Equity Injections Research Articles

State-owned enterprises as countercyclical instruments: Quasi-experimental evidence from the infrastructure sector

This paper examines the effects of a negative macroeconomic shock on the financial performance of state-owned enterprises (SOEs) in infrastructure. The main aim of the paper is to explore whether SOEs serve as countercyclical instruments or whether they end up generating fiscal costs during a downturn, perhaps amplifying negative shocks. The paper introduces a new measure of fiscal injections that includes subsidies, equityrecapitalizations, and loans from the government, other SOEs, or state-owned financial institutions. The empirical setup uses a quasi-experimental setting that exploits the differential effects of a drastic fall in oil prices (in 2014–15) for SOEs in countries that experience a negative aggregate demand drop as a consequence of this shock versus similar firms in countries that do not suffer a downturn from the shock. The results—based on a balanced sample using coarsened exact matching and a differences-in-differences estimation—show that SOEs in treatment countries received increases in fiscal injections as a percent of average assets of 3.5 percent the year after the shock, equivalent to a significant recapitalization. These fiscal injectionstake the form of equity injections and loans from the government and state-owned financial enterprises. The results also show that capital expenditure as a percent of average assets in fully owned infrastructure SOEs decreased by 3.5 percentage points the year after the negative shock, equivalent to a 40 percent decline relative to its average level. In sum, this paper presents evidence that shows that SOEs do not serve as countercyclical tools and, in fact, may amplify negative shocks by requiring fiscal injections for SOEs while also lowering their capital expenditures.

Strategic recommendations for financing green and sustainable energy projects

Abstract The main hindrances to the large-scale development of renewable-energy projects are the lack of bankability and the inability to align investments and investors with suitable financial instruments or robust policy measures. To illustrate a bankable project, this paper presents a research-based case study on the installation of solar photovoltaic panels on the rooftops of 195 trains of the Indian Railways. Detailed information on the annual running hours, exposure to sunlight, efficiency of solar photovoltaic generation and electrical power demands of each rail coach is considered to conduct a quantitative measure of the tentative amount of fossil fuel savings. The purpose is to provide insight into the types of renewable-energy projects that can be highly attractive to financial institutions and promoters due to their lucrative internal return on investment. As seen in this case study, there are annual savings in diesel of 12 323 088 litres and a CO2 reduction of 32 755 tonnes, with return on investment of 1.3 years. Furthermore, this study conducts a comprehensive analysis of the limitations of existing renewable-energy project financing mechanisms in India. Subsequently, three policy measures are recommended to develop a robust financial mechanism that can effectively meet the needs of investors and investors. These measures include increasing equity injection through a buy-and-hold strategy, providing direct tax benefits to promoters and financing through real-estate investment trusts. The findings are highly relevant to address the challenges associated with bridging the financial gap between access to finance and capital investment in the renewable-energy sector, especially for Asian countries.

Fiscal support and banks’ loan loss provisions during the COVID-19 crisis

We study the effect of governments’ fiscal support on banks’ loan loss provisioning during the COVID-19 pandemic. In addition, we decompose fiscal support into direct support and liquidity support to examine the effect of different types of support measures on banks’ loan loss provisioning. Direct support generally refers to cash transfers, tax reliefs, and tax deferrals, while liquidity support generally refers to government-backed loans and equity injections. We find that direct support reduced banks’ loan portfolio risk whereas liquidity support did not. Moreover, we find the effect goes beyond a macroeconomic stabilization effect, suggesting that direct support directly contributed to mitigating banks’ loan portfolio risk during the pandemic. Our results are robust to controlling for other policy interventions, alternative model specifications, and an instrumental variable approach. We further discuss the policy implications of our analysis.

Round duration and equity injection in venture capital. An empirical analysis in the medtech sector

ABSTRACT The pandemic has brought extraordinary attention (and therefore funds) to the medical technology (medtech) sector. The urgent need for innovation in this industry is widely acknowledged; thus, venture capitalists (VCs) are playing a major role in supporting its renovation. The present research aims to identify how venture capitalists approach medtech companies, which are typically perceived as considerably risky. Specifically, the objective is to highlight the features of the control mechanisms employed by VCs when financing firms operating in the health care industry, with explicit focus on the staged structure of the investment. Previous studies have supported the hypothesis of shorter financing rounds with higher required equity stakes when a VC firm approaches a hazardous investment. To test the consistency of such evidence with the case of medtech firms, two sets of regressions on a unique dataset have been performed. The results reported show partial suitability of the expectations to the specific case.

