High Leverage Firms Research Articles

Sovereign risk and intangible investment

This paper measures the output and TFP losses from sovereign risk, considering firm-level intangible investment. Using Italian firm-level data, we show that firms reallocated from intangible assets to tangible assets during the 2011–2012 Italian sovereign debt crisis. This asset reallocation is more pronounced among small firms and high-leverage firms. This reallocation affects aggregate output and TFP. To explain the reallocation pattern and quantify the output and TFP losses, we build a sovereign default model incorporating firm intangible investment. In our model, sovereign risk deteriorates bank balance sheets, disrupting banks’ ability to finance firms. Firms with greater external financing needs are more exposed to sovereign risk. Facing tightening financial constraints, firms shift their resources towards tangibles because they can be used as collateral. We find that elevated sovereign risk explains 45% of the observed output losses and 31% of the TFP losses in Italy from 2011 to 2016.

The asymmetric impact of monetary policy and firm leverage on firm investment: some insights from Pakistan

PurposeThis paper aims to investigate whether negative and positive monetary policy (MP) shocks have asymmetric impacts on corporate firms’ investment decisions in Pakistan using firm-level panel data set. Moreover, the authors emphasized on symmetric effects of MP; the authors examine whether high-leverage and low-leverage firms respond differently to negative and positive unanticipated shocks in MP instruments.Design/methodology/approachIn contrast to the conventional framework of VAR, it uses an alternative methodology of Taylor rule to estimate unanticipated MP shocks. The two-step system-generalized method of movement (GMM) estimation method is applied to examine the effect of MP shocks on firm investment through leverage-based asymmetry.FindingsThe two-step system-GMM estimation results indicate that unanticipated negative changes (unfavorable shocks) in MP instruments have negative, significant effects on investment. In contrast, unanticipated positive changes (favorable shocks) have statistically insignificant impacts on firm investment. The results also reveal that firm leverage has a significant role in establishing the effect of unanticipated negative changes in MP instruments on investments. Finally, the results indicate that high-leverage firms respond more to negative changes than low-leverage firms. Yet, the results show that only low-leverage firms positively respond to unanticipated positive shocks in MP.Practical implicationsThe findings of the paper suggest that MP authorities should pay due attention to the asymmetric effects of MP shocks on firm investment while designing MP. Because firm leverage has a significant influence on the effects of MP shocks, firm managers should take into account such role of leverage while deciding capital structure of their firms.Originality/valueFirst, unlike “Keynesian asymmetry” and most of published empirical research work, the authors use both unanticipated negative and positive MP shocks simultaneously. Departing from the conventional empirical literature, the authors differentiate between unanticipated positive and negative shocks in MP using the backward-looking Taylor rule. Second, the authors contribute to the existing literature by investigating the differential effects of positive and negative unanticipated MP shocks on firms’ investment decisions. Unlike the published studies that have emphasized on the symmetric effects of MP, the authors examine whether high-leverage and low-leverage firms respond differently to negative and positive unanticipated shocks in MP instruments.

Corporate bankruptcy and banking deregulation: The effect of financial leverage

We investigate the impact of deregulation-induced banking competition on corporate credit risk. Although banking competition does not, on average, affect corporate bankruptcy rates, we find that it causes corporate bankruptcies to increase significantly for high-leverage firms. We show that higher borrowing costs for high-leverage firms post-deregulation and the resulting credit rationing may be key factors behind our findings. The effect of deregulation lasts for up to seven years after the introduction of deregulation and originates mainly from firms that have high short-term debt and are financially constrained. Our results suggest that banking competition, which is expected to expand lending and reduce its cost, may, in fact, create more challenging credit conditions, particularly for firms that are more heavily dependent on external funding.

Unlocking the mergers and acquisitions puzzle in the United Arab Emirates: Investigating the impact of corporate leverage on target selection and payment methods.

