Cost Of External Financing Research Articles

Impact of environmental, social, and governance performance on cash holdings in BRICS: Mediating role of cost of capital

AbstractAs businesses globally navigate the intricate landscape of environmental, social, and governance (ESG) practices, understanding their financial implications becomes paramount. The primary objective is to illuminate the impact of ESG performance on cash holdings (CHO) within the context of the BRICS nations. Additionally, the study aims to explore the mediating role of the cost of capital (COC) in shaping these relationships. The empirical analysis was conducted on comprehensive dataset over the period 2010–2022 of BRICS. We establish the regression analysis by utilizing a fixed effect and system GMM models. The empirical findings reveal a significant negative (−0.012 coefficient value) impact of ESG performance on CHO, indicating that a one‐unit increase in ESG can decrease the CHO by 1.2% and this effect is significant at 1%. This further highlights declining trend in cash reserves among companies embracing sustainability practices. Notably, the study documents the mediating role of the COC, showcasing its influence in reducing internal cash reserves in the presence of low external financing costs. The study highlights the financial benefits associated with robust ESG practices. Companies in the BRICS nations are encouraged to integrate sustainability considerations into their business strategies, recognizing the potential for reduced CHO and favorable COC outcomes. Beyond financial gains, the study underscores the societal and environmental contributions of ESG practices. This study contributes to the literature by uncovering the mediating role of the COC, providing a comprehensive understanding of how sustainability practices influence internal cash reserves in the context of diverse economic landscapes.

Fintech, financing constraints and corporate green innovation

This study comprehensively analyzes the panel data of 4195 listed companies in the A-share market during the period from 2011 to 2022, aiming to explore the mechanism of fintech's influence on corporate green innovation. The study adopts a two-way fixed effects model to confirm the positive association between fintech and corporate innovation, and reveals the role of fintech in promoting corporate innovation output by alleviating financing constraints with the help of a mediated effects model. The findings suggest that FinTech not only directly promotes firms' innovation activities, but also provides important support for firms' innovation by reducing financing constraints, a finding that is confirmed by a series of robustness tests.On this basis, this paper emphasizes that, in the face of market changes brought about by fintech, firms should proactively adapt to and take advantage of these changes to mitigate the pressure of high costs of external financing by maintaining good credit records and reducing information asymmetry. Such a strategy not only helps firms obtain more funds for R&D and innovation, but is also key to achieving sustainable development goals. In addition, policymakers should also recognize the important role of fintech in promoting business innovation and green transformation and take measures to encourage its development and application for the long-term health of the economy.

Human rights and value of cash: Evidence from Islamic and non-Islamic countries

This study examines whether and how human rights (HR) have bearings on the value of cash. Given the positive effect of HR improvement on corporate governance (CG) and that of CG on cash value, HR should positively affect cash value through CG. Using 23 Organization of Islamic Cooperation countries and 88 other countries during the period 1995–2019 as the sample, this study finds that the value of cash and excess cash is lower in Islamic countries than in other countries. Additionally, HR have a positive effect on cash value, but this effect is weaker for Islamic countries than for other countries. Furthermore, economic development (ED) (rule of law (RL)) reinforces the positive effect of HR on cash value, and this effect is stronger (weaker) for Islamic countries than for other countries. Study results provide important implications. Given the observed striking differences in results between Islamic and other countries, future related research should consider them to improve validity and reliability of empirical results. Multinationals or firms that consider establishing subsidiaries in foreign countries should also consider country-specific factors, like types of countries, HR, ED, and RL, because they may affect the agency and external financing costs. Furthermore, national governments can evaluate the effectiveness of HR promotion by referring to the study results regarding HR's positive effect on cash value such that they can fine tune their HR and economic policy as well as enforcement of RL to better achieve their intended goal of improving HR and CG.

