Use Of Equity Financing Research Articles

Financial constraints and financing sources in mergers and acquisitions

We study the effects of financing sources and financial constraints in mergers and acquisitions. We explicitly distinguish between methods of payment and financing used in takeovers and find that financial constraints have a strong influence on choices of both payment and financing methods. Financially constrained firms are less likely to pay for acquisitions in cash. Greater financial constraints are associated with greater use of equity financing, followed by internal funds, with debt as the least preferred financing alternative. Consistent with agency theory, more constrained bidders experience higher takeover announcement returns. However, we find financing sources to have little impact on abnormal returns.

Split-share reforms and capital structure adjustment in China: a dynamic panel fractional estimation

PurposeThe purpose of this study is to explain the adjustment rate toward the target capital structure of Chinese nonfinancial listed firms and to investigate the impacts of the split-share reforms (2005–2006) on the capital structure adjustment rate.Design/methodology/approachThe authors control for the unobserved heterogeneity and the fractional nature of the adjustment rate by applying an unbiased dynamic panel fractional estimator on the unbalanced panel data of 27,545 firm-year observations of Chinese nonfinancial firms listed during 1998–2015.FindingsThe authors find that Chinese firms adjust at an annual rate of 19–27% to reach their capital structure targets. The authors also find a positive impact of the split-share reforms on the adjustment rates of Chinese nonfinancial firms toward their target capital structure. Split-share reforms also helped Chinese firms to increase the use of equity financing in their capital structure.Practical implicationsThe authors argue that the government should strengthen capital markets to enable easy access to more financing options so that Chinese firms can acquire cheaper external financing.Originality/valueTo the best of authors' knowledge, this is the first study that applies an unbiased dynamic panel fractional estimator on an extended data set of 27,545 firm-year observations of Chinese nonfinancial firms listed during 1998–2015.

Firm Financing over the Business Cycle

Firm financing is the link between financial markets and the real economy. In this paper, we investigate how firm financing depends on the state of the economy. Using Compustat data, we look at the external financing decisions of firms over the business cycle. We find that firm financing is cyclical, but that the cyclicality depends on size. Whereas large firms seem to substitute between debt and equity financing over the business cycle, small firms are unable to do so, increasing financing in good times and reducing it in bad. More importantly, small firms make extensive use of equity financing which is generally more expensive. In this paper, we propose a mechanism that explains these empirical facts in a heterogeneous firm optimization model. Our mechanism is based on two main features: (1) small firms are growing and therefore need more funds and (2) cost of debt financing is higher for more leveraged firms. These features imply that small firms’ funding needs cannot be satisfied by debt alone - especially not in booms when growth opportunities and therefore funding needs are higher. For this reason they turn to equity. The model accounts for the cyclical patterns we see in the data.

The cost of capital: U.S.-based multinational corporations versus U.S. domestic corporations

Using firm-level panel data, this paper examines whether the cost of capital (COC) differs significantly between U.S.-based multinational corporations (MNCs) and U.S. domestic corporations (DCs). The results suggest that U.S.-based MNCs have higher COC than U.S. DCs and that industry importantly influences COC. The study also finds that there is a significant time effect on COC, and the time effect follows the trend of the U.S. economic growth rate. Using a Bayesian Markov chain Monte Carlo approach, we estimate jointly cost of equity, cost of debt, and capital structure, and find that the higher cost of capital for MNCs is due mainly to their higher cost of equity and greater use of equity financing; the cost of debt financing does not differ significantly for MNCs versus DCs.

The use of equity financing in debt renegotiation

Debt renegotiation is often modeled as pure debt for equity or debt for debt swaps in the theoretical literature. However, the empirical evidence in the debt repurchase literature shows that a combination of debt and equity, along with asset sales is used in renegotiation. In this paper we analyze the use of equity financing in addition to debt financing and asset sales in debt repurchases. Firms with larger volatility, lower cash flow growth rates, or higher recovery rates are more likely to use equity financing in debt renegotiation. Flotation and renegotiation costs, the bargaining power of the creditors, and macroeconomic variables also influence this choice. When equity issuance is a possible source of financing in renegotiation, firms optimally choose smoother coupons and welfare increases as compared to pure debt for debt swaps. We provide closed-form solutions for the optimal use of funding and we derive novel testable empirical implications regarding the use of equity financing in debt repurchases.

Poverty alleviation through financing microenterprises with equity finance

PurposeThis paper aims to achieve scale, efficiency and mitigate high monitoring costs, and explores the efficacy of micro equity finance at the enterprise level. The study compares the economic features of the proposed framework with interest-based debt finance.Design/methodology/approachThis study uses a mathematical model to highlight the problem of agency costs including adverse selection and moral hazard.FindingsDebt finance requires frequent repayments and indebtedness for financial inclusion. Conversely, the Islamic equity modes of financing in their current baseline structure suffer from high agency costs. By using enterprise level finance and distinct entry criterion for availing Islamic debt-based and micro equity finance, Islamic microfinance institutions (IMFIs) can reach the right targets and effectively mitigate the problem of adverse selection and high monitoring costs. The study suggests a framework in which equity financing could be used to fund microenterprises that will employ poor people with related skills.Research limitations/implicationsAs the preferable modes of Islamic finance, i.e. Musharakah and Mudarabah, are not used by Islamic financial institutions (IFIs), empirical analysis of performance is not possible as they are rarely used.Practical implicationsThe study suggests a workable model that can use Islamic equity-based modes of financing to improve microfinance outreach and achieve scale. The use of equity financing will help the Islamic finance industry to move toward its egalitarian vision, and the practical implementation of the model will help in reducing poverty in the Muslim majority countries.Social implicationsMuslim countries host half of global poverty, even though their share in global population is only one-fourth. Hence, there is need for solutions in achieving scale in poverty alleviation efforts.Originality/valueUsing a mathematical model, the paper presents agency problems in Islamic microfinance and proposes a solution through distinct entry criterion and enterprise level micro equity finance.

