Factors Determining Bank Debt vs Bond Debt of Canadian Corporations

Transcription

1 Factors Determining Bank Debt vs Bond Debt of Canadian Corporations May 2012 Preliminary; do not quote George J. Georgopoulos Department of Economics York University, Toronto, Canada Abstract This paper will investigate the determinants of two forms of financing and the effects on the volume of these instruments from the financial crisis and the associated contraction in overall credit. Specifically, we look at publicly listed Canadian corporate holdings of two such debt instruments, syndicated bank loans and bond issues. We investigate potential differential effects of the financial crisis on the levels of the two instruments, controlling for firm specific financial performance and structure measures. We also investigate whether a firm s size has any bearing on the degree of impact on each financial instrument holding during the financial crisis. Using firm specific data over the period 1997Q1 2009Q3, we find that firm size is a consistent determinant of both forms of debt issue. Furthermore this factor becomes more pronounced during the financial crisis. JEL Classification: F23, F30 Keywords: Debt Issue, Syndicated Bank Loans, Bonds, Agency Costs Correspondence to George J. Georgopoulos, Department of Economics, York University, 4700 Keele Street, Toronto, Canada, M3J 1P3; phone: x georgop@yorku.ca I would like to thank Veronica Kockberg, Siqing Liang, and Maxwell Serebryanny for valuable research assistance. All remaining errors are mine.

2 1. Introduction With the rapid growth over the past 15 year of various financial instruments in money market and long term financial markets, the options available to firms for financing has considerably increased. While the spectrum of securities is wide and continuous, the two general categories of such instruments are equity and debt, and from these groupings a voluminous literature exists on the optimal debt equity ratio or capital structure firms strive to achieve. In light of the recent financial crisis emanating from the sub prime mortgage market in the United States, there has been considerable interest in the financing behavior of corporations and the effects of their funding opportunities in financial markets during the crisis. Specifically, many firms, both of high and low credit quality, faced considerable financing constraints and restrictions as lending markets contracted during the crisis. Whether a firm experienced a considerable setback in economic and operating performance depended to a large extent on their ability to substitute between various sources of financial instruments and markets when seeking funds. While the effects of the financial crisis reached Canadian banks and corporations, the extent of the severity was relatively lower in Canada, partly due to differing banking structure and regulations relative to the U.S. and other developed nations. This paper will investigate the determinants of two forms of financing and the effects on the volume of these instruments from the financial crisis and the associated contraction in overall credit. Specifically, we look at publicly listed Canadian corporate holdings of two such debt instruments, syndicated bank loans and bond issues. We investigate potential differential effects of the financial crisis on the levels of the two instruments, controlling for firm specific

3 financial performance and structure measures. We also investigate whether a firm s size has any bearing on the degree of impact on each financial instrument holding. That is, in employing theories of asymmetric information and agency costs associated with financing, we determine whether small firms were impacted greater than large firms in their ability to source bonds, where bonds in general are more available to large size firms given their lower degree of agency costs. To support this notion studies outline that smaller firms are subject to greater asymmetric information problems than large firms (Gertler and Gilchrist, 1994). Stiglitz and Weiss (1981) show that banks reduce lending to more risky firms at the margin. Thus, bank lending will be reduced to smaller firms in periods of economic uncertainty, such as the financial crisis of We will investigate this issue with our data set of Canadian companies and the amount of bank loans and bonds issued over this period. While there are a large amount of studies investigating financing choices of U.S. and European corporations, to our knowledge there are no studies that look at Canadian corporations and their choice between syndicated loans and bond issues, along with the potential differential effects of large vs. small firms on their choice in light of the financial crisis. The paper is organized as follows. Section 2 provides a literature review on corporate finance sourcing. Section 3 presents the data and the empirical model. Section 4 presents the results, and Section 5 provides conclusions and areas of future research.

4 2. Literature Review In the classic paper by Modigliani and Miller (1958), in a world of perfect and complete capital markets, the financial position of a firm is independent of its financing choices. Specifically, in such an environment firms are indifferent between sourcing funds internally or externally. However with the existence of asymmetric information, common to actual markets for capital, produces issues relating to adverse selection, moral hazard and associated principal agent issues. The consequence of asymmetric information is differing costs of financing, where in general external financing is more costly then internal. Financial status and creditworthiness then determine the amount of the premium paid on financing externally, with a lower external finance premium paid by less risky, stable firms. Prominent studies modeling asymmetric information and the consequences on financing include Myers (1984), Myers and Majluf (1984), Greenwald, Stiglitz and Weiss (1984), and Bernanke and Gertler (1989, 1990). In this study we look at debt financing as opposed to equity financing given the former s dominant share for financing amongst corporations. For Canadian companies, debt financing accounted for approximately 80% of financing on average in 2002 (Mishkin and Serlitis, 2011). Of the studies investigating the choice between debt instruments, various explanations are provided for the benefits and costs of using bank debt versus public debt (e.g., Diamond 1984, 1991; Fama 1985; Rajan, 1992; Park 2000). Denis and Mihov (2003) examine the link between a firm s credit quality and its choice of debt source. Lin, et al. (2012) find a statistically and economically significant effect that reveals that firms with wider divergences between