Economic policy uncertainty and local government debt: Evidence from China

AbstractThis paper investigates the effects of economic policy uncertainty on local government debt issuance in China and identifies a transmission channel through the cost of capital. Our findings demonstrate that economic policy uncertainty raises the cost of external financing for local governments, leading to decreased levels of debt issuance. Specifically, a 1% increase in uncertainty related to economic policy variations leads to a reduction in government debt issuance of 0.0478%. In addition, our analysis reveals that local governments located in regions experiencing lower fiscal pressure, lower economic catch‐up pressure, and higher sensitivity to uncertainty are more responsive to economic policy uncertainty changes.

Uncertainty, precautionary saving, and investment: Evidence from prescheduled election cycles

AbstractWe show empirically that firms increase cash holdings starting as early as one year before prescheduled (i.e., predictable) elections. Then, for four quarters around elections when uncertainty and external financing costs are high, firms decrease investment and draw down saved cash balances to avoid tapping external financing. We use a dynamic model of firm investment and saving to demonstrate the importance of anticipation of future financing costs to firms' pre‐election precautionary saving behavior. Theoretically, if election uncertainty were only to affect potential investment, lower firm investment would result in higher contemporaneous cash balances, which is inconsistent with our empirical results.

From red tape to innovation: How does municipal government financing reform affect corporate R&D activities?

AbstractWe evaluated the effect of an exogenous shock on municipal government debt financing reform on corporate innovation for a sample of Chinese‐listed firms from 2009 to 2019. The results show that this reform stimulates corporate innovation capacity, and the effect is more pronounced in non‐state‐owned and financially constrained firms. We attribute these findings to reduced external financing costs and the crowding‐out effect of a firm's real estate investment. Our results are robust to alternative variable definitions, model specifications, and estimation techniques and provide novel evidence concerning the role of municipal government financing in corporate innovation.

Tax avoidance, investor protection, and investment inefficiency: An international evidence

This paper provides new evidence on the relationship between corporate tax avoidance, and investment inefficiency. Based on a sample of 82,487 firm-year observations across 38 countries, we find that tax avoidance is positively associated with inefficient investments. Particularly, the positive effect of corporate tax avoidance is due to the underinvestment problem suggesting that firms engaging in tax saving activities suffer from exacerbated information asymmetry issues leading them to underinvest. More importantly, the results show that the relationship between tax avoidance and investment inefficiency is more prevalent during crisis periods, suggesting that in periods of economic shortfalls, the investment behavior is altered due to high external financing cost. We also find that the relation between tax avoidance activities and investment inefficiency is less prevalent in countries with strong investor protection. These findings are robust to alternative samples, measures of tax avoidance, investor protection and to endogeneity issues.

Banking uncertainty and corporate financial constraints

AbstractThis article investigates an essential channel through which uncertainty may harm the economy—firms' financing constraints. Unlike prior literature focusing on the aspect of aggregate economic policy uncertainty, we look into the dimension of disaggregate uncertainty in the banking system. Examining financial data of commercial banks and listed companies in Vietnam during 2008–2022, we document that banking uncertainty positively impacts corporate financial constraints. Moreover, we explore how firm‐specific and macroeconomic factors interact with the relationship between uncertainty and financing constraints. Our analysis indicates that this link is more pronounced for non‐state‐owned firms, firms with more intangible assets, and firms listed on the Hanoi stock exchange. Meanwhile, macro shocks, such as the financial crisis and the COVID‐19 pandemic can strengthen the effect of banking uncertainty on financing constraints. Finally, we examine the mechanisms through which banking uncertainty causes an increase in firms' financial constraints. We document that banking uncertainty exacerbates financial constraints by raising the cost of external financing, not by lowering firm performance.

