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The profit versus loss heuristic and firm financing decisions |
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| Authors: | Matt Pinnuck Chander Shekhar |
| Institution: | 1. Department of Accounting, University of Melbourne, Parkville, VIC 3010, Australia;2. Department of Finance, University of Melbourne, Parkville, VIC 3010, Australia;1. Cardiff Business School, Colum Drive, Cardiff CF10 3EU, Wales, UK;2. The University of Sydney Business School, The University of Sydney, Building H69, NSW 2006, Australia;3. Faculty of Business and Law, University of Newcastle, NSW 2308, Australia;1. Victoria University of Wellington, School of Accounting and Commercial Law, PO Box 600, Wellington 6140, New Zealand;2. John F. Welch School of Business, Sacred Heart University, Fairfield, CT 06825, United States;3. Virginia Commonwealth University, Department of Accounting, School of Business, 301 W. Main Street, Richmond, VA 23284-4000, United States;1. The University of Illinois at Urbana-Champaign, 4004 Business Instructional Facility, 515 East Gregory Drive, Champaign, IL, 61820, USA;2. The University of Washington, Foster School of Business, Box 353200, Seattle, WA, 98195, USA;3. Portland State University, Karl Miller Center 360M, 631 SW Harrison St, Portland, OR, 97201, USA |
| Abstract: | This paper examines the extent to which the profit versus loss heuristic directly affects debt issuance decisions. We hypothesize that reporting a loss and its use as a heuristic rather than firms’ economic fundamentals has an impact both on the decision to raise external debt finance and on the choice between debt and equity financing. The results are consistent with the hypothesis. We find that there is a sharp and economically-significant discontinuity around the zero-earnings threshold in the level of debt issues. Firms reporting small losses issue significantly less debt than firms reporting small profits. We also find that the loss heuristic has an impact on the choice between debt and equity in that loss firms issue less debt relative to equity. Taken together the results are consistent with the notion that profit versus loss heuristic impacts the debt issuance decision and provide explanations that add to those offered by the traditional theories. |
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