Debt Holders Research Articles

On the design of bail-in-able bonds from the perspective of non-financial firms

To prevent black swan events such as the financial tsunami or COVID-19 from crashing overall economic systems, governments provide bailouts to too-big-to-fail financial institutions and non-financial firms such as airline companies with tax payers’ money. To avoid unfair bailouts, using bail-in-able bonds to absorb an issuing bank’s losses and to fulfill capital requirements such as BASEL III has been widely studied. Without capital adequacy requirements, non-financial firms also issue bail-in-able bonds because the embedded loss-absorbing mechanism can cut debt repayments down to reduce bankruptcy risk and thus increase the overall benefits of these firms’ claim holders. However, bond investors require higher rewards to compensate for their potential losses once this mechanism is triggered. In addition, unlike financial institutions, which are strictly regulated, such a mechanism may induce non-financial issuers to take on excessive risk to benefit themselves at the expense of their debt holders. To investigate how the issuances of various (non)-bail-in-able bonds influence the equity and the existing debt holders’ benefits from a non-financial issuer’s prospective, we develop novel quadrature pricing formulas based on the structural credit risk model. We find that while non-bail-in-able bonds can be wise choices for low-leverage issuers, bail-in-able bonds with benefit-sharing mechanisms allowing investors to share issuers’ upside profits can efficiently suppress interest expenses and circumvent the asset substitution problem for high-leverage issuers. If the value of an issuer (such as an oil shale firm) mainly depends on the value of that asset (such as oil), issuing a bail-in-able bond referring to the asset could be a wise choice. Otherwise, issuing a bond referring to the issuer’s stock price could provide timely fund injections and low interest expenses for a high-leverage public firm.

IFRS Mandatory Adoption and Earnings Quality in an Emerging Market: The Case of Ecuador

This paper examines changes in earnings quality, including accruals, earnings smoothing, and asymmetric loss recognition schedules, following the mandatory adoption of IFRS in Ecuador. Using 5,436 year-firm observations, we employ a differences-in-differences approach, comparing the effect of IFRS on an initial group of adopters (publicly traded companies) with non-adopters (small and medium-sized enterprises) with essentially the same financial reporting requirements. Our findings indicate a decrease in accrual levels and more timely recognition of losses, with no evidence of changes in earnings smoothing. These results suggest that companies use the increased flexibility of IFRS to meet debt holders' demand for timely loss recognition. The decrease in accruals suggests earnings management for tax purposes. This study contributes to the literature on IFRS and earnings quality by using a more robust research design and providing evidence on the consequences of IFRS adoption in an emerging market dominated by debt capital and family-owned firms.

Credit default swaps and firm risk

AbstractThis study investigates how initiating a credit default swap (CDS) affects firm risk. Using the firm value volatility as a measure of firm risk, we document that firm risk decreases following the commencement of CDS trading. Further analysis indicates that the empty creditor channel, which arises when a debt holder with CDS protection has no interest in preserving the company it provides funds, is the primary way of influence. Our findings reveal a significant impact of financial innovation on a firm's behavior. We also document that market frictions affect the degree of such effect.

CEO inside debt and downside risk: Evidence from internal and external environments

In this study, we investigate whether inside debt held by CEOs is associated with downside risk and also consider the impact of internal (CEOs' and firms' characteristics) and external (industry competition and macroeconomic uncertainty) factors on the connection to CEO inside debt, which is debt-like compensation and corporate downside risk. We find that CEOs who hold more inside debt reduce downside risk. However, the negative impact of inside debt holdings on downside risk is offset in firms managed by younger or male CEOs, whereas the ability of inside debt held by a CEO to decrease corporate downside risk is amplified in firms operated by overconfident CEOs. Moreover, this reduction effect occurs in firms of good quality (higher earnings, smaller size, lower leverage, higher cash surplus, higher excess returns, and higher profitability). Finally, we find that this effect is more pronounced for firms operating in a low-competition industry, facing low economic policy uncertainty, and low equity market volatility.

