US Public Firms Research Articles

Financial Hedging, Corporate Cash Policy, and the Value of Cash

AbstractWe study the implications of financial hedging for corporate cash policy and the value of cash holdings. Using a web crawler program to collect data on the use of financial derivatives between 1993 and 2016, we find that US public firms with financial hedging programs have smaller cash reserves but a higher value of cash than firms without hedging contracts in place. Our empirical results are robust when controlling for potential endogeneity issues, corporate governance, cash regimes and alternative measures of cash holdings. Further, we find that financial hedging not only increases the investment sensitivity to internal cash, but also has a positive effect on investment efficiency. The positive effect of financial hedging on the value of cash is more pronounced for firms with more financial constraints, higher information asymmetry and weaker corporate governance. Collectively, our paper highlights the importance of corporate cash policy as a channel through which financial risk management increases firm value.

Does real earnings smoothing reduce investors’ perceived risk?

AbstractThis study examines whether real earnings smoothing influences equity and credit investors’ perceptions of risk. Using a large sample of US public firms, we find that real earnings smoothing is negatively associated with option‐implied volatility, suggesting that real earnings smoothing lowers equity investors’ perceived risk. We also find that real earnings smoothing is negatively associated with credit default swap spread, implying that real earnings smoothing lowers credit investors’ perceived risk. Our results are robust to multiple sensitivity analyses and to various tests used to address potential endogeneity. Moreover, the effect of real earnings smoothing is greater than that of accrual‐based smoothing, suggesting that real earnings smoothing is more difficult for investors to detect and unravel. Overall, our study documents a new factor that influences both equity and credit investors’ ex‐ante perceptions of risk.

Monetary policy and corporate investment: A panel-data analysis of transmission mechanisms in contexts of high uncertainty

This paper investigates the impact of monetary policy on firm-level investment in contexts of economic turmoil. Using a panel of US public firms for the period 2000–2019, we show that policy-rate-based transmission mechanisms are undermined when uncertainty spikes. Furthermore, we find evidence of the existence of asymmetries at the firm level. In line with real options theory's predictions, firms with higher levels of investment irreversibility, operational inflexibility, and market power, as well as firms with lower cash flows and who operate in low-innovation sectors tend to be less responsive to changes in monetary policy. The effectiveness of monetary policy thus depends on the ability of monetary authorities to reduce uncertainty via expectations-based monetary tools, whilst targeting those sectors more likely to be affected by monetary-policy shifts.

Impacts of Asset Utilization, Market Competition and Market Distance on Stock Returns

To empirically study the effects of asset utilization, market competition and market distance on stock returns of 1961 US public firms of different industry categories over 2001-2015. The heterogeneous panel data set consists of 23,532 (N= 1961*T= 15) observations. Pedroni’s panel co-integration, panel vector errorcorrection model (PVECM), panel dynamic OLS (PDOLS), and panel generalized method of moments (PGMM) are implemented. Both asset utilization and market competition have short-run and long-run positive effects on stock returns. But the effects of market distance are negative. The evidence for convergence toward the long-run equilibrium is very weak. Firms should be strategic to improve asset utilization, be more competitive and expand market distance to maximize stockholders’ wealth.

Quad-qualified audit committee director: Implications for monitoring and reducing financial corruption

Financial corruption has an extensive adverse impact on corporate stakeholders. Over the last two decades, numerous prescriptions have been offered to improve the governance of US public firms, yet financial corruption is still prevalent. Board of directors' audit committees are typically charged with the responsibility of assuring that the corporation's financial reports satisfy the criterion of accuracy. We propose that a quad-qualified audit committee director can serve as an exemplar corporate overseer of financial reporting and minimize the likelihood of corruption. We predict that by having the qualifications of independence, directorship experience and financial expertise, bandwidth, and stock ownership, the effectiveness of monitoring financial reporting by such a director will be considerably enhanced, thus complementing the benefits of the US Sarbanes-Oxley Act (SOX) enacted in 2002. To test our predictions, we employed a time-lagged, matched-pairs sample of 328 large US corporations (164 financially corrupt firms plus a comparison group of 164 compliant firms). Controlling for covariates, we found that the presence of a quad-qualified audit committee director reduced the likelihood of financial corruption in a public firm by 72%. Combined with the benefits from SOX, having at least one quad-qualified audit committee director decreased the probability of financial corruption by 92%. Our results also show that having just one quad-qualified audit committee director is more effective than the combination of the individual qualifications dispersed among the committee members.

