Borrowing Costs Research Articles

Proxy favors: Confidential proxy voting with institutional dual holders

AbstractResearch Question/IssueFor firms with institutional dual holders, is proxy voting affected by whether the vote is confidential? Does confidential voting affect firms' cost of debt?Research Findings/InsightsConsistent with social exchange theory and reciprocity norms, we find that, in the absence of confidential voting, firms with institutional dual holders gain more favorable votes for proposals and, in particular, for management‐sponsored compensation proposals. Further, these firms pay a higher cost of borrowing. This reciprocity relation does not exist if the firm has confidential voting in place.Theoretical/Academic ImplicationsThe results are consistent with reciprocity norms creating a psychological obligation to repay valuable favors between firm managers and institutional dual holders when proxy votes are not confidential.Practitioner/Policy ImplicationsThe findings support the popular position that confidential voting is in the best interests of shareholders and rigorous external corporate governance.

Voluntary Disclosure, Moral Hazard, and Default Risk

We study a dynamic moral hazard setting where the manager has private evidence that predicts the firm’s cash flows. Bad-news disclosure is rewarded by a lower borrowing cost relative to the no-evidence case, whereas no disclosure leads to higher borrowing costs. For a given capital structure, disclosure reduces the firm’s default risk by lowering its pay-for-performance sensitivity. However, for a set of low-profitability firms, the anticipation of future disclosure of information by managers lowers both firm value and managerial rents at the financing stage because of a reduction in the firm’s initial liquidity. The model can reconcile the empirical evidence on the effects of providing earnings guidance, especially for loss firms. This paper was accepted by Bruno Biais, finance. Funding: S. Fu is supported by the Shanghai Pujiang Program and the Program for Professor of Special Appointment (Eastern Scholar) at Shanghai Institutions of Higher Learning [Grant 0900000182]. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.4860 .

The Interplay between U.S. Economic Indicators and Insurance Firm Financial Health

This study examined the relationship between U.S. economic indicators and the financial health of insurance firms over a decade, from 2010 to 2020. Utilizing a quantitative research approach, data was collected from top insurance companies, juxtaposed against macroeconomic indicators like GDP growth, inflation rate, interest rate, and unemployment rate. Through regression analysis, the study revealed significant correlations between these macroeconomic variables and insurance firms' profitability, solvency, and liquidity metrics. The results indicated that GDP growth was positively correlated with insurance firms' profitability, suggesting that in periods of economic expansion, insurance firms tend to be more profitable. In contrast, inflation rate showed a negative relationship with solvency ratios, pointing to the strain of rising costs on the firms' ability to meet long-term obligations. Interest rates were found to significantly affect the liquidity of insurance firms, where higher rates led to decreased liquidity, likely due to increased costs of borrowing and alterations in the value of rate-sensitive assets and liabilities. Lastly, unemployment rates were negatively correlated with insurance firms' premium collections, implying lower policy underwriting during times of higher joblessness. Moreover, while the interrelationships were evident, the degree of sensitivity varied across firms, with larger insurance providers appearing to be more resilient to macroeconomic fluctuations than their smaller counterparts. The study concluded that while insurance companies are inherently influenced by broader economic trends, the extent of their vulnerability or resilience is also determined by firm-specific factors like size, asset management strategies, and product diversification. The findings underscore the need for proactive management strategies for insurance firms in navigating the ever-shifting economic landscape. Keywords: U.S. Economic Indicators, Insurance Firm Profitability, Macroeconomic Fluctuations, Financial Health, Solvency Ratios

