The path of lease resistance: How changes to lease accounting treatment may impact your business

In this installment of Accounting Matters, we examine potential consequences of the Financial Accounting Standards Board's Proposed Accounting Standards Updates for Leases. In the context of a previous accounting change (FIN 48), we investigate how these changes will affect firms’ accounting choices, investment decisions, debt covenant requirements, and analysis of other key financial data. Changes in accounting standards may have significant indirect economic effect on companies as they can trigger debt covenant violations, restrict access to capital, and distort key financial information used by investors and lenders. New accounting standards may also directly affect the calculation of employee bonuses and incentives that utilize EBITDA or operating income as benchmarks. We include recommendations for managers and identify specific debt covenant components that may limit the negative consequences of the proposed change to lease accounting.     

Does the decision to issue public debt affect firm valuation? Russian evidence

This paper examines the association between firm valuation and the sources of debt financing. In particular, using a sample of 353 firms, we test whether the decision to issue bonds affects the firm's stock market performance in the emerging Russian markets. Our results indicate that public debt financing may have a negative effect on the firm's market valuation. After controlling for the differences in firm-specific characteristics and addressing potential endogeneity issues, we document that the firms which rely on public debt underperform relative to firms with other sources of debt financing in terms of stock market valuation.     

Covenants and Small Business Lending: The Finnish Case

This study examines the use and determinants of covenants in Finnish small firms' loans. The results show that 72 of the 642 loan contracts examined include at least one covenant. Negative covenants are more common than affirmative covenants in our sample. We use loan characteristics, firm characteristics, and bank relationship variables to explain the use of covenants. Our results suggest that loans with real estate collateral are less likely to contain covenants than loans with other types of collateral. Larger firms are more likely to offer covenants, while the inverse holds for manager-owned firms. Firms with high corporate leverage, a high level of investments and a high sales growth rate offer covenants more often than other firms. Bank relationship length, changes of main bank and interbank competition also affect the use of covenants.     

非上市中小企业资本结构的决定因素分析

本文利用11723家非上市中小企业的财务数据,分析反映企业特征的因素与财务杠杆之间的关系。研究发现,在全体中小企业、国有中小企业以及民营中小企业,企业规模对长期负债率和总负债率产生正的影响,盈利性对长期负债率和总负债率产生负的影响,资产的有形性对长期负债率具有正的影响,而与总负债率之间呈负相关关系。成长性仅对全体企业和民营企业的资本结构具有一定的影响,而非债务税盾的影响较弱。企业规模、盈利性和资产的有形性是中小企业资本结构的重要影响因素。研究结果基本上支持权衡理论和优序融资理论的观点。     

The impact of firm and industry characteristics on small firms’ capital structure

We study the impact of firm and industry characteristics on small firms’ capital structure, employing a proprietary database containing financial statements of Dutch small and medium-sized enterprises (SMEs) from 2003 to 2005. The firm characteristics suggest that the capital structure decision is consistent with the pecking-order theory: Dutch SMEs use profits to reduce their debt level, and growing firms increase their debt position since they need more funds. We further document that profits reduce in particular short-term debt, whereas growth increases long-term debt. We also find that inter- and intra-industry effects are important in explaining small firms’ capital structure. Industries exhibit different average debt levels, which is in line with the trade-off theory. Furthermore, there is substantial intra-industry heterogeneity, showing that the degree of industry competition, the degree of agency conflicts, and the heterogeneity in employed technology are also important drivers of capital structure.     

Firm diversification and equilibrium risk pooling: The Korean financial crisis as a natural experiment

We use the Korean Financial Crisis as a natural laboratory for examining interactions among firm diversification, equilibrium capital structure and tail probability events. When the crisis hit in 1997, several major firms, including a large number of highly leveraged conglomerates (Chaebols), experienced bankruptcies. We show how diversified Chaebols obtain higher equilibrium leverage than non-Chaebols (a “cosigner effect”). In the event of a low probability macro-economic shock, the model predicts a systematic change in relative bankruptcy risks of Chaebol firms. To examine this implication, we introduce an empirical methodology that decomposes equilibrium debt into demand, supply and Chaebol-specific factors, for use in a bankruptcy prediction model. We find that the primary cause of Chaebol firm bankruptcies was not idiosyncratic leverage, but leverage systematically related to greater equilibrium access to debt during normal times.     

