Competition and the cost of debt

This paper empirically shows that the cost of bank debt is systematically higher for firms that operate in competitive product markets. Using various proxies for product market competition, and reductions of import tariff rates to capture exogenous changes to a firm's competitive environment, I find that competition has a significantly positive effect on the cost of bank debt. Moreover, the analysis reveals that the effect of competition is greater in industries in which small firms face financially strong rivals, in industries with intense strategic interactions between firms, and in illiquid industries. Overall, these findings suggest that banks price financial contracts by taking into account the risk that arises from product market competition.     

Options trading and the cost of debt

Equity option markets can have a dual effect on firms' cost of debt. On the one hand, options attract more informed investors, which increases price informativeness and reduces information asymmetries in the market, facilitating firm financing. On the other, by attracting more informed investors who provide reassurance regarding managerial career concerns, options can increase the potential for risk shifting in firms. We explore these two channels via different tests on corporate bond yields and use different econometric specifications including quasi-natural experiments to mitigate endogeneity concerns. We find evidence consistent with the preeminence of the risk-shifting channel when private managerial risk-taking incentives are sufficiently high and debtholders are more exposed to expropriation.     

CEO incentives and the cost of debt

Motivated by concerns that stock-based compensation might lead to excessive risk-taking, this paper’s main purpose is to examine the relations between CEO incentives and the cost of debt. Unlike prior research, this paper uses the sensitivities of CEO stock and option portfolios to stock price (delta) and stock return volatility (vega) to measure CEO incentives to invest in risky projects. Higher delta (vega) is predicted to be related to lower (higher) cost of debt. The results show that yield spreads on new debt issues are lower for firms with higher CEO delta and are unrelated to CEO vega. The results also show that yield spreads are higher for firms whose CEOs hold more shares and stock options. In sum, the results suggest that both percentage-ownership and option sensitivity variables are important in understanding relations between CEO incentives and the cost of debt.     

Income smoothing and the cost of debt

The literature on income smoothing focuses on the effect of earnings smoothing on the equity market.This paper investigates the effect of income smoothing on th...     

Corporate hedging and the cost of debt

For a large sample of U.S. firms from 1994 to 2009, we empirically examine the impact of corporate hedging on the cost of public debt. We find strong evidence that hedging is associated with a lower cost of debt. The negative effect of hedging on the cost of debt is consistent across industries, and remains economically and statistically significant under various controls and econometric specifications. A cross-sectional analysis based on propensity score matching suggests that hedging initiation firms experience a drop in cost of debt, while suspension firms sustain a jump. We confirm our findings after employing an extensive array of models to address potential endogeneity. The influence of hedging on cost of debt is mainly through the lowering of bankruptcy risk and agency cost, and the reduction in information asymmetry. Finally, hedging mitigates the negative effect of rising borrowing costs on capital expenditure and firm value.     

Political rights and the cost of debt

We examine the impact of country-level political rights on the cost of debt for corporate bonds issued by firms incorporated in 39 countries. Similar to, but separate from, the relation for creditor rights, greater political rights are associated with lower yield spreads. A one standard deviation increase in political rights is associated with an 18.6% decline in bond spreads. We find evidence that political and legal institutions are substitutes; marginal improvements in political rights produce greater reductions in the cost of debt for firms from countries with weaker creditor rights. We examine potential factors through which political rights may affect the cost of debt and find that greater freedom of the press provides an important channel for reducing bond risks. Moreover, debt of firms with cross-listed equity trades at a premium in U.S. markets, but this relation appears to be more consistent with improved visibility than with bonding effects.     

Executive compensation and the cost of debt

This study examines how different components of executive compensation affect the cost of debt. We find that debt-like and equity-like pay components have differing effects: an increase in defined benefit pensions is associated with lower bond yield spread, while higher share holdings lead to higher spreads. In addition, we find that stock options have a mixed impact on the cost of debt whereas cash bonus has no significant impact. Overall, our results indicate that corporate bondholders are fully aware of both risk-taking and risk-avoiding incentives created by various executive pay components.     