Does internal cash flow-external financing sensitivity react to economic policy uncertainty and geopolitical risk? Evidence from Saudi Arabia

PurposeThis study aims to investigate the influence of economic policy uncertainty (EPU) and geopolitical risk (GPR) on the relationship between internal cash flow and external financing in an emerging market, Saudi Arabia. It also examines the role of asset tangibility and financial crisis in establishing this relationship.Design/methodology/approachThe sample was taken from non-financial sector companies listed on the Saudi Stock Exchange between 2002 and 2019. The data were analyzed using panel data regression analysis, including ordinary least squares and fixed effects model. The author addresses potential endogeneity through the generalized method of moments.FindingsThis study found that both EPU and GPR reduce the sensitivity of external financing to internal cash flow. This implies that firms depend more on internally generated funds during periods of increased EPU and GPR. Besides, this study found that the influence of EPU and GPR on the sensitivity of external financing to internal cash flow is more (less) negative for more tangible firms (during the financial crisis period). This result implies that Saudi firms boasting a higher level of tangibility are more flexible when it comes to seeking external financing. However, the presence of uncertainty during the crisis period makes the external financing costly, and therefore, firms will be less likely to raise funds from external sources.Practical implicationsThis study has important implications for managers, policymakers and regulators. First, the paper findings provide insights for corporate decision-makers in helping them to focus on internal funds to finance their investment during uncertain times. Second, the findings help managers to understand the role of asset tangibility in raising external funding when firms face financial constraints due to uncertainty. Third, this study also helps corporates to focus on internal funds to finance their investment during the crisis period because EPU and GPR increase the cost of external finance. Finally, the results provide guidelines for policymakers and regulators to make appropriate policy measures to increase the easy availability of external finance during periods of increased EPU and GPR.Originality/valueThis paper is the first to shed light on the impact of internal funds on external financing while paying close attention to the role of EPU and GPR.

External financing, corporate governance and the value of cash holdings

This study investigates the role of corporate governance in the deployment of internal resources when access to credit is hampered and external financing is costly. The extant literature has focused on the rise in cash holdings amongst firms, but little is still known about when and under what conditions firms deploy and use accumulated internal resources. Using a panel data of 1,599 U.S firms for the period 2004 to 2016, the 2008 financial crisis as a quasi-natural experiment and a difference-in-difference estimation strategy, we examine how managers deploy and allocate cash reserves and excess cash. We find that the propensity to invest out of pre-crisis cash reserves is highest for weakly-governed firms and that these firms finance additional investment using short-term debt and allocate a higher fraction of post-crisis excess cash towards building up cash balances. Contrastingly, well-governed firms have a higher propensity to allocate excess cash towards increasing the value of pledgeable assets and deploy any accumulated cash balances to reduce short-term debt financing. Our findings are important as they reconcile the flexibility and the spending hypothesis of cash holdings, showing that well-governed firms trade-off the cost of cash holdings against the benefit of minimizing future demand for costly external financing; effectively hedging against foregoing profitable future investment opportunities.

Unconventional monetary policy, financial frictions, and the equity tandem

A key feature of many DSGE frameworks designed to model Quantitative Easing (QE) is that net worth only plays a relevant role on bank’s balance sheets. In reality, however, net worth of borrowers and lenders plays a relevant role in financing investment projects. I show that this equity tandem has important implications. Net worth of non-financial firms acts as a first line of defense, since non-financial firm’s balance sheets are hit in the first place by real sector shocks. Modeling the equity tandem increases the resilience of the model and, therefore, implies smaller gains of unconventional monetary policy. A novel insight from the simultaneous modeling of borrowers and lenders net worth is that by decreasing the cost of external finance a QE policy is redistributing net worth from banks to non-financial firms. Additionally, considering the reverse operation, a credibly announced Quantitative Tightening (QT), helps to stabilize the spread between the return to capital and the deposit rate during the zero lower bound period. However, different anticipated QT paths are shown to have little consequences for output and inflation.

Long-lived employment effects of delays in emergency financing for small businesses

Delays in the provision of loans under Paycheck Protection Program due to the rapid exhaustion of initial funding had a large and persistent negative effect on employment. We estimate that increasing the size of the initial PPP funding by 10 percent could have increased employment by over 2 million jobs through the summer of 2020 and more than 1 million jobs through the fall. The implied costs per job saved are low for a stimulus program, while our effect sizes are in line with recent estimates of the effects of payment timing and the costs of external financing for small businesses. In addition, the smallest firms were most likely to face delay and we find suggestive evidence that the costs of delay were more acute for workers in these firms and for the self-employed. Heterogeneous effects are consistent with these borrowers facing greater difficulty in obtaining alternative financing and suggests that a more targeted program could have achieved even greater efficacy.