Debt Structure

We review the literature on debt structure, which is a central element in a firm's capital structure. We first survey both theoretical and empirical research pertaining to debt characteristics—maturity and priority—and debt types—bank loans, corporate bonds, credit lines, commercial paper, and capital leases. We then present comprehensive empirical evidence on public US firms’ debt structure over the period 2002–2018, highlighting that more than three-quarters of US firms concentrate their borrowing in one debt type, and offer some suggestive explanations for the observed pattern. Finally, we discuss directions for future research, including a better understanding of debt structure choices by non-US firms and by private firms, the cross-sectional and temporal variations in debt structure, the corporate policy implications of firms’ debt structure choices, and the interaction between types of assets and debt structure.

Impact of Total Asset Turnover Ratios on Equity Returns: Dynamic Panel Data Analyses

This paper is an empirical exploration of the impact of total asset turnover ratios on stock returns of 1961 US public firms in different types of industries from 2001 to 2015. Stock prices are significantly influenced by operating performance of a company in efficiently utilizing its assets. For that matter, operating efficiency (as measured by total asset turnover ratio) plays a role in portfolio investment decisions. Pedroni’s heterogeneous panel co-integration procedures, associated bivariate error-correction model (ECM), dynamic ordinary least squares (DOLS) and generalized method of moments (GMM) are applied. Both stock returns and total asset turnover ratios in levels are nonstationary with I (1) behavior. Subsequently, both variables are found cointegrated. The panel ECM estimates suggest convergence of variables toward long-run equilibrium at moderate pace with short-run interactive positive feedback effects. Again, both DOLS and GMM estimates reveal short-run contemporaneous positive effects of total asset turnover ratios on stock returns in levels. In view of the findings of this study, firms should strive to improve operating efficiency, among others, to enhance competitiveness and thereby to boost their stock prices for rewarding shareholders.

Evaluating the Heterogeneous Effect of Firm Risk on Firm Value

Purpose- This paper aims to investigate the effect of firm risk on the firm value to see how the firm value is changing when the risk level is changed. Our result indicates that a higher level of risk can reduce firm value. Design/Methodology- We apply a Bayesian causal technique for a sample data set of US public firms. The causal approach helps us to focus on the reliable and unbiased results instead of the association-based findings. Findings- The results show a negative effect of risk on the firms’ value for the sample data. However, we investigate the potential effect of the risk across the distribution of the firm value. We witness the more substantial effect of risk on firms with a higher value. Practical Implications- Helps firms to evaluate their risk and its effect, so they can adjust their decisions and take actions to reduce the undesired effects of firm risk.

Firm selection and corporate cash holdings

Since the early 1980s, the composition of US public firms has progressively shifted toward less profitable firms with high growth potential (Fama and French, 2004). We estimate a dynamic corporate finance model to quantify the role of this selection mechanism for the secular trend in cash holdings among US public firms. We find that an increase in the precautionary savings motive—primarily driven by the decline in initial profitability among R&D-intensive new lists—explains about 50% of the upward trend in cash holdings. This selection mechanism also explains part of the upward trend in sales growth volatility.

Across the Pond: The Impact of the GDPR on the Resiliency of U.S. Firms’ Board of Directors

One of the prime responsibilities of the board of directors is to understand and oversee its firm’s risk profile. We exploit a recent European Union (EU) regulation, the General Data Protection Regulation (GDPR), as a quasi-exogenous shock to the cyber risk landscape to assess whether boards of US firms changed their focus and governance structures to deal with this new challenge. The GDPR encompasses a sweeping set of regulations aimed at protecting EU citizens from unwanted uses of their personal Internet data. Although an EU regulation, the GDPR applies to all US public firms with at least one EU user. Adopting a difference-in-differences methodology, we use firms that already fell under a US data privacy regulation as a control group, and find that boards of treated US firms, on average, increase their focus on cyber risk, add more directors with cyber/IT expertise, and more frequently assign cyber risk oversight to the board or to a board committee. In cross-sectional tests, we show that these changes are positively associated with a firm’s ex ante cyber risk, but are unrelated to whether a firm had a large EU presence, suggesting a more global reaction to the GDPR. In addition, we examine some of the consequences of these board changes. We find boards that promptly responded by changing their board focus, expertise, and monitoring assignment of cyber risk around the passage of GDPR had fewer future cyberattacks/data breaches and less related media attention. Our findings suggest that, on average, American corporate boards promptly responded to changes in the cyber risk environment in ways that reduced their firms’ overall future cyber risk. Our results have implications for the efficacy and flexibility of US corporate boards to respond to unexpected changes in risk.