Sustainability and Inflation: A Bi-front Malaise

The singular presence together of inflation and deflation is only apparently improper because we must always distinguish on the subject of inflation, about which phenomenon we are talking. In general, we can say that the two phenomena - called classics - cannot share. With an important distinction. If inflation or deflation is - as already said "classical" - that is, it affects the economic system due to errors made by governments in managing the economy. In this case, inflation has its own characteristics: that is, it is subject to constant acceleration and its race continues until monetary policy intervenes with the rise in the interest rate. Different the case of inflation from international prices, due to the increase in the cost of energy and rare earths, as well as cereals, etc. Well in this case, the subjection of daily prices is linked to the evolution to which they are subject due to speculation and to the selfishness of producers. In the case of international price inflation, the decision of central banks to raise the cost of borrowing has a marginal effect on cost inflation. However, it has a strong indirect effect because the rising cost of credit puts lead into the pockets of speculators. With the result of containing the speculative thrust to the advantage of domestic prices which are slowing down. We are in a period of creeping deflation and tensions on the stock markets and capital assets front, two phenomena that have direct repercussions on daily spending and aggravate the difference between the rich and classes close to poverty. It is therefore essential to mitigate the social tensions that accumulate that the issue of international price controls, starting with wheat and energy, are addressed at the G7 and G20 level for a policy of moderation on these prices. On the topic of the recurring pressure of stock market values and of equity assets, in search of the reasons for the unjustified rise, we point out the hypothesis that this for the moment moody rise in values has the possibility that it could be a sort of hypothetical foretelling of human society when we have achieved full neutrality with nature. At the time, a sharp acceleration in development could change our economics of scarcity.

Central bank digital currency: Payment choices and commercial bank profitability

This study examines how the issuance of a central bank digital currency (CBDC) affects consumers' payment instrument choices, asset allocation decisions, and the profitability of financial intermediaries. Specifically, we advance a theoretical model in which introducing an interest-bearing CBDC expands market participants' payment and investment options but also poses a potential threat to financial intermediaries if it raises their borrowing costs significantly. The existence of a network externality further complicates the analysis by affecting consumers' choice of payment mechanism. Our results suggest that the issuance of a CBDC is a double-edged sword for an economy. Although it provides additional payment and investment options for market participants, it increases competition and weakens financial intermediaries' margins.

Mandatory retirement savings in the presence of an informal labor market

This paper shows how mandating workers to save more for retirement can lead them to work informally and save less. Consider a worker who is more productive in the formal sector but works informally to avoid mandatory retirement contributions. Lowering the contribution rate (the share of wages mandated to be saved) will paradoxically increase her retirement savings. The reason for this is that working informally acts as borrowing against mandatory savings. The implicit cost of such borrowing, and hence the opportunity cost of working informally, rises as the contribution rate drops. This creates a substitution effect favoring formal work, driving the worker towards the formal sector. As her formal income increases, the base for her mandatory contributions rises, expanding her retirement savings. Therefore, the optimal contribution rate is no greater than the highest contribution rate under which the worker prefers to work exclusively in the formal sector.

Ethnic politics and sovereign credit risk

How does domestic politics affect sovereign credit risk? To date, scholars have largely focused on how economic interests along class-cleavages influence sovereign default risk and borrowing costs. Ethnic dynamics are another important political factor that explains governments’ creditworthiness, yet are understudied. We investigate how ethnic politics shape governments’ credit access and argue that the fiscal incentives generated by ethnic coalitions influence credit risk differently than those created by class cleavages. Because ethnic coalitions are usually smaller than class coalitions, left governments with ethnic support can commit to lower spending and receive more favorable risk assessments. Right governments that rely on ethnic support, however, will have greater spending demands because of their need to satisfy ethnic groups. We test our argument using a new indicator of government ethnic support and four indicators of sovereign credit risk. We find that, in emerging markets, the borrowing costs of right governments increase as they become more dependent on ethnic groups for political support. Our findings suggest that financial markets are attuned to multiple dimensions of domestic politics and demonstrate that ethnic divisions can have strong implications for governments’ access to credit.

Macroprudential policy leakage: Evidence from shadow banking activities of Chinese enterprises

AbstractUsing entrusted loan data of Chinese listed enterprises, we study whether the implementation of macroprudential policy leads to enterprise policy arbitrage. Our findings reveal that tightening macroprudential policies significantly contribute to the promotion of shadow banking activities among Chinese enterprises, confirming the existence of policy leakage. When the overall credit is tight, non‐affiliated loans and loans to privately‐owned enterprises increase significantly. Tightening policies also have a more substantial effect on the borrowing cost of non‐affiliated and privately‐owned enterprise borrowers. To enhance the effectiveness of macroprudential policy, our results suggest the necessity of providing appropriate credit supports for small and medium enterprises.