Impacts of COVID-19 pandemic on corporate cash holdings: Evidence from Korea

We examine how corporate cash management in Korea has evolved during the COVID-19 crisis, focusing on the interaction between COVID-19-related uncertainty and financing frictions. Compared with the 2008 global financial crisis, massive expansionary financial policy measures have resulted in low external financing costs shortly after the early negative shocks to external financing. This provides a unique opportunity to investigate the separate effects of uncertainty and financing frictions on corporate cash holdings. Consistent with the precautionary motive for cash holdings, we find that firms reserve more cash in 2020 in response to the increased uncertainty; this is especially the case if they are negatively affected by the COVID-19 crisis and financially constrained. However, unaffected firms with better access to financial markets and internal capital markets also increase their cash holdings. The COVID-19 pandemic does not systematically change corporate cash management policies. In 2021, firms decrease their cash holdings as uncertainty declines. Overall, our evidence implies that uncertainty is the primary determinant of corporate cash management decisions, whereas financing frictions play a secondary role. We discuss the policy implications of the amplified inequality between financially constrained and unconstrained firms resulting from massive expansionary financial policy measures.

Precautionary motive or private benefit motive for holding cash: Evidence from CEO ownership

This study examines how CEO ownership affects the motivation of firms to hold cash. We document a monotonic and positive relationship between CEO ownership and cash holdings. The effect is more pronounced for firms with higher firm-specific risk and larger external financing costs, suggesting that CEO ownership encourages firms to hold more cash as precautionary savings. However, we find no evidence that CEO ownership leads to cash hoarding in firms with weak corporate governance. Moreover, we show that firms with high CEO ownership and excess cash holdings have more capital expenditures and R&D expenses but do not have higher dividend payments and share repurchases. Nonetheless, shareholders’ perceived value of cash increases with CEO ownership, indicating that shareholders place a positive value on high levels of cash holdings associated with CEO ownership in the context of growing investment prospects. Overall, our findings support the notion that firm ownership aligns the interests of CEOs and shareholders, rather than encouraging managers to extract private benefits through hoarding cash.

Mandatory minimum dividend, agency problems, and corporate investment

This study aims to better understand the adverse consequences of mandatory dividend rules. Specifically, we identify two main reasons why some firms only pay the mandatory minimum dividend: financial constraints and private benefits. We also argue that the consequences of these rules for firms should depend on the reasons behind their choice to only pay the minimum dividend. Using a sample of publicly traded Brazilian companies and multivariate regressions, we find strong evidence that financially constrained firms are more likely to only pay the minimum dividend, with weak evidence that firms whose managers who use the dividend decision to enjoy private benefits are more likely to only pay the minimum dividend. Moreover, and consistent with our expectations, firms that only pay the mandatory minimum dividend due to financial constraints tend to have a higher value attached to their cash holdings, and they tend to reduce investments more intensely in response to shocks that increase the cost of external financing. Thus, we conclude that mandatory dividend rules can adversely affect some firms and that more flexible rules should be considered.

Investor sentiment and firm capital structure

We provide novel evidence of the role of investor sentiment in determining firms' capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms' debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is slower in low sentiment periods, indicating higher costs of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms' financing decisions and stock returns.

Financial market opening and corporate tax avoidance: Evidence from staggered quasi-natural experiments

This paper examines whether financial market opening, as introduced by the staggered launches of the Stock Connect programs between China's mainland and Hong Kong, affects corporate tax avoidance. Using a difference-in-differences approach, we find that the financial market opening significantly reduces tax avoidance behavior in Chinese A-share listed companies. In addition, we find that the observed effects are more prominent in firms that experience increased foreign institutional ownership following regulatory changes, and in firms with ex-ante weaker external monitoring and stronger external financing needs. These results are consistent with our hypothesis that financial market opening affects corporate tax avoidance through improved governance and reduced external financing costs. We further find that financial market opening decreases capital costs. Overall, our findings indicate that the opening of emerging financial markets to foreign investors is crucial for curtailing opportunistic tax avoidance by local firms.

