DETERMINANTS OF CAPITAL STRUCTURE IN BUSINESS START‐UPS: THE ROLE OF NONFINANCIAL STAKEHOLDER RELATIONSHIP COSTS

According to the finance literature, nonfinancial stakeholders (NFS), such as customers, suppliers, and employees, take into account their expected liquidation costs when dealing with a firm. In this framework, firms can influence their probability of liquidation by choosing an appropriate capital structure. Also, the literature suggests NFS bargaining power may affect firm financing decisions. In the current article we investigate these ideas for initial financing decisions by business start‐ups, where ex ante failure risk is high and NFS must decide whether to make relationship‐specific investments. We find that start‐ups imposing larger costs on their NFS following liquidation significantly reduce leverage. This effect is strengthened when suppliers have greater bargaining power. We also document a marginally negative effect of NFS liquidation costs on the proportion of bank loans. Finally, business start‐ups rely less on bank loans when customers and suppliers are in a powerful bargaining position.     

Corporate Leverage and Specialized Investments by Customers and Suppliers

A company's performance in the product market depends in part on the willingness of its suppliers and customers to invest in the relationship—to make specialized investments of human as well as financial capital that may have no value outside that relationship. Consistent with Stewart Myers's concept of debt overhang and underinvestment, the authors hypothesize that companies can encourage their suppliers and other key stakeholders to make such specialized investments by limiting their use of debt financing, thereby addressing their stakeholders' concerns about their long‐term performance and staying power. In this article, the authors report the findings of a recently published study of a sample of U.S. industrial companies during the period 1984‐2003. Using the benchmark input‐output accounts for the U.S. economy, the authors identified supplier and customer industries for each company in their sample while also collecting data on the firm's actual suppliers and customers from Compustat's segment files. Using empirical proxies for the intensity of specialized investments, they find that companies that operate in environments requiring specialized investments by suppliers and customers tend to operate with lower levels of debt. At the same time, the authors report evidence suggesting that the suppliers and customers of highly leveraged companies make lower levels of specialized investment than the suppliers and customers of less leveraged firms.     

Corporate suppliers and customers and accounting conservatism

We argue that a firm's suppliers and customers prefer it to account more conservatively due to information asymmetry and these stakeholders' asymmetric payoffs with respect to the firm's performance. We predict that a firm meets this demand for accounting conservatism when suppliers or customers have bargaining advantages over it that enable them to dictate terms of trade or whether trade occurs at all. We show that when a firm's suppliers or customers have greater bargaining power, the firm recognizes losses more quickly. Our findings provide insights into how a firm's powerful suppliers and customers are associated with its accounting practices and also support the contracting explanation for accounting conservatism.     

Good cop,bad cop: Complementarities between debt and equity in disciplining management

We demonstrate an inherent conflict between ex ante efficient monitoring and liquidation decisions by outside claimholders. We show it can be useful to commit to inefficient liquidation when monitors fail to produce information: this provides stronger incentives to monitor. The implication for firm capital structure is that more information is generated about firm prospects – and hence firm value increases – when a firm’s cash flow is split into a ‘safe’ claim (debt) and a ‘risky’ claim (equity) compared to when a single claim is sold. We also derive the optimal allocation of control rights between safe and risky claims. This partially resolves the Tirole (2001) puzzle as to why firms issue multiple securities that generate ex post conflicts of interest.     

Do firms' relationships with principal customers/suppliers affect shareholders' income?

In this paper, we examine whether a firm's relationship with its principal customers/suppliers affects its payout policies. A firm has customer–supplier relationships when its business depends on a small number of major customers/suppliers. The extant literature indicates two channels through which customer–supplier relationships might negatively affect a firm's dividend payments: 1) the high financial distress costs associated with relationship-specific investments and 2) the information certification effect of the principle customer. Consistent with expectations, our study reveals a negative relationship between a firm's dependence on customer–supplier relationships and its dividend payments. This result is robust to various model specifications and consistent with evidence regarding the time-series properties of dividends. Moreover, we find that high financial distress costs associated with relationship-specific investments are the key channel through which a firm's customer–supplier relationship affects its dividend payments. Overall, our results suggest that a firm's relationship with its non-financial stakeholders, such as principal customers/suppliers, is an important determinant of its shareholders' income.     

Executives’ professional ties along the supply chain: The impact on partnership sustainability and firm risk

This paper investigates the effect of management-level professional ties between suppliers and customers on the sustainability of business partnerships. We find that the presence of cross-firm professional ties between directors and senior executives along the supply chain significantly reduces the probability of relationship termination around customers’ industry negative shocks and during financial crises. The results are robust using professional-tie strength as an alternative measure. Exploring contingency effects, we find that, for suppliers who lack R&D, face high competition, are smaller in size, or are less important to customers in terms of sales, such professional ties are more helpful in sustaining such relationships. Furthermore, we find that professional ties also significantly reduce firm risk during periods of market turbulence. Taken together, our results suggest that professional ties along the supply chain can facilitate information flow and build mutual trust, which can lead to healthy long-term relationships and can help firms survive economic and industry downturns.     