5 controlling shareholders voting rights and cash flow rights tend to rely more on bond financing than bank financing. The studies above that focus on the choice between different debt securities, most commonly bank loan and bond issues, theoretically rely on the notion of differing degrees of asymmetric information between the two types of debt security. Along these lines, firms with greater monitoring needs reflecting greater agency costs will be unable to source a large amount of its funds in the form of bonds as potential bondholders are unwilling to monitor due to high transaction costs. Banks are able to better monitor lenders due to their specialization in monitoring and risk assessment resources (Fama 1985). Smaller firms inherently have larger monitoring costs due to a relative lack of the availability of public information, lack of credibility and goodwill. Hence, small firms tend to source more funds from banks, larger firms which require less monitoring acquire funds in the form of bonds. Studies looking at various debt choices of firms also appeal to the notion of differing fixed costs between bonds and bank loans (Blackwell and Kidwell (1988), and Carey et al. (1993). That is, the issue of public debt entails significant fixed costs in the form of registration, legal, trustee s and accountants fees. Hence, large debt offerings are more common than small debt offerings. This is one rationale which we will investigate in this study why large firms are more likely to issue public debt than small firms. Accordingly, during the credit contraction of the financial crisis, small firms were more constrained in finding alternative financing. In this study we examine a firm s choice between two debt instruments, syndicated bank loans and bonds. We focus on publicly listed Canadian companies, given the wider availability of firm performance measures, along with the notion that it is more feasible that they would be

6 more likely to face a choice of syndicated bank vs. bond sourcing (Houston and James, 1996). We look at syndicated loans given their close substitutability to bonds and provide a separate asset class from standard bank loans, and potentially a separate ranking in the pecking order of financing. We also look at the potential impact of debt issue over the financial crisis. 2. Data and Empirical Model We focus on two debt sources, syndicated loans and bonds. The syndicated loan data is sourced from Dealscan, which provides information on newly issued syndicated loans, seniority, purpose, and type of loan, among other categories. The bond issue by firm is retrieved from the Financial Post database. The remaining variables modeled below are from the Capital IQ Database. Figures 1 and 2 plot the issue of both types of instruments over 1997Q1 2009Q3. Both figures show issues of these two instruments steadily rising since 2002, with slower growth and volatility beginning in 2007, continuing to 2008 and 2009 during the height of the crisis. The lower panel of each figure shows the volatile movements of these two debt instruments over the period during the financial crisis. Syndicated loans are issued to a single borrower by a group of lenders, typically banks, where there is a lead bank sponsoring the loan with other banks involved in lending, allowing for greater diversification of risk by each lending bank. While syndicated loans are offered to private firms, in the Canadian market over the past 5 years approximately 55% of total loans issued are to public listed firms. As mentioned the Dealscan loans are provided on the basis of

7 use type; approximately 55% are used for working capital or general business fixed investment spending. We will look at the determinants of these two types of debt instruments, those being syndicated loans and bonds, focusing on the differential effects on the holdings from the factors, including the events over the crisis. For each of the two types of debt instruments, we estimate the following regression: Log(Debt Issue) it = β 0 + β 1 log(total Assets it ) + β 2 (ROA it ) + β 3 log(altman Z it ) + β 4 (MarketBook it ) + e it (1) The dependent variable (Debt Issue) is either the value of the syndicated loans issued over the period or the value of bond issues over the period. The choice of control variables follow from previous literature including Denis and Mihov (2003), Santos (2009), and Bharath et al. (Total Assets) is the firm s total assets, where it is hypothesized that larger firms are more diversified and have more collateral, and as such are less risky. Thus we expect the sign to be positive on the coefficient. (ROA ) is the return on assets. The coefficient on the (Altman Z) variable is expected to have a positive relationship. (Market Book) is the firm market value over its book value. The coefficient is expected to be negative given it is a proxy for growth. We include company fixed effects. The sample period covers 1997Q1 2009Q3. Table 1 presents the descriptive statistics.

8 4. Results We begin with the base model suggested by equation 1 for syndicated bank loans and bond issues. Columns 1 and 3 of Table 2 present the results. For determinants of syndicated loans, firm size, as proxied by total assets, is statistically significant and has a positive coefficient. This is consistent with the notion that the larger the firm size, the lower the degree of asymmetric information due to the higher credit quality of the firm, thus the larger the loan issue available to the firm. The coefficient on Altman Z has the theoretically correct sign and is statistically significant at the 10% level. For column 3 showing the determinants of bond issues, firm size is the only statistically significant variable and has a theoretically consistent sign. We next investigate potential impacts of the financial crisis on syndicated bank and bond issue. As noted by Figures 1 and 2 the amount of debt issued at an annual level slowed and became volatile beginning in To determine potential differential impacts on loan issues and bond issues, during the crisis period, along with determining whether firm size is particularly more relevant when sourcing debt, we interact a dummy variable taking on a value of 1 in 2007Q1 to 2009Q3 with firm size (Total Assets). Columns 2 and 4 present the results with the interacting variable. What is of interest is that in both types of debt, the importance of firm size is more pronounced and accentuated during the crisis period of 2007 and 2008, as is signified by the positive and statistically significant coefficients on both interacting variables. During the crisis with the advent of adverse selection and credit contraction, firm size becomes more of a critical factor when allocating a limited supply of credit.

