that a technology (or financial innovation) shock might facilitate CDS trading. As the markets expand and become more liquid, the timing of CDS trading is likely to be exogenously affected by the ease with which traders locate prices and counterparties owing to the accumulated experience and knowledge of CDS trading. Notwithstanding, I address endogeneity concerns further by performing a propensity score matched sample analysis (Rosenbaum and Rubin (1983)). Matched firms, identified as firms that have never traded CDS but have similar characteristics to firms with CDS, are used as a control group. This paper contributes to a growing literature of the implications of credit derivatives on corpora- tions, particularly corporate debt financing. To the best of my knowledge, my paper is one of the first to address the impact of CDS on the cost of debt through the strategic default channel. Arping (2014) examines the impact of CDS on lending relationships and develops a theoretical model where CDS have positive implications for borrower incentives ex-ante. Norden and Wagner (2008) document that CDS trading affects the syndicated corporate loan market by providing a lead bank with a hedging opportunity. Narayanan and Uzmanoglu (2014) analyze the relation between CDS and the strategic behavior of firms but do not compare bond values for before and after the introduction of CDS. Saretto and Tookes (2013) examine the impact of CDS on a firm’s debt capacity, but not debt values, which is the focus of my study. Das, Kalimipalli, and Nayak (2014) investigate the impact of CDS trading on the corporate bond market, focusing on its efficiency and liquidity. Ismailescu and Phillips (2014) show that CDS initiation provides significant price efficiency benefits in the underlying sovereign market.
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If the causes detailed above had been appropriately taken care of by all the players, probably we can avoid such huge numbers queueing up for CDR. There have been instances of banks extending credit to doubtful debtors (who wilfully default on debt) and getting kickbacks for the same. Ineffective legal mechanisms and inadequate internal control mechanisms have made this problem grow – quick action has to be taken on both counts so that both the defaulters and the authorising officer are made accountable judiciously without paralysing their decision making abilities as is currently the state in the country. Without this, all the mechanisms may prove to be ineffective. On a broader note, there is the need for contingency planning for too-big-to-fail companies— both state-and privately owned—that have potential systemic impact. Prudent management of state-owned companies in tranquil times could help avoid counter-cyclical interventions at a time of crisis when the opportunity cost of fiscal resources is particularly high. Lessons once learnt should be included in the tool box for good liability management across board so that history does not repeat itself.
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We consider a simple, stylized two-period model of financing under asymmetric information. The time line and key aspects of the model are summarized in Figure 1. There are three dates, t= 0, 1, and 2, and two groups of agents, i.e. entrepreneurs and financiers. Entrepreneurs have no initial wealth. At date 0, each entrepreneur needs to make an investment of amount I to undertake an indivisible project that generates cash flows over two periods. The entrepreneur chooses the optimal maturity structure of debt to fund this investment: he does so by issuing short-term debt, long-term debt, or a mix between the two types of debt. Short-term debt matures at date 1 whereas long-term debt matures at date 2. Each issuance of short-term or long-term debt implies a fixed transaction cost, c . Both entrepreneurs and financiers are risk neutral. The risk-free interest rate is zero. For simplicity, we assume that there are two financiers who are involved in Bertrand competition. Our focus is the entrepreneur’s choice of short-term debt as a fraction of total debt issued.
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Additional testing shows that firms with high reputation face less stringent covenants and are less likely to be the target of SEC fraud investigations. We also find that the Fortune reputation score captures an aspect of credit risk not captured by traditional measures of distress risk. We find a highly significant inverse relation between our measure of reputation and the likelihood of firm default , even after controlling for credit rating, Merton’s distance -to-default measure, and a comprehensive list of accounting and market variables used by Campbell, Hilscher and Szilagyi (2008, hereafter CHS). While many firm-level characteristics, such as leverage, profitability and idiosyncratic volatility, have been found to predict firm failures, we identify an additional variable that is derived from industry experts’ knowledge and perception of the firm . This additional failure predictor refl ects unique information about whether a firm’s true type is one that honors its commitments. Overall, the evidence suggests that reputation is an important determinant in the pricing of public corporate debt.
