Low Leverage Firms Research Articles

Commitment and Investment Distortions Under Limited Liability

We study how frictions originating from limited liability distort firms' investment and financing choices. By financing new investments with debt, firms can use limited liability to credibly commit to defaulting earlier—allowing both firm owners and new creditors to benefit from diluting existing creditors. In a dynamic setup, this leads to time-inconsistency, increasing the cost of external funds and discouraging investment. We show that the interaction of these two forces leads to heterogeneous investment distortions, where highly-indebted firms overinvest and those with low levels of debt underinvest. Allowing firm owners to pay themselves directly from new debt issuance can mitigate overinvestment but, in the presence of repeated investment opportunities, tends to exacerbate underinvestment among low-leverage firms.

Climate risks and corporate tax shields

ABSTRACT This study investigates the influence of climate risks on the tax shields of US-based firms. The findings show a significant negative correlation between climate risks and debt-related tax shields (DTS), indicating reduced reliance on debt financing due to potential financial risks and regulatory uncertainties. Conversely, non-debt tax shields (NDTS) demonstrate a positive relationship with climate risks, highlighting firms’ proactive efforts to seek tax benefits from alternative sources. Additionally, the study uncovers distinct dynamics for high and low-leveraged firms in utilizing tax advantages. The research contributes valuable insights into the intricate interplay of climate risks, tax benefits, and corporate financing decisions.

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.

Social reputation, loan contracting and governance mechanisms

PurposeThis study aims to investigate whether social reputation via corporate social responsibility (CSR) awarding facilitates access to debt and decreases the cost of debt and whether governance mechanisms moderate this relationship.Design/methodology/approachThe sample covers the period between 2002 and 2021, during which CSR award data were available in the Thomson Reuters Eikon/Refinitiv database. The empirical models are based on country, industry and year fixed-effects regression.FindingsWhile the main findings produced an insignificant result for access to debt, they indicated strong evidence for the positive relationship between CSR awarding and the cost of debt. Moreover, the moderating effect highlights that while the sustainability committee helps CSR-awarded companies access debt more easily, independent directors help firms decrease the cost of debt via CSR awarding. Furthermore, the results differ between the US and the non-US samples, earlier and recent periods, high- and low-leverage firms and large and small firms.Originality/valueFor the first time, to the best of the authors’ knowledge, the authors assess whether social reputation via CSR awarding facilitates access to debt and decreases the cost of debt in an international and cross-industry sample. Little is known about the effect of social reputation on loan contracting, although social reputation conveys broader information that goes beyond the firm’s internal (performance) and external (reporting) CSR practices. The authors also draw attention to the differing roles of distinct governance mechanisms in leveraging social reputation for loan contracting.

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.

Does local government debt affect corporate social responsibility? Evidence from China

We examine the influence of local government debt on local firms' corporate social responsibility (CSR). Using a sample of Chinese public companies, we find that local government debt is negatively associated with local firms' CSR performance, indicating that government debt financing behaviour dampens firms' CSR engagement. Furthermore, the adverse influence of local government debt on CSR is particularly evident for non-state-owned enterprises and low-leverage firms. This article makes a contribution to CSR research by furnishing empirical evidence about the nexus between government debt and firms' CSR performance. Our study indicates that a company conditions social responsibility decisions on the availability of external financing resources, and local governments should be aware that excessive government debt generates an adverse impact on firms’ CSR fulfillment. This study is the first to explore the link between government debt and CSR, and the results help enrich our understanding of the determinants of CSR and the consequences of local government debt.

Targeted poverty alleviation initiatives and corporate sustainable value creation: Determining the role of corporate internal governance control in China

This study examines the impact of firms' targeted poverty alleviation activities on corporate value and how corporate internal governance regulates this relationship. This study uses Fixed Effects and System GMM estimations to test hypotheses by analyzing data from Chinese non-financial listed firms from 2016 to 2021. The results demonstrate that corporate targeted poverty alleviation and internal corporate governance control affect company value and governance. Corporate value increases as a result of effective internal governance. Internal governance control enhances the positive relationship between the firm's targeted poverty reduction and value creation. This study's findings are robust to alternative measures of poverty alleviation initiatives. Furthermore, heterogeneity analysis reveals that non-SOE firms, small and low-leverage firms engaging in anti-poverty activities are in a better position to achieve value creation. This study adds to the literature on poverty reduction, sustainable corporate value creation, and corporate internal governance control. Study results may help policymakers and managers in evaluating their business strategies by focusing more on fulfilling social responsibilities to eradicate poverty from the region by improving governance policies to generate sustainable value for the firm.

Cash flow management and its effect on firm performance: Empirical evidence on non-financial firms of China.