Does Private Equity Over-Lever Portfolio Companies?

Detractors have warned that Private Equity (PE) funds tend to over-lever their portfolio companies because of an option-like payoff, building up default risk and debt overhang. This paper argues PE-ownership leads to substantially higher levels of optimal (value-maximizing) leverage, by reducing the expected cost of financial distress. Using data from a large sample of PE buyouts, I estimate a dynamic trade-off model where leverage is chosen by the PE investor. The model is able to explain both the level and change in leverage documented empirically following buyouts. The increase in optimal leverage is driven primarily by a reduction in the portfolio company's asset volatility and, to a lesser extent, an increase in asset return. Counterfactual analysis shows significant loss in firmvalue if PE sub-optimally chose lower leverage. Consistent with lower asset volatility, additional tests show PE-backed firms experience lower volatility of sales and receive greater equity injections for distress resolution, compared to non PE-backed firms. Overall, my findings broaden our understanding of factors that drive buyout leverage.

Do Costly Internal Equity Injections Reveal Bank Expectations about Post-Crisis Real Outcomes?

We construct a novel signal of bank expectations utilizing confidential data and a regulatory constraint imposed on bank internal capital markets during the 2008 crisis that made internal equity injections to commercial bank subsidiaries difficult to reverse.

Contingent convertible bonds: Optimal call strategy and the impact of refinancing

In this paper, we analyze if banks financed with contingent convertible bonds (CoCos) can rely on the classical (CoCo value minimizing) call strategy. Due to further debt positions outstanding, we can show that the optimal (equity value maximizing) call strategy can sharply differ from the simple classical approach. A crucial driver of the optimal call decision is the refinancing assumption of the call price, which determines whether an equal, an early or a late call occurs. In an empirical study comprising 79 European CoCos, we find that the critical stock price triggering a call deviates (on average) by 56.49% from the classical case, which carries over to a CoCo price deviation equal to 8.73%. Our results reveal that the classical call strategy is only justifiable in the special cases of equity injection or junior debt refinancing for a CoCo with a low face value and a late call. Otherwise, the optimal call strategy significantly differs from the classical version and requires knowledge of the particular refinancing assumption.

Financial effect of long-term policy equity injection: evidence from special construction funds in China

ABSTRACT Chinese two policy banks implemented long-term equity injections for some listed companies through special construction funds from 2015 to 2016. We use the PSM-DID method to examine the effect of this equity injection on corporate financing decisions. We find that the equity injection has the financial effect of broadening corporate financing channels and optimizing debt structure, which raises the speed of capital structure adjustment and encourages corporate investment. Financing cost, financing channel, and corporate governance mechanisms can explain the financing effect of equity injection policy, showing that the signal channel plays a vital role in the equity injection policy. Companies with weak financing capabilities, such as private, small scale, weak profitability, central and western region companies, benefit more from the equity injection policy. Corporate governance capabilities significantly affect policy effectiveness. Our conclusions are robust after satisfying the assumptions and other factors that may interfere with the empirical results. We confirm the role of equity injection in reducing corporate financing costs, stabilizing investment, and encouraging long-term, high-quality development of corporations.

Supporting SMEs during COVID-19: The case for targeted equity injections

We analyze the potential role of equity injections in addressing solvency risks among small and medium-sized enterprises (SMEs) after the COVID-19 crisis. Building on firm-level balance sheet projections for a sample of European economies, we simulate selected policy interventions and find that equity injections are quite effective at dampening the rise in insolvencies. Cost effectiveness requires careful targeting, however; under an illustrative scenario, leaving aside any costs arising from imperfect information and implementation, the cost of a program targeting only those SMEs worth saving is just a tenth of the cost of an untargeted approach directed to all insolvent firms. Overall, our paper provides a case for governments to rely more on targeted equity injections in responding to major shocks that trigger mass solvency risks.

