Firm Borrowing Research Articles

International exposure and the transmission of financial shocks: Evidence from China

This study explores the impact of adverse financial shocks on Chinese firms through the bank lending channel and the firm borrowing channel. Using new data linking Chinese firms to their bank(s) and three measures of exposure to international markets, we find that banks with greater exposure to the international markets cut lending more during the financial and sovereign debt crises or when there is a negative shock to OECD GDP growth. Furthermore, state-owned bank loans are more pro-cyclical than private bank loans, and would have been even more pro-cyclical if state-owned banks had not assumed any responsibility for stimulus policies. With regard to the firm borrowing channel, we find that firms with higher weighted aggregate exposure to the international markets through banks have lower net debt, cash, employment, and capital investment during crises or when there is a negative shock to OECD GDP growth. Our results have significant implications for how global financial shocks are transmitted in a regulated financial market such as China.

Assessing financialization under international financial subordination: a mixed-methods study of Brazilian and Turkish non-financial corporations

Abstract This article investigates the changing financial behaviour of Brazilian and Turkish non-financial corporations (NFCs) in the context of international financial subordination. Recent empirical evidence shows that emerging capitalist economies’ (ECEs) NFCs have increased their holdings of very short-term financial assets (mainly cash), whilst borrowing heavily from (international) financial markets and banks. Drawing on an extensive mixed-method study, we show that, instead of being paradoxical or driven by speculative carry trade operations, the ‘wasteful’ combination of holding very liquid and lower yielding assets while borrowing at higher costs (largely denominated in foreign currency) can be contextualized in the subordinate integration of ECEs firms into the global economy. Whereas cash holdings protect against macroeconomic uncertainty, ECEs firm borrowing is largely determined by international market conditions in the context of structural financing constraints. Moreover, our results show the dualistic and heterogenous nature of ECEs firm financial behaviour, which mirrors the polarity observed in those economies’ productive structure and structural balance of payments constraints: only firms with secure access to foreign exchange—either through exports or active internationalization—have the collateral to interact with global—dollar dominated—financial markets. Finally, our article points to the important, yet contradictory, role of the state in ECEs firm financial behaviour. In instances where foreign exchange generating activities in the private sector are not given, the state assumes a crucial role in enabling firms’ engagement with global financial markets; yet it is that same engagement, which—in the context of international financial subordination—creates acute macroeconomic vulnerabilities which at times force the state to restrict those same operations.

Accounting Conservatism in Borrowers’ Financial Reporting and Earnings Management

[Purpose] This study examines the association between conservatism in borrowers’ financial reporting and their earnings management behavior.
 [Methodology] Based on non－financial companies listed on KOSPI and KOSDAQ for the fiscal years from 2012 to 2021, we find the effect of bank loans on conservatism in borrowers’ financial reporting and their earnings management. We calculate earnings management by using the absolute value of discretionary accruals from the modified Jones model (Dechow et al. 1995) and the absolute value of discretionary accruals from the performance－matched discretionary accrual model (Kothari et al. 2005). We measure the value of firm－year accounting conservatism from Khan and Watts’ (2009) conservatism scores.
 [Findings] We find that earnings management behavior of a borrowing firm decreases as the firm’s accounting conservatism increases.
 [Implications] The results of this study indicate that firms’ accounting conservatism in financial reporting plays an effective role in constraining their earnings management behavior. In addition, results imply that conservatism in financial reporting has an incremental contribution to the governance role of banks in constraining borrowing firms’ opportunistic reporting behavior. Overall, the findings of this study demonstrate that accounting conservatism plays a complementary role to a bank’s monitoring function.