Moderating Effects of Firm Age on the Relationship between Debt and Stock Returns

This article investigates the moderating effects of firm age on the relationship between debt and stock returns. The system generalized method of moment’s results indicate that firm age has a positive moderating effect on the relationship between book debt and stock returns. The results are robust, as firm age positively moderates the relationship between market debt and stock returns. Moreover, firm age has a direct positive effect on stock returns. Results suggest that as firms grow older, they use their experience to make effective capital structure decisions (i.e., optimal debt-equity mix) to maximize debt interest-tax-shield and increase shareholders’ returns.     

The Choice between Bank Debt and Trace Credit in Business Start-ups

This paper investigates the choice between bank debt and trade credit in business start-ups. While trade credit is more expensive than bank debt, suppliers tend to follow a more lenient liquidation policy when client firms encounter financial distress. As a result, suppliers are more willing to renegotiate the outstanding debt or grant additional debt whereas banks are more likely to liquidate borrowers upon default. Given the risky nature of business start-ups, we argue that the entrepreneur’s choice of debt instruments reflects these differences in liquidation policy between lenders and is thus determined by the venture’s failure risk, the entrepreneur’s private control benefits that are lost upon liquidation and the liquidation value of firm assets. Using unique data on 325 first-time business start-ups, we find that firms in industries with high historical start-up failure rates and entrepreneurs who tend to highly value private benefits of control use less bank debt. These effects are especially prevalent in start-ups where assets have a high liquidation value and thus banks are more likely to liquidate the venture following default. An erratum to this article can be found at     

Firm-Level Determinants of the Financing Decisions of Small and Medium Enterprises: Evidence from Argentina

This article studies the determinants of the financing decisions of small and medium enterprises (SMEs), which we characterize through three cases: trade-off behavior, pecking order, and extreme aversion to debt. We test our hypotheses using a dataset of firms from Bahía Blanca (Argentina) for two years: 2006 and 2010. We find that firm characteristics related to information asymmetries, such as firm age, size, and legal form; and personal factors, such as owner’s age and education; and perception of emotional bankruptcy costs, are relevant variables in SME financing behavior. The recognition of extreme aversion to debt motivates reconsideration of the underleverage problem of SMEs.     

International Debt Shifting: The Value-Maximizing Mix of Internal and External Debt

Abstract

We study the capital structure of multinationals and expand previous theory by incorporating international debt tax shield effects from both internal and external capital markets. We show that: (i) multinationals’ firm value is maximized if both internal and external debt are used to save tax; (ii) the use of internal and external debt is independent of each other; and (iii) multinationals have a tax advantage over domestic firms, which cannot shift debt across international borders. We test our model using a large panel of German multinationals and find that internal and external debt shifting are of about equal importance.     

A comparison of new firm financing by gender: evidence from the Kauffman Firm Survey data

This study uses data from the new Kauffman Firm Survey to explore gender differences in the use of start-up capital and subsequent financial injections by new firms. We find that, consistent with previous studies, women start their businesses with significantly lower levels of financial capital than men. A new finding from this research is that women go on to raise significantly lower amounts of incremental debt and equity in years two and three. These results hold even controlling for a variety of firm and owner characteristics, including the level of initial start-up capital and firm sales. Our findings also reveal that women rely heavily on personal rather than external sources of debt and equity for both start-up capital as well as follow-on investments. Our findings have implications for further research into gender differences in financing sources and strategies and business outcomes.     

The effect of internationalization on firm capital structure: A meta-analysis and exploration of institutional contingencies

Despite extensive research on the relationship between internationalization and firm capital structure, findings in this research area remain inconclusive. In this paper, we review the literature on the internationalization–capital structure relationship and investigate its direction, effect size, and multiple contingencies through a meta-analysis of 31 studies with a grand total of 223,658 firm observations and at least two separate samples each. Our cumulative evidence indicates lower debt ratios of multinational corporations compared to domestic corporations, in line with arguments of increased risk and agency costs in international operations. We extend our analysis to institutional characteristics in firms’ home countries and find that much of the existing variation in study findings can be explained using theory arguments on firm risk in internationalization. We contribute to an integration of international business and finance literature and point to directions for future research on determinants of the internationalization–capital structure relationship and its multiple contingencies.     