Analyst forecast characteristics and the cost of debt

We examine the relation between analyst forecast characteristics and the cost of debt financing. Consistent with the view that the information contained in analysts’ forecasts is economically significant across asset classes, we find that analyst activity reduces bond yield spreads. We also find that the economic impact of analysts is most pronounced when uncertainty about firm value is highest (that is, when firms have high idiosyncratic risk). Our findings are robust to controls for private information in equity prices and level of corporate disclosures. Overall, the results indicate that the information contained in analyst forecasts is valued outside the equity market and provide an additional channel in which better information is associated with a lower cost of capital.     

Institutional ownership stability and the cost of debt

This study documents that the stability of institutional ownership plays an important role in determining the cost of debt. After controlling for other determinants of the cost of debt, and correcting for the endogeneity of institutional ownership stability, three major results are uncovered. First, there is a robust negative relationship between the cost of debt and institutional ownership stability. Second, institutional ownership stability plays a bigger role in determining the cost of debt, than the institutional ownership level commonly used in the literature. Third, institutional ownership stability affects the cost of debt to a greater extent for firms that are subject to more severe information asymmetry and greater agency costs of debt.     

Executive risk-taking and the agency cost of debt

Firms compensate managers to maximize shareholder value, yet these same incentives affect bondholder risk. We investigate the relation between executive equity pay and the cost of debt. Our findings indicate a “u-shaped” relation between bond yields and equity pay. These results are consistent with the notion that bondholders prefer a moderate amount of executive equity pay and above or below that level, bondholders increase yields to protect their interests. These findings suggest that moderate levels of equity pay mitigate the agency costs between firm shareholders and bondholders.     

Corporate political transparency and the cost of debt

Review of Quantitative Finance and Accounting - We examine whether the predictive power of initial yield spreads of mortgage-backed securities (MBS) vary with the financial cycle. Using a...     

Share‐pledging and the cost of debt

We examine how corporate insiders pledging their equity stakes to collateralise personal loans influences firm cost of debt. Pledging enables managers to diversify personal holdings, potentially increasing risk‐taking incentives. However, exposure to contingent risks creates potentially stronger risk‐reducing incentives. Using hand‐collected data with OLS, difference‐in‐differences, and instrumental variables models, we find significant decreases in yield spreads associated with executive share‐pledging. Reductions in spreads surrounding share‐pledge disclosures suggest investors update their risk assessment to reflect pledging managers’ risk‐taking incentives. Consistent with risk‐reducing incentives, firms with share‐pledging executives subsequently reduce leverage.     

Founding family ownership and the agency cost of debt

We investigate the impact of founding family ownership structure on the agency cost of debt. We find that founding family ownership is common in large, publicly traded firms and is related, both statistically and economically, to a lower cost of debt financing. Our results are consistent with the idea that founding family firms have incentive structures that result in fewer agency conflicts between equity and debt claimants. This suggests that bond holders view founding family ownership as an organizational structure that better protects their interests.     

Terrorism and its impact on the cost of debt

We extend the literature on the costs of terrorism by examining its long-term impact on financial markets, an underdeveloped strand of research within the terrorism construct. Specifically, we look at its effect on the sovereign risk of 102 countries (a much broader sample than examined before), which forms the basis of the cost of debt in those countries, postulating that it results in a lower credit rating and that this impact is more pronounced in developing as opposed to developed markets. In operationalizing the risk of terrorism, we utilize the Institute for Economics and Peace's Global Terrorism Index, the most comprehensive index constructed to date which incorporates both the economic and social dimensions of terrorism and is based on the Global Terrorism Database covering 104,000 documented incidents. The results of the study support the hypothesis that terrorism results in a higher cost of debt for sovereigns and by extension, firms in impacted countries. In fact, a two-point increase in terrorism on the utilized 10-point scale on average results in a half notch reduction in a sovereign's credit rating, roughly equivalent to a change in outlook. Furthermore, this impact is more pronounced in developing markets where we find that a comparable two-point increase in terrorism on average results in an entire notch downgrade in the sovereign credit rating, e.g., from BB to BB-. Finally, we find that our model demonstrates predictive power on an out-of-sample basis and as such, could be useful for investors seeking to construct more efficient diversified asset portfolios.     

