Industry conditions,growth opportunities and market reactions to convertible debt financing decisions

Firms that issue convertible debt have high debt- and equity-related costs of external finance. Existing theories of convertible debt finance differ primarily in their identification of the specific causes of the debt- and equity-related costs of external finance. To assess the theoretical issuance motives separately, we propose a simple framework that characterizes how issuers should design convertible debt to efficiently mitigate specific debt- and equity-related costs of external finance. We provide evidence from 588 security offer announcements that supports the hypotheses that: (1) convertible debt can be designed to mitigate different combinations of debt- and equity-related costs of external finance and (2) share price reactions depend on the security design decisions. The results also illustrate that the relations between firm value, financial leverage, investment opportunities, and the rate of future growth are more complex among convertible debt issuers than situations where firms issue standard financial securities.     

The pricing of risky assets on the Belgian stock market

This paper presents the first empirical examination of the relationship between the average return and the risk of a comprehensive sample of 200 securities which traded continuously from 1966 to 1980 on the Brussels Stock Exchange, a relatively thin equity market. Based on our empirical findings, we cannot reject the hypothesis that the pricing of common stocks on the Brussels Stock Exchange conforms to the Capital Asset Pricing Model.     

The revaluation of assets as a signalling device: a theoretical and an empirical analysis

In many countries, firms can choose whether or not to report a revaluation in the financial statements. An analytical model is developed to indicate conditions in which it is more likely that successful firms will choose not to revalue assets as a credible signal to potential investors. These industry settings include a high variance in performance and low equity-to-debt ratios. The empirical results for Belgium confirm that successful firms are less likely to revalue assets in those industries. However, only the revaluation of fixed tangible assets and not financial assets seems to be a credible signal. Finally, the results support the choice to revalue, but not the amount of revaluation, as a signalling device.     

The impact of junior debt issuance on senior unsecured debt’s risk premiums

Numerous studies have examined the impact of security issuance upon the value of pre-existing debt and equity but the focus has largely been on changes in equity value. We examine changes in senior unsecured debt risk premiums that accompany new junior debt issues. Additionally, we test several hypotheses regarding the potential impacts of junior debt issues. Extant theory suggests senior debt value may be threatened under certain conditions by the issuance of junior debt. Our results indicate that when junior debt replaces bank debt, senior default risk premiums experience abnormal declines. The result is broadly consistent with the elevation of the senior unsecured debt by way of the elimination of a separate and more senior class of debt claimants. In contrast, we also find that larger junior bond issues are associated with abnormal increases in senior risk premiums, broadly consistent with issue size being correlated with negative information about firm cash flows. We find strong evidence of interaction effects. For example, replacement of bank debt results in greater changes in default risk premiums the larger the issue size. We also find lower credit ratings magnify other effects. For example, if the junior debt issued matures before the outstanding senior unsecured bond, senior risk premiums experience abnormal increases for lower rated debt.     

The impact of firm size on bank debt use

I use a sample of US firms to examine the determinants of the concentration of bank debt in total debt. The results indicate that the factors vary by size of the firm. A small- to medium-sized firm has a high concentration of bank debt when it has a low level of discretionary spending. In contrast, a large firm has a high concentration of bank debt when it is difficult for outsiders to observe. The results support the Diamond [J Polit Econ 99 (1991) 689] reputation view that a firm faces different debt choices as it grows. When evaluating bank regulations, policymakers should consider the importance of the reputation-building services, which a bank provides to businesses.     

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.     

The historical significance of the revaluation of fixed assets in Japan's state-owned railway system, 1955-6

The Government Railways of Japan (GRJ) established a fixed assets accounting system on the accruals basis after the Second World War. The revaluation of tangible fixed assets was indispensable for GRJ's introduction of depreciation in 1948. GRJ scheduled the revaluation to secure a reasonable depreciation expense, because the company had applied the replacement method to all tangible fixed assets since its foundation in 1869. At the same time, GRJ assumed the balance of the revaluation reserve account to be a means of dealing with possible future accumulated losses.     