The Asymmetric Effect of Trade Openness on Output Volatility: Empirical Evidence from Ethiopia

A better understanding of the effect openness on volatility can lead to more effective government policy that addresses the adverse outcomes of volatility. By using NARDL model, Hodrick-Prescott (HP) filter, and annual time-series data from the period 1981 to 2020, this study examined the effect of openness on output volatility in Ethiopia. From the NARDL bound test, the research find a long-run cointegration between output volatility, agricultural output, trade openness, lending rate, and money supply. We also found a long-run negative asymmetric effect, and short-run negative symmetric effect of openness on volatility—suggesting this open trading activity has a relationship that can reduce output volatility in Ethiopia. This possibility shows Ethiopia would benefit from international trade and openness reduces the adverse effects of volatility. Besides, we confirmed the positive asymmetric effect of agricultural output both in the long run and short run. The lending rate, that represents the cost of borrowing, has a positive effect on output volatility. The long-run and short-run coefficients of money supply have a negative and significant effect on output volatility.

Prepayment and credit utilization in peer-to-peer lending

PurposeThis research analyzes borrowers' credit utilization through prepayment behavior in peer-to-peer (P2P) lending. The authors investigate factors influencing the decision to prepay and assess the role of P2P lending as an alternative source of consumer credits.Design/methodology/approachThe authors use individual loan-level data from the LendingClub, one of the largest P2P platforms in the USA. The authors use a Logit model and a sample selection model estimated by the two-stage Heckman method. The empirical analysis considers borrower-specific and loan-specific characteristics as well as macroeconomic factors.FindingsThe authors present a number of significant findings that can enhance understanding consumers' financing decisions. The authors offer evidence that borrowers are able to take advantage of cheaper loans offered by P2P lending to better manage credit card balance and consolidate debt. The authors find that borrowers tend to prepay P2P loans quickly when the aggregate cost of borrowing is low, suggesting that P2P lending offers an efficient alternative to obtain credit. This is particularly true for creditworthy borrowers that are able to take advantage of competing sources of finance. The authors' results provide evidence that P2P lending can improve consumers' optimal credit utilization.Originality/valueP2P lending has grown exponentially and has become a significant credit supplier to consumers and small businesses. While the existing literature mostly focuses on default risks, prepayment has received much less attention. This research fills in the gap and investigates borrowers' prepayment behavior in P2P loans and the role of P2P lending as an alternative source of consumer credits.

The study "Unravelling the Impact: Assessing the Impacts of Rising Rates of Interest and Inflation on Individual Finances"

The impact of rising interest rates and hyperinflation on personal finances is examined in this abstract. It draws attention to how these two economic aspects are interconnected and what it means for people's financial security. This abstract offers insights into how changes in mortgage rates and inflation affect personal finances by looking at the impact on costs of borrowing, deposits, savings, and purchasing power. The link between rate of interest and borrowing costs is the first topic covered in the abstract. When interest rates increase, borrowing money becomes increasingly costly for people, which has an impact on many facets of personal finances like credit card debt, home loans, and auto loans. According to the abstract, increasing borrowing costs can result in bigger debt loads, decreased affordability, and possible difficulties with debt payback. The abstract also looks at how inflation affects people's personal budgets. Over time, inflation reduces the monetary value of money, raising the cost of goods and services. The abstract focuses on how inflationary affects the costs of living, covering necessities like housing, food, and medical care. It emphasizes how crucial it is to factor inflation into long-term financial planning and budgeting in order to preserve financial stability and lessen the loss of wealth. The abstract also discusses how the rate of interest and inflation interact. It illustrates how interest rates are frequently employed by central banks as a tool to manage inflation. By decreasing consumption and slowing economic expansion, an increase in financing costs can help control inflation. However, this additionally has a negative impact on a person's personal finances, especially if they have investments or loans with variable rates or loans that are susceptible to changes in interest rates. The abstract also looks at ways that people might manage the effects of inflation and higher interest rates on their personal budgets. It talks on the value of financial literacy, investment diversification, responsible management of debt, and proactive steps like refinancing or modifying spending patterns to accommodate shifting economic conditions.

