Financing Cycles and Financial Flexibility
Paper Session
Sunday, Jan. 7, 2024 1:00 PM - 3:00 PM (CST)
- Chair: Kai Li, University of British Columbia
Maturity Overhang: Evidence from M&A
Abstract
In the context of mergers and acquisitions, this paper analyzes a maturity overhang problem that is due to shorter debt maturities creating higher rollover risk. Using bond transaction data, we develop a market-based measure of rollover risk and find that i) rollover risk dampens merger activities at the firm and aggregate levels; ii) acquirers facing higher rollover risk are more sensitive to changes in cash reserves and prefer equity as a payment method over cash; and iii) positive market reactions to cash payment are observed only when firms have low rollover risk. To shed light on our empirical findings, we study a dynamic investment model that underscores the importance of precautionary savings and rollover risk for maturity overhang.Inferring Financial Flexibility: Do Actions Speak Louder than Words?
Abstract
Firms invest intermittently, and a significant part of capital formation occurs during “investment spikes”. Industry-level “spike waves”, during which growth opportunities in an entire industry surge and a large fraction of firms in the industry generate investment spikes, also occur quite regularly. We define financial flexibility as the capacity to accommodate large shortfalls between a firm’s investment needs and cash flows, as is the case when it has an investment spike. We develop an index for financial flexibility (FF) based on which firm-specific variables differentiate firms that generate investment spikes and those that do not during industry spike waves. In out-of-sample tests, our FF Index outperforms five popular financial constrained (FC) indices in predicting investment spikes, as well as regular investment and R&D investment. We use ChatGPT to evaluate the financial constraint status of a large sample of firms based on management statements in 10-Ks and generate new financial constraint measures; however, FF also outperforms these measures. The superior performance of our FF measure suggests that firms’ actions are more revealing of their financial status and its determinants than what is disclosed in annual reports. We validate our empirical approach using data simulated in a model adapted from Gao, Whited, and Zhang (2021). As an application, we show that the FF Index predicts the capacity of firms to sustain investment during economic downturns, and again outperforms the FC Indices.How does Supply Chain Fragility Affect Corporate Policies?
Abstract
Using new data on more than 11,000 foreign suppliers of U.S. manufacturing companies during 2007 to 2011, I show that the supply chains of typical U.S. manufacturing firms are fragile due to their complex production processes, numerous inputs, and limited alternative suppliers for some critical inputs. This concept of supply chain fragility carries important implications for corporate policies. Firms with fragile supply chains tend to hold less cash, possess higher book leverage, and maintain larger inventories than otherwise similar firms. Moreover, the evolution of corporate policies around supply chain shocks suggests that these firms choose to have less liquidity to finance inventory buildup. These effects are economically large and puzzling considering prevailing theories on the precautionary demand for corporate liquidity. In those theories, companies typically increase their cash holdings or maintain debt capacity as a safeguard against potential adverse shocks. However, I propose that corporate liquidity is less advantageous for firms with fragile supply chains because such firms are less likely to have access to spot markets for inputs after disruptions. Consistent with this channel, I find no evidence of intensive or extensive margin reallocations after persistent supply chain disruptions, regardless of whether firms have corporate liquidity ex-ante. Overall, these findings suggest that supply chain risk has important firm-level implications beyond the direct transmission of shocks from suppliers to customer firms.Discussant(s)
Harjoat Bhamra
,
Imperial College London
Zhiguo He
,
University of Chicago
Ran Duchin
,
Boston College
Janet Gao
,
Georgetown University
JEL Classifications
- G3 - Corporate Finance and Governance