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It should also be noted that from the $86 trillion of outstanding corporate debt globally previously mentioned, $75 trillion (or approximately 87%) relates to securitized or nonsecuritized bank loans and $11 trillion are connected to corporate bonds outstanding. Bradley and Roberts (2004) also report that private debt, including bank loans, tends to be at least two to three times the amount of public debt. Apart from their differences in order of magnitude, the role of banking institutions as “quasi insiders” (Goss and Roberts, 2011) provides a basis to assert that the loan market is more efficient than the bond market and as such, the financial effects of CSR will be more prominently exhibited there. Banks have access to unique information related to a firm’s operational and financial standing, a specialised skillset needed to appropriately assess this information in order to make a lending decision and the privilege of being able to set the terms regarding the monitoring of the borrower during the duration of the loan. Therefore, it is sensible to expect a greater degree of market efficiency in the corporate loans market. Altman et al. (2010) have in fact concluded that syndicated loan markets are more informationally efficient compared to bond markets as they manage to reflect the probability of default more quickly. Based on the above, it is surprising that more emphasis has been given to the likely impact of CSR on the cost of internal debt financing, i.e. through bond issuance, compared to the effects of CSR on external debt financing, i.e. through bank lending. Not only is this part of the empirical literature scarce in terms of overall number of studies, it is also underdeveloped in a variety of ways, as we will demonstrate in our perusal of related research in the next section of this paper. We aim to extent previous work on the financial impacts of corporate social responsibility by: i) Focusing on the link between CSR and cost of debt (which has not been extensively researched, unlike the cost of equity), and more specifically on the cost of banks loans (which have received less attention compared to financing through bond issuance), ii) Providing an international framework of analysis using a sample comprised of borrowers from
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This paper adopts the micro panel data of listed companies in China from 2003 to 2015, and uses the housing market value as a substitute variable for housing collateral value. Based on the mediating effect model, it models the col- lateral value, the debt level and company’s investment, and studies the relation- ship and its mechanism between collateral value and changes in corporate in- vestment. The results of this paper show that controlling the individual effect and annual effect of the company, the collateral value of the house has a signifi- cant positive impact on the company’s investment, and according to the prin- ciple of testing the intermediary effect, named the step-by-step test method , the collateral value of the house affects the company’s investment and the em- pirical results is significant, but the mechanism of it is part of the mediating ef- fect, not the full mediating effect. In addition to using the Office Building Price, this paper also uses the Price of the Commercial Housing and the House Price to match the company’s building for calculating the collateral value of the property. It is found that there is still a significant positive relationship between the colla- teral value of the house and the company’s investment.
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The firm size greatly influences the availability of funds from different sources. Large firms are likely to be diversified and less prone to bankruptcy since a large company has greater flexibility in designing its capital structure (Rajan and Zingales, 1995). A large company can obtain loans on easy terms whereas small firms find it quite hard to raise long term loans (Titman and Wessels, 1988). It is quite common for small firms to depend on internal funds to survive, since the available funds for them are quite restricted. Accordingly, TOT predicts a positive correlation between size and leverage. Deesomsak et al. (2004) find that large firms have the potential to borrow more than smaller firms. Indeed, large firms have relatively low bankruptcy costs (Drobetz and Fix, 2003). This view implies that large firms have stable cash flows and can afford higher levels of leverage. On the other hand, Suhaila et al. (2008) find that there is an inverse relationship between firm size and leverage. The result suggests that large firms have less demand for leverage than small firms. As stated in the POT, size is subject to information asymmetry between the firms and capital markets. Large firms exhibit less information asymmetry because information about these firms is publicly available in the market place. Thus, these firms potentially can disseminate information to react to market sensitivity and are less dependent on debt. Therefore, we hypothesize a positive relationship between leverage and firm size. GLCs have easy access to funding since they are more diversified and profitable. Also, lenders are more willing to give them loans because they can meet their obligations in interest payments and have less exposure to financial distress. Previous studies measured firm size as a logarithm of net sales (Maghyereh, 2005; Ooi, 1999; Rajan and Zingales, 1995; Titman and Wessels, 1988; Wiwattanakantang, 1999). We use a natural logarithm of sales, since sales are expecs to reflect the borrowing capacity of a firm.
