Weak Firms Research Articles

Trade debts and bank lending in years of crisis

We provide a causal investigation of the substitutability between trade indebtedness and bank loans following credit supply shocks, using a large sample of Italian firms at the time of the sovereign debt crisis. We find a negative and significant elasticity of trade debt to bank loans, consistently with the pecking order theory. This allows firms to rebalance their financial structure, increasing their resilience to external credit shocks. However, the substitutability is found to be much lower or absent for smaller, riskier, highly leveraged firms: weaker firms may not be able to replace bank credit with trade credit when needed.

Drivers of Corporate Investment in India: Assessing the Impact of Monetary Policy and COVID

Empirical investigation finds that firm-specific factors, namely deleveraging of balance sheets, comfortable cash flows and improving debt servicing capacity impact fixed investment in private corporate sector positively. Monetary policy impacts fixed assets investment growth of financially constrained firms more compared to non-financially constrained firms. Furthermore, the impact of COVID pandemic on investment was more adverse in case of weak firms. JEL Codes: G3, E22, O16, E52

Competitive Firms’ Optimal Decisions on Entering Accessory Market

The smartphone is now a widespread trend that causes phone accessory markets to rise. The high penetration rate of smartphones has led to a saturated market. The accessory market not only has tremendous business opportunities but also high potential. In practice, the decision of whether to join the accessory market differentiates by each smartphone firm. This study analyzed and discussed the main product firms’ optimal decisions of whether to enter the accessory market by using game theory as a construct model. Considering the different competition situations, the decision of whether the main product firm invests in the accessory market affected the market demand, pricing, and profit of all firms. Furthermore, we analyzed the differences in the external environment to determine what the best decision for the main product firm was. The results of the research show that complementary effects do not always have a positive influence on firms’ willingness to join the accessory market. When weak main product firms have different market forces in the main product market, the dominant main product firms are not necessarily more willing to join the accessory market than weak firms.

“Yes-Man” Firms: Government Campaign and Policy Positioning of Businesses in China

Abstract We demonstrate material origin of strategic preference expression in authoritarian systems, where firms express dissent against or conform to the government's position based on what they seek to obtain from the government: politically powerful firms are more likely to dissent to negotiate policy concessions while politically weak firms are more likely to conform to the government's position to obtain side payments or to avoid punishment. We test this argument using survey experiments with firm executives in China. A treatment that signals the government's commitment to liberalize inward foreign direct investment increases the percentage of firms that report to “benefit” from the policy between 14 and 36 percentage points. Powerful firms (state- and foreign-owned) conform the least to the government and politically vulnerable firms and the recipients of government contracts conform the most. Our results suggest that political standing is a key driver of business position-taking in China.

Pay of political directors in China

Independent directors of firms benefit from prior political connections acquired during the public service. Such so-called “politician directors” are found to receive excessive directorship fee. In a quasi-natural experiment, the anti-corruption campaign of “Eight-Point Policy” significantly reduces excessive directorship fee of politician directors. We rule out monitoring or advising role that might otherwise explain excessive directorship fee of politician directors. Finally, weak firms with low productivity or poor performance tend to hire politician officials mainly for accessing bank financing. The evidence highlights the dark side of politician directors and suggests resource misallocation of credit allocation due to political connections.

System‐Wide Runs and Financial Collapse

AbstractThis paper presents a model in which small shocks to asset values can trigger system‐wide runs. When lenders cannot distinguish which financial institutions have suffered losses after an adverse shock to asset values, healthier institutions can differentiate themselves from weaker firms by offering to borrow less at more favorable prices. However, to successfully separate, the healthy institutions must liquidate a fraction of their portfolio causing asset fire sales. Fire sales worsen the balance sheet integrity of the firms and, if too severe, this leads to a complete collapse of the financial system: a system‐wide run.

Make or buy? Explaining diverging frigate procurement approaches in Denmark and Norway

ABSTRACT Why did Denmark and Norway opt for respectively a domestic “make” and a “buy” abroad approach when acquiring comparable major surface combatants given both host a capable shipbuilding industry? Three explanations are examined: (1) Balancing concerns inch small states towards “buy” abroad decisions, if requirements are deemed urgent and if junior alliance partners fear abandonment by senior partners. Junior partners by contrast prefer “make at home” if entanglement is a greater concern. (2) National innovation systems can be biased towards large projects, such as complex warship programmes, or have a knowledge diffusion focus emphasising niche capabilities. The former point to a “make” decision whereas the latter is inclined towards “buy.” (3) Domestic defence industry advocate “make” decisions with the qualification that weaker firms favour “buy” with offset arrangements. Political executives balance job creation with military capability, but recent adverse domestic procurement experiences may prompt governments to favour “buy.”