The signaling effects associated with convertible debt design

In this paper we investigate whether the terms used in the design of a convertible debt issue act as a signal of the issuing firm's future growth prospects. Our general premise is that convertible debt design terms are interrelated and arranged in a manner that signals asymmetric information to market participants. Empirical tests support our hypothesis, even after controlling for risk, firm size, time-to-maturity, and industry effects. Firms issuing convertible debt that arrange terms to take advantage of relatively better future growth prospects are found to have a relatively lower negative price reaction around the announcement of the offer.     

Debt signaling and outside investors in early stage firms

By imposing a market like governance and directing entrepreneurs towards professional management, debt, and especially business debt, can serve as a reliable signal for outside equity investors. Such signals of firm accountability can alleviate the stringent information asymmetry at the early stages of the firm, and become stronger for bank business debt, in the presence of personal debt, and in high capital industries. Using the Kauffman Firm Survey, we find evidence consistent with our hypotheses. Outside investors can rely on the governance role of debt and its underpinnings such as the bank-firm relationship. We also corroborate that young firms tend to focus on growth rather than profitability.     

The Tax Sensitivity of Debt in Multinationals: A Review

The OECD in its BEPS Action Plan Four addresses tax base erosion by profit shifting through the use of tax deductible interest payments. Their main concern is interest deductions between outbound and inbound investment by groups. Studies of multinational firms show that the tax sensitivity of debt is more modest than one would expect given the incentives for profit shifting. The purpose of this paper is to review existing literature and add to knowledge on multinational firm behavior that pertains to the use of debt.     

Which firms do prefer Islamic debt? An analysis and evidence from global sukuk and bonds issuing firms

The Islamic debt instrument sukuk has been in the market for two decades; still, we do not know why a firm prefers an Islamic debt over conventional debt, set aside religiosity issue. We argue there is a genuine reason to choose Islamic debt because it has lighter indebtedness, benefits of avoiding external monitoring, and tax incentives. Based on the cross-country data for 346 firms issuing dollar-denominated global sukuk and bonds, we find that firms that prefer Islamic debt and issue sukuk are financially more unstable, and thus exposing to higher insolvency risk as compared to bond issuing firms.     

Firm Characteristics as Determinants of Capital Structures in Australia

This study investigates capital structures of Australian firms in relation to firm characteristics. Using an unbalanced panel of 367 firms observed over a 15‐year period from 1992 to 2006, our panel data regression results show that debt–asset ratio is positively related to asset tangibility but inversely related to growth prospects and business risk measured by unlevered beta of equity. We also find that although levered firms are generally more profitable than unlevered firms, profitability decreases the debt ratio of levered firms. We do not find that firm size affects the capital structure of Australian firms. These results are consistent with the pecking order and the agency cost theories but contradict the trade‐off theory.     

How do emerging debt market participants recognize firm internationalization?Evidence from effects on credit ratings

We explore the firm internationalization's impact on firm credit ratings in emerging economies. Adopting Chinese data from 2009 to 2018, we document that firm internationalization varies negatively with its credit ratings, indicating that emerging debt market participants are risk averse and prioritize the risks involved in firm internationalization endeavors. This association is amplified for firms operating in host countries with lower institutional quality, decreased cultural distance from home countries, and when firms do not hold tax haven subsidiaries. We observe that the main association is consistent when alternative dataset (India, Russia, and Brazil) or proxy (cost of debt) is applied.     

Debt source choices and stock market performance of Russian firms during the financial crisis

This paper examines the relationship between stock returns and the sources of corporate debt during the financial crisis of 2008. In particular, using data on large-capitalization Russian firms, we investigate whether dependence on either bank debt or bonds affected stock returns during the credit crunch. Our results indicate that the firms which rely entirely on bank debt significantly outperformed the firms with public debt amidst the crisis. This finding suggests that bank debt may be particularly valuable in harsh times. However, we also document that the stock prices of the bank dependent firms recovered more slowly in the post-crisis period.     

Currency depreciations, financial transfers, and firm heterogeneity

The present paper investigates five episodes of currency collapse from the perspective of non-financial firms operating in Argentina, Brazil and Mexico. We focus on two aspects: wealth and income transfers from borrowing firms to lenders and firm heterogeneity. At the firm level, we find that the currency collapses are preceded and associated with sharply rising financial transfers from firms to lenders. The debt and income structure is central in explaining the asymmetric firm dynamics. Most affected are firms with high levels of unhedged foreign-currency debt. At the country level, Argentina, Brazil, and Mexico display three contrasting examples. Argentina has a large currency mismatch, Brazil balances the currency denomination of debt and income (natural hedge), and Mexico occupies an intermediate position.