The performance of acquisitions by high default risk bidders

The prevailing view is that ESG performance contributes to corporate financial stability, particularly regarding long-term sustainability objectives. However, there is a notable lack of critical research exploring its short-term financial effects, especially within capital-intensive sectors experiencing green transformation. This study examines the theoretical gap by investigating whether increased ESG performance may unintentionally heighten the financial burden and default risk in the short run. To verify the stability of each variable in the series, we employed the short-panel unit root test on panel data from 234 Chinese energy industry companies covering the years 2015 to 2023. Including enterprise fixed effects as well as time fixed effects, we find that higher ESG ratings increase the possibility of default risk in the Chinese energy sector. This effect remains robust after controlling firm size, financial leverage, return on assets, return on equity, earnings per share, beta and firm age. In addition, we conduct robustness checks using alternative default risk measures, both endogeneity- and component-based, and the outcomes demonstrate that the impact is substantial and consistent. Consequently, we may draw the conclusion that raising the ESG rating has an adverse effect on reducing corporate default risk, which fills the knowledge gap regarding the influence of listed companies’ default risk on China’s energy sector. Moreover, it has been found that green innovation plays a strengthening role in the analysis of the interaction term between green innovation and ESG on default risk. This suggests that while green innovation is a strategic initiative aimed at long-term sustainability, it requires a significant amount of capital and resources in the short term, which may result in higher default risk in the beginning.

In this paper, we address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. Using an implementation of Merton's option-pricing model for the value of equity to estimate firms' default risk, we construct a factor that measures the excess return of firms with low default risk over firms with high default risk. We then compare results from asset pricing tests for the German and the U.S. stock markets. Since Germany is the prime example of a bank-based financial system, where debt is supposedly a major instrument of corporate governance, we expect that a systematic default risk effect on equity returns should be more pronounced for German rather than U.S. firms. Our evidence suggests that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts some previous results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio. It further turns out that the composition of corporate debt affects equity returns in Germany. Firms' default risk sensitivities are attenuated the more a firm depends on bank debt financing.

Prior research uses the basic one-period European call-option pricing model to compute default measures for individual firms and concludes that both the size and book-to-market effects are related to default risk. For example, small firms earn higher return than big firms only if they have higher default risk and value stocks earn higher returns than growth stocks if their default risk is high. In this paper we use a more advanced compound option pricing model for the computation of default risk and provide a more exhaustive test of stock returns using univariate and double-sorted portfolios. The results show that long/short hedge portfolios based on Geske measures of default risk produce significantly larger return differentials than Merton’s measure of default risk. The paper provides new evidence that mediates between the rational and behavioral explanations of value premium.

This paper demonstrates the relative importance of default and liquidity risks in equity returns. While previous studies have shown that both default and liquidity risks affect equity returns, none, to our knowledge, has examined their interrelation and relative importance for equity returns. We consider three alternative liquidity measures: the Pastor-Stambaugh measure, the turnover measure, and the illiquidity ratio measure. The default measure of choice is the one based on Merton's (1974) contingent claims approach. The alternative liquidity measures are very different from each other, but they are all related to our default measure. While we know from past research that low liquidity stocks earn higher returns than high liquidity stocks, we demonstrate here that this is the case only when these stocks also have high default risk, and in no other case. In contrast, high default risk stocks always earn higher returns than low default risk stocks, independently of their liquidity level. Vector autoregressive tests reveal the existence of a two-way causal relation between default risk and stock market returns, which is not present in the case of liquidity. Liquidity risk does not affect the future path of stock market returns. The robustness of these relations remains unaltered when we take into account the correlation of the default and liquidity measures with aggregate stock market volatility. Consistent with previous evidence, the inclusion of default and liquidity variables in popular asset pricing specifications improves a model's performance. However, the improvement is much larger when the included variable is default, rather than liquidity. In the presence of the default variable, the inclusion of a liquidity proxy in an asset pricing specification results in only a marginal improvement of the model's performance. The opposite is not true.