CEO performance‐based grants’ vesting provisions and debt contracts: Evidence from GAAP, Non‐GAAP and KPI metrics

AbstractWe examine the influence of CEOs’ equity and cash grants’ vesting provisions that are based on (i) accounting performance metrics prepared under US generally accepted principles (GAAP), (ii) non‐GAAP performance metrics and (iii) key performance indicators (KPIs) on debt contracts. We find that grants with vesting provisions based on GAAP metrics and KPIs lead to a lower cost of debt, a lower likelihood of collateral requirements and less restrictive covenant terms. In contrast, performance‐based grants with non‐GAAP vesting provisions lead to a higher cost of debt, a higher likelihood of collateral requirements and more restrictive covenant terms. Supplementary analyses reveal that our results are incremental to other debtholder‐friendly features in the CEO contracts, such as grants with debt‐related performance measures and CEOs’ inside debt holdings, and robust to alternative variable definitions and specifications. Overall, our results suggest that debtholders understand the differing incentives associated with GAAP, non‐GAAP and KPI‐based performance measures, and incorporate these differences into debt contracts.

Asset redeployability and CEO inside debt

AbstractUsing a large sample of US firms for the period 2006–2015, we investigate the relationship between asset redeployability (AR) and a Chief Executive Officer's (CEO) inside debt holdings (CID) (pension benefits and deferred compensation). We find a positive association between AR and CID. In addition, we also find that this relationship is stronger in firms that are more financially constrained and during times of economic uncertainty. Collectively, these findings suggest that asset market frictions captured by AR are better determinants of liquidation value than asset tangibility. Our results are robust to an array of sensitivity/robustness tests and endogeneity concerns.

Board Composition and Performance of Indian State-owned Enterprises: Moderating Role of Leverage

Debt holders monitoring influence on the business performance has been noted in several research. Another body of research investigates the board of directors and performance linkages. The impact of debtholders on the board composition and firm performance linkage, particularly in State-Owned Enterprises (SOEs), has received little attention in the literature. As a result, this article aims to determine whether the composition of Indian SOE boards has an impact on their performance. It also looks into how leverage influences the association between the composition of Indian SOE boards and their performance. From 2001 to 2019, the panel data regression is performed on 19 Indian SOEs registered on the Bombay Stock Exchange. According to the study, board size, nominee directors improve Indian SOE performance, while independent directors reduce performance. Furthermore, in high-leverage SOEs, board of directors’ supervision is reduced or removed. The findings have implications for policymakers and the government.

Did small banks trade off lending with government bond purchases during the Sovereign debt crisis?

At the beginning of the decade, many banks in euro-area periphery countries shifted their portfolios from corporate lending towards sovereign debt holdings. According to some scholars, this was the result of the moral suasion exerted by domestic authorities; others suggest instead that it was the outcome of a free choice of weak banks that bet-for-resurrection increasing the holdings of risky, high yielding government bonds. Our analysis shows that the contemporaneous increase in banks’ total assets and the portfolio readjustment from loans to government bonds can be explained by a surge in the risk-premium required by banks on corporate lending. After briefly describing our hypothesis within a simple model of a bank’s portfolio choice, we test its empirical implications on a large sample of individual loan data granted by over 100 Italian small banks during the post sovereign debt crisis period (2012–2014). Our results provide convincing evidence in support of the hypothesis that the banks which increased the most their government bond holdings were also those which reduced more significantly their credit supply.

Dark Knights: The Rise in Firm Intervention by Credit Default Swap Investors

There have been several cases in recent years where credit default swap (CDS) buyers and sellers intervene in the restructuring of a distressed firm. We show theoretically that this can increase firm value. Intervention by CDS buyers solves the commitment problem between equity and debt holders but increases the probability of inefficient liquidation. Intervention by CDS sellers reduces the issue of excessive liquidation while keeping the benefits of CDS buyer intervention. Having both types of intervention decouples the commitment problem from the liquidation problem. Under certain assumptions, the so-called empty creditor problem can be solved, and firm value reaches first best. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The internet appendix is available at https://doi.org/10.1287/mnsc.2023.4717 .

