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Network Effects in Corporate Financial Policies
We study a network of interconnected firms and examine the impact of the firm’s business relationships with peers, rivals, and customers on its capital structure. Peer effect models commonly define peers based on three- or four-digit Standard Industrial Classification (SIC) codes. This renders them susceptible to measurement error and identification problems. These issues are of consequence, since we show that: a) many firms change industry affiliations over time and b) over one-half of peers revealed by managers to shareholders in a given year reside in industries that differ from the firm’s static of historical SIC code. We find that peer effects on financial policy are robust when the firm’s revealed peer group consists of self-disclosed rivals that share at least one customer with the firm in a two-year time window.
We show that private equity-sponsored public-to-private buyouts in the US evoke positive externality effects among their targets’ industry peers. Industrial organization and strategic theory suggest buyouts may impact their industry peers as a result of increased takeover threat and competitive pressure felt by the peers. We document that buyouts are associated with positive market returns and better fundamental performance in the three years following a buyout acquisition in the industry. Drilling down into specific channels of improvement, we document that industry peers mitigate the increased takeover threat and competitive pressure by significantly improving several dimensions of operational efficiency, by engaging in long-term innovation and by enhancing their corporate governance. Our results suggest that competitive factors rather than takeover threat is responsible for the spillover effects.
We examine two firms’ strategic choices of capital structure in the presence of negative bankruptcy spillovers. The low-profitability firm (denoted by firm L) that bankrupts earlier affects the high-profitability firm (denoted by firm H). Against negative bankruptcy spillovers, firm H takes either of the two contrasting responses: decreasing leverage to prepare for operations after firm L’s bankruptcy or increasing leverage to bankrupt simultaneously with firm L. Firm H prefers simultaneous bankruptcy when the tax benefits of increased debt dominate the cash flows from operations after firm L’s bankruptcy. With more negative bankruptcy spillovers, a smaller profitability difference, and lower volatility, firm H is more likely to choose simultaneous bankruptcy. The simultaneous bankruptcy equilibrium shows a novel mechanism in which firms’ strategic capital structure choices cause simultaneous bankruptcy of firms in corporate networks. This mechanism can explain empirical findings of chains of bankruptcies and herding behavior for corporate financial policies in corporate networks.
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