Diversification and the cost of debt of bank holding companies

In this study, we investigate the relationship between various dimensions of diversification and the cost of debt for publicly traded bank holding companies (BHCs). We find that both domestic geographic diversification of deposits and diversification of assets lead to a lower bond yield-spread. Diversification of non-traditional banking activities leads to a lower cost of debt only when yield-spread and diversification are estimated simultaneously. In addition, we find that medium-sized BHCs experience a greater reduction in bond yield-spread than small-sized and large-sized BHCs. This is consistent with the too-big-to-fail (TBTF) effects in the banking industry. Furthermore, we document that the association between diversification and yield-spread is bidirectional with higher yield-spreads being associated with greater asset and activity diversification and lower geographic deposit dispersion. The effect of diversification on bond yield-spread is robust after accounting for cross-sectional and serial correlation, and the endogeneity of diversification.     

Criminals,bankruptcy, and cost of debt

Review of Accounting Studies - We examine whether criminal records of CEOs and rank-and-file employees are associated with firms’ likelihood of bankruptcy, and whether lenders adjust their...     

Financial analysts' career concerns and the cost of private debt

Career-concerned analysts are averse to firm risk. Not only does higher firm risk require more effort to analyze the firm, thus constraining analysts' ability to earn more remuneration through covering more firms, but it also jeopardizes their research quality and career advancement. As such, career concerns incentivize analysts to pressure firms to undertake risk-management activities, thus leading to a lower cost of debt. Consistent with our hypothesis, we find a negative association between analyst career concerns and bank loan spreads. In addition, our mediation analysis suggests that this association is achieved through the channel of reducing firm risk. Additional tests suggest that the effect of analyst career concerns on loan spreads is more pronounced for firms with higher analyst coverage. Our study is the first to identify the demand for risk management as a key channel through which analysts help reduce the cost of debt.     

Acquisitions and the cost of debt: Evidence from China

A large body of literature has examined the effect of mergers and acquisitions (M&As) on firm valuation, and generally find that M&As reduce acquirers' shareholder value. However, relatively little is known about the effect of M&As on the pricing of corporate debt by debtholders, especially for firms in less developed countries. Using a sample of Chinese listed firms with outstanding bonds from 2007 to 2020, we find that the cost of debt is lower for acquirers than for non-acquirers, and that the effect of acquisitions in reducing cost of debt is more pronounced for firms from provinces with less developed markets, for private firms, and for firms undertaking cross-province acquisitions. Our results are robust to a series of robustness checks that address various endogeneity concerns, including the use of a matched-sample approach, the use of the Heckman two-stage model and a change analysis, the control for acquirers' pre-acquisition bond yield spread, and the exclusion of acquisitions of publicly listed targets. Our analyses of provincial institutional factors show that the relationship between M&As and cost of debt is moderated by government relations to market, private economy development, and the development of market intermediaries and legal environment. We further document that acquirers have lower default risk during the post-acquisition period because of a coinsurance effect, and that acquirers attract more analyst following and investors after acquisitions. Overall, our results indicate that acquisitions can reduce cost of debt through reducing firms' default risk and information risk, and that institutional factors matter for the effect of M&As on the cost of debt.     

The market for corporate control and the cost of debt

How do bondholders view the existence of an open market for corporate control? Between 1985 and 1991, 30 states in the U.S. enacted business combination (BC) laws, raising the cost of corporate takeovers. Relying on these exogenous events, we estimate the influence of the market for corporate control on the cost of debt. We identify different channels through which an open market for corporate control can benefit or harm bondholders: a reduction in managerial slack or the “quiet life,” resulting in higher profitability and firm value; a coinsurance effect, in which firms become less risky after being acquired; and an increasing leverage effect, in which bondholder wealth is expropriated through leverage-increasing takeovers. Consistent with the first two mechanisms, we find that the cost of debt rose after the passage of the BC laws; moreover, it rose sharply for firms in non-competitive industries, and for firms rated speculative-grade. In contrast, there is virtually no effect for firms in competitive industries, or firms rated investment-grade.