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macroeconomic stability (in the form of inflation, unemployment and poverty), discourages the inflow of capital, depreciates the local currency, and produces hindrances for government to bring reforms in different sectors of the economy (Ahmad, 2015). The empirical findings suggest that external borrowing leads to depress the growth process by increasing the uncertainty of investors about future decisions of the government, especially the taxes, to meet its debt servicing obligations, which causes deterioration in the macroeconomic environment by hindering the level of investment and growth. Factors like persistent level of current account deficit, sluggish economic growth, imprudent utilization of the stock of debt, increase in debt service payment (cost of debt), stagnant exports, short fall in foreign exchange reserves, high fiscal deficit, devaluation of currency, huge defense expenditures, incompletion of different developmental projects by the government, and frequent changes in its policies are considered to be the crucial factors of external debt accumulation in Pakistan (Awan and Asghar, 2011; Sheikh et al., 2013; Awan et al., 2015; Azam and Feng, 2017). Figure 1 presents the history sheet of external debt in Pakistan, whereas Figure 2 depicts its relationship with the gross domestic product.
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As China has entered a new stage, economy growth has shifted from high speed to medium-high speed. In view of the current economic situation, the central economic working group creatively put forward a new strategy of supply-side structural reform at the central economic work conference in December 2015, and further defined the economic work deployment of supply-side structural reform as five tasks, among which cost reduction has been repeatedly empha- sized. Whether cost of capital in China has already fell? How can we reduce cost of capital? To answer these questions, the first job is to calculate the cost of capi- tal and find out its influence factors, Chinese scholars have done much in calcu- lating cost of capital and studying the relationship between one certain factor and cost of capital. However, different scholars used different measuring me- thods and studied different factors. What’s more, they have done less in litera- tures review so they can’t understand the whole thing. To make up for the lack How to cite this paper: Li, H.H. (2019)
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First, this study contributed to the existing body of knowledge by responding to the lack of finance and accounting literature by assessing the association between audit quality using external auditor proxies such as audit fees, non-audit services, and industry specialist auditors, and the cost of debt capital. No previous studies have examined the relationship between audit quality using these external auditor’s proxies and the cost of debt capital in Malaysia context. Currently, more regulatory emphasis has been placed on the requirement for independent external auditors, the extent of the consultancy services they offer, the non-audit services provided to audit customers, and the use of the industry specialist auditors. The strong industry specific knowledge of the industry audit specialists contributes to a better quality audits, more accurate financial information, and better monitoring, all of which reduce information asymmetry (Amir et al., 2010; de Fuentes and Sierra, 2015; Dhaliwal et al., 2008; Fernando et al., 2010; Hajiha and Sobhani, 2012; Hope et al., 2009; Li et al., 2010). Better monitoring by auditors allows investors to forgo their own costly monitoring actions used to reduce the risk of expropriation by managers. The investigation of Malaysia companies expanded existing knowledge by providing evidence from external CG practices, different institutional settings, and litigation each of which encourage quality in the audit market. This study’s findings contributed to signaling theory by providing evidence that higher audit quality is associated with lower cost of debt capital.
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The results show that, the return on asset of banks significantly determines the total debt ratio (TDR), the short-term debt ratio (STDR) and the long-term debt ratio (LTDR) and this confirms the pecking order theory. The relationship between debt ratios and return on asset which is a measure of profitability is negative indicating that, when banks performance well they would have a lot of retained earnings and will therefore depend less on debt since they can rely on their retained earnings to finance their operations and this confirms the pecking order theory which is contrary to the agency cost theory and static trade-off theory of capital structure. Banks in Sub-Sahara Africa prefer internal financing because the use of such funds does not send any negative signal that may lower their stock prices. If external finance is required, firms prefer to issue debt first before issuing equity. This pecking order occurs because debt issue is less likely to send a negative signal.