The Real Effects of Shadow Banking: Evidence from China

We provide firm-level evidence on the real effects of shadow banking in terms of technological innovation. Firm-to-firm entrusted loans, the largest part of the shadow banking sector in China, enhance the borrowers’ innovation output. The effects are more prominent when the borrowers are subject to severer financial constraints, information asymmetry, and takeover exposures. A plausible underlying channel is capital reallocations from less productive but easily financed lender firms to more innovative but financially less privileged borrower firms. Our paper suggests that shadow banking helps correct bank credit misallocations and thus, serves as a second-best market design in financing the real economy. This paper was accepted by Kay Giesecke, finance. Funding: X. Tian and Y. Wang acknowledge financial support from the National Natural Science Foundation of China [Grant 71825002] and the Beijing Outstanding Young Scientist Program [Grant BJJWZYJH012019100003014]. G. Tu acknowledges financial support from the National Natural Science Foundation of China [Grant 72010107001]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00953 .

Delegated Bank Monitoring by Bond Investors: Evidence from Japanese Main Banks

We investigate whether bank monitoring based on private information in private debt reduces the reliance on public earnings information in public debt. We focus on Japanese main banks, which have a high ability to access the private information of borrowing firms by exploiting their position as both large creditors and shareholders. Previous studies show that the Japanese main bank has a strong incentive to monitor borrowing firms when they are performing poorly, while it never intervenes in their management as long as their financial performance is stable. We find that under stable financial conditions in bond-issuing firms, accrual quality is negatively associated with bond yield spreads. In contrast, when bond-issuing firms with a main bank have a high default risk, there is no relationship between accruals quality and bond yield spread. The results suggest that when a main bank has a stronger incentive to monitor its borrowing firms, bondholders are more likely to delegate the screening role to the main bank with private information, leading to a reduction in the reliance on firms’ public earnings information in bond contracts.

CFO facial beauty and bank loan contracting

AbstractWe examine whether the facial attractiveness of borrower firms' chief financial officers (CFOs) influences bank loan contracting terms. Using a machine learning‐based algorithm to measure facial attractiveness, we document that firms led by CFOs with greater facial attractiveness receive more favourable loan contracts from their banks. We further show that the relation between CFO facial attractiveness and bank loan contracting terms is significantly influenced by the characteristics of both the borrower and the lender. Collectively, our results suggest that loan contracting is not an entirely rational process, as the ‘beauty premium’ is at least partly driven by taste‐based discrimination.

The role of culture in firm-bank matching

We assemble a unique dataset containing population-level information on loan applications in a region hosting two cultural groups to study the role of culture in firm borrowing decisions. We find that firms are more likely to apply for loans from culturally close banks. This effect is stronger for opaque firms, but not for less performing firms, indicating that firms do not expect preferential treatment from same-culture banks. Loan applications to culturally distant banks increase sharply with firms’ size and age, suggesting a role of information asymmetry in firm-bank matching. In contrast, we find no effect of cultural proximity on loan supply. Overall, our results show that demand-side factors play a key role in the formation of same-culture lending relationships.

Bankruptcy Prediction using Machine Learning Techniques: Evidence on Indian companies under Insolvency and Bankruptcy Code

This paper attempts to evaluate the predictive ability of four machine learning models: logit, decision tree, random forest and 2-class support vector machine and to identify the key predictors of default. The models are applied on a dataset of 57 companies under the Insolvency and Bankruptcy Code (IBC) in India and a matched sample of 55 solvent companies spanning over ten years from FY06-FY 2016. The solvent companies are matched on size (log of total assets) and sector and are rated ‘AAA’ and ‘AA’. 31 explanatory variables are identified by us for the study which include (i) financial ratios (ii) size and age of the company, (iii) ownership pattern and (iv) market ratios. The empirical findings reveal that random forest strongly outperforms all other models in their predictive ability, followed by SVM, DT and logit model. The findings also confirm relevance of size and age of the firm, market ratios and ownership pattern as predictors of default in addition to financial ratios. We conclude that both parametric (logit) and non-parametric models are useful in the study of default prediction as reflected in the robustness of all models with accuracy of over 75 percent. These models can help banks in strategizing their lending decisions based on credit quality of borrower firms. Our contribution is that to the best of our knowledge this is the first paper that is using the database of companies that are legally defined as insolvent and bankrupt and also taking a balanced sample to avoid biasness and inaccuracy from data imbalance. Also, this study has gone beyond traditional financial statements in identifying key default drivers.