The significance of working capital management in determining firm profitability: Evidence from developing economies in Africa

PurposeThe purpose of this study is to examine the relationship between working capital efficiency and corporate profitability and in particular, to determine their significance across countries with differential industrial levels.DesignThe paper adopts a quantitative approach using balanced panel data of manufacturing firms in Egypt, Kenya, Nigeria and South Africa. We accessed financial statements of manufacturing firms from the Orbis database for the period 2005–2009. The database is known to be reliable and has universal acceptability.FindingsThe study reveals that there is a strong negative relationship between profitability, measured through net operating profit, and cash conversion cycles across different industrialisation typologies. The negative association implies that, when the cash conversion cycle increases, the profitability of the firm declines.Practical implicationsManagers can create positive value for shareholders by reducing the days customers settle their accounts, ensuring that they sell off their inventories as quickly as possible and delaying the payments to their suppliers, as long as this does not affect their credit rating.OriginalityTo the best of our knowledge, this is the first paper to provide a fresh perspective on how working capital management influences profitability across Africa within different typologies.     

Resolution of financial distress under agency frictions

We introduce, in a dynamic-contracting framework with moral hazard, the possibility of recapitalization as an alternative to liquidation when a firm is distressed. This is achieved by considering a risk-averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long-term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost-benefit analysis.     

Internal control quality and relationship‐specific investments by suppliers and customers

This paper investigates the association between the quality of internal control over financial reporting (ICOFR) and relationship‐specific investments by suppliers/customers. I find a significant negative association between the disclosure of a material weakness (MW) in ICOFR and changes in the relationship‐specific investments of suppliers/customers. Relationship‐specific investments of suppliers/customers have a stronger negative association with inventory‐related MW. The negative association between MW disclosures and the relationship‐specific investments of suppliers/customers is stronger when economic dependence between the firms and the suppliers/customers is more important and when the suppliers/customers have greater bargaining power. Also, suppliers/customers significantly increase their relationship‐specific investments following the remediation of ineffective ICOFR. Overall, my findings show that a firm's quality of ICOFR affects the relationship‐specific investment decisions of suppliers/customers.     

A Theory of Capital Structure Relevance under Imperfect Information

Firms raise debt and equity capital to finance a positive net present value project in perfectly competitive capital markets; firm insiders know the function generating the random firm cash flow but potential capital suppliers do not. Taking into account the incentives of insiders to misrepresent their firm type, capital suppliers attempt to design financing mixes of debt and equity that eliminate the adverse incentives of insiders and correctly price securities. Necessary conditions for a costless separating equilibrium are developed to show that the amount of debt used by a firm is monotonically related to its unobservable true value.     

Venture Capital and Private Equity: A Review and Synthesis

This paper reviews the existing literature on venture capital and private equity. The paper emphasises the importance of examining venture capital in the light of recent developments in corporate finance and its distinctiveness from other forms of finance. In order to understand current developments, the paper adopts a framework which combines industry/market and firm levels of analysis. Existing literature is reviewed using this framework. Industry level issues relate to rivalry between firms, the power of suppliers and customers, and the threats from new entrants and substitutes. Firm level issues concern deal generation, initial and second screening, valuation and due diligence, deal approval and structuring, post-contractual monitoring, investment realisation, and entrepreneurs' exit and recontracting with venture capitalists. This is followed by a review of the evidence on the performance of venture capital firms. The paper suggests potentially fruitful areas for further research including the extension of analysis to cover all stages of venture capital investment, examination of the inter-linkages between industry and firm level issues and between stages in the venture capital process, as well as further analysis of deal structuring issues and investment realisation and recontracting.     

Corporate capital structure and the characteristics of suppliers and customers

We investigate the link between a firm's leverage and the characteristics of its suppliers and customers. Specifically, we examine whether firms use decreased leverage as a commitment mechanism to induce suppliers/customers to undertake relationship-specific investments. We find that the firm's leverage is negatively related to the R&D intensities of its suppliers and customers. We also find lower debt levels for firms operating in industries in which strategic alliances and joint ventures with firms in supplier and customer industries are more prevalent. Consistent with a bargaining role for debt, we find a positive relation between firm debt level and the degree of concentration in supplier/customer industries.     

Trade credit,collateral liquidation,and borrowing constraints

Assuming that firms’ suppliers are better able to extract value from the liquidation of assets in default and have an information advantage over other creditors, the paper derives six predictions on the use of trade credit. (1) Financially unconstrained firms (with unused bank credit lines) take trade credit to exploit the supplier's liquidation advantage. (2) If inputs purchased on account are sufficiently liquid, the reliance on trade credit does not depend on credit rationing. (3) Firms buying goods make more purchases on account than those buying services, while suppliers of services offer more trade credit than those of standardized goods. (4) Suppliers lend inputs to their customers but not cash. (5) Greater reliance on trade credit is associated with more intensive use of tangible inputs. (6) Better creditor protection decreases both the use of trade credit and input tangibility.     