Following a long stream of literature on the drivers of Mergers and Acquisition (M&A) activities, this study examines the effect of corporate leverage on several decisions of M&A deals in the context of the United Arab Emirates (UAE). Using M&A data from the Thomson One database for the period between 2005 and 2022, we find that corporate leverage significantly influences the type of M&A target. This study further adds to the prior literature on the contradictory behaviours of high and low leverage firms by examining whether acquisition decisions differ amongst them in M&A deals in the UAE context. Results indicate that high (low) leverage firms are less (more) likely to acquire private targets and more (less) inclined to acquire a target from a different (same) industry. Furthermore, our results show that the relationship between the method of payment used in M&A deals and corporate leverage is insignificant. We control for endogeneity using Heckman's two-stage method. In brief, this paper extends the literature with conclusive evidence that considerations of capital structure can significantly anticipate and explain firms' behaviour toward M&A choices. The implication of findings may include a call to reform some aspects of the Competition Law in the UAE by requiring private firms to enhance their disclosure practices similar to their public counterparts.

CEO compensation and CSR: Economic implications and policy recommendations

The theoretical underpinning of compensation for CSR in the SDG era emerges as a trending area for researchers. However, the measurability of CSR is a technical problem for CSR research in developing nations. This study uses 5,699 firm-year observations and entropy measures to assign CSR engagement scores based on CSR breadth and depth. The results reveal that total compensation (TC) behaves according to stewardship theory and positively influences CSR engagement, breadth, and depth. However, fixed (FC) and variable (VC) compensations follow agency theory and have a negative and positive impact on CSR engagement, breadth, and depth, respectively. We also examine the impact of TC, FC, and VC on CSR engagement levels in firms’ external and internal control. We observe that high-leverage firms hold the baseline result, whereas, in internal control, the non-business group firms hold the baseline result. Moreover, in institutional ownership, we find that TC and VC follow the stewardship and agency theories and positively affect CSR engagement. In contrast, the impact of FC on CSR engagement is not affected by institutional ownership. The findings of this study can help policymakers improve CEO compensation structures to increase CSR practices and ensure the achievement of SDGs by 2030.

Flexibility costs of debt: Danish exporters during the cartoon crisis

We study how firms respond to an unexpected demand shock, exploiting the 2006 boycott of Danish products after publication of Muhammad caricatures. On average, affected firms lose the majority of their exports to Muslim countries and experience a significant decrease in total sales. However, firms with low financial leverage redirect sales to new and existing product-destination markets in non-Muslim countries, which allows them to fully offset their losses. In contrast, high-leverage firms do not enter new markets and instead actively downsize. Our results highlight the importance of financial flexibility in times of crisis, consistent with declarations of practitioners.

Founder ownership and value relevance of IFRS convergence: Role of institutional investors

We examine how founder shareholders switch between alignment and entrenchment and thereby shape the value relevance impact of IFRS convergence. Using a sample of Indian firms adopting the IFRS converged standards in the first phase, we find that founder ownership affects the ability of IFRS to improve value relevance non-monotonically and this effect holds even after addressing the endogeneity concern in founder ownership. However, we find that the non-monotonic effect is limited to domestic owners and not foreign owners. Further analysis shows that the non-monotonic founder effect is present only in large-size firms and high-leverage firms which are experiencing higher equity adjustment post convergence. We also find that active(passive) institutional investors have a positive (negative) effect on the relationship between founder shareholding and IFRS impact suggesting that monitoring incentives rest with active investors and not passive investors. On solving for the turning points, we find that founders facilitate effective IFRS implementation only when they hold enough equity which qualifies as significant influence but not exceeding the super-majority level (around 60%), indicating an alignment effect. However, entrenchment prevails at extreme levels of founder shareholding leading to opportunistic IFRS implementation which deteriorates value relevance. Our results advocate that a minimum public shareholding at around 35% is desirable to promote financial transparency and disclosure.