Life insurance policyholder protection, government green subsidy, and cap-and-trade transactions in a black swan environment

Previous research has examined the cap-and-trade mechanism with carbon emission reduction for productive firms. This paper encompasses the earlier studies by integrating borrowing firms (productive firms) conducting cap-and-trade transactions with life insurer lending decisions in a black swan environment. Our research provides the first cap call option model to describe the insurer-borrowing firm situation. In particular, we find that a black swan event stimulates life insurance businesses. The cap-and-trade scheme increases the guaranteed rate of the life insurance policy and policyholder protection. Enhancing the subsidy for the green borrowing firm deteriorates the policyholder protection in a black swan environment.

Why Do Firms Borrow Directly from Nonbanks?

Abstract Analyzing hand-collected credit agreements for a sample of middle-market firms over 2010–2015, we find that one-third of all loans are directly extended by nonbank financial intermediaries. Two-thirds of such nonbank lending can be attributed to bank regulations that constrain banks’ ability to lend to unprofitable and highly levered borrowers. Firms with negative EBITDA and debt/EBITDA greater than six are 32$\%$ and 15$\%$ more likely to borrow from nonbanks. These firms pay significantly higher interest rates, especially following the 2013 leveraged loan guidance revisions. Nonbank borrowers also receive different nonprice terms compared to firms borrowing from banks. 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 effects of a megabank merger on firm-Bank relationships and loan availability

We examine the effects of the largest-ever bank merger in the world at the time on unlisted firms through their firm-bank relationships to find the following: (1) Firms that transacted with both of the merged banks prior to the merger saw their borrowing costs increase by 13 bps relative to those that transacted with only one of them. (2) Firms that transacted with only one of the two merged banks saw their borrowing costs increase by a margin of 15 bps and a decrease in the amount of loans relative to firms that transacted with neither. The deterioration in borrowing conditions is more pronounced for smaller firms. (3) Despite the deterioration in firms’ borrowing conditions, there is no evidence of a persistent decline in borrower firms’ investment or sales. (4) There is no significant difference in the extent that borrowing costs increased and loan amounts decreased between firms that transacted with the acquiring bank and those that transacted with the acquired bank.

How Does Investor Demand Affect CLO Creation, Firm Borrowing, and Investment?

How Does Investor Demand Affect CLO Creation, Firm Borrowing, and Investment?

Bank deregulation and stock price crash risk

This paper examines the influence of bank branch deregulation on corporate borrowers' stock price crash risk. Using a large sample of U.S. public firms over the period 1962–2001, we provide robust evidence that intrastate branch reform contributes to the reduction of firms' stock price crash risk. Further analysis shows that the negative relation between bank branch deregulation and crash risk is more pronounced among firms that are more dependent on external finance and lending relationships, as well as firms that have weaker corporate governance and greater financial constraints. Our findings are consistent with the notion that bank branch reform improves bank monitoring efficiency, thereby reducing borrowing firms' bad news formation and hoarding, and hence their stock price crash risk. Overall, our empirical evidence suggests that, as a reform aimed at removing restrictions on bank branch expansion, bank deregulation also helps protect shareholders' wealth.

Leverage and productivity

This paper argues that earnings-based borrowing is important for understanding the extent to which financial frictions lower aggregate productivity (TFP). It builds a general equilibrium model of misallocation due to financial frictions wherein firms borrow by pledging assets and earnings. The model is disciplined to match evidence on aggregate leverage and on the firm-level relationship between leverage and the output-to-capital ratio. Conditional on aggregate leverage, the TFP loss from financial frictions shrinks with the pledgeability of earnings. Similarly, for a given difference in aggregate leverage between two countries, financial frictions may contribute significantly more to TFP differences when the poorer country has lower pledgeability of earnings.