Sources of Value Creation in Private Equity Buyouts of Private Firms

Abstract Despite the prevalence of private equity (PE) buyouts of private firms, little is known about how these transactions create value. We provide evidence that PE acquirers disproportionately target private firms with weak operating profitability and those that have growth potential but are highly levered and dependent on external financing. Target firms grow rapidly post-buyout, especially those undertaking add-on acquisitions, and profitability increases for both profitable and unprofitable targets. Our evidence suggests that PE acquirers create value by relaxing financing constraints for firms with strong investment opportunities and improving the performance of weak firms, while financial engineering plays a limited role.

A Survival Model for Wilful Default Prediction – Bayesian Approach

This study develops an insolvency model to predict the possible wilful non-payment of debt obligations that turn into bad assets. This paper reveals that financially weak firms have been in deep financial distress somewhere between two to three years prior to their declaration as a wilful defaulter by the initial credit institution and its reporting on the same to the credit information companies. The Cox proportional hazards model (PHM) has been employed, which is a well-known and profusely applied approach not just in medical science but also in forecasting firm bankruptcy. This widely recognized model has been utilized to estimate the effects of different covariates influencing the times-to-event data. The application of Bayesian methods has the benefit in dealing with censored data in small sample over frequentists’ approach. Herein, Bayesian survival framework is applied incorporating normal priors that generally performs better than the traditional likelihood estimation to forecast wilful default. Subsequently, Markov Chain Monte Carlo (MCMC) sampling enables to provide the Bayesian estimator. In the Bayesian structure, the Survival model is used with the help of hazard function. The gamma distribution is selected as the prior for the standard hazard equation in PHM. In order to solve for posterior distribution, the Metropolis Hastings scheme is followed that avoids solving complicated equations with OpenBugs platform.

Corporate Governance, Product Market Competition and Announcement Returns of Spinoff Firms

Our paper investigates the relationship between corporate governance (internal corporate governance mechanism) and announcement returns of spinoff firms, and examines whether such relationship can be explained by product market competition (external corporate governance mechanism). Using a sample of 269 completed spinoffs between 1983 and 2009, we find a nonlinear U-shaped relationship between corporate governance and the cumulative abnormal return around the announcement period. Moreover, we find that such a nonlinear relationship hinges on the level of competition in the market in which the spinoff firms operate. Specifically, we find that weak governance firms experience higher announcement period return only in highly competitive industries, while strong governance firms exhibit higher announcement period return, but only in moderately competitive industries. Our findings reconcile the mixed results in the literature regarding the relationship between corporate governance and firm value by examining the effect of product market competition on this relationship. Our results highlight the importance of product market competition as a moderator between corporate governance and the announcement period return of the spinoff firms.

The relevance of relational capabilities in collaborative decisions

PurposeThis study aims to focus on inter-firm collaboration, exploring the main capabilities that can make a business more or less open to collaboration; it also considers the role of both firm-specific and relationship-specific capabilities. The paper proposes a model that can be used to study how the combination of the two categories of capabilities determines a firm’s approach to collaboration.Design/methodology/approachThrough a survey of high-end hotels in tourist destinations in Italy and the USA, this paper tests variable connected with firm-specific and relationship-specific aspects, using confirmatory factor analysis.FindingsFirms with greater capabilities are less open to cooperation; weaker firms with fewer resources appear to be more inclined to cooperate, probably to gain access to resources and competencies they do not possess.Research limitations/implicationsFrom a scientific perspective, this paper suggests an analysis based on both individual and relational capabilities when deciding whether to collaborate, while most studies based on a relational view just consider relational capabilities. The study could be enlarged to other countries and contexts.Practical implicationsFrom a practical perspective, it indicates the importance of accounting for different and sometimes diverging aspects when deciding to cooperate.Social implicationsIn terms of social implications, it shows that, apart from the relational capabilities they have, potential partners can decide not to collaborate.Originality/valueThe paper suggests a method of analyzing both individual and relational capabilities when deciding whether to engage in a collaboration. It shows that firms’ behavior does not necessarily depend on the firm’s relational capabilities.

