Discussion of “inventory policy, accruals quality and information risk”

Krishnan et al. (Review of Accouting Studies, 2008) investigate how the choice of LIFO versus FIFO affects firms’ accruals quality and cost of capital. The authors show that LIFO firms have better accruals quality and lower cost of capital than FIFO firms and that the cost of capital effect associated with the inventory valuation method is not subsumed by differences either in fundamental risk or accruals quality between LIFO and FIFO firms. This discussion is focused on key design choices and underlying assumptions.     

A test of the firm characteristics hypothesis for LIFO choice of Canadian firms

This paper examines whether characteristics of Canadian firms can explain the observed difference in the use of LIFO for valuing inventory between the U.S. and Canada. Characteristics that help explain the choice between LIFO and FIFO use in the U.S. are used to compare Canadian firms to U.S. LIFO users and FIFO users separately. If Canadian firms are characteristically similar to U.S. FIFO users, then the firm characteristics hypothesis would be supported and LIFO would be infrequently used in Canada because few firms are LIFO-like in their underlying characteristics. Univariate nonparametric tests are used to compare U.S. and Canadian firms in the same industries on both an unmatched and matched basis. The results of this comparison indicate that Canadian average cost firms have more characteristics in common with U.S. LIFO users than FIFO users and Canadian FIFO firms have characteristics like both U.S. FIFO and U.S. LIFO firms. Logit models were estimated using the U.S. firms. These models predict that between three and 28% of Canadian firms would use LIFO. Thus, the firm characteristics explanation for infrequent use of LIFO in Canada is not supported by the data. These results imply that several Canadian firms may use LIFO if the institutional setting in Canada was more like that in the U.S.     

Agency costs of free cash flow and conditional conservatism

This study investigates whether agency costs of free cash flow (FCF) are associated with conditional conservatism. Prior research documents that conditional conservatism improves ex ante efficient investment decisions and facilitates ex post monitoring of managers’ investment decisions. As conditional conservatism can provide protection from possible managerial expropriation, the demand for conditional conservatism should increase with the agency costs of FCF. Using excess cash as a proxy for the agency costs of FCF, I provide evidence that firms with higher agency costs of FCF incorporate losses in a timelier manner relative to gains compared to their counterparts. Additionally, the association between excess cash and conditional conservatism predictably varies with the presence of alternative monitoring mechanisms that mitigate FCF problems, such as debt or dividend payouts or repurchases. Further investigation suggests that greater conservatism is associated with a lower likelihood of overinvestment among firms bearing high agency costs of FCF, demonstrating the ability of conservatism to reduce agency costs of FCF.     

LIFO-FIFO, ACCOUNTING RATIOS AND MARKET RISK: A RE-ASSESSMENT

This paper re-examines the effect of the inventory costing method on the association between accounting risk measures (ARMs) and market risk, and extends earlier research in several respects. The groups of FIFO and LIFO firms are matched on the basis of various financial characteristics to reduce selfselection bias, and the effect of inventory costing methods on the usefulness of ARMs in predicting market risk is investigated. The findings indicate that predictions based on FIFO show an improvement on market based predictions, but predictions based on LIFO fail to show such an improvement.     

Inventory policy, accruals quality and information risk

This paper provides evidence consistent with firms with Last-in-first-out (LIFO) inventory policy being priced by the market as having lower information risk than First-in-first-out (FIFO) firms. Furthermore, the paper shows that this pricing differential is sustained after controlling for accruals quality, suggesting that the inventory policy signals some information risk characteristics that are not captured by accruals quality measure. We investigate the relation between inventory policy and accruals quality and find that accruals quality is systematically worse for FIFO firms than for LIFO firms after controlling for correlated omitted variables and known firm attributes. These findings complement the currently established relationship between the cost of capital, market pricing and accruals quality by focusing on the need for understanding the incremental effects of individual accounting policies.     

An Analysis of Joint Effects of Investment Opportunity Set,Free Cash Flows and Size on Corporate Debt Policy

This study, based on a sample of 1869 observations from 1989 to 1993 for non-regulated U.S. firms, examines the association between investment opportunity set (IOS), free cash flows (FCF) and debt, and also tests whether firm size acts as a moderating variable on this association. The results show that there is a significantly positive association between FCF and debt for low IOS firms, which provide support to Jensen's (1986) control hypothesis. The results also show that the positive association between debt and high FCF for low IOS firms is more pronounced for large firms, suggesting that the firm size serves as a moderating variable on the association.     

Managerial ability and debt maturity

We examine whether and how managerial ability affects corporate debt maturity decisions. The demand for shorter maturity debt is expected to be higher in firms operated by high-ability managers, who possess the superior skills needed to anticipate firms’ economic prospects and communicate their private information, thereby alleviating information asymmetry and bolstering their reputation. We document that firms with high ability managers are associated with more short-term debt financing. The effect becomes stronger for firms facing severe information asymmetry problems, unconstrained firms or high quality firms. Supportive evidence is found from the analysis of short- and long-term debt issuance activity. Our findings remain robust to alternative measures of managerial ability and debt maturity choice, and are not driven by omitted variable bias, endogeneity concerns or industry group. Overall, we provide robust evidence that supports the signalling theory for debt maturity structure and contributes to the literatures on managerial ability.     