Optimal extended liability rule in a competitive financial market with heterogeneous borrower firms

This paper provides a perspective that unifies two controversial arguments about the extended liability rule in a competitive financial market, i.e., the negative arguments about the exaggeration of the judgment proof problem and the positive arguments about the entry deterrence of inefficient firms. This paper also gives the theoretical solution for the optimality of the extended liability rule. In this paper, heterogeneous firms are assumed for the cost parameter of the precautionary effort, and distortions are dependent on the heterogeneities. Then, even considering extended liability with any share to the financier, the extended liability rule never achieves a socially first-best situation. Alternatively, the conditions under which the second-best optimal extended share to the financier should suffice are provided. Furthermore, I discover that the information structure is one of the crucial factors in determining the socially second-best solution for the extended share.

Private lenders and borrowers’ internal control weaknesses

AbstractThis study examines whether the presence of private lenders is associated with the effectiveness of borrowers’ internal controls. I provide evidence that the presence of private lenders is an important determinant of internal control weaknesses in borrower firms. To monitor loan contracts, lenders use borrowers’ financial information, reliability of which to a great extent depends on the effectiveness of borrowers’ internal controls. I argue that lenders are likely to influence borrowers to maintain effective internal controls so that they can reliably use borrowers’ financial reporting information. Using a battery of tests, I find that the presence of private lenders has a significant negative association with the probability of borrowers’ disclosing a material weakness in internal controls.

Equity Short Selling and the Bank Loan Market

AbstractUsing a difference‐in‐differences approach, we show that relaxation of short‐sale constraints helps to filter out low‐quality borrowers from the bank loan market. Treated firms that can still borrow from banks enjoy a lower loan spread, compared with control firms without this sorting mechanism. The results show that such treated borrowers have improved information asymmetry and credit risk, as well as better nonprice contract terms. Overall, equity short selling has a real effect on the bank loan market by weeding out poor‐quality borrowers, resulting in a lower cost of private debt for remaining borrower firms.

Real earnings management and borrowing costs: The moderating effect of the directors’ and officers' liability insurance

Abstract The purpose of this paper is to investigate the effects of real earnings management on firm borrowing cost of public-listed in Taiwanese manufacturing industry during 2010 to 2017, and also examines the moderating effect of the directors’ and officers’ liability insurance (D&O insurance) on real earnings management and borrowing costs. The empirical results show that borrowing cost is positively related to real earning management but negatively related to D&O insurance purchase. Therefore, the firms with D&O insurance than those without have lower borrowing costs, but the higher the D&O insurance amount, the higher the borrowing costs. Furthermore, D&O insurance has a moderating effect between the real earnings management and borrowing costs. Our findings suggest the relationship between D&O insurance and real earning management, which through the D&O insurance purchasing decision to impact on corporate borrowing costs. JEL classification numbers: G22, G32, M41. Keywords: Real earnings management, Directors’ and officers' liability insurance, Borrowing costs, Moderating effect.

A bank-account-information-based credit scoring method with Bayesian hierarchical modeling

Recent interest in financial technology (fintech) lending business has caused increasing challenges of credit scoring models using bank account activity information. Our work aims to develop a new credit scoring method based on bank account activity information. This method incorporates borrower firms’ segment-level heterogeneity, such as a segment of sales size and firm age. We employ Bayesian hierarchical modeling, which mitigates data sparsity issue due to data segmentation. We describe our modeling procedures, including data handling and variable selection. Empirical results show that our model outperforms the traditional logistic model for credit scoring in information criterion. Our model realizes advanced credit scoring based on bank account activity information in fintech lending businesses, taking segment-specific features into credit risk assessment.

Loan syndication under Basel II: How do firm credit ratings affect the cost of credit?

This paper investigates how syndicated lenders react to borrowers’ rating changes under heterogeneous conditions and different regulatory regimes. Our findings suggest that corporate downgrades that increase capital requirements for lending banks under the Basel II framework are associated with increased loan spreads and deteriorating non-price loan terms relative to downgrades that do not affect capital requirements. Ratings exert an asymmetric impact on loan spreads, as these remain unresponsive to rating upgrades, even when the latter are associated with a reduction in risk weights for corporate loans. The increase in firm borrowing costs is mitigated in the presence of previous bank-firm lending relationships and for borrowers with relatively strong performance, high cash flows and low leverage.