Can Global Sourcing Strategy Predict Stock Returns?

In this study, we empirically test the proverbial notion that global supply chains are associated with shareholder value creation as they enable firms' to better serve demand by combining the best of offshore and onshore suppliers. We find that information concerning firms' global sourcing strategy (GSS) strongly predicts their future stock returns. Using a transaction-level imports dataset for the period 2008 to 2019, we measure US public firms' five GSS choices: the extent of global sourcing; supplier relationship strength; supplier concentration; sourcing lead time; and sourcing countries' logistical efficiency. For each of the five measures, we examine returns of a zero-cost investment strategy of buying from the highest and selling from the lowest quintile of that measure. Collectively these investment strategies yield an average annual four-factor alpha of 6% to 9.6% with value-weighted portfolios, and 6% to 13.9% with equal-weighted portfolios. These measures exhibit incremental return predictability over other operations-motivated return predictors such as inventory turnover and cash-conversion cycle and their return predictability is persistent across different supply chain positions, and their predictive power is robust to alternate risk models, sample construction, inventory measures, and empirical specifications. Together, these results indicate that the GSS measures embody independent information about firms' future profitability, a likely explanation for their return predictability power. In accordance, we find that the GSS measures are predictive of firms' future earnings surprises and abnormal returns around the earnings announcement days.

A Model of Market Discipline

We develop an equilibrium model where cash holdings, costly refinancing policies, and managerial incentives are jointly determined to quantify the market's influence on management's ex ante behavior. We also derive a general formula that shows how agency and financing distortions shape payouts and compensation, two easily measured quantities. Our calibrated model estimates agency conflicts are nearly 10 times more severe than financial frictions for US public firms. Our analysis suggests that cutting corporate income taxes while introducing a tax on refinancing can reduce the relative severity of agency.

Financial Hedging and Corporate Cash Policy

We study the implications of financial hedging for corporate cash policy and the value of cash holdings. Using a web crawler program to collect data on the use of financial derivatives between 1993 and 2016, we find that US public firms with financial hedging programs have smaller cash reserves but a higher value of cash than firms without hedging contracts in place. Our empirical results are robust when controlling for potential endogeneity issues, corporate governance, cash regimes, and alternative measures of cash holdings. Further, we find that financial hedging not only increases the investment sensitivity to internal cash, but also has a positive effect on investment efficiency. The positive effect of financial hedging on the value of cash is more pronounced for firms with more financial constraints, higher information asymmetry, and weaker corporate governance. Collectively, our paper highlights the importance of corporate cash policy as a channel through which financial risk management increases firm value.

Public Firm Borrowers of the US Paycheck Protection Program

We document that nearly half of public firms were eligible for the Paycheck Protection Program (PPP), with 30.3% of those eligible choosing to borrow. Consistent with the program's objectives, borrowers tended to be smaller, have less cash, have higher leverage, and fewer investment opportunities. In addition, they faced negative profits in the second quarter of 2020 and their firm values declined upon PPP loan announcement. We further document that 17.7% of PPP borrowers, in particular the healthier firms, returned their loan after public backlash. Overall, concerns of reputational harm from public disclosure appeared to prevent eligible firms from availing emergency government funding.

Impact of Total Asset Turnover Ratios on Equity Returns: Dynamic Panel Data Analyses

This paper is an empirical exploration of the impact of total asset turnover ratios on stock returns of 1961 US public firms in different types of industries from 2001 to 2015. Stock prices are significantly influenced by operating performance of a company in efficiently utilizing its assets. For that matter, operating efficiency (as measured by total asset turnover ratio) plays a role in portfolio investment decisions. Pedroni’s heterogeneous panel co-integration procedures, associated bivariate error-correction model (ECM), dynamic ordinary least squares (DOLS) and generalized method of moments (GMM) are applied. Both stock returns and total asset turnover ratios in levels are nonstationary with I (1) behavior. Subsequently, both variables are found cointegrated. The panel ECM estimates suggest convergence of variables toward long-run equilibrium at moderate pace with short-run interactive positive feedback effects. Again, both DOLS and GMM estimates reveal short-run contemporaneous positive effects of total asset turnover ratios on stock returns in levels. In view of the findings of this study, firms should strive to improve operating efficiency, among others, to enhance competitiveness and thereby to boost their stock prices for rewarding shareholders.