Can Central Banks Boost Corporate Investment? Evidence from ECB Liquidity Injections

AbstractLiquidity injections by central banks have become frequent and massive, but their real effects on corporate investment remain unclear. We examine the longer-term refinancing operations (LTROs) of the European Central Bank (ECB) during the eurozone sovereign crisis and show that greater LTRO funding to banks is associated with lower corporate investment. Riskier banks received funds through the LTROs and subsequently increased their holdings of risky sovereign debt. Corporate investment reductions are associated with these banks. Further, concurrent fiscal and regulatory policies impeded the effectiveness of the ECB liquidity injections. Our findings identify the contributing factors for these failures of monetary policy. (JEL E52, E58, G32)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.

Skilled labor and bank loan contracting

AbstractThis paper examines the credit risk implications of a firm's reliance on skilled labor and provides an empirical analysis of the effect of skilled labor on loan contracting outcomes. Using a sample of listed US firms from 1998 to 2017, we predict and find that banks charge higher interest rates to firms relying on high‐skill workers than low‐skill workers. This effect is stronger for firms with higher asset‐based operating leverage, higher probabilities of employee turnover and severer conflicts of interest between equity holders and debt holders. In addition, consistent with the idea that banks consider the specific costs and benefits associated with skilled labor, we show that a firm's reliance on skilled labor is positively (negatively) associated with the relative usage of capital (performance) covenants. Our results hold when applying different matching methods, fixed‐effect models or exogenous shocks from two quasi‐natural experiments. Overall, our study demonstrates the impact of skilled labor, an important labor‐force heterogeneity, on debt contract design and contributes to the understanding of the interaction between labor and capital, that is, the two primary inputs of a firm.

Does Managerial Compensation Impact the Likelihood of Product Market Failures? Evidence from Inside Debt Holdings

Does Managerial Compensation Impact the Likelihood of Product Market Failures? Evidence from Inside Debt Holdings

Does economic policy uncertainty impact firms' capital structure policy? Evidence from Western European economies.

This study specifically investigates the impact of economic policy uncertainty (EPU) on travel and leisure (TL) companies' debt holdings policy. To the best of our knowledge, there is a momentous gap in exclusively conducting the impact of EPU on the debt holdings policy behavior of Western European firms operating in the TL sector and its sub-sectors, namely the airlines, gambling, hotels, recreational services, restaurants and bars, and travel and tourism. In this sector, external financing is strongly needed to finance enormous investments and replace, expand, and modernize tangible and intangible assets. To fill the gap, the present study selects 92 publicly listed TL companies operating in Western Europe's top tourist destinations, namely, the UK, Germany, France, Spain, and Italy, and performs both the static and dynamic panel data estimation approaches during the 2005-2019 period. The results reveal that the EPU negatively impacts TL firms' debt holdings, implying that firms tend to decline in debt levels by rising EPU. Consequently, the results highlight that the level of EPU matters, and firms' debt ratios are relatively lower in countries having a higher EPU and vice versa. Besides, the results underscore that the EPU negatively impacts firms' debt holdings in each sub-sector; however, the negative effect is most prominent on the debt ratios of the firms, particularly those operating in gambling, hotels, travel, and tourism, and also recreational services sub-sectors. The results are robust and have important suggestions for regulatory bodies, policymakers, and firms' managers.

CEO contractual protection and debt contracting

AbstractChief Executive Officer (CEO) contractual protection, in the forms of CEO employment agreements and CEO severance pay agreements, is prevalent among S&P 1500 firms. While prior research has examined the impact of these agreements on corporate decisions from shareholders’ perspective, there is little research on the impact from debt holders’ perspective. We find that, compared with other loans, loans issued by firms with CEO contractual protection on average contain more performance covenants and performance‐pricing provisions. This effect increases with CEOs’ risk‐taking incentives and opportunities, but it decreases with CEOs’ preference for and opportunity of enjoying a quiet life. Furthermore, for loans issued by firms with CEO contractual protection, debt holders include stricter covenants, charge a higher interest rate and use a more diffuse syndicate structure. Collectively, these results shed light on the impact of CEO contractual protection on debt contracting.

