Constraints Priced? Evidence from Firm Fundamentals and Stock Returns

Using comprehensive firm‐ and aggregate‐level data, this paper studies the real and financial implications of capital market imperfections. We first examine whether financially constrained firms' business fundamentals (capital spending and operating earnings) are more sensitive to macroeconomic movements than unconstrained firms' fundamentals. We then examine whether financial constraint “return factors” respond to macroeconomic shocks in tandem with the responses from business fundamentals. The evidence in this paper points to financial constraints affecting both fundamental quantities and asset returns.     

Private and Public Merger Waves

We document that public firms participate more than private firms as buyers and sellers of assets in merger waves and their participation is affected more by credit spreads and aggregate market valuation. Public firm acquisitions realize higher gains in productivity, particularly for on‐the‐wave acquisitions and when the acquirer's stock is liquid and highly valued. Our results are not driven solely by public firms' better access to capital. Using productivity data from early in the firm's life, we find that better private firms subsequently select to become public. Initial size and productivity predict asset purchases and sales 10 and more years later.