Credit Default Swaps and the Cost of Capital

This study uses the universe of US public firms to examine the impact of credit default swap (CDS) trading on a firm’s cost of capital during the period 2001–2018. Our results robustly show that the inception of CDSs causes a significant reduction in a firm’s weighted average cost of capital (WACC). We also find an increase in the number of analysts who recommend buying CDS firms’ stocks post-CDS trading, suggesting an improvement in the firms’ information environment. Further analyses reveal that highly levered firms tend to reduce their debt weight, while firms with low leverage increase their usage of debt. In equilibrium, we find a marginally decreased net debt issuance post-CDS trading. Moreover, CDS referenced firms adjust their debt placement by using more arm-length debts, while they simultaneously decrease the usage of revolving credits and term loans from banks. The change in capital financing choices may be ascribed to the improved information environment and reflects the fact that CDS trading increases debt renegotiation costs and simultaneously reduces capital supply side frictions.

The Fundamental-to-Market Ratio and the Value Premium Decline

Recent evidence indicates the value premium declined over time. In this paper, we argue this decline happened because book equity, BE, is no longer a good proxy for fundamental equity, FE, defined as the equity value originating purely from cash flows. Specifically, we estimate FE for public US firms (from 1973 to 2018) and find that the premium associated with the fundamental-to-market ratio, FE/ME, subsumes the BE/ME premium and has been stable while the cross-sectional correlation between FE/ME and BE/ME decreased over time, inducing an apparent decline in the value premium. We also show that FE/ME provides a better value premium signal than several alternative valuation ratios beyond BE/ME.

Cost of Information Acquisition and Board Independence: Evidence From a Change in Accounting Standard

Independent directors are valuable because they do not suffer from the agency costs that afflict executive directors. Independent directors also operate at an informational disadvantage compared with executive directors, which makes it hard for them to carry out their duties of advising and monitoring, and thus affects their value. I test the impact of the cost of information acquisition on board structure by exploiting a change in an accounting standard that forced US public firms to be more transparent about their operations. Analysts’ forecasts subsequently became more precise and less dispersed for the firms more affected, suggesting that the cost of information acquisition has decreased. Consistent with independent directors’ greater value, I document an increase in appointed independent directors. Cross-sectional tests suggest that independent directors are more valuable because of their improved monitoring capacity, as opposed to their advising capacity. Robustness tests using alternative data sources do not confirm the findings. Implications are discussed.

The CDS Market Reaction to Loan Renegotiation Announcements

This paper analyzes the credit market's reaction to loan renegotiation announcements through changes in credit default swap (CDS) spreads. Using a sample of public US firms during the period 2010-2017, we document a positive and significant CDS market reaction (decrease in CDS spreads). The strongest reactions are for material amendments such as line of credit amount or tranche amount. On the contrary, we find no significant stock market reaction. Moreover, we identify an anticipation effect of up to 30 days before the announcement date on the CDS market. Finally, we show that firm-specific CDS returns lead the idiosyncratic component of stock returns especially around the announcement date and for speculative-rated firms.

Government contracts and US bond yield spreads: A study on costs and benefits of materialized political connections

AbstractIn a 1991–2013 sample of bonds issued by US public firms, we find that the cost of debt (yield spread relative to comparable Treasuries) of suppliers to government agencies is contingent on the strategic importance of the supplier's industry. The yield spreads for strategically unimportant government suppliers are higher than for firms that are not government suppliers. If government contracts serve as tangible evidence of political connections, these higher yield spreads indicate that weaker corporate governance as a cost of political connections outweighs the benefits of said connections. For the subsample of government suppliers from strategically important industries, where the benefits of implicit bailout guarantees and revenue stability outweigh the corporate governance problems, the cost of debt is lower than for firms that are not government suppliers. The higher (lower) cost of debt for strategically unimportant (strategically important) suppliers is confined to contracting with the federal government. Our findings are robust to alternative variable and sample specifications, and to endogeneity concerns.