Managing Earnings with Intercorporate Investments

Abstract:  We explore to what extent firms deliberately manage their financial reports by exploiting the flexibility of generally accepted accounting principles. Using a sample of Oslo Stock Exchange-listed firms with 20–50% equity holdings in other firms, we find that firms with high financial leverage tend to maximize reported earnings from these investments through their choice between the cost method and the equity method, possibly in an attempt to reduce debt renegotiation costs or to avoid regulatory attention. In contrast, managers do not systematically bias reported earnings to extract private benefits or to signal revised expectations about future cash flows. Firms use different earnings management tools in a consistent way, as the earnings effect of the cost/equity choice is not offset by discretionary accruals.     

过度自信与企业融资偏好:基于高管性别的纠偏

以中国沪深两市2010-2015年A股上市公司为研究对象,实证检验管理者过度自信和女性高管对上市公司融资偏好的影响。结果表明：当中国上市公司进行融资时,遵循的融资偏好依次为股权融资、债权融资、内部融资;而当公司内部的管理者过度自信时,容易选择更冒险的融资方式;在加入高管性别作为调节后,发现女性高管能够理性调整融资方式,具体表现为整体降低过度自信管理者的激进程度,使得过度自信产生的融资偏好趋近理性。     

Do Banks Provide Financial Slack?

We study the decision to choose bank debt rather than public securities in a firm's marginal financing choice. Using a sample of 500 firms over the 1980 to 1993 time period, we find that firms are relatively more likely to choose bank loans when variables that measure asymmetric information problems are elevated. The sensitivity of the likelihood of choosing bank debt to information problems is greater for firms with no public debt outstanding. These results are consistent with the hypothesis that banks help alleviate asymmetric information problems and that firms weigh these information benefits against a wide range of contracting costs when choosing bank financing.     

How Entrenchment, Incentives and Governance Influence REIT Capital Structure

Although recent literature has confirmed the importance of viewing a firm??s capital structure choices of leverage and debt maturity as jointly determined, to date there has been little analysis of the importance of traditional governance variables on a firm??s capital structure decisions using a simultaneous equations approach. We examine the influence of managerial incentives, traditional managerial monitoring mechanisms and managerial entrenchment on the capital structure of Real Estate Investment Trusts (REITs). Using panel data, we estimate a system of simultaneous equations for leverage and maturity and find that firms with entrenched CEOs use less leverage and shorter maturity debt. This is consistent with the expectation that managers acting in their own self interest will choose lower leverage to reduce liquidity risk and use short maturity debt to preserve their ability to enhance their compensation and reputations by empire building. We also find evidence that traditional alignment mechanisms such as equity and option ownership have an offsetting effect; and that firms where the founder serves as CEO choose higher leverage and longer maturity debt. The results also provide evidence that leverage and maturity are substitutes, firms with high profitability and growth opportunities use less leverage and firms with liquid assets use more leverage and longer maturity debt.     

HOW DO SMALL FIRMS MAKE INVENTORY ACCOUNTING CHOICES?

In the past, the attention of studies on inventory method choices has invariably been focused on large firms' motivations to use LIFO. Small firms' inventory accounting decisions are different from those of large firms due to the fact that there are differences in financial reporting considerations. This study examines small firms' inventory accounting choices from the perspective of three major factors (firm size, risk, and managerial ownership). It was found that firm size, financial risk, and the interaction effect between financial risk and business risk are significantly correlated with the LIFO choice for small firms.     

The Choice of Debt Source by UK Firms

We examine the choice of borrowing source among public debt, syndicated bank loans, bilateral bank loans and non‐bank private debt. Using a sample of 400 non‐financial firms over the period 2000–2012, we find strong support for the reputational theory of borrowing source. Larger firms are more likely to borrow in public debt markets. Bank dependent firms are less likely to borrow in public debt markets and choose between bank and non‐bank private debt based on maturity, collateral available to lenders and other firm characteristics. These results are consistent with the role of borrower reputation being the primary determinant of borrowing source for UK listed firms.     

Corporate ownership structure and the choice between bank debt and public debt

This article examines the relation between a borrowing firm's ownership structure and its choice of debt source using a novel data set on corporate ownership, control, and debt structures for 9,831 firms in 20 countries from 2001 to 2010. We find that the divergence between the control rights and cash-flow rights of a borrowing firm's largest ultimate owner has a significant negative impact on the firm's reliance on bank debt financing. In addition, we show that the control-ownership divergence affects other aspects of debt structure including debt maturity and security. Our results indicate that firms controlled by large shareholders with excess control rights may choose public debt financing over bank debt as a way of avoiding scrutiny and insulating themselves from bank monitoring.     