The Strength of Weak Firms: New Venture Organizing Flexibility

How do the strategies of startups differ from those of the established organizations? It is important to understand two fundamental liabilities of new ventures to find answers to this inquiry. First, because founders tend to have prior work experience from other companies in the same industry, and they are already encultured to the industry norm, it is difficult for entrepreneurs to differentiate their organizational form, culture and identity, and products and services from their potential competitors. Second, many new ventures start their businesses in the markets where established players dominate. The stability of new ventures is often questioned, and they also lack the status of larger established firms, so resource mobilization is extremely challenging. This symposium aims to investigate the strategies that startups can take to leverage these two fundamental burdens, so that they turn into advantages instead. To that end, we invite scholars whose respective work falls under one of the following two categories: startup strategies to (a) gain and create resources and (b) organize activities. Unlocking Value from Startups’ Ties to Established Firms: The Role of the Entrepreneurs’ Background Presenter: Sarath Balachandran; The Wharton School, U. of Pennsylvania Chasing Talent: Startup Hiring Through Firm-Driven Search Presenter: J. Daniel Kim; The Wharton School, U. of Pennsylvania Presenter: Michael Pergler; The Wharton School, U. of Pennsylvania When Do New Ventures Use a Clean Slate to Build Something Different? Presenter: Yeonsin Ahn; INSEAD Deference and Asymmetric Alliance Formation Between Ventures Presenter: Emily Cox-Pahnke; U. of Washington Presenter: Toby Li; Texas A&M U. Presenter: Michael Deane Howard; Texas A&M U., College Station Presenter: Leif Brändle; U. of Hohenheim Biased Sampling of Early Users and the Direction of Startup Innovation Presenter: Ruiqing Cao; - Presenter: Rembrand Michael Koning; Harvard Business School Presenter: Ramana Nanda; Imperial College London

Fundamental analysis, low accruals, and the accrual anomaly: Korean evidence

ABSTRACT Prior studies in Korea document that low accrual firms yield extremely low returns, driving away abnormal returns of an accrual-based trading strategy. We examine whether the performance of an accrual-based trading strategy can be improved using fundamental analysis to distinguish financially strong firms (‘winners’) from financially weak firms (‘losers’) within low accrual firms. Using Korean data from 1994 to 2018, our findings are summarised as follows. First, applying FSCORE in Piotroski (2000) [Journal of Accounting Research, 38(supplement), 1–41] to distinguish winners from losers within low accrual firms, we find that winners yield much higher future returns than losers. Second, after excluding losers in the low accrual group, the accruals-based hedge portfolio exhibits higher abnormal returns. Lastly, we find that, among low accrual firms, higher FSCORE is associated with less negative accruals, higher future probability, and lower probability of delisting. Overall, our findings imply that the extremely negative accruals (i.e., low accruals) do not signal good fundamentals, although Piotroski (2000) treats the negative sign of accruals as a universally positive signal of future performance. It also implies that investors do not fully incorporate the implications of low accruals for future performance.

The financial impact of COVID-19: Evidence from an event study of global hospitality firms

This paper examines the daily abnormal stock price returns of a sample of 154 publicly-traded hospitality firms from 23 different countries representing over $400 billion in combined market capitalization around the time that COVID-19 was first viewed by stock market participants as a major—possibly even existential—threat. The findings of the study suggest that, financially, hotels performed better than restaurants, which themselves performed better than casinos. These findings are consistent with medical recommendations concerning the relative safety of various hospitality-related activities and, therefore, also with the tenets of financial market efficiency in the hospitality sector. Additional findings suggest that hospitality firms with strong balance sheets and income statements characterized by relatively low leverage ratios, high market value (consistent with a “too big to fail” mentality), and higher price/earnings ratios (implying higher relative profitability) all fared better than smaller, weaker firms. Although, in no case, did Bloomberg's proprietary environmental, social, and governance (ESG) variable possess any predictive power, variables reflecting cross-country cultural differences support Huynh’s (2020) finding that “individualism” was an important factor in explaining the economic impact of the COVID-19 pandemic on hospitality firms.

Bonding and bridging social capital in family firm internationalization

Purpose of the paper: This paper aims to study how family firms manage their Global Value Chain (GVC). In particular, we investigate how family firms are able to keep control over operations outsourced to foreign partners. Prior research focused on understanding how firms control their GVC has mainly concentrated on large multinational enterprises. However, while large multinational enterprises can overcome transaction cost complexities by exploiting their superior legitimacy and power control over weaker firms, family SMEs often do not have that amount of power due to financial and managerial constrains. In this study, we thus conceptually examine a unique characteristic that can help family SMEs to overcome resource limits and gain control over the GVC: their distinctive social capital. Methodology: Conceptual Findings: Family SMEs can exploit their superior social capital in order to build long-term relationships based on trust with foreign partners, thereby being able to control their GVC without legally owning it. Research limits: The study is conceptual, future research should test the model and empirically examine the theorized mechanisms. Social capital is only grasped according to its positive side and in relation to cohesion, future research should examine the negative side of social capital and the role of conflict in our model. Finally, family firm heterogeneity is currently neglected. Practical implications: Our study offers insightful managerial suggestions to family firm executives and their foreign partners in terms of design and governance of their GVC. Originality of the paper: Our study offers theoretical and managerial contributions to the current understanding of family firm internationalization beyond exports.

