Creditor Control Rights and Firm Creditor Control Rights and Firm Investment PolicyInvestment Policy
by Greg Nini, Amir Sufi, and David Smithby Greg Nini, Amir Sufi, and David Smith
Comments by Carlos D. RamirezComments by Carlos D. Ramirez
The StoryThe Story
Empirical literature appears to have largely Empirical literature appears to have largely overlooked the importance of contractual overlooked the importance of contractual restrictions on capital expenditures.restrictions on capital expenditures.
These restrictions appear to be a very big These restrictions appear to be a very big deal--about 40% of all loan contracts in the deal--about 40% of all loan contracts in the sample contain an explicit restriction sample contain an explicit restriction provision.provision.
The Story, part 2:The Story, part 2:
These restrictions appear to bind! A firm that These restrictions appear to bind! A firm that experiences a deterioration in its financial experiences a deterioration in its financial health (a downgrade), also experiences a 52 health (a downgrade), also experiences a 52 percent increase in the likelihood of being percent increase in the likelihood of being imposed a capital expenditure restriction in its imposed a capital expenditure restriction in its loan contract.loan contract.
Main CommentMain Comment
VERY GOOD PAPER!VERY GOOD PAPER!
Another motivation point:Another motivation point:
Paper can form part of investment-cash flow Paper can form part of investment-cash flow sensitivity debate– FHP (and others) vs. KZ (and sensitivity debate– FHP (and others) vs. KZ (and others)others)
In a nutshell: KZ claim that cash flow sensitivities do In a nutshell: KZ claim that cash flow sensitivities do not appear to increase monotonically with measures not appear to increase monotonically with measures of liquidity constraints.of liquidity constraints.
These results can offer an explanation of why this These results can offer an explanation of why this monotonic relationship may not show up in the monotonic relationship may not show up in the data…data…
The Widespread Use of Capital Expenditure RestrictionsThe Widespread Use of Capital Expenditure Restrictions
(From Sufi’s Slides)(From Sufi’s Slides)
MeanMean MeanMean
Restriction {0,1}Restriction {0,1} 0.3820.382
By industryBy industry Has credit ratingHas credit rating 0.4440.444
Ag, minerals, constructionAg, minerals, construction 0.1780.178 Does not have credit ratingDoes not have credit rating 0.3140.314
ManufacturingManufacturing 0.3820.382
TCUTCU 0.3190.319 Conditional on rating:Conditional on rating:
Trade—WholesaleTrade—Wholesale 0.4230.423 Investment gradeInvestment grade 0.0930.093
Trade—Retail Trade—Retail 0.4800.480 JunkJunk 0.4940.494
ServicesServices 0.4580.458 AAA, AAAAA, AA 0.0000.000
By size quintileBy size quintile AA 0.0470.047
11 0.5110.511 BBBBBB 0.1120.112
22 0.4900.490 BB BB 0.4640.464
33 0.4430.443 BB 0.5270.527
44 0.3100.310 CCC or worseCCC or worse 0.6270.627
55 0.1520.152
Main Concern:Main Concern:
Authors recognize a serious difficulty: Authors recognize a serious difficulty: CAUSALITYCAUSALITY
Sequence of events:Sequence of events:
1. A firm’s financial health decreases1. A firm’s financial health decreases
2. New loan contracts contain capital 2. New loan contracts contain capital expenditure restrictionsexpenditure restrictions
3. Capital expenditures decline3. Capital expenditures decline
What’s the problem?What’s the problem?
You can go from 1 to 3, without 2!You can go from 1 to 3, without 2! Example: Exogenous (macro, industry) shockExample: Exogenous (macro, industry) shock
How to deal with this?--1st Test:How to deal with this?--1st Test:
Look at a plot of the actual restriction relative Look at a plot of the actual restriction relative to investment spending.to investment spending.
Result: Most of the actual spending Result: Most of the actual spending concentrates around the restriction.concentrates around the restriction.
Authors argue that this is too much of a Authors argue that this is too much of a coincidence.coincidence.
11stst Test problem? Test problem?
Loan amounts are about 40 percent of assets. (Table 2 Loan amounts are about 40 percent of assets. (Table 2 of paper) Thus, these loans are large!of paper) Thus, these loans are large!
Given that they are so large, firms have a significant Given that they are so large, firms have a significant incentive to incentive to negotiatenegotiate these loan contracts, including these loan contracts, including the restriction amount.the restriction amount.
Banks have an incentive to monitor the firms, hence Banks have an incentive to monitor the firms, hence they offer contracts that force firm managers to they offer contracts that force firm managers to release more information.release more information.
If so, the kink is not coincidental.If so, the kink is not coincidental.
2nd Test: Regression analysis2nd Test: Regression analysis
Regress Capital Expenditures changes on Regress Capital Expenditures changes on whether the firm had a loan restriction whether the firm had a loan restriction imposed, controlling for year effects and firm imposed, controlling for year effects and firm performance.performance.
Main ResultsMain Results Cap ExpenditureCap Expenditure Cap ExpenditureCap Expenditure
chg yr bef to yr aftchg yr bef to yr aft chg 2yr bef to 2yr aftchg 2yr bef to 2yr aft
RestrictionRestriction -0.003-0.003 -0.004-0.004
[0.002][0.002] [0.002][0.002]
New RestrictionNew Restriction -0.002-0.002 -0.002-0.002
[0.003][0.003] [0.002][0.002]
Diff in CF/ADiff in CF/A 0.0750.075 0.1070.107
[0.026][0.026] [0.024][0.024]
Diff in qDiff in q 0.0230.023 0.0260.026
[0.002][0.002] [0.003][0.003]
R^2R^2 0.120.12 0.190.19
NN 22062206 22062206
22ndnd Test Problem: Test Problem:
The capital expenditure coefficient appears to The capital expenditure coefficient appears to be “fragile” -- sometimes insignificant or be “fragile” -- sometimes insignificant or significant at the 10 percent.significant at the 10 percent.
Hence it is important to do more robustness Hence it is important to do more robustness checks.checks.
Suggestion for Robustness Checks:Suggestion for Robustness Checks:
Include other measures of performance as controls. Include other measures of performance as controls. (Examples:1.Change in revenues (accelerator theories (Examples:1.Change in revenues (accelerator theories of investment); 2. The stock of liquid assets to total of investment); 2. The stock of liquid assets to total assets (liquidity constrained)).assets (liquidity constrained)).
Look at a subsample of firms that received a Look at a subsample of firms that received a downgrade. (This constrains the sample to those firms downgrade. (This constrains the sample to those firms that are likely to reduce investment spending, that are likely to reduce investment spending, regardless of restriction impositionregardless of restriction imposition.).)
Split this subsample by the existence of a capital Split this subsample by the existence of a capital restriction.restriction.
Last Comment:Last Comment:
A great paper for $10,000!!A great paper for $10,000!!