Understanding the dynamics of capital structure, corporate governance, and corporate social responsibility in high- and low-leveraged US and Chinese firms.

Corporate social responsibility turned into a global sensation from the inception of the twenty-first century in the corporate world and grabbed immense engrossment from all stakeholders in their decision-making process. Capital structure and corporate governance practices are the well-mellowed facets of corporate finance literature. In this study, the moderating role of corporate social responsibility (CSR) between corporate governance and leverage of the US and Chinese listed firms has been established, with a further extension of analyzing the moderating role of CSR between corporate governance and leverage in high vs low leveraged firms and high CSR vs low CSR firms as the novelty of this study and has never been examined in both economies and globally. The data of 1989 Chinese-listed firms from 28 sectors of the economy and 6640 US-listed firms from 27 sectors of the economy has been taken from 2001 to 2019 and analyzed through fixed effect regression and system generalized method of moment (GMM). Results of the study reveal that CSR and corporate governance are negatively associated with the leverage of both Chinese and US firms. Moreover, the moderating role of CSR has established between corporate governance and leverage negative relationship. The moderating role of CSR in the relationship of leverage and corporate governance is established only in low-leveraged firms whereas it is insignificant in high-leveraged firms. System GMM confirms the signs and significance of the regression results; that is why regression results are robust and reliable, and there is no endogeneity problem in our model. The study also gives an insight for future research on high- and low-leveraged firms and firms with more CSR score than less CSR score with other dimensions such as firm performance and firm value variables.

Capital Structure Decisions of Listed Firms in Transport Equipment Industry in India

Aims: The study predominantly attempts to examine the capital structure decisions of listed firms in Transport Equipment Industry by analyzing the relationship between leverage and profitability.
 Study Design: Descriptive research design is used to describe the characteristics of the firms belonging to industry. The study envisages an extensive use of data extracted from professional database CMIE prowess and from reports Ministry of Statistics and Programme Implementation, Annual Survey of Industries and Satista.
 Place and Duration of Study: The sample for the study consists of all listed firms National Stock Exchange (NSE) affiliated under Transport equipment Industry (CMIE classification). There were totally 86 firms as on 31st March 2018. The relevant data sets are retrieved for a period of 10 years (2008-2018). Thus, a panel data of 860 different observations were considered for study.
 Methodology: To analyze the data collected, Econometric model for longitudinal data with repeated measures known as Hierarchical linear regression model is adopted. This helps in estimation of industry grand mean, segment mean and firm mean for multilevel nested data.
 Results: The result of the study indicates that segment means are approximately equal to industry mean of 0.2898. Further, the segment-level means of all eight segments follows normal distribution with firms having high and low leverage firms. Finally, the firm-level variance is comparably high indicating that firms’ influence on capital structure decisions is predominant of all in this industry which has been found to be consistent over past decade.
 Conclusion: The underleveraged firms in Transport Equipment Industry exhibit relatively higher average Return on Equity (ROE) and Return on Capital Employed (ROCE) compared to optimal leveraged firms. On the other hand, overleveraged firms indicate inverse relationship with profitability. This is justified by the pecking order theory that higher profitable firms incorporate internally generated funds available at lower cost compared to external financing.

Monetary shocks and the analyst coverage of the firm

Contractionary monetary shocks, which are known to reduce growth and tighten lending, significantly reduce firm-level analyst coverage. The reduction in analyst coverage of high-leverage firms is almost 50% larger, and faster, than the reduction in the coverage of low-leverage firms.

Modeling and forecasting firm-specific volatility: The role of asymmetry and long-memory

We analyze the relevance of asymmetry and long-memory in modeling and forecasting firm-specific volatility. The asymmetric effect and the degree of long-memory seem to be more pronounced for equity than for firm's asset volatility. However, once the asymmetry is allowed in the model along with long-memory, firm's asset volatility is more persistent than equity volatility for high leverage firms. A horse race among different GARCH-type models (GARCH, EGARCH, IGARCH, FIGARCH, HYGARCH, FIEGARCH, and FIAPARCH) shows that more sophisticated (FIEGARCH and FIAPARCH) models outperform other specifications in out-of-sample firm-level volatility forecasting. The simplest GARCH and IGARCH models show the worst performance.