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This effect of excessive debt was what I had in mind when I said of Africa: “I expect they do not have a lot of private-sector debt, or their economy couldn’t bounce back.” (I’d like to say for sure that this is true, but I find no information on African domestic private debt. Oh, there is plenty on the Internet regarding public debt, and plenty about external debt, and plenty about debt problems in Africa, but nothing about domestic private debt.)
The equations  and , define the levered cost of equity of the firm as direct derivation of the MM’s Propositions I and II. A relevant problem concerns the rate used to discount the expected tax savings. Usually, the tax savings are discounted to the cost of debt as in the MM’s Propositions. The main reason is that the risk of the expected tax savings is strictly related to the risk of debt. Tax savings arising from debt. Therefore, the firm does not realize tax savings if it is unable to face debt obligations. Consequently, it is possible to discount the expected tax savings by the cost of debt (K D ). Several studies are placed in a critical way and highlight the need to use the unlevered cost of equity (K EU ) to discount the expected tax savings (Miles and Ezzell, 1980; Taggart, 1991; Kaplan and Ruback, 1995; Ruback, 2002). The main argument is that the debt level is known in the first year only. Thus, only in this case, it is possible to use the cost of debt to discount the expected tax savings. In each year different from the first, the debt level is unknown because the firm levered value is unknown; it is function of the tax savings that, in turn, are function of the debt level that, unfortunately, is unknown. Consequently, the risk of the expected tax savings is similar to the risk on firm’s assets value, and thus they must be discounted to the unlevered cost of equity (K EU ). The Miles and Ezzell (ME) (1980) cost of capital model tried to solve some problems about WACC. As well as, the WACC also ME’s model is based on the MM’s approach.
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Corporate finance literature argues that the incentive properties of short-maturity debt make it a more effective controlling mechanism than long term debt in mitigating agency conflicts between management and shareholders. For instance, Myers (1977) shows that short-term debt alleviates conflicts between bondholders and shareholders over the exercise of growth options and thus underinvestment problems. Firms with greater growth options face greater underinvestment problems. Therefore, Myers (1977) notes that firms with more growth options are likely to employ shorter-maturity debt. Debt that matures before the execution of investment options cannot lead to suboptimal investment decisions. Given that underinvestment deteriorates profits in the long run, such behaviour implies a negative relationship between long term debt and firm performance. Further, Leland and Toft (1996) show that short-term debt can reduce the agency costs associated with the shareholders’ risk-shifting behavior (asset substitution). Similarly, short-maturity debt is more eﬀective than longer maturity debt in disciplining managers by imposing a reﬁnancing pressure on them and transferring control rights from owners to creditors, (e.g., Diamond, 1991; Hart and Moore, 1994;1998; Rajan and Zingales, 1995; Stulz, 2000).
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Other contradicting situations also emerge from debt policy. Debt policy brought debtholders to concern on their investment. On the contrary, managers and shareholders also concern on how to shift their business risk to debtholders. As the result of such thought, managers and shareholders could expropriate cash from debt for their own interest and left debtholders bear all the cost. Firm with enough cash flow as internal sources of fund will use debt instead to support their investment opportunity. Debtholders who are willing to support such a behavior argue that they support a prospective firm with reliable investment opportunity, and internal sources. Those debtholders bear the cost if managers and shareholders exploit debtholders spirit, and use their internal cash flow for their own interest. This research suggests that the condition calls debt-facilitate expropriation (DFE).
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Furthermore, considering the size of economy, non- sustainable management of the government’s debt can cause the lowering of credit ratings, as well as reduction of the borrowing possibilities, an economic decline, stagnation or even bankruptcy of the country (Neck & Sturm, 2009; Afonso & Rault, 2010; De Grauwe & Ji, 2012; Snieska & Draksaite, 2013). If there is no sustainable debt management, in case of economic shock any country could suffer these consequences. Small open economy would be affected to a greater extent to compare to a big open economy and would be more volatile to such sudden unexpected changes of economy. Non-sustainable government borrowing in big open economy’s case could cause even more significant negative effect on the global markets.