Corporate governance and product market competition: evidence from import tariff reductions

Using large reductions in import tariffs as an exogenous shock to the competitive environment, this paper examines how an increase in foreign competition affects the importance of corporate governance. Consistent with prior studies, weak governance is associated with lower firm value, lower operating performance, lower labor productivity, higher capital expenditures, higher non-production expenses, and higher wages in the absence of increased competition. However, the differences between weak and strong governance firms along each of these dimensions are reduced or eliminated after a tariff cut. The effects are concentrated among firms in previously noncompetitive industries, defined as having sales concentration above the median or import penetration below the median in the year before the tariff cut. These conclusions are supported through the use of multiple alternative measures of operating performance and corporate governance. Altogether, the evidence indicates that an increase in competition can mitigate agency costs and serve as a substitute for traditional corporate governance mechanisms.

Reputational dynamics in financial networks during a crisis

Firm reputation plays a vital role in financial networks, and it is especially impactful in times of market stress or a financial crisis. This paper uses a novel theoretical model to study reputational dynamics in financial networks, taking into account that firms begin with incomplete information, learn about others over time, and update their connections as their beliefs evolve. In our model, stronger firms develop high reputations and remain in the network, while weaker firms will eventually drop in reputation and get shut out. We show that more information revelation during crisis generally increases network fragility and harms social welfare. It is thus crucial to maintain anonymity among firms during a crisis. Certain network structures, such as core-periphery networks, are more systemically resilient against negative informational effects.

Clusters and firm-level innovation: A configurational analysis of agglomeration, network and institutional advantages in European aerospace

Clusters have the potential to strengthen firm innovation. However, our knowledge of how firms are affected by the external resources found in clusters, and how this relates to their level of internal resources, is limited. There are seemingly conflicting theoretical assumptions and empirical findings on both the individual and combined impact of these resources. Our paper seeks to reconcile these by adopting a configurational lens, allowing for multiple pathways to innovation. Applying fuzzy-set Qualitative Comparative Analysis (fsQCA) to a sample of firms in European aerospace clusters, we uncover that innovation outcomes can only be explained through combinations of internal assets, and external resources provided by geography, networks, and institutions. No single resource, in isolation, is sufficient. We distinguish between a total of seven pathways. These vary from weak firms benefitting from localized knowledge spillovers, to strong firms with extensive non-local networks. We find that the relationship between internal and external resources is causally complex, with even the potential for negative innovation impacts. Hence, we provide a first step towards harmonizing the literature's different approaches to understanding clusters’ impact on firms.

Debt-Equity Swap, Subsidy and Optimal Government Policy

In 2016, the Chinese government proposed a one-time debt-equity swap (DES) program to assist firms in financial distress and to reduce the leverage ratio of non-financial firms. We use a dynamic capital structure model to study the effects of this program on firms with and without subsidy. A DES can increase a firm’s value by lowering its leverage ratio and reducing its expected bankruptcy cost. The subsidized firms initially take more debt and are thus more incentivized to undertake a DES. Notably, a firm’s undertaking a DES can have opposite effects on government value: on the one hand, it can increase government value from the tax-benefit channel, but on the other hand, it can reduce government value by extending the period of tax shields and subsidies granted to a firm. Consequently, we show that the optimal government policy depends on the characteristics of firms and the ultimate goals of government. In particular, the optimal policy for subsidized weak firms is a DES with subsidy removal, which introduces a tradeoff between a DES and a subsidy.

A Theoretical and Experimental Investigation into the Welfare Consequences of Late Payments

Motivated by payment terms observed in regulatory reporting data, we construct a signalling model to analyse how late payments affect market entry and price competition in business-to-business transactions. Buyers first signal a payment term to potential suppliers, either standard or extended. Suppliers then decide whether to incur a fixed and irreversible cost to enter into competition for the contract. After the seller and the winning bid is determined, the buyer chooses whether or not to honour the agreed payment term. We show theoretically that late payments feed into higher prices and reduced competition. Reneging on a standard payment term entails a penalty for the buyer. If this penalty is not set carefully, a welfare loss arises due to price spillover effects in the market. The effectiveness of the penalty is diluted when it accrues as interest to the creditor, relative to when it is collected by a third party. We provide experimental evidence that the probability of a timely payment responds to the institutional environment, that free-riding behaviour may emerge among weaker firms, and that extended payment terms reduce consumer surplus. Our findings have implications for the horizontal effects of supply chain payment practices and for the design of regulatory interventions to deter late payments.