Staged venture capital contracting with ratchets and liquidation rights

This paper uses real options analysis to study later round financing in the presence of two standard venture capital contracting provisions: anti-dilution (ratchet) and liquidation preference. We argue that such provisions can preclude financing of a positive NPV venture in the case of a large follow-on financing relative to firm value. Liquidation preference contracting at multiples greater than one is not feasible in the later round if the financing is small relative to firm value. We highlight an interaction effect between the two provisions: increasing the liquidation multiple can help to avoid dilution and the need for the prior venture capitalist to waive ratchet provisions.     

How do suppliers benefit from customers’ voluntary disclosure? the effect of customers’ earnings guidance on upstream firms’ investment efficiency

We explore whether and how the issuance of customers’ financial forward-looking information affects the investment efficiency of their upstream firms. Using earnings guidance as a proxy for forward-looking information, we find that firms wherein customers disclose earnings forecasts invest more efficiently than those where customers withhold forward-looking information. Our findings hold after controlling for a set of firm characteristics, employing alternative model specifications and measurements, and using the 2011 Thailand flood as a quasi-experiment. Further analyses offer support that the positive impact of customers’ earnings guidance on upstream firms’ investment efficiency is stronger for customers issuing more informative, disaggregated, and accurate forecasts and suppliers with weaker bargaining power. We also observe an asymmetric response of suppliers’ investments toward customers’ good-news versus bad-news forecasts. Furthermore, by conducting a textual-based analysis, we find that suppliers’ investment efficiency increases with more embedded supply chain relevant information in customers’ earnings guidance reports. Overall, our findings suggest that suppliers benefit from customers’ earnings guidance to better assess their investment decisions, thereby achieving greater investment efficiency.     

商业信用与合作型客户关系的构建——基于提供给大客户应收账款的经验证据

利用我国上市公司前5名应收账款欠款人信息以及前5名大客户信息的披露数据,本文较为直接地考察了企业是否以及如何利用应收账款的产品质量担保功能与大客户构建合作型客户关系。研究结果表明,客户集中度越高,企业提供给大客户的信用政策越宽松,即应收账款金额越多,信用期限越长;进一步研究发现,在与主要客户地理位置相似度较低的企业、处于竞争性行业的企业以及营商环境较好的地区,上述两者之间的正相关关系有所增强。最后,本文发现,在与大客户构建合作型客户关系时,企业向这些大客户提供的应收账款越多,企业的业绩越好。     

Last resort gambles, risky debt and liquidation policy

This paper develops a real option model in which the interaction between debt, liquidation policy and risky investments is studied. We consider a manager who owns the firm and faces the opportunity to invest in risky projects which may boost current profits at the cost of bankruptcy if they turn out to be unsuccessful. These investments are “last resort gambles” in the sense that, if successful, they save the company from insolvency, while, if unsuccessful, they make liquidation unavoidable. It is shown that last resort gambles delay liquidation. We study how the liquidation trigger and the last resort investment decisions are affected by the firm's capital structure.     

Why are social network transactions important? Evidence based on the concentration of key suppliers and customers in China

Based on a new institutional economy framework, this study examines the formation and economic consequences of social networks (guanxi) from the perspective of key suppliers and customers in China. Results show that commercial activities which depend on networks are determined by the institutional environment. For example, companies that have lower accumulated social capital (less trust among people) and are subject to more government invention depend more on social network transactions than on the market. In addition, this study shows that network transactions can provide benefits to firms, especially in weak institutional environments. Networks can reduce transaction costs by reducing information asymmetry, i.e., increased network dependence is associated with lower credit costs and lower advertising and sales costs. Networks can also reduce the effect of industry shocks, especially negative shocks, by creating a bonding mechanism. This study contributes to our understanding of social networks in emerging markets by providing evidence on network transactions with key suppliers and customers and their influence on firms’ accounting behavior.     

Multidimensionality of text based financial constraints and working capital management

Using a novel text-based measure of financial constraints and primarily employing firm fixed-effect model, we find that financial constraints have a significantly negative association with cash conversion cycle (CCC), implying that financially constrained firms have a higher level of working capital management efficiency. In order to get a deeper insight, we consider two distinct dimensions, − ‘growth oriented’ and ‘contractual-obligation oriented’ financial constraints - and re-examine the relationship with CCC and its components. We find that firms facing growth oriented (contractual-obligation oriented) financial constraints have shorter (longer) CCC. It appears that compared to contractual-obligation oriented financially constrained firms, growth-oriented constrained firms receive more favorable treatments from their suppliers (longer payable period) as well as from their customers (shorter receivable period) - leading to a lower CCC. On the other hand, contractual-obligation oriented financially constrained firms have a longer inventory period, resulting in a longer CCC.     

Does corporate social responsibility protect shareholder value from the shock of COVID-19? Evidence from China

Our study examines whether and how increased engagement in social responsibility activities by a firm affects movements in its stock prices during the COVID-19 public health crisis, which is regarded as an exogenous shock to economic ties between focal firms and their customers, employees, and suppliers. We find that corporate social responsibility has an inverted U-shaped relationship with shareholder value. The nonlinear relationship is more dominant at firms with higher cash-flow constraints and weaker cost-adjustment capabilities. Our research also generates meaningful implications for business practices.