Economic Consequences of the Cost of Government Borrowing in European Transition Economies

Abstract Given the need of transition economies to fund the investments necessary for development partly through borrowing, this paper investigates empirically the economic consequences of the government cost of borrowing for European transition economies during the period 2003-2016. The investigation analyses the impact of sovereign borrowing costs, in turn, on interest rates on loans to businesses and households, on the growth rates of investment and consumption, and, ultimately, on general economic activity. By utilizing a panel VAR technique our results indicate that consequent upon a positive shock to the cost of sovereign borrowing, the cost of borrowing for loans to both Non-Financial Corporations (NFCs) and households increases. We find that the price transmission from government borrowing costs to the private sector is at play with respect not only to borrowing rates but also to macroeconomic activity at large. Following an increase in sovereign borrowing costs, we observe substantial negative responses in the growth rates of investment, household consumption, and GDP growth. Also, while a price of borrowing increase for NFCs is found to negatively affect investment, household consumption is unaffected by an increase in household borrowing rates. These findings have valuable policy implications for policymakers and stakeholders in transition economies. Specifically, the results suggest that efforts to reduce the cost of sovereign borrowing could have a positive impact on the economy by lowering borrowing costs for households and businesses, promoting investment and consumption, and ultimately boosting economic growth.

Pricing of project finance bonds: A comparative analysis of primary market spreads

This paper provides a comparative analysis of project finance (PF) and traditional corporate finance (CF) bond spreads and pricing. Using a cross-section of 47,196 bonds issued worldwide in the 1993–2020 period, we show that PF and CF bonds are differently priced, PF bonds have higher spreads than comparable CF bonds, and although ratings are the most important pricing determinant for PF and CF bonds at issuance, investors rely on other contractual, macroeconomic, and firms' characteristics beyond these ratings. Our results do not support the hypothesis of PF transactions as mechanisms of reducing sponsoring firms' funding costs: the cost of borrowing affects financing choices and PF transactions' weighted average spread is higher than that of comparable CF bond deals. We also find that economies of scale, risk management, and information asymmetry arguments affect sponsoring firms' choice between PF and CF transactions.

Determinants of government bond spreads in European transition economies and implications for small and medium enterprises

Given the need for transition economies to finance some of the investment required for development through borrowing, this paper empirically examines the determinants of government bond spreads, focusing on institutional quality as a contextual dimension. The literature generally assumes that market assessments of sovereign risk - i.e., the probability of default - and hence the cost of sovereign borrowing over the risk-free rate are based on the borrower’s macroeconomic fundamentals, solvency, and liquidity indicators related to fiscal and financial variables, and indicators of external financial market volatility. Using fixed effect estimation, our findings suggest that government bond spreads in European transition economies are sensitive to domestic macroeconomic fundamentals and global financial market volatility. From macroeconomic fundamentals, fiscal deficit levels, inflation rates, and countries’ effective exchange rates emerge as the leading indicators determining bond spreads over the observed period. Moreover, our results suggest that financial markets consider the quality of institutions when assessing default probabilities; hence, the potential risks arising from the quality of institutions are factored into the cost of sovereign borrowing. These results are robust to various extensions and robustness tests.

TURBULENCE IN DISGUISE IN THE BANKING SECTOR CREATE PANIC WITHDRAWAL OF MONEY IN BANGLADESH

Bankers may find it difficult to get deposits from households as a result of financial market turmoil. Negative returns on bank assets cause creditors to worry about financial stability, causing them to exaggerate the possibility of a bank failure in the future and withdraw money from banks in a panic. This article provides a simplified alternative for building beliefs about panic withdrawal. By lowering asset prices and raising the cost of bank borrowing, banks’ balance sheet positions deteriorated, which caused worries for the depositors, who became panicked. This article discusses potential bank panic scenarios in Bangladesh due to several internal causes that vary countercyclically. Although the major issue confronting the banks was not illiquidity but rather insolvency due to a high percentage of nonperforming loans, bank supervisory authorities may respond to this panic situation by offering liquidity support, government policy intervention, ensuring good governance, limiting the number of withdrawals, and so on.

Capital appreciation bonds and the cost of borrowing

AbstractA Capital Appreciation Bond (CAB) is a financial instrument that is most attractive as a resource‐flow management instrument. It bridges multiple fiscal years for jurisdictions experiencing rapid growth, potentially stretching for decades, but may also be used by localities experiencing fiscal distress. Using debt issuance data by independent school districts in Texas, who utilized almost all such bonds in the state, we present empirical evidence that CABs are associated with both the service and fiscal pressure factors. We further observe that, though the threat from CABs in terms of borrowing costs may have been exaggerated, enacting limits on debt repayment ratios (ratio of payment size at maturity to premium size) was likely the right legislative intervention.