The basic results of Vassalou and Xing (J.Finance 2004) held in the UK over the period 1970-1989: high default risk companies earned a substantial premium, this is concentrated among small stocks, conversely the size effect appears primarily among high default risk stocks and the impact of changes in default risk on returns is short lived. Nevertheless, after 1990 this default risk premium has disappeared, along with the size effect. In addition, even over the 1970-1989 period, tests that go beyond those of Vassalou and Xing suggest important differences between high default risk and small stocks: most importantly, high default risk stocks underperform in risky environments whereas small stocks outperform. Finally, changes in measured default risk seem to be driven mainly by known effects like short-term reversal.

This study investigates the effect of institutional investors’ site visits on corporate default risk. Using the sample of Chinese firms listed on the Shenzhen Stock Exchange (SZSE) from 2013 to 2020 and the data from the China Stock Market & Accounting Research (CSMAR) database, we conduct a least squares regression and find that institutional investors’ site visits can significantly reduce corporate default risk. The result remains robust after a series of robustness checks, including alternative measures of default risk, instrumental variable regression, propensity score matching, and placebo tests. Mechanism tests suggest that institutional investors’ site visits decrease default risk by easing financing constraints and decreasing the volatility of profitability. Further analyses show that the effect of institutional investors’ site visits on default risk is more pronounced for firms with higher leverage, and firms operating in uncertain policy environments or competitive product markets. Our findings highlight the spillover effect of institutional investors’ site visits from a non-shareholder stakeholder perspective. And we offer implications for regulators to improve governance efficiency and information environment by market mechanisms.

This study, at the micro level, takes the Chinese central government's implementation of the "deleveraging" policy as a quasi natural experiment. Based on data from listed companies from 2013 to 2017, this study introduces the Metron default distance that balances financial indicators and asset value fluctuations to measure default risk. Therefore, the DID method is used to test the innovation situation of enterprises with high default risk under the "deleveraging" policy. Research has found that companies with significant default risks under policy shocks have significantly improved their innovation levels and increased their innovation achievements. Furthermore, this research studies the mechanism of the "deleveraging" policy on enterprise innovation from three perspectives: enterprise financing, investment, and business management. The implementation of the "deleveraging" policy will enhance the cash holdings and management governance level of enterprises with high default risk, thereby promoting enterprise innovation.

This paper analyzes the role of default risk in the momentum effect focusing on data from four developed European stock markets (France, Germany, Spain and the United Kingdom). Using a market‐based measure of default risk, we show that it is not the hidden factor behind this effect. While the loser portfolio is characterized by high default risk, small size, high book‐to‐market and illiquidity, characterization of the winner portfolio is somewhat more complex. Given that the momentum strategy is the return differential between the winners and the losers, factors such as the stock market cycle or the evolution of momentum portfolios against their reference point make momentum profits difficult to forecast.

This article addresses the limited empirical evidence on risk-shifting behavior in industrial firms, by focusing directly on asset volatilities implied from the U.S. equity market. These are inferred using the iterative algorithm of Moody's KMV and the Leland & Toft (1996) model. Indeed, Leland & Toft (1996) relate key variables relevant for the equityholders' risk incentives, and allow for intermediate financial distress, bankruptcy costs and tax shields. Hypotheses on risk-shifting and risk-avoidance are carefully derived from the model, with a special emphasis on the role of default risk and debt maturity. The results strongly indicate, that firms with a high default risk or leverage subsequently risk-shift relative to their industry peers. In addition, we find firms with an intermediate level of distress to risk-avoid. Some evidence indicates, that long debt maturity makes asset volatility increases more pronounced for firms close to the default barrier. However, the additional increase is larger for firms with the shortest debt maturity. Indeed, these firms are more default risky.