The macroeconomics of a pandemic: A minimalist framework*

To analyze the macroeconomics of a pandemic we build a minimalist framework with two essential components. The first is productivity-related: if the virus forces firms to shed labor beyond a certain threshold, productivity suffers. The second component is a credit market imperfection: because lenders cannot be sure a borrower will repay, they only lend against collateral. Expected productivity determines collateral value; in turn, collateral value can limit borrowing and productivity. As a result, adverse shocks have large magnification effects, in an unemployment and asset price deflation doom loop. There may be multiple equilibria, so that pessimistic expectations can push the economy to a bad equilibrium with limited borrowing and low employment and productivity. The model helps identify policies to fight the effects of the pandemic. Traditional expansionary fiscal policy has no beneficial effects, while cutting interest rates has a limited effect if the initial real interest rate is low. By contrast, several unconventional policies, including wage subsidies, helicopter drops of liquid assets, equity injections, and loan guarantees, can keep the economy in a high-employment, high-productivity equilibrium. Such policies can be fiscally expensive, so they are feasible only with ample fiscal space or emergency financing from abroad. Preliminary macroeconomic evidence is consistent with the mechanisms in our model.

Do Costly Internal Equity Injections Reveal Bank Expectations about Post-Crisis Real Outcomes?

Do Costly Internal Equity Injections Reveal Bank Expectations about Post-Crisis Real Outcomes?

Financial Risk Capacity

Financial crises are particularly severe and lengthy when banks fail to recapitalize after bearing large losses. We present a model that explains the slow recovery of bank capital and economic activity. Banks provide intermediation in markets with information asymmetries. Large equity losses force banks to tighten intermediation, which exacerbates adverse selection. Adverse selection lowers bank profit margins, which slows both the internal growth of equity and equity injections. This mechanism generates financial crises characterized by persistent low growth. The lack of equity injections during crises is a coordination failure that is solved when the decision to recapitalize banks is centralized. (JEL D82, E32, E44, G01, G21, G32, L25)

Supporting Smes During Covid-19: The Case for Targeted Equity Injections

Supporting Smes During Covid-19: The Case for Targeted Equity Injections

Does Private Equity Systematically Over-Lever Portfolio Companies?

Detractors have warned that Private Equity (PE) funds tend to over-lever their portfolio companies because of an option-like payoff, building up debt overhang and widespread bankruptcy risks. Drawing on standard trade-off theory, this paper argues PE-ownership leads to higher levels of optimal (value-maximizing) leverage. I embed key features of PE-ownership into a model of firm value, leverage and credit risk. Using a large sample of PE-sponsored leveraged buyouts (LBO), the estimated model fully explains both the level and change in leverage ratios in the data following PE-takeover. Higher levels of optimal leverage arise endogenously from (i) lower asset volatility (ii) higher expected future return and (iii) lower deadweight bankruptcy costs. In equilibrium, tax benefit is greater and expected distress cost of debt is much lower since bankruptcy is both less likely and less costly. Counterfactual analysis reveals substantial loss in firm value if PE sub-optimally chose lower leverage. Post-LBO, I estimate Distance-to-Default increases by 28 percent and credit spreads narrow by 3.6 percentage points for the median firm, suggesting concerns about default risks may have been overstated. Additional tests show PE-backed firms receive equity injections from sponsoring funds if they fall into financial distress, corroborating the lower distress cost channel. My results suggest new policies regulating leveraged loans should focus on the borrower's optimal capital structure.

On the distributional effects of bank bailouts

This paper studies distributional consequences of equity injections that are funded with financial-sector levies. In the model economy, financial intermediation supports both productive investment and individual consumption smoothing, subject to an equity requirement. When intermediary equity is low, then an equity injection involves a trade-off between increasing credit supply immediately and distortive levies that reduce credit supply in the future. I find that equity injections redistribute from poor to wealthy households, even though average welfare increases. While wealthy savers benefit greatly from an increased return on savings, poor households suffer from lower future wages.

Government Equity Investments in Coronavirus Rescues: Why, How, When?

