GFDR 2015 2015 Long-Te Term Finance Chapte pter 2 2: The he Use - PowerPoint PPT Presentation

GFDR 2015 2015 – Long-Te Term Finance Chapte pter 2 2: The he Use sers o s of Lo Long-Term F Finan ance e GFDR SEMINAR SERIES FEBRUARY 9, 2015

Use of long-term finance by firms  Why would a firm want to use long-term vs. short-term finance?  What are the implications for firm performance?  Which factors can limit firms’ access to long-term finance? Firm characteristics and evidence o Cross-country characteristics and evidence o  Policy recommendations

Why would a firm want to use long-term vs. short-term finance?  Match maturity of assets and liabilities: use long-term debt to purchase fixed assets or equipment (Hart and Moore 1995) o Empirical evidence for Ecuador, India, Italy, the UK, the US (Graham and Harvey 2001; Jaramillo and Schiantarelli 1996; Schiantarelli and Sembenelli 1997; Schiantarelli and Srivastava 1996; Stohs and Mauer 1996)  Long-term debt minimizes risk of having to refinance in bad times “Liquidity risk” of short-term debt: lenders may be reluctant to refinance if o borrower experiences a negative shock or credit market conditions deteriorate (Diamond 1991, 1993; Graham and Harvey 2001) Firms that expect to experience positive shocks may want to refinance debt o frequently to obtain better loan terms later (Barclay and Smith 1995; Diamond 1991; Guedes and Opler 1995)

What are the implications of long-term finance for firm performance?  Theoretical literature is inconclusive on how debt maturity affects investment and firm performance o Long-term debt allows firms to invest in projects that bring in returns in a long time horizon, including new technologies, which may increase firm productivity and profitability (Hart and Moore 1995) o Long-term debt can reduce managers’ incentives, hampering investment and firm performance (Jensen 1986; Myers 1977; Rajan 1992)  Empirical evidence is needed, but it’s challenging to identify causal effects vs. correlations o Many studies carefully control for confounding factors, but can still be subject to estimation bias

Empirical evidence suggests long-term finance increases firm investment  Cross-country study shows a positive relationship between long-term finance and firm performance - unless it is provided in the form of directed credit (Demirguc-Kunt and Maksimovic 1998)  Within country evidence on long-term debt and performance is less clear Positive relationship: Ecuador, India, Italy, UK (Jaramillo and Schiantarelli 1996; o Schiantarelli and Sembenelli 1997; Schiantarelli and Srivastava 1996) No or negative relationship: China, US (Cull, Liu and Xu 2014; Jiraporn and Tong 2010; o Li, Yue and Zhao 2009)  Within country studies find a positive effect of long-term debt on investment Studies for the US and Belgium use decline in credit availability during recent financial o crisis to assess causal effect of long-term credit on firm investment (Almeida et al. 2012; Duchin, Ozbas and Sensoy 2010; Vermoesen, Deloof and Laveren 2013)

Small firms use less long-term finance than larger firms  World Bank Enterprise Surveys Average % of Purchase of Fixed Assets Financed from External Sources o 123 countries 40 38 o 2006 to 2014 34 35 o Firm size defined based on number of employees 30 26  Lenders often have less information 25 on smaller firms than on large firms, 20 % which makes them reluctant to 15 provide long-term debt to small 10 firms (Custódio, Ferreira and Laureano 2013; Magri 2010) 5 0 Small Firms (< 20) Medium Firms (20 - 99) Large Firms (> 100)

Differences in use of long-term finance across firm size are driven by bank credit – use of equity is limited for all firms Sources of External Finance for Purchases of Fixed Assets 30 26 25 20 20 15 % 11 10 8 6 6 5 4 4 5 3 3 2 0 Bank Trade credit Equity Other Small Firms (< 20) Medium Firms (20 - 99) Large Firms (> 100)

Firms in developing countries finance a lower share of purchases of fixed assets externally  World Bank Enterprise Surveys Average % of Purchase of Fixed Assets Financed from External Sources o 123 countries 45 38 40 o 2006 to 2014 37 35 o Representative at the country level 29 30 25 o Broad coverage of low and lower 20 % 20 middle income countries (not many 15 high-income countries) 10 5 0 High Income Upper Middle Lower Middle Low Income Income Income