The Influence of Regulation Fair Disclosure on Firm Financing Decisions

Extant theory claims a firm's information environment impacts the choice between debt and equity financing. However, empirical evidence supporting this contention is limited. We evaluate this relation within the context of Regulation FD (Reg FD) which prohibited the use of selective disclosure. We find firms with high proprietary costs of public disclosure are more likely to resort to debt financing following the passage of Reg FD. This relation is not sensitive to whether a firm has relied on selective disclosure in the pre Reg FD regime. We also evaluate changes in firm disclosure policy and find firms that adopted an expansive public disclosure policy are more likely to turn to equity financing. Overall, our evidence is consistent with the pecking order theory: firms with deteriorated firm information environments increase their use of less information sensitive debt while firms with improved information environments favor the use of equity financing.

Does the Firm Information Environment Influence Financing Decisions? A Test Using Disclosure Regulation

Extant theory claims a firm’s information environment impacts the choice between debt and equity financing. However, empirical evidence supporting this contention is limited. We evaluate this relation within the context of Regulation Fair Disclosure (Reg FD), which prohibited the use of selective disclosure. We find that firms with high proprietary costs of public disclosure are more likely to resort to debt financing following the passage of Reg FD. This relation is not sensitive to whether a firm has relied on selective disclosure in the pre-Reg FD regime. We also evaluate changes in firm disclosure policy and find that firms that adopted an expansive public disclosure policy are more likely to turn to equity financing. Overall, our evidence is consistent with the pecking order theory: firms with deteriorated firm information environments increase their use of less information-sensitive debt, whereas firms with improved information environments favor the use of equity financing. This paper was accepted by Mary Barth, accounting.

Effects of family ownership and management on small business equity financing

Equity financing is important in financing growth but its special features in small business have not been well addressed in the finance or entrepreneurship literature. Since many small firms have family involvement and research shows that family firms have both advantages and disadvantages in managing agency costs, how family involvement and agency issues interact to affect equity financing in small business is an important topic of research. This study examines the effects of family ownership and management on two dimensions of small business equity financing, the use of equity financing and the use of public equity financing within the agency theory of financing. The results show that family involvement and agency issues interactively and separately influence equity financing in small business.

Trade-Off and Pecking Order Theories of Debt

Taxes, bankruptcy costs, transactions costs, adverse selection, and agency conflicts have all been advocated as major explanations for the corporate use of debt financing. These ideas have often been synthesized into the trade-off theory and the pecking order theory of leverage. These theories and the related evidence are reviewed in this survey. A number of important empirical stylized facts are identified. To understand the evidence, it is important to recognize the differences among private firms, small public firms and large public firms. Private firms seem to use retained earnings and bank debt heavily. Small public firms make active use of equity financing. Large public firms primarily use retained earnings and corporate bonds. The available evidence can be interpreted in several ways. Direct transaction costs and indirect bankruptcy costs appear to play important roles in a firm's choice of debt. The relative importance of the other factors remains open to debate. No currently available model appears capable of simultaneously accounting for all of the stylized facts.

THE ASIAN CRISIS: LESSONS FOR CRISIS MANAGEMENT AND PREVENTION

The succession of financial crises that swept through Asia, Russia, and Latin America in 1997 and 1998 has led to considerable debate about both the role of the IMF and possible actions to limit further crises. Some have argued that international financial markets do not function well and are subject to periodic contagious panics that can be stemmed by an international lender of last resort. This paper argues that the IMF has neither the resources nor the superior information to play such a role. However, there may be a need for an international financial institution that can use its leverage to secure policy changes in the affected countries.The paper also takes issue with the view that the IMF is simply bailing out imprudent international banks and that measures are needed to “bail them back in” again. The source of the Asian crisis lay in the real economy, but the effect of the crisis was greatly exacerbated by the financial structure of the affected countries. In particular, much of the risk was borne by domestic banks that borrowed dollars in the short‐term interbank market and made longerterm loans in the local currency. Public policy needs to be directed to ensuring that the risks in emerging markets are distributed efficiently across both foreign and domestic investors. That involves greater use of equity finance and structured debt, as well as possibly a more direct role for foreign banks in funding local activities.

The Asian Crisis: Lessons for Crisis Management and Prevention

The succession of financial crises that swept through Asia, Russia and Latin America in 1997 and 1998 led to considerable debate about both the role of the IMF and possible actions to limit further crises. Some have argued that international financial markets do not function well and are subject to periodic contagious panics that can be stemmed by an international lender of last resort. This paper argues that the IMF has neither the resources nor the superior information needed to fulfil such a role. However, there may be a need for an international financial institution that can use its leverage to secure policy changes in the affected countries. The paper also takes issue with the view that the IMF is simply bailing out imprudent international banks and that measures are needed to bail them back in again. The source of the Asian crisis lay in the real economy, but the effect of the crisis was greatly exacerbated by the financial structure of the affected countries. In particular, much of the risk was borne by domestic banks which borrowed dollars in the short‐term interbank market and made longer‐term loans in the local currency. Public policy needs to be directed to ensuring that the risks in emerging markets are distributed efficiently across both foreign and domestic investors. That involves greater use of equity finance and structured debt.