How Does Geopolitical Risk Affect Corporate Innovation? Evidence from China’s Listed Companies

ABSTRACT Unlike most previous studies focused on the impact of domestic risk on firms’ innovation activities, this research places more effort on identifying whether and how geopolitical risk affected corporate innovation behavior in China over the period 2003–2019. By constructing firm-level panel data that combine financial information with data on geopolitical risk and patenting activity, we find that geopolitical risk exerts a negative impact on firms’ innovation activity through increased external financing costs and by reducing firms’ willingness to raise capital. This inhibitory effect is more pronounced for companies with high innovation capability, export-oriented firms, and firms facing higher macro-risk exposure. In addition, political connection can alleviate these restricting effects of geopolitical risk on firm innovation. Knowledge of these impacts should help firm managers, government, and policymakers to develop more efficient development strategies and mitigate the impact of such risk on corporate operations.

Economic policy uncertainty, geopolitical risk and cash holdings: evidence from Saudi Arabia

PurposeThis study aims to investigate the influence of economic policy uncertainty (EPU) and geopolitical risk (GPR) on corporate cash holding level and speed of adjustment (SOA) in one of the most important emerging markets in the Middle East and North Africa, Saudi Arabia. It also investigates whether Shariah-compliance as well as financial constraints affect the relationship between both EPU and GPR and corporate cash holdings.Design/methodology/approachThe study employs GMM regression considering a sample of 140 nonfinancial firms drawn from the Saudi stock market over the period 2002 to 2019.FindingsThe authors find evidence in support of the precautionary motive hypothesis. Facing costly external financing induced by economic policy-related uncertainty and geopolitical tension, Saudi firms tend to accumulate cash as a buffer against negative shocks to their cash flows. The results also show that the positive impact of EPU and GPR on the level of cash holding is less pronounced in Shariah-compliant firms, whereas it is more pronounced in more financially constrained firms. Evidence also reveals that the estimated adjustment coefficients show that Saudi firms adjust more quickly toward their target cash ratio in periods of high economic instability and geopolitical risks.Practical implicationsThis study has important implications for managers, policymakers and regulators. For managers, the study is an important reference to understand and design cash management policies by considering factors measured at the country level. More specifically, managers should pay more attention to periods of heightened uncertainties and geopolitical tensions in which the availability of funds is reduced. For policymakers and regulators, this study may be useful in assessing the effect of economic instability on firm’s cash holding decision. Therefore, in an effort to increase the supply of external financing available to firms, policymakers may devise investment friendly environment by controlling country-specific factors.Originality/valueThis paper shows how EPU and GPR as institutional environment factors affect cash holding decision in an oil-rich country.

Does oil price uncertainty affect corporate innovation?

This study examines the relation between oil price uncertainty (OPU) and corporate innovation productivity. Using firm-level innovation data of US firms, we find that OPU is negatively associated with future innovation outcomes, proxied by the number of patents and subsequent citations, and the dollar value of innovation. However, this negative relation is more pronounced for non-green innovation than for green innovation and predominantly driven by oil supply shocks. Our supply-side explanation suggests that since oil supply shocks induce uncertainty about future economic growth opportunities and cost of operation, firms tend to decrease their investment in innovation activities. This negative relation is pronounced more in manufacturing firms and firms located in non-oil-producing states, and the pre-financial crisis period. Further analysis suggests that increases in the cost of external financing and cash holdings appear to be the underlying mechanisms through which OPU impedes firm innovation. The results survive from several model specifications, alternative variable definitions, and controlling additional firm and macroeconomic factors. Overall, OPU seems to have an important implication in shaping firms' investment in innovation. Several implications are discussed.