Low Interest Coverage Research Articles

Are zombies for real? Evidence from zombie dynamics

This paper analyses zombie firms in a dynamic setup where firm survival not only depends on its current returns, but the firm's exit decision is forward-looking. Building on a model of firm entry and exit and using firm-level data from Finland, we show that the expected future value and growth of a firm are key determinants in whether it is likely to recover from losses accumulated during a spell of weak performance. We find that including firm growth in zombie identification substantially reduces zombie incidence in the data as one third of low interest coverage ratio firms in a common zombie definition are growing companies. Moreover, over a half of exits from zombie status are recoveries to become healthy firms. A policy that may promote the survival of zombie firms is public subsidies. Our analysis does indeed support the notion that subsidized firms are less likely to die, but also their chances of recovery are higher.

Data breaches and firm credit risk

Data breaches may affect firms' future performance, financial stability, and risk profiles, thus potentially resulting in increased credit risk. Using firm-level credit ratings and credit default swap (CDS) spreads to proxy for credit risk, we find that data breaches lead to increases in firm credit risk. Firms exposed to data breaches are more likely to experience credit rating downgrades and an increase in the CDS spread of traded bonds. Also, firms who suffer data breaches report lower sales and ROA, experience an increase in financial distress, and conditional on a data breach incident, the likelihood of a future data breach increases. Lastly, these effects are magnified for firms with low interest coverage ratios.

Capital Market Consequences of the Libor Scandal and Phaseout for Public Borrowers

The London Interbank Offer Rate (LIBOR), based on inputs from banks, is plausibly the most important set of reference interest rates in the world. Following the LIBOR rigging scandal and the post-2008 decline in interbank lending underpinning LIBOR, banks and regulators have agreed to sustain LIBOR only through the end of 2021, after which, LIBOR updates are likely to cease. In this paper, we use an event-based design to study the implications of the LIBOR scandal and phaseout (LSP) on capital markets, focusing on firms with U.S.-traded public debt. Using LSP events as exogenous shocks to the optimality of existing contracts, we provide causal evidence on the effects of the LSP on firms and their stakeholders. Our findings suggest that the consequences of the LSP, as measured by stock and bond returns, are immaterial for the average firm, but negative for firms with fewer outside options to renegotiate or repurchase debt (i.e., with credit ratings below investment grade or lower interest coverage ratios). These results suggest that the negative consequences of the LSP have mostly been borne by the shareholders and bondholders of borrowers with limited options to renegotiate or repurchase debt.

What drives financial hedging? A meta-regression analysis of corporate hedging determinants

We examine the drivers of heterogeneity for the determinants of corporate hedging by applying meta-regression analysis on a sample of 175 primary studies. Taken all previous findings together, hedgers are large, profitable and geographically diversified firms with high capital expenditures and dividend payouts, large debt ratios, and low interest coverage. When breaking the effects down across different world regions, it becomes apparent that the importance of the hedging determinants varies and not all determinants have the same relevance in all geographical areas. Moreover, we find that the type of risk exposure, the source of the hedging data, the inclusion of relevant control variables, and the journal ranking of the publication outlet explain the variation in previous results. There is also evidence that accounting for endogeneity and operational hedging methods are responsible for differences in the reported findings. Researchers should be aware of these drivers of heterogeneity when comparing and interpreting empirical estimates for the hedging determinants obtained from different data and method selections.

What Drives Financial Hedging? A Meta-Regression Analysis of Corporate Hedging Determinants

We examine the drivers of heterogeneity among the determinants of corporate hedging by applying meta-regression analysis on a sample of 175 primary studies. Taken all previous findings together, hedgers are large, profitable and geographically diversified firms with high capital expenditures and dividend payouts, large debt ratios, and low interest coverage. When breaking the effects down across different world regions, it becomes apparent that the importance of the hedging determinants varies and not all determinants have the same relevance in all geographical areas. Moreover, we find that the type of risk exposure, the source of the hedging data, the inclusion of relevant control variables, and the journal ranking of the publication outlet explain the variation in previous results. There is also evidence that accounting for endogeneity and operational hedging methods are responsible for differences in the findings across studies. Researchers should be aware of these drivers of heterogeneity when comparing and interpreting empirical estimates for the hedging determinants obtained from different data and method selections.