The emergence of market monitoring in Japanese banks: Evidence from the subordinated debt market

This paper uses a unique data set on the spreads of subordinated debts issued by Japanese banks to investigate the presence of market monitoring. The results show that subordinated debt investors punished weak banks by requiring higher interest rates. Moreover, I find that the spreads and the sensitivity of spreads to Moody’s bank ratings both increased dramatically after the Japanese government allowed a large city bank, Hokkaido Takushoku Bank, to fail and passed the Financial Reform Act and the Rapid Revitalization Act in the late 1990s. These results suggest that the decline of conjectural guarantee led to the emergence of market monitoring. In addition, I find the relationship between spreads and accounting measures of bank risk to be quite fragile.     

Bank reputation in the private debt market

We examine the impact of lead arrangers' reputation on the design of loan contracts such as spread and fees charged. Controlling for the non-randomness of the lender–borrower match (self-selection bias), we find that the reputation of top tier arrangers leads to higher spreads, and that top tier arrangers retain larger fractions of their loans in their syndicates. These larger spreads are especially pronounced for borrowers without credit rating that have the most to gain from the certification assumed by virtue of a loan contract with a top tier arranger. This certification channel differs from the one found in public markets, where certification leads to a reduced spread offered to the best clients. These differences between public and private markets can be explained by differences in the way they operate and are structured. Interestingly, the effect is strongest for transactions done after the changes in the banking regulations (including the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994) that led to significant consolidations in the banking industry, including among the largest commercial banks.     

News spillovers in the sovereign debt market

We study the effect of a sovereign credit rating change of one country on the sovereign credit spreads of other countries from 1991 to 2000. We find evidence of spillover effects; that is, a ratings change in one country has a significant effect on sovereign credit spreads of other countries. This effect is asymmetric: positive ratings events abroad have no discernable impact on sovereign spreads, whereas negative ratings events are associated with an increase in spreads. On average, a one-notch downgrade of a sovereign bond is associated with a 12 basis point increase in spreads of sovereign bonds of other countries. The magnitude of the spillover effect following a negative ratings change is amplified by recent ratings changes in other countries. We distinguish between common information and differential components of spillovers. While common information spillovers imply that sovereign spreads move in tandem, differential spillovers are expected to result in opposite effects of ratings events across countries. Despite the predominance of common information spillovers, we also find evidence of differential spillovers among countries with highly negatively correlated capital flows or trade flows vis-á-vis the United States. That is, spreads in these countries generally fall in response to a downgrade of a country with highly negatively correlated capital or trade flows. Variables proxying for cultural or institutional linkages (e.g., common language, formal trade blocs, common law legal systems), physical proximity, and rule of law traditions across countries do not seem to affect estimated spillover effects.     

The market reaction to debt announcements: UK evidence surrounding the global financial crisis

We examine the stock market response to announcements of public, bank and privately placed debt issuance by large UK firms surrounding the global financial crisis of 2008. Prior to the crisis, we find that stock prices respond positively to announcements of bank debt issuance only. This is restricted to the sub-sample of syndicated bank loans and this is suggestive of the certification from multiple lenders conveying a signal of creditworthiness. We find that abnormal returns on the announcement of bank loans have declined since the financial crisis, both in absolute terms and in comparison to alternative borrowing sources. Overall, our results suggest that surrounding the global financial crisis of 2008, bank loans have become less informative as a signal of the creditworthiness of borrowing firms.     