Firms in developing countries have fewer long-term liabilities than firms in high-income countries Median % of Firms Reporting Any Long-  Balance sheet data from ORBIS Term Liabilities (Demirguc-Kunt, Martinez Peria 120 and Tressel 2015a) 97 100 92 92 o 87 countries 80 78 80 o 2004 to 2011 66 60 % o Data not necessarily representative of firms in each country 40 o Mostly includes high-income and 20 upper middle income countries 0 Small Firms (< 20) Medium Firms (20 - 99) Large Firms (> 100) Developing Countries High-Income Countries

Firms’ loan maturities are shorter in developing than in high-income countries Average maturity of loan or line of  World Bank Enterprise Surveys credit o 43 countries 70 59 o 2006, 2007, and 2009 60 50 o Duration of firms’ most recently Months received loan or line of credit 37 36 40 30 23 20 10 0 High Income Upper Middle Lower Middle Low Income Income Income

Macroeconomic and political stability are associated with greater use of long-term finance  Low inflation, little corruption, and strong property rights protection imply lower country risk and lower price of long-term debt o Beck, Demirguc-Kunt and Maksimovic (2008), Broner, Lorenzoni, and Schmukler (2012), Demirguc-Kunt and Maksimovic (1999), Fan, Titman and White (2012)

Financial development matters for firms’ access to long-term finance Source: Demirguc-Kunt, Martinez Peria and Tressel (2015a)

Sound legal institutions can increase firms’ use of long-term finance  Sound legal institutions allow lenders to enforce claims and reduce need to rely on the disciplinary role of short-term debt  Creditor rights, bankruptcy laws, overall contract enforcement, efficiency of the legal system are correlated with use of long-term finance o Bae and Goyal (2009); Demirguc-Kunt and Maksimovic (1999); Demirguc-Kunt, Martinez Peria and Tressel (2015a); Fan, Titman and White (2012); Kirch and Terra (2012); Qian and Strahan (2007)  Gopalan, Mukherjee and Singh (2014): debt recovery tribunals in India caused firms to use more long-term debt instead of short-term debt o Causal estimates based on variation in introduction of the debt recovery tribunals across states and time

Information sharing through credit bureaus fosters long-term finance  Information sharing through credit bureaus reduces lenders’ need to monitor and discipline firms through short-term debt (Magri 2010)  Firms’ average loan maturity lengthens after the introduction of a private credit bureau, but not after the introduction of a public credit registry (Martinez Peria and Singh 2014) Average loan maturity Most credit 60 bureau reformers Months 40 introduced a credit bureau in 20 2004 or 2055 0 2002 2003 2004 2005 2006 2007 2009 Year Credit bureau reformers Non-reformers

Collateral registries for movable assets can help firms obtain long-term loans  Firms often need to post assets as collateral for long-term loans o Movable assets, such as machinery or equipment, typically account for a large share of assets o Banks in developing countries may be reluctant to accept movable assets if these are not listed in a registry  Introduction of registries for movable assets is associated with an increase in the maturity of bank loans to firms (Love, Martinez Peria, and Singh 2013)

Good corporate governance can allow firms to use more long-term debt  Monitoring firm managers through independent boards and stronger shareholder protections can substitute for monitoring through short-term debt  Corporate governance reforms that improve shareholder rights are associated with a decrease in short-term vs. long-term debt (Anginer, Demirguc-Kunt, Maksimovic, and Tepe 2015)

Policy recommendations regarding the use of long-term finance by firms  Governments should strive to provide o A stable political and macroeconomic environment o A contestable, well regulated financial system o Sound legal institutions for contract enforcement o An effective corporate governance framework  Specific institutions that have been shown to foster use of long-term finance by firms include o Credit bureaus o Collateral registries for movable assets  Financial development matters for firms’ access to long-term finance o But subsidies, directed credit, and government banks are likely to backfire

The U e Use e of of L Lon ong-Ter erm F Finance b e by Ho Househo holds

Use of long-term finance by households  Why would households want to use long-term financial instruments?  What are the risks associated to the usage of long-term finance?  Who uses long-term financial products?  Which factors can limit household usage of long-term finance?  Policy recommendations in promoting long-term finance by households