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Corporate Cash Holdings and the Refinancing Risk of Bank Debt and Non-Bank Debt

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Corporate Cash Holdings and the Refinancing Risk of Bank Debt and Non-Bank Debt Stockholm School of Economics Department of Finance Master Thesis in Corporate Finance Spring 2015 Corporate Cash Holdings and the Refinancing Risk of Bank Debt and Non-Bank Debt Andreas Joha* Tomas Neumüller† Abstract We empirically examine the relationship between a firm’s debt composition and refinancing risk. In particular, we analyze the effects of non-bank debt on refinancing risk as the existing literature shows that both the ex-ante and ex-post costs of refinancing problems are higher for non-bank debt than for bank debt. We therefore propose that non-bank debt is associated with higher refinancing risk than bank debt. Following recent research findings we employ firms’ cash holdings as a proxy measure of refinancing risk for a sample of U.S. incorporated firms over the ten year period from 2003 to 2013. We find that firms seem to accumulate cash in order to offset the refinancing risk associated with non-bank debt. Further analysis indicates that the effect is most accentuated for firms with relatively high leverage and for firms with relatively high non-bank debt proportions. We also find indications that the observed hedging behavior could be either of negative value to shareholders or mispriced by equity markets. Keywords: Debt financing; Cash holdings; Capital structure; Bank lending; Refinancing risk Tutor: Francesco Sangiorgi Date: 18.05.2015 ____________________________ *[email protected] †[email protected] Acknowledgements We would like to express our gratefulness to Francesco Sangiorgi for all the assistance and guidance provided. He has been most supportive throughout the entire process, giving us valuable insights. Stockholm, May 18, 2015 Andreas Joha Tomas Neumüller 2 Table of Contents 1 Introduction ......................................................................................................................... 6 2 Literature Review and Hypothesis Development ............................................................... 8 2.1 Cash Holdings .............................................................................................................. 8 2.2 The Choice between Private and Public Debt ............................................................. 9 2.3 Refinancing Risk of Private and Public Debt ............................................................ 10 2.4 Cash Holdings and Refinancing Risk ........................................................................ 12 2.5 Hypothesis ................................................................................................................. 12 3 Methodology and Sample Data ......................................................................................... 13 3.1 General Methodology ................................................................................................ 13 3.2 Estimating the Effect of Non-Bank Debt on Cash Holdings ..................................... 13 3.3 Summary Statistics .................................................................................................... 17 4 Multivariate Results and Analysis .................................................................................... 20 4.1 Multivariate Results – First Stage Regression .......................................................... 20 4.2 Multivariate Results – Second Stage Regression ...................................................... 22 4.3 Potential for Bias ....................................................................................................... 26 4.4 The Effect of Non-Bank Debt on Cash Holdings ...................................................... 28 4.5 Subsample Analysis ................................................................................................... 30 4.6 The Use of Cash Accounts and Short-Term Investments .......................................... 33 4.7 Non-Bank Debt and the Contribution of Cash Holdings to Market Value ............... 34 5 Conclusion ........................................................................................................................ 37 References ................................................................................................................................ 39 Appendix 1 – Summary Statistics Winsorised Sample ............................................................ 44 Appendix 2 – Actual and Predicted Non-Bank Debt Proportions ........................................... 45 Appendix 3 – First Stage Regression Initial Sample ................................................................ 46 Appendix 4 – First Stage Regression Winsorised Sample ....................................................... 47 Appendix 5 – Second Stage Regression Summary of Effects on Cash ................................... 48 3 Appendix 6 – Second Stage Regression Initial Sample ........................................................... 49 Appendix 7 – Second Stage Regression Winsorised Sample .................................................. 50 Appendix 8 – Random-Effects Model and Fixed-Effects Model ............................................ 51 Appendix 9 – Second Stage Regressions of Cash Accounts and Short-Term Investments ..... 53 4 List of Tables Table 1 – Summary Statistics Initial Sample ........................................................................... 18 Table 2 – Summary Statistics Final Sample ............................................................................. 19 Table 3 – First Stage Regression of Non-Bank Debt ............................................................... 20 Table 4 – Second Stage Regression of Cash Holdings ............................................................ 22 Table 5 – Coefficient Summary Second Stage Regression ...................................................... 25 Table 6 – The Effect of Non-Bank Debt on Cash Holdings .................................................... 28 Table 7 – The Cash Effect to Debt Effect of Non-Bank Debt ................................................. 29 Table 8 – The Cash Effect to Debt Effect of Non-Bank Debt at Different Leverage Levels .. 29 Table 9 – Second Stage Regressions for Subsamples of Non-Bank Debt Proportions ............ 30 Table 10 – Second Stage Regression for Subsamples of Leverage ......................................... 32 Table 11 – The Use of Cash and Short-Term Investments ...................................................... 33 Table 12 – The Effect of Non-Bank Debt on the Market Valuation of Cash Holdings ........... 35 Table 13 – Summary Statistics Winsorised Sample ................................................................. 44 Table 14 – First Stage Regression of Non-Bank Debt (Initial Sample) ................................... 46 Table 15 – First Stage Regression of Non-Bank Debt (Winsorised Sample) .......................... 47 Table 16 – Second Stage Regression Summary of Effects on Cash ........................................ 48 Table 17 – Second Stage Regression of Cash Holdings (Initial Sample) ................................ 49 Table 18 – Second Stage Regression of Cash Holdings (Winsorised Sample)........................ 50 Table 19 – Random Effects Model .......................................................................................... 51 Table 20 – Fixed Effects Model ............................................................................................... 52 Table 21 – Second Stage Regression of Cash Accounts .......................................................... 53 Table 22 – Second Stage Regression of Short-Term Investments ........................................... 54 List of Figures Figure 1 – Observed Effects for Firms with Low and High Non-Bank Debt Proportions ...... 31 Figure 2 – Observed Effects for Firms with Low and High Leverage ..................................... 33 Figure 3 – Actual and Predicted Proportions of Non-Bank Debt over Time ........................... 45 5 1 Introduction Over the last years U.S. companies have accumulated record cash holdings while at the same time issuing record amounts of debt both in the form of loans and bonds. According to Butters (2015) the cash and short-term investment holdings of S&P 500 firms (excluding financial firms) amounted to a record $1.43 trillion at the end of January 2015. The same firms issued $89.4 billion in financial debt obligations during the last quarter of 2014 marking it the third highest total for a quarter over the past ten years. Both cash holdings and debt financing have long been subjects to various theories in corporate finance. Financial economists have analyzed corporate cash holdings as firms’ primary liquidity pool and researched their determinants from various perspectives, foremost in the context of financing frictions, capital structure theories and agency conflicts. Key findings and empirical evidence of this research indicate that firms build up cash reserves for precautionary reasons (e.g. Kaynes (1936), Bates et al. (2009)) and to offset direct transaction costs and indirect costs due to information asymmetries (Opler et al. (1999)) as observed in some corporate governance measures (e.g. Ditttmar and Mahrt-Smith (2007)). Other recent approaches to cash holdings focus, for example, on the organizational structure of firms (e.g. Duchin (2010)) and the effect of tax structures (e.g. Foley et al. (2007)). Harford et al. (2014) analyze cash holdings in the context of firms’ debt refinancing risk and propose that firms accumulate cash holdings in order to mitigate the adverse effects
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