The impact of the sovereign debt crisis on the activity of Italian banks

We examine the implications of the sovereign debt tensions on the Italian credit market by estimating the effect of the 10-year BTP-Bund spread on a wide array of bank interest rates, categories of loans and income statement variables. We exploit the heterogeneity between large and small intermediaries to assess to what extent the transmission of sovereign risk differed in relation with different banks’ balance-sheet characteristics and business strategies. Regarding the cost of funding, we find that changes in the BTP-Bund spread have a sizeable effect on the interest rates on term deposits and newly issued bonds but virtually no effect on overnight deposits. Furthermore, the sovereign spread significantly affects the cost of credit for firms and households and exerts a negative effect on loan growth. All these results are magnified when considering alone the five largest banks, which are typically less capitalized, have a larger funding gap and incidence of bad loans and rely more on non-traditional banking activities. Sovereign tensions also affect the main items of banks’ income statement.     

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.     

The impact of regulation on market risk

While it is crucial to understand the impact of regulatory changes on market risk, the literature does not show how risk responds to expected regulatory changes that are specifically designed to change risk. Our paper fills this gap by providing a detailed study of one such case. Using both a sample of privatized U.K. companies, and U.K. and U.S. control portfolios, between 1993 and 2000, we show (both for the single-factor market model and the three-factor Fama-French model) that the observed changes in market risk are significant and consistent with theory.     

Underlying assets for which options complete the market

This paper shows that investigations on the spanning power of options in spaces of integrable and continuously distributed payoffs can be conducted in the space of Lebesgue integrable claims on [0,1]. It is proved that there are infinite many underlying assets for which options span spaces of integrable claims. It is also shown that options on a single underlyer fail to complete the spaces of continuous contingent claims that are defined over a noncompact state-space.     

The impact of company responses to exchange queries on the Australian equity market

This study examines the impact of company responses to trading‐induced queries made by the Australian Securities Exchange over the period January 2007–December 2008, inclusive. We utilise event study methodology and a matched sample approach to assess the impact of trading query announcements. We use multivariate analysis to investigate any cross‐sectional determinants affecting abnormal returns and volume, and find significant positive shareholder wealth and volume effects associated with query announcements. Further, the unexplained abnormal returns observed prior to the announcement of the trading query persist post‐announcement. Subsequent analysis reveals the industry effect reported in the literature loses significance after accounting for sample selection bias.     

The impact of narrative disclosure readability on bond ratings and the cost of debt

Prior research on the determinants of credit ratings has focused on rating agencies’ use of quantitative accounting information, but the there is scant evidence on the impact of textual attributes. This study examines the impact of financial disclosure narrative on bond market outcomes. We find that less readable financial disclosures are associated with less favorable ratings, greater bond rating agency disagreement, and a higher cost of debt. We improve causal identification by exploiting the 1998 Plain English Mandate, which required a subset of firms to exogenously improve the readability of their filings. Using a difference-in-differences design, we find that the firms required to improve the readability of their filings experience more favorable ratings, lower bond rating disagreement, and lower cost of debt. Collectively, our evidence suggests that textual financial disclosure attributes appear to not only influence bond market intermediaries’ opinions but also firms’ cost of debt.     

The impact of hedging on the market value of equity

We examine the annual stock performance of firms that disclose the use of derivatives to hedge over the period 1995 to 1999. We find that only 21.6% of publicly traded U.S. corporations in our sample hedged with derivative instruments over this period and their use is concentrated in the larger companies. Similar to other studies we find that when derivatives are used, interest rate and currency securities are used much more frequently than commodity products. Our sample of 1308 companies that hedge outperforms other securities by 4.3% per year on average over our sample period. This result is robust to several alternative methods of estimating abnormal returns. When we segment performance by the type of hedge used, however, we find that the over-performance is due entirely to larger firms that hedge currency. We find no abnormal returns for firms hedging either interest rates or commodities. The abnormal returns in firms hedging currency is robust to alternative models that seek to control for exchange rate fluctuations and global equity returns; however, we find no significant abnormal returns to currency hedgers when using an augmented model that controls for the role of intangible assets.     

The market value of outstanding government debt, 1919–1975

Several new series on the market value of outstanding government debt are reported and their methods of construction described. The new series on Federal debt are compared with other existing estimates and are shown to be markedly superior to them.