Governments around the world are attempting to support individuals’ incomes, rescue distressed businesses, and preserve employer-employee relationships damaged in the coronavirus pandemic by adopting fiscal stimulus programs of unprecedented scale. Although the bulk of this spending will involve direct payments to individuals or some type of direct lending or loan guarantees to businesses, large sums will (and should) take the form of government purchases of equity in distressed firms — either by direct purchase or by exercising warrants attached to rescue loans. We discuss why we think these equity injections will be necessary, but only in a limited number of cases; how they should be structured; when investments should be made and, almost as important, exited. We summarize (and tabulate) both the modest recent history of governments rescuing non-financial firms with equity injections and the voluminous research examining the efficacy of governments rescuing failing banks using equity investments. We highlight the dangers that would likely arise if governments permanently retain and vote the equity stakes purchased during the current crisis. Where equity investments must be made, we argue that these should: (1) be effective, in being large enough to be decisive; (2) be passive after the initial injection, when some financial restrictions should be imposed; (3) be temporary and preferably self-liquidating through open-market sales or redemptions; (4) provide taxpayers an upside claim if and when the rescued firm recovers; (5) be restricted to exchange-listed companies in all but extreme cases; and (6) be timely, as speed is crucial. In most cases, the default instrument to employ should be either non-voting preferred stock or warrants that convert into immediately marketable common shares, and we present a numerical example of how a preferred stock-with-warrants equity investment could pay off handsomely for taxpayers if rescued companies recover even partially.

Fake-meat firms raise funds for growth

Faux-meat firms are poised to increase capacity and product introductions thanks to new investment. Impossible Foods has received an equity injection of $500 million from Mirae Asset Global Investments, Khosla Ventures, and others, bringing its total funding to $1.3 billion. The company, famous for plant-based burgers that “bleed,” is adding a pork substitute and has quadrupled production capacity. Meanwhile, Nature’s Fynd—formerly Sustainable Bioproducts, a C&EN Start-Up to Watch in 2019—raised $80 million in a new funding round. The firm is developing meat-like products from fungal mycelium.

How Do Foreclosures Exacerbate Housing Downturns?

AbstractThis article uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyse foreclosure mitigation policy. We consider a dynamic search model in which foreclosures freeze the market for non-foreclosures and reduce price and sales volume by eroding lender equity, destroying the credit of potential buyers, and making buyers more selective. These effects cause price-default spirals that amplify an initial shock and help the model fit both national and cross-sectional moments better than a model without foreclosure. When calibrated to the recent bust, the model reveals that the amplification generated by foreclosures is significant: ruined credit and choosey buyers account for 25.4% of the total decline in non-distressed prices and lender losses account for an additional 22.6%. For policy, we find that principal reduction is less cost-effective than lender equity injections or introducing a single seller that holds foreclosures off the market until demand rebounds. We also show that policies that slow down the pace of foreclosures can be counterproductive.

Banks’ Balance Sheets and Liquidation Values: Evidence from Real Estate Collateral

Abstract This paper finds that declining bank equity or liquidity reduces liquidation values of bank-owned real estate and accelerates the pace of asset sales. Buyers of these assets earn significant returns for providing liquidity to banks, as prices tend to rebound sharply after sales by illiquid banks. Lower liquidation values also depress the prices of nearby real estate transactions. Policy interventions, such as equity injections and central bank asset purchases, increase liquidation values by providing institutions with the balance sheet capacity to slow asset sales. This evidence suggests that balance sheet adjustments at financial institutions can explain real asset price dynamics. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

The Macroeconomics of the Greek Depression

The Greek economy experienced a boom until 2007, followed by a decade-long collapse with magnitude and persistence that have no precedent among modern developed economies. We assess quantitatively the sources of the boom and bust and the role of policies in an estimated dynamic general equilibrium model with heterogeneous households and multiple production, banking, government, and external sectors. Demand from the rest of the world and the government fueled the boom in production, whereas realized and anticipated transfers fueled the boom in consumption. Contractionary tax policies, amplified by a decline in factor utilization and financial frictions, account for the largest fraction of the bust in production, whereas the rise of uninsurable idiosyncratic risk accounts for the largest fraction of the bust in consumption, decline in prices, and the sudden stop of capital flows. Fiscal policy amplified the depression by concentrating the burden of adjustment on taxes instead of spending and by raising the fraction of taxes that firms prepay before revenues are realized. By contrast, equity injections to banks mitigated the depression by lowering the cost of borrowing.