The main purpose of this research is to investigate the impact of changes in cash flow measures and metrics on firm financial performance. The study uses generalized estimating equations (GEEs) methodology to analyze longitudinal data for sample of 20288 listed Chinese non-financial firms from the period 2018:q2-2020:q1. The main advantage of GEEs method over other estimation techniques is its ability to robustly estimate the variances of regression coefficients for data samples that display high correlation between repeated measurements. The findings of study show that the decline in cash flow measures and metrics bring significant positive improvements in the financial performance of firms. The empirical evidence suggests that performance improvement levers (i.e. cash flow measures and metrics) are more pronounced in low leverage firms, suggesting that changes in cash flow measures and metrics bring more positive changes in low leverage firms' financial performance relatively to high leveraged firms. The results hold after mitigating endogeneity based on dynamic panel system generalized method of moments (GMM) and sensitivity analysis considering the robustness of main findings. The paper makes significant contribution to the literature related to cash flow management and working capital management. Since, this paper is among few to empirically study, how cash flow measures and metrics are related to firm performance from dynamic stand point especially from the context of Chinese non-financial firms.

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.

High Inflation: Low Default Risk and Low Equity Valuations

AbstractWe develop an asset pricing model with endogenous corporate policies that explains how inflation jointly affects real asset prices and corporate default risk. Our model includes two empirically founded nominal rigidities: fixed nominal debt coupons (sticky leverage) and sticky cash flows. These two frictions result in lower real equity prices and credit spreads when expected inflation rises. A decrease in expected inflation has opposite effects, with even larger magnitudes. In the cross-section, the model predicts that the negative impact of higher expected inflation on real equity values is stronger for low leverage firms. We find empirical support for the model’s predictions.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.

Managerial compensation and fixed intangible assets investment: the role of managerial ownership and firm characteristics

PurposeThis study examines how cash and stock bonus compensations influence top executives to allocate a firm's resources to fixed intangible assets investment and the extent to which this relationship is conditional on executives' ownership, firm growth, internal cash flow and leverage.Design/methodology/approachUsing data from 213 non-financial and non-utility UK FTSE 350 firms for the period 2007–2015, generating a total of 1,748 firm-year observations, panel econometric methods are employed to test the authors’ model.FindingsThe authors observe that executives' cash bonus compensation positively impacts fixed intangible assets investment. However, executives' stock bonus compensation has a negative and significant influence on fixed intangible assets. The authors further observe that executives either cash bonus or stock bonus crucially invest more in fixed intangible assets when the firm has a growth potential. Also, both cash bonus and stock bonus executives in firms with lower internal cash flow spend less on fixed intangible assets. Similar results are also observed for those stock bonus-motivated executives with an increase in fixed intangible assets for low leverage firms but a decrease for high leverage ones.Research limitations/implicationsA key limitation of this study is its concentration on a single country (United Kingdom). Thus, future studies can expand the focus of this study by looking at it from the perspective of multiple countries.Practical implicationsThe practical relevance of the study results is that firms with high growth opportunity in fixed intangible assets activity can use more cash bonus compensation (risk-avoiding incentive) to induce corporate executives to invest more in such activity. This finding is particularly important given the increasing appetite of firms in this knowledge-based economy to create expansion through fixed intangible assets investment. That is, for firms to increase fixed intangible assets investment, this study suggests that executive cash bonus compensation cannot be ignored.Originality/valueWhile this paper builds on the classic Q theory of investment literature, it is the first – to the best of the authors’ knowledge – to explore how cash and stock bonus compensations influence top executives to allocate a firm's resources to fixed intangible assets investment and the extent to which this relationship is conditional on executives' ownership, firm growth, internal cash flow and leverage.

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.

Environmental uncertainty and corporate cash holdings: The moderating role of CEO ability

AbstractThis article empirically tests the association between environmental uncertainty and corporate cash holdings and whether CEO ability moderates this association. Based on the precautionary motive for holding cash, we predict that firms will hold more cash when operating in an environment of high uncertainty. To test this prediction, we utilize a panel of non‐financial U.S. firms throughout 1980–2016. Using the coefficient of variation in sales as a proxy for environmental uncertainty, we find that environmental uncertainty increases firm cash holding. We then explore the moderating role of CEO ability and find that more‐able CEOs weaken the positive association between environmental uncertainty and cash holding. Further, the results demonstrate that small‐sized, financially sound, and low leveraged firms are likely to hoard more cash during periods of heightened uncertainty. Our study provides new insights for investors, shareholders, and policymakers into companies' decision‐making concerning liquid assets.

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.

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.

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.

Crossing the Credit Channel: Credit Spreads and Firm Heterogeneity

We show that credit spreads rise after a monetary policy tightening, yet spread reactions are heterogeneous across firms. Exploiting information from a unique panel of corporate bonds matched with balance sheet data for US non-financial firms, we document that firms with high leverage experience a more pronounced increase in credit spreads than firms with low leverage. A large fraction of this increase is due to a component of credit spreads that is in excess of firms' expected default -- the excess bond premium. Consistent with the spreads response, we also document that high-leverage firms experience a sharper contraction in debt and investment than low-leverage firms. Our results provide evidence that balance sheet effects are crucial for understanding the transmission mechanism of monetary policy.