An empirical investigation of the impact of firm characteristics on the smoothness of dividend

This paper empirically investigates the smoothness of dividends on non-financial companies in Jordan by applying the asymmetric partial adjustment model. In addition, this research investigated the data for 65 non-financial companies (37 industrial and 28 services) listed on the Amman Stock Exchange (ASE) covering the period 1997–2020. Fixed and random-effects techniques have been applied to check the smoothness of dividends. The results confirmed that the non-financial Jordanian companies smooth their dividends at a moderate rate, our results contradict the signaling theory; we find that large companies smooth their dividend faster than small ones. Furthermore, in line with the agency cost theory, low-leveraged firms smooth their dividends faster than high-leveraged firms. Also, our results confirmed that highly profitable companies smooth their dividend more and this comes in line with the signaling theory.

Do Investors Still Acknowledge Excessive Corporate Leverage? Understanding Divergence of Valuation During the Age of ZIRP and QE

Times of financial crisis generate often irregular monetary policy response. In the past decade, much focus has surrounded zero, and even, negative interest rate policies along with quantitative easing. While corporate borrowing continues to be ‘cheap,’ it is important to analyse as to whether investors have distinctly, and geographically, attributed differential valuations surrounding the use of corporate leverage? Differentiating corporate entities across six of the largest international exchanges, this research focuses on the performance of companies based on time-varying debt/equity performance, with particular emphasis on the implementation of quantitative easing. Results indicate that the average returns of the highly-leveraged firms significantly diverge during both interest rate and quantitative easing events, however, variation is found to be dependent on both the geographical distribution and concentration of leverage in the form of both debt and equity. After a thorough investigation, the results strongly suggest that positive returns are achieved by highly leveraged firms following asset purchasing programmes.

Intangible Investment during Sovereign Debt Crisis: Firm-level Evidence

This paper measures the output and TFP costs of sovereign risk by focusing on firm-level investment. Combining Italian firm-level and aggregate-level data, we show that firms reduce their investment and reallocate their resources away from intangible assets and towards tangible assets during the sovereign debt crisis. This asset reallocation is more pronounced among small and high-leverage firms, indicating the role of financial constraints. In our model, sovereign risk deteriorates banks' balance sheets, disrupting banks' ability to finance firms. Firms with greater external financing needs are more exposed to sovereign risk. Facing tightening financial constraints, firms internalize that tangibles can be used as collateral while intangibles can not, thus reallocating resources towards tangible investment. In a counterfactual analysis, we find that elevated sovereign risk explains 86% of output losses and 72% of TFP losses during the 2011-2013 Italian sovereign debt crisis.

One Size Does Not Fit All: TFP in the Aftermath of Financial Crises in Three European Countries

We analyse the impact of both the Global Financial Crisis of 2008 and the European sovereign and banking crisis of 2011-13 on firm-level productivity in France, Italy and Spain. We show that relying on a single break date in 2008 misses both the Eurozone crisis and countries' institutional specificities. Although leverage and financial constraints affect firm-level productivity negatively, high-leverage firms suffer more from financial constraints only in Italy, when they are relatively small or when their debt is of short maturity. These results call for approaches taking into consideration country-level characteristics of financial institutions and time varying financing constraints of the firms, instead of pooling data and adopting a common break date. One size does not fit all when it comes to identifying the impact of financial crises on firm level productivity.