A COMPARATIVE STUDY ON PROFITABILITY OF SELECTED INDIAN CEMENT COMPANIES

Profitability means a company’s ability to earn return on investment through its business activities. It shows how the resources are efficiently utilised to achieve its goal of earning profits. Profits are essential for the organisation to make dividend payments to its shareholders as well as retain a part of profits as reserves to overcome the unforeseen circumstances in the near future. The attempt is made in this study to know the profitability position of three cement companies in terms of gross profit margin, net profit margin and return on equity and return on capital employed and deep insight is to be made with regards to return to shareholders as well as debt holders of the company. Shree cement limited stands first in satisfying both equity holder and debt holder as compared to Ultra tech cement and Dalmia Bharat cement limited, KEY WORDS: Gross Profit Margin, Net Profit Margin, ROE, ROCE,

Missing in Action? Investor Responses to the War in Ukraine

Following the Russian annexation of Crimea in 2014, many investors responded by unloading their Russian sovereign debt holdings. However, data from Bloomberg show that at the time of the 24 February Russian invasion of Ukraine, ESG funds – investment funds pursuing environmental, social and governance goals – still held at least $8.3 billion in Russian assets;1 and while more than a thousand companies have curtailed their Russian operations and over 500 are holding off on new investments in the wake of Russia’s invasion,2 investors have been accused of being ‘missing in action’.3

CEO compensation and bank loan contracts

This paper studies the relationship between bank CEO inside debt holdings and banks’ syndicated loan decisions. Using a two-stage selection model, we find that banks with higher CEO inside debt holdings extend syndicated loans to safer borrowers and have a smaller number of lenders in the syndication; these loans have a lower spread, less restrictive covenant, and longer maturity. These results suggest higher bank screening efforts and lower risk-taking incentives associated with bank CEO inside debt. The findings are robust to potential endogeneity bias and simultaneity of various loan terms.

Redistribution and the Monetary–Fiscal Policy Mix

We show that the effectiveness of redistribution policy is tied to how much inflation it generates, and thereby, to monetary-fiscal adjustments that ultimately finance the transfers. In the monetary regime, taxes increase to finance transfers while in the fiscal regime, inflation rises, imposing inflation taxes on public debt holders. We show analytically that the fiscal regime generates larger and more persistent inflation than the monetary regime. In a two-sector model, we quantify the effects of the CARES Act in a COVID recession. We find that transfer multipliers are larger, and that moreover, redistribution is Pareto improving, under the fiscal regime.

CEO inside debt holdings and credit ratings

In this paper we investigate the relationship between chief executive officer (CEO) inside debt holdings (pension benefits and deferred compensation) and long-term credit ratings. We provide evidence that firms with a higher level of inside debt holdings enjoy better credit ratings. Our results are robust to the use of alternative regression estimation and alternative measures of key variables. We employ instrumental variable–based two-stage least squares regression and instrumental variable regression estimation using heteroskedasticity-based instruments to mitigate the endogeneity concern. In addition, we employ propensity-matched sample and entropy balancing estimates to alleviate endogeneity concerns. Our cross-sectional analyses reveal that the relationship between CEO inside debt holdings and credit ratings is more pronounced in firms with a poor information environment, a weak monitoring mechanism, and powerful CEOs. Overall, findings from our study suggest that credit rating agencies evaluate CEO insider debt holdings positively in assessing the creditworthiness of a firm.

A STUDY OF DETERMINANTS OF FIRM VALUE OF INDIAN IT SECTOR: WITH SPECIAL REFERENCE TO EFFECT OF FOREIGN EXCHANGE RISK

Foreign currency risk is one of the most common types of risk that foreign businesses face, and risk management has become one of the most important aspects of comprehensive financial management in recent years. The exposure of a company to changes in foreign exchange prices is called foreign exchange risk, whilefirm value is an economic metric that reflects the market value of a company as a whole, i.e. the value that should be distributed among its shareholders and debt holders. The main objective of this study is to identify the effect of foreign exchange exposure on Firm Value for selected Indian IT companies. Five IT companies covering the tenyear data (2009 to 2018) have been selected for the study. Secondary data have been collected from their annual reports which have been analyzed through regression and analysis of variance with a view to predict the effect of foreign exchange risk. The study reveals that Foreign Exchange Risk is least consistent variable and there is a negative correlation between Foreign Exchange Risk on Firm Value.Result of Regression Analysis shows that there isinsignificant positive impact of Foreign Exchange Risk on Firm Value