Managerial Ability and Credit Ratings

AbstractWe test whether credit rating analysts consider managerial ability as a credit risk factor and find that higher‐ability managers obtain more favorable credit ratings. Controlling for past performance, these results suggest that managerial ability is itself a significant credit rating factor. Cross‐sectional analyses indicate that managerial ability is beneficial specifically in firms facing financial or competitive pressure. We find that high‐ability managers mitigate the adverse impact on ratings of other credit risk factors including negative earnings and low interest coverage. Our results contribute to a growing literature documenting economic benefits to hiring and retaining high‐quality management.

Intangible Capital and Leverage

This study investigates the causal effect of intangible capital on leverage. We use court invalidations of patents by the U.S. Court of Appeals for the Federal Circuit as a proxy for reductions in intangible capital and mitigate endogeneity concerns by exploiting random assignment of judges to court cases. Using an instrumental variable research design, we show that a loss of intangible capital causes a reduction in a firm’s leverage. The effect is stronger for firms with low interest coverage, high proximity to default and small firm size, and if an invalidated patent is pledged as collateral.

Managerial Ability, Credit Ratings, and the Cost of Debt

We test whether credit rating analysts consider managerial ability as a credit risk factor and find that higher-ability managers obtain more favorable credit ratings. Controlling for past performance, these results suggest that managerial ability is itself a significant credit rating factor. Cross-sectional analyses indicate that managerial ability is beneficial specifically in firms facing financial or competitive pressure. We find that high ability managers mitigate the adverse impact on ratings of other credit risk factors including negative earnings and low interest coverage. Our results contribute to a growing literature documenting economic benefits to hiring and retaining high quality management.

Challenging the payment effect in bank-financed takeovers

In the context of bank-financed takeovers, I examine the influence of loans and their characteristics on the success of acquisitions. The unique setting of matched syndicated loans allows me to forego the regular assumption in academic literature of cash payment being equal to debt financing. Consequently, I am able to distinguish between the payment effect and the financing effect of an acquisition. My three main findings are: (i) Payment method is just an estimator of the debt proportion in takeovers. Although percentage of cash has significant explanatory power to account for the sources of financing, variation still remains. (ii) Controlling for the real financial structure renders the payment method insignificant. Hence, the well-known outperformance of cash payment around the announcement of a takeover might actually just be an outperformance of debt-financed takeovers. (iii) Bank-financed acquisitions are associated, on average, with positive abnormal returns for acquirers’ stockholders. Higher bank involvements—approximated by greater deal leverage, higher loan costs, longer maturity, lower interest coverage, or no previous banking relationship—are signals for a more successful takeover.

Split Ratings and Differences in Corporate Credit Rating Policy between Moody's and Standard & Poor's

AbstractThis paper investigates split credit ratings awarded by Moody's and Standard & Poor's (S&P) to U.S. corporations. Bivariate probit model estimates, analyzing 5,238 firm‐year observations from dual‐rated S&P 500/400/600 index‐constituent corporations, indicate firm‐specific financial and governance characteristics predict split ratings. Large, profitable companies with enhanced interest coverage, a greater percentage of independent directors, and more institutional investment are less likely to receive splits. Moody's appears more conservative in its evaluations, assigning lower ratings to smaller, less profitable companies with low interest coverage. Moody's also associates external, independent constraints on managerial autonomy with a higher corporate credit standing relative to S&P.