Traditionally portfolios are optimized with the single-regime Markowitz model using the volatility as the risk measure and the historical return as the expected return. This study shows the effects that a regime-switching framework and alternative risk measures (modified value at risk and conditional value at risk) and return measures (CAPM estimates and Black–Litterman estimates) have on the asset allocation and on the absolute and relative performance of portfolios. It demonstrates that the combination of alternative risk and return measures within the regime-switching framework produces significantly better results in terms of performance and the modified Sharpe ratio. The usage of alternative risk and return measures is also shown to meet the need that asset returns very often are not distributed normally and serially correlated. To eliminate these empirical shortcomings of asset returns an unsmoothing algorithm is used in combination with the Cornish–Fisher expansion. JEL codes: G12, G11, C32.

In this paper, we address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. Using an implementation of Merton's option-pricing model for the value of equity to estimate firms' default risk, we construct a factor that measures the excess return of firms with low default risk over firms with high default risk. We then compare results from asset pricing tests for the German and the U.S. stock markets. Since Germany is the prime example of a bank-based financial system, where debt is supposedly a major instrument of corporate governance, we expect that a systematic default risk effect on equity returns should be more pronounced for German rather than U.S. firms. Our evidence suggests that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts some previous results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio. It further turns out that the composition of corporate debt affects equity returns in Germany. Firms' default risk sensitivities are attenuated the more a firm depends on bank debt financing.

PurposeThis study aims to provide additional insights by further investigating the governance aspects including board composition, risk monitoring and management by the board, ownership structures as well as the incentive compensation.Design/methodology/approachThis study investigates the relationships between corporate governance, risk-taking behaviors and default risk by analyzing 78 publicly listed Japanese regional banks during the 2007-2008 crisis period.FindingsBanks that were more diversified in the run-up to the crisis were associated with higher default risk during the crisis. Foreign shareholders may have prompted banks to engage in higher risk-taking activities in pursuit of higher returns, putting banks at a higher risk of default. On the other hand, board-level risk management committees may have mitigated the risks to protect firms from rising default. Finally, banks perceived to have better quality accounting information, by being audited by one of the Big 4 auditors, benefitted by mitigating price misevaluation and thus reducing default risk during the crisis.Originality/valueDifferent from the majority of previous related studies on the relationship between governance and performance of stock returns, the current study focuses on the relationship between governance and default risk during the crisis which has a more direct link through which governance practices can affect risk-taking behaviors and thus the default risk during the crisis. In addition to examining conventional governance aspects, this study also focuses on the more relevant aspects of banks’ risk monitoring functions.

In a rational, representative agent model, a firm's default risk can relate to its expected equity return in a non-linear fashion, with higher default risk firms possibly having lower expected equity returns than lower default risk firms. This might explain the often unintuitive pattern between these two variables in recent empirical studies. Although default risk changes induced through the expected asset payment and debt associate positively with expected equity return changes, for highly distressed firms higher default risk induced through lower volatility has an ambiguous impact on the expected equity return. When default risk is extremely high, higher volatility benefits equity-holders through a higher chance of obtaining a positive payment, but can also hurt them through probability mass being shifted from highly desirable to less desirable states of nature. In this setup, the default risk premium also depends on macroeconomic conditions. Preliminary empirical evidence is consistent with these conjectures.

Executive Summary Following some significant changes in monetary policy, India's banking sector has come under scrutiny. The cost of funds for banks has increased significantly as the Reserve Bank of India (RBI) raised interest rates to help the falling Indian currency, the Rupee. This may show up as a rise in non-performing assets (NPAs) and a drop in profitability. Internal and external factors have an effect on bank profitability. The aim of this paper is to compare and evaluate the financial performance of India's largest public and private sector banks and also to understand their trends of NPAs through secondary data analysis. Both banks' earnings were guided by bank-specific metrics and risk factors. Leverage financial ratios of SBI were found at higher default risk than HDFC. Productivity measures were the key drivers of profits at India's largest private sector bank HDFC but not at SBI. Asset usage efficiency measures were almost same of both the banks. NPA ratios were much higher at India's largest public sector bank SBI. The single most important determinant of SBI proved to be the liquidity ratios. Two sample T test assuming equal variances was also conducted to check if there was significant difference between the NPA ratio of SBI and HDFC bank over the last 3 years.

Does societal trust make firms more trustworthy?