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Doan & Nguyen (2011) examined the relationship between firm’s characteristics, capital structure and operational performances among a sample of 427 companies listed on the Vietnamese Stock Exchange during the period of 2007 to 2009. They have followed the examples of Titman & Wessels (1988) and Chang et.al (2009) and adopted a structural equation modeling (SEM) approach rather than the multiple regression analysis used by most of the previous studies. Specifically, they employed path analysis to analyze simultaneous relationship among the various variables. The results suggested that for listed enterprises in Vietnam, operational performances have had a negative effect on both of the measures of capital structure considered, namely, long term debt to total assets ratio (LDR) and the short term debt to total assets ratio (SDR), while the extent of state ownership has a positive effect on both. Further, they identified that the enterprise size has positive effect on LDR only, while enterprise age has a positive effect on SDR only. By contrast, business risk affects only LDR negatively. The ratio of LDR affects the two capital structure measures in opposite ways; the effect is positive on LDR and negative on SDR. They consider the evidence to be inconclusive on the question of direction of causality between operational performance and LDR. Sivaprasad & Muradoglu (2007) conducted an empirical study on the effect of firm’s leverage on stock returns. They used explicit valuation model of Miller & Modigliani which was
It is believed that debt-to-GDP ratio could be driven by several apparent factors: recessions, wars, and political parties. I show that debt-to-GDP is a new predictor instead of a proxy for business cycle, wars, and parties. First, in economic downturns, low GDP and counter- cyclical surplus raise the debt-to-GDP ratio and meanwhile the counter-cyclical expected return is high. To alleviate this concern, I show that the results are similar if a recession dummy is included in the regression. The debt-to-GDP ratio is acyclical in Figure 1.1. The average ratio is 40% in normal time and 37% in recessions. In the recent decade, even though the Great Recession ends in 2010, the ratio keeps rising afterwards. This reassures that government debt cycle and business cycle are distinct phenomena. Excluding the dramatic increase of the ratio after the recession from 2007 to 2014 doesn’t alter the results. Second, the evident link between debt and wars leads to the conjecture that the forecasting power of the debt-to-GDP ratio is related to wars. I include a war-time dummy in the regression. The insignificance of the coefficients across horizons and time periods shows that the forecasting power remains in peacetime and wartime. Third, different political stance might simply determine the tightness of government debt policy. The high stock return under Democratic presidents are documented by Santa-Clara and Valkanov (2003) and Pastor and Veronesi (2017). However, debt-to-GDP still contributes to the explanatory power as before after I include a dummy of president’s party.
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It was proven by Ramly (2013) that government ownership could be one of the factors that affected cost of debt. Government ownership is the number of shares owned by the government. Through its ownership, the government has the right to determine the company's director. Besides, the government can control measures taken by management to fit the interests/aspirations of the government. In order to survive, companies must be able to synchronize itself with the government (Amran and Devi, 2008). Government ownership can reduce the cost of debt due to the effective monitoring by the regulatory parties can lead to the use of debt to decline (Crutchley et al., 1999). Additionally, government ownership in large numbers made outside party the company do a closer scrutiny of the management so that management is encouraged to improve company performance. The increased performance of firms making company risks becoming smaller so the return desired by lenders are lower. Furthermore, the effect of government ownership is becoming stronger for companies that have high levels of information asymmetry (Wang and Zhang, 2009). Thus, government ownership can decrease the cost of debt.
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In this article we discuss fundamentals of the debt securities pricing. We begin with a generalization of the present value concept. Though the present value is the base valuation method in the modern finance we will illustrate that this concept does not sufficiently accurate in producing instrument pricing. The incompleteness of the unique present value approach stems from variability of the interest rates. Admitting variability of the interest rates we define two present values one for buyer other for seller. Therefore future buyer and seller cash payments can be described by the correspondent present values. Usually used assumption that future interest on investment over a specified time period would be the same as before specified period is a theoretical simplification that might be admitted or not. Admitting such assumption leads to eliminating an important component of the market risk. Recall that the assumption that a future payment can be invested with the same constant interest rate equal to the one used in the past is a component of the group conditions that specify frictionless of the market. We use this new concept that splits present value within two counterparties to outline details of the new valuation method of the fixed income securities.
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