Cash Flow Volatility and Corporate Bond Yield Spreads

We conduct a detailed empirical study of the effects of cash flow volatility on corporate bond yield spreads. Using a lengthy sample of transaction prices for investment grade straight bonds, we show that cash flow risk has strong statistical significance and economic effects on spreads, after controlling for a large number of factors which are known to be important determinants of spreads such as equity return volatility, credit rating, time to maturity, coupon rate, interest coverage ratio, leverage ratio, etc. The effects of cash flow risk are magnified considerably for firms that are at greater risk of default, as proxied by either relatively low interest coverage ratios or relatively low credit ratings. We consider several alternative ways to measure cash flow risk. While all of them exhibit strong statistical and economic significance, the squared difference between the current quarter's cash flow relative to that from the same quarter in the preceding year stands out as being particularly important.

Research on Influence of the Balance Sheet Channel Effect on Enterprise Investment

In this paper, we selected 98 listed companies as simples and by studying their investment behavior before and after the U.S. subprime mortgage crisis in 2008, we make an empirical analysis of the effect of the balance sheet channel on China's enterprises. Adopt changes in net assets due to changes in asset prices as a variable measure of the balance sheet channel effects, reflecting the impact of the mechanism of direct investment. The results show that: before the crisis, the balance sheet channel effect for low interest coverage ratio greater corporate influence; after the crisis, the impact of the mechanism for the enterprise becomes low interest coverage ratio is not significant, but the impact of high interest coverage ratio of enterprises is still significant, and the impact is greater than before.

Evidence from German Companies of Effects of Corporate Risk Management on Capital Structure Decisions

The author investigates the interaction between risk management and capital structure among publicly listed German companies. By surveying executives at these companies, she computes a risk management score for each company indicating the extent of risk management practices. The scores reflect not only the companies' use of derivatives and “at‐risk” ratios, but also the respondents' assessments of how well risk management has been integrated into existing corporate processes.Some results, though not all, are consistent with finance theory. Most important, companies with more extensive risk management activities have higher debt ratios and lower interest coverage ratios. At the same time, such companies also exhibit lower volatility of cash flow, sales, EBIT, and net income, which helps explain their ability to service more debt. And, finally, companies with more extensive—and, according to their responding executives, more effective—risk management also tend to be larger, have longer debt maturities, lower average costs of debt, and have more tangible assets.

Evidence of Motives and Market Reactions to Sale and Leasebacks

In this paper I find systematic differences between firms using sale-and-leaseback transactions in comparison to industry averages. I find evidence supporting the primary theoretical reason for leasing, namely taxes and mixed support for asymmetric information costs and bankruptcy costs relating to leasing. Contrary to theory, I find that these firms are typically large and solvent with high growth potential but have low interest coverage and high leverage suggesting that the need for cash in tandem with capital constraints are driving these transactions. Controlling for credit constraints, I find abnormal market returns are positively correlated with P/E and negatively correlated with debt structure suggesting that the market perceives sale-and-leaseback funds likely to be used for growth as value enhancing while firms likely to use funds to meet debt obligation experience lower event returns.

An Examination of Mandatorily Convertible Preferred Stock

AbstractI investigate the determinants of the use of mandatorily convertible preferred stock and assess market reaction to its issue. The security is dividend enhanced and converted into common stock within four years. Issuers have high debt ratios, low interest coverage, and bankruptcy risk. Market response to the issue was neutral suggesting the preferred issue resolved the lemon problem associated with common stock. Firms' Z‐scores and abnormal returns are inversely related indicating the issues reduced financial distress. Market response was most positive for low risk firms with high cash flows.

The Determinants of Timing in the Adoption of New Accounting Standards: A Study of SFAS No. 87, Employers' Accounting for Pensions

This study examines whether debt contracting and political costs influence companies' decisions regarding the timing of the initial adoption of Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions. The results are consistent with the debt contracting hypotheses: early adopters tended to have higher leverage and a higher income effect from the adoption and a lower interest coverage ratio and a larger increase in this ratio from the adoption. Our findings, however, do not support the political cost hypothesis.