Can the cure kill the patient? Corporate credit interventions and debt overhang

Interventions in corporate credit markets were a major innovation in the policy response to the 2020 recession. This paper develops and estimates a model to quantify their impact on borrowing and investment. Even during downturns, credit interventions can be a bad policy idea, because they exacerbate debt overhang and depress investment in the long run. However, if the downturn is accompanied by financial market disruptions, they initially help forestall inefficient liquidations. These short term benefits quantitatively dominate the long run overhang costs. Additionally, constraining shareholder distributions, and targeting high-leverage firms substantially increases the bang for the buck of credit interventions.

Testing the pecking order theory of capital structure: Evidence from Turkey using panel quantile regression approach

This study tests the validity of the pecking order theory at different investment levels for manufacturing firms listed on the Borsa Istanbul. The study covers the period from 2000 to 2018, and the quantile regression method was employed to determine the relative importance of internal and external funding sources in the financing of firm investments. The empirical findings of the present study reveal that the pecking order theory is valid for the choice behaviour of firms listed on the Borsa Istanbul and that the sensitivity to internal funds and debts increases as investment levels increase. In addition, it is found that small firms act in accordance with the pecking order. The empirical findings show that the pecking order theory is not valid for high- and low-leverage firms; high-leverage firms prefer equity financing at high investment levels when internal funds are insufficient to finance investment expenditures, and low-leverage firms prefer to borrow as their first choice. Moreover, it is found that the firms acted in accordance with the financial hierarchy in the period before the global crisis (2000–2009); in the post-crisis period (2010–2018), debt/borrowing was preferred for investment financing. Finally, firms operating in the food, drink and tobacco product manufacturing; chemical, petroleum, rubber and plastic product manufacturing; and stone- and soil-based industrial product manufacturing subsectors are found to display pecking order behaviour.

Doubling Down on Debt: Limited Liability as a Financial Friction

We investigate how a combination of limited liability and preexisting debt distort firms’ investment and equity payout decisions. We show that equity holders have incentives to “double-sell” cash flows in default, leading to overinvestment, provided that the firm has preexisting debt and the ability to issue new claims to the bankruptcy value of the firm. In a repeated version of the model, we show that the inability to commit to not double-sell cash flows leads to heterogeneous investment distortions, where high leverage firms tend to overinvest but low leverage firms tend to underinvest. Permitting equity payouts financed by new debt mitigates overinvestment for high leverage firms, but raises bankruptcy rates and exacerbates low leverage firms’ tendency to underinvest—as the anticipation of equity payouts from future debt raises their cost of debt issuance. Finally, we provide empirical evidence consistent with the model. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Corporate Governance and Capital Structure: Evidence from Sustainable Institutional Ownership

Because corporate sustainability enhances corporate governance principles, firms are increasing their efforts to provide transparency and public disclosure. These efforts inform the public about the relationship between corporate governance and sustainability. Well-informed shareholders know about this relationship, which is becoming more apparent over time. In this study, we empirically examined the possible bilateral relationships between institutional ownership and a firm’s capital structure. Methodologically, we used an instrumental variable approach and the two-step generalized method of moments. The implications of this study are two-fold. First, we found that a firm’s debt level was low if its institutional ownership level was high. Institutional monitoring may substitute for external debt monitoring, leading firms to employ low leverage. Second, we found that the level of institutional ownership was high if a firm’s debt level was high. This association suggests that institutional investors prefer high-leveraged firms because institutional owners decrease their monitoring costs through debt monitoring. In the long run, sustainable institutional ownership materially impacts the capital structures of firms.

State ownership and adjustment speed toward target leverage: Evidence from a transitional economy

Using a quantile regression approach and 5,374 Vietnamese firm-year observations from 2000 to 2016, this paper examines the effect of state ownership on the speed of adjustment SOA toward target leverage across various levels of capital structure. The findings consistently show that these effects on SOA vary depending on the leverage level. The relationship is negative for low-leveraged firms, positive for high-leveraged firms, but insignificant in the central area of leverage distribution. Moreover, the negative effects are greater than the positive effects.