Bankruptcy recovery rate and small businesses’ innovation

ABSTRACT Small businesses often face a high risk of bankruptcy and harsh financing conditions, which can hamper them from engaging in innovation. This paper investigates whether a bankruptcy system that guarantees a good recovery rate for creditors in case of firms’ liquidation stimulates small businesses’ innovation investments through lower interest rates and therefore easier access to credit. With the help of a borrower-lender model, we derive insights about the interactions between bankruptcy recovery rate, borrowing interest rates and firms’ investments in innovation. The model gives theoretical underpinnings for a subsequent empirical analysis. By using a cross-country sample of micro (1–9 employees)-, small (10–49 employees)-, and medium (50–249 employees)-sized enterprises (MSMEs), our study provides three main results. It shows that an increase in the bankruptcy recovery rate a) is positively associated to MSMEs’ investments in innovation (investment effect); b) reduces the share of MSMEs that are credit constrained because the cost of borrowing is too high (constraint effect); c) reduces the interest rates dispersion for highly profitable MSMEs (dispersion effect). Overall, our findings suggest that improving creditors recovery rate can help promote the innovative behaviour of small businesses through easier financing conditions.

Government securities in ensuring the debt security of Ukraine in conditions of full-scale war

The subject of research there is conceptual principles of issuing government securities to ensure debt security in conditions of full-scale war. The purpose of the article is to clarify the economic essence of the debt security category through the definition of its structural elements, as well as the features, advantages and reasons for issuing government securities in conditions of full-scale war. Method or methodology of the study. During the research, historical, analytical-empirical, inductive-deductive, comparative research methods were used to implement the principle of objectivity of scientific presentation; the method of analysis and synthesis - when evaluating indicators of debt security; graphical presentation of research results - when calculating the weighted average yield of military bonds. Results of the article. The article examines the issue of the essence, reasons for the issue and profitability of government securities in the conditions of martial law in Ukraine, considers the need for the management of government securities as the only tool in subordinating the government from the standpoint of ensuring Ukraine's debt security in the conditions of a full-scale war. It is considered that a full-fledged and liquid internal market of government securities will allow to reduce the cost of state borrowing and reduce the risks of default. Attention is paid to the matter of the issue and profitability of a new financial instrument for Ukraine - military OVDP. Debt security is studied as a dynamic process taking into account the positive effects of the use of borrowed external and internal funds. It was determined that the full-scale war reversed the positive trend towards a decrease in the share of public debt in GDP and forced a departure from the strategy of strengthening debt security, and the growth of governamental debt during the state of war is a forced phenomenon. Field of application of results. The results of the research can be used in the theory and practice of public debt management in conditions of full-scale war. The assessment of debt indicators and their analysis will be a relevant source of information for developing ways to strengthen Ukraine's debt security in peacetime. Conclusions. The growth of the public debt during martial law is a forced phenomenon: tax revenues allow to finance expenditures by only one third. Having analyzed the structure of the public debt from the standpoint of instruments for attracting funds, we can come to the conclusion that government securities are the only state-controlled instrument for ensuring debt security in conditions of forced and uncontrolled growth, primarily of external state debt. Military bonds have a specific purpose, and the economic risks caused by a military invasion do not allow the use of OZDP and Eurobonds as debt refinancing instruments.

Impact of Corporate Subsidies on Borrowing Costs of Local Governments: Evidence from Municipal Bonds

Abstract We analyze the impact of $40 billion of corporate subsidies given by US local governments on their borrowing costs. We find that winning counties experience a 15.2 basis points (bps) increase in bond yield spread as compared to the losing counties. The increase in yields is higher (18–26 bps) when the subsidy deal is associated with a lower jobs multiplier or when the winning county has a lower debt capacity. However, a high jobs multiplier does not seem to alleviate the debt capacity constraints of local governments. Our results highlight the potential costs of corporate subsidies for local governments.

Capital misallocation and financial market frictions: Empirical evidence from equity cost of capital

This paper quantifies the impact of capital misallocation on the loss in total factor productivity (TFP), arising from financial frictions. A two-period model is built to map the dispersion in the cross-sectional borrowing costs into the TFP loss. Equity cost of capital, which closely relates to the expected profitability, is the main measure of borrowing costs. For the manufacturing sector in U.S., such productivity loss ranges from 3.7 to 9.5 percent. The TFP loss is stronger when credit is tightening and among firms with larger financial constraints. I also explain why Hsieh and Klenow (2009) may overstate the impact of capital misallocation.