9 To summarize, on the comparison of syndicated loans and bond issue and their factors, preliminary evidence suggests that the predominant factor is firm size, as this coefficient is statistically significant in both models. Moreover this factor becomes more pronounced during the financial crisis. On this basis it suggests that these two forms are relatively close substitutes, which is consistent with the fact that syndicated loans are of large minimum denominations, implying it is economically feasible for large firms to take out such loans. The high fixed costs of issuing bonds also implies that generally large firms will undertake such an sourcing option. 5. Conclusions and Future Work Preliminary results show that firm size is a relevant factor determining holdings of bank loans and debt issues, with a pronounced effect during the financial crisis. Further work would be to investigate further relationships by estimating using an incremental approach as is done in Denis and Mihov (2003). This involves using multinomial probit analysis, along with having initial outstanding debt as a regressor in equation 1. A further extension involves estimating loans by purpose type, as alternative purposes may be affected by different factors.

10 References Bernanke, Ben, and Mark Gertler, 1989, Agency costs, net worth, and business fluctuations, American Economic Review 79, Bernanke, Ben, and Mark Gertler, 1990, Financial fragility and economic performance, Quarterly Journal of Economics 105, Bharath,,S., Dahiya,S., Saunders, A., and Srinivasan, A. (2010).Lending relationships and loan contract terms. Review of Financial Studies, Blackwell DW, Kidwell DS (1988) An investigation of cost differences between public sales and private placements of debt. J Financ Econ 22: Carey MS, Prowse SD, Rea JD, Udell GF (1993) The economics of the private placement market. Financ Mark Inst Instrum 2:1 66 Denis, D., Mihov, V., The choice among bank debt, non bank private debt, and public debt: evidence from new corporate borrowings. Journal of Financial Economics 70, Diamond, D., Financial intermediation and delegated monitoring. Review of Economic Studies 51, Diamond, D., Monitoring and reputation: the choice between bank loans and directly placed debt. Journal of Political Economy 99, Fama, E., What s different about banks? Journal of Monetary Economics 15, Gertler,M.,and Girlchrist, S.(1994).Monetary policy, business cycle, and the behavior of small manufacturing firms. Quarterly Journal of Economics, 109: Greenwald, Bruce, Joseph Stiglitz, and Andrew Weiss, 1984, Information imperfections and macroeconomic f luctuations, American Economic Review 74, Houston, J., James, C., Bank information monopolies and the mix of private and public debt claims. Journal of Finance 51, Lin, C., Ma, Y., Malatesta, P. and Xuan, Y., Corporate Ownership Structure and the Choice Between Bank Debt and Public Debt, Manuscript

11 Mishkin, F., and Serlitis, A., 2011, The Economics of Money, Banking, and Financial Markets, Pearson Publishing. Modigliani, Franco, and Merton H. Miller, 1958, The cost of capital, corporation finance, and the theory of investment, American Economic Review 48, Myers, Stewart C., 1984, The capital structure puzzle, Journal of Finance 39, Myers, Stewart C., and Nicholas Majluf, 1984, Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics 13, Park, C., Monitoring and structure of debt contracts. Journal of Finance 55, Rajan, R., Insiders and outsiders: the choice between informed and arm s length debt. Journal of Finance 47, Santos, J. (2009). Bank corporate loan pricing following the subprime crisis. SSRN Stiglitz, J. and Weiss, A. (1981). Credit rationing in markets with imperfect information. American Economic Review, 71:

12 Figure 1. Total Quarterly Issue of Syndicated Loans held by Canadian Corporations Billions Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Billions Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 2006

13 Figure 2. Total Quarterly Issue of Bonds held by Canadian Corporations Billions Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Billions Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 2006

14 TABLE 1. SUMMARY STATISTICS, 1997Q1 2009Q3 ALL COMPANIES N Mean SD 25th Median 75th Total Assets ROA Altman Z Market to Book Deal Amount (Deal Scan) ,484,413 1,010,409, ,473, ,675, ,568,758 Total Debt Issued (FP) ,523,124 1,024,195, ,000, ,000, ,000,000

15 Table 2. Regression Results, Fixed Effects, 1997Q1 2009Q Log(Total Assets) Log(Synd.Loans Issues) (0.001) Log(Bond Issues) (0.001) Log( Syndicated Loans) (0.004) Log(Bond Issues) (0.526) Return on Assets (0.169) (0.263) (0.920) (0.629) Altman Z (0.098) (0.106) (0.473) (0.362) Market to Book (0.583) (0.611) (0.694) (0.289) Interacting Dummy (0.003) (0.001) Number of Observations P values are in parenthesis Interacting Dummy: Dummy * log(total assets), where dummy takes on a value of 1 from 2007Q1 2009Q3.