Firms’ debt choice in Africa: Are institutional infrastructure and non-traditional determinants important?

We use a World Bank survey data on the financing of incremental production to examine firms’ debt choice decision in eleven African countries, where capital markets are evolving and/or fraught with inadequate institutional infrastructure. Such a landscape suggests that hitherto overlooked nontraditional factors and institutions may be important determinants of debt choice. Interestingly, we find that some nontraditional factors and institutional infrastructure are robust debt choice determinants. Education level of managers, national incidence of corruption and ethnicity of owners are important for non-bank debt choice in Africa, with non-bank debt markets populated largely by the less formal trade credit and lease markets. Both effective legal and political infrastructures foster firms’ preference for non-bank debt while macro-instability discourages preference for non-bank debt; thus, flagging institutional infrastructures as vital for effective non-bank debt markets. Furthermore, we find evidence which confirms that capital markets in Africa are insufficiently spanned by the necessary debt markets; this should motivate relevant authorities to hasten development of public debt markets to supplement the currently limiting non-bank debt markets of trade credits and leases.     

Too much of a good thing? A theory of short-term debt as a sorting device

This paper shows that the liquidity risk associated with short-term debt financing can be used to sort insolvent firms out of financial markets when their solvency risk is private information. Notwithstanding this sorting role of short-term debt, unregulated financial firms tend to choose an inefficiently short debt maturity structure. This inefficiency arises for two reasons. First, by issuing more short-term debt, low-risk firms reduce their expected funding costs. This leads to a misalignment of private and social incentives as firms fail to fully internalize the social costs of becoming illiquid. Second, while the sorting role of short-term debt is reflected in a decline of long-term interest rates when more short-term debt is issued, creditors’ inability to observe firms’ solvency risk leads to an excessive reduction of long-term interest rates. This further distorts firms’ funding choice towards short-term debt.     

Financing decisions when managers are risk averse

Leverage raises stock volatility, driving a wedge between the cost of debt to shareholders and the cost to undiversified, risk-averse managers. I quantify these “volatility costs” of debt and examine their impact on financing decisions. I find that: (1) the volatility costs of debt can be large for executives exposed to firm-specific risk; (2) for a range of empirically relevant parameters, higher option ownership tends to increase, not decrease, the volatility costs of debt; and (3) for managers with stock options, a stock price increase typically raises volatility costs. For a large sample of US firms, I find evidence that volatility costs affect both the level of and short-term changes in debt, and that volatility costs help explain a firm's choice between debt and equity.     

Debt covenants and asset versus equity acquisitions

We examine whether the presence of loan covenants leads firms to choose either an asset or equity acquisitions. Asset acquisitions involve the selective purchase of a target company's assets, and equity acquisitions involve acquisitions of common stocks. We document that firms with loan covenants are more likely to engage in asset acquisitions as opposed to equity acquisitions. Our results are robust to alternative measures of loan covenants and to endogeneity concerns. Furthermore, the association between loan covenants and asset acquisitions is stronger among firms with greater debt covenant intensity, more severe agency problems, and lower profitability. Acquirers facing more intense competition within their industries are also likely to choose asset acquisitions. Our findings suggest that acquirers' incentives to avoid wealth transfer at the expense of debtholders drive the relation between debt covenants and choice of acquisition structure.     

Does corporate governance influence convertible bond issuance?

We examine the influence of corporate governance quality on firms' choice between convertible debt, straight debt, and equity using a Western European sample of security offerings made between 2000 and 2010. We find that weaker firm-specific and country-specific corporate governance quality increases firms' likelihood of issuing convertible debt instead of straight debt and common equity. We also find that stockholder reactions to convertible debt announcements are more favorable for firms with weaker corporate governance. Our results suggest that corporate governance quality is a significant security choice determinant, with firms using convertible debt as a substitute for high quality governance mechanisms.     

Asset Revaluations and Debt Contracting

The research question investigated is: Do managers of Australian firms use upward asset revaluations to reduce debt contracting costs? Prior research, using sample periods from the 1970s and early 1980s, provides evidence that asset revaluations are used to reduce the costs of debt contracting (see Whittred and Chan, 1992; Brown et al., 1992; Cotter and Zimmer, 1995). However, considerable changes to the institutional set-ting have occurred in the past decade. These institutional changes include increased regulation of asset revaluations and disclosures, changes in the macroeconomic environment, and changes in the Australian debt market. Particularly, there has been a shift in emphasis from public to private debt. The relationship between asset revaluations and debt contracting is examined in the current setting, using refined measures of contracting variables. Interestingly, the results of prior research do not replicate in the current setting. In order to further examine the potential impact of changes to the institutional setting, a series of interviews with chief financial officers is undertaken. The conclusion drawn from this additional analysis is that the relatively closer relationship between firms and their bankers in the current institutional setting has caused many firms to choose footnote disclosure of undervalued assets in preference to recognizing an upward asset revaluation in the balance sheet.