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Article
Publication date: 1 November 2001

Lesley Franklin and Penelope Tuck

Now that debt has replaced equity as the preferred source of finance for many UK companies, the correct calculation of the cost of debt assumes even greater importance…

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Abstract

Now that debt has replaced equity as the preferred source of finance for many UK companies, the correct calculation of the cost of debt assumes even greater importance than it has done formerly. While financial management textbooks are in agreement on how to calculate the pre‐tax cost of debt, there is much less agreement on how to calculate the after tax cost of debt. The different approaches taken by different authors leave students and practitioners confused and unsure as to how they should proceed. This article explores the calculation of the after tax cost of debt in order to help both students and practitioners to understand the interaction of tax and debt in the current UK environment and to be aware of the limitations of the various simplifications which are made, explicitly or implicitly, in the textbooks.

Details

Journal of Applied Accounting Research, vol. 6 no. 2
Type: Research Article
ISSN: 0967-5426

Keywords

Book part
Publication date: 18 September 2017

Raquel Meyer Alexander, Andrew Gross, G. Ryan Huston and Vernon J. Richardson

We investigate the interaction of debt covenants and tax accounting on the adoption of Financial Interpretation No. 48 (FIN 48). We examine how firms respond to the…

Abstract

We investigate the interaction of debt covenants and tax accounting on the adoption of Financial Interpretation No. 48 (FIN 48). We examine how firms respond to the potential tightening of covenant slack upon FIN 48 adoption and whether these actions are penalized by creditors and anticipated by equity markets. We find that upon FIN 48 adoption, the majority of sample corporate borrowers increase their tax reserves and reduce equity. Firms close to debt covenant violation were even more likely to increase tax reserves upon FIN 48 adoption; however, the size of the adjustment was relatively smaller, suggesting that the FIN 48 standards limited, but did not eliminate, firms use of discretion in reporting uncertain tax positions to avoid costly covenant violations. For firms near net worth debt covenant violation, the act of decreasing equity upon FIN 48 adoption imposes real economic costs, as the average cost of debt increased by 43 basis points. Finally, we extend prior research on the market response to FIN 48 by showing how the market response to FIN 48 adoption is a function of debt covenant slack and tax aggressiveness. Specifically, the cumulative abnormal return at the FIN 48 exposure draft release date is negative only for tax aggressive firms that are close to debt covenant violation.

Details

Advances in Taxation
Type: Book
ISBN: 978-1-78714-524-5

Keywords

Article
Publication date: 3 August 2021

Nicola Raimo, Alessandra Caragnano, Massimo Mariani and Filippo Vitolla

In recent years, policymakers have increasingly pushed firms to disclose non-financial information. In Europe, integrated reporting (IR) is an increasingly adopted tool to…

Abstract

Purpose

In recent years, policymakers have increasingly pushed firms to disclose non-financial information. In Europe, integrated reporting (IR) is an increasingly adopted tool to fully comply with the requirements of the Directive 2014/95/EU. This study aims to examine the financial benefits of IR quality and specifically the effect on the cost of debt.

Design/methodology/approach

A manual content analysis is performed to measure the quality of the information contained in integrated reports. A panel regression model is used to test the effect of the IR quality on the cost of debt on a sample of 399 observations (a balanced panel of 133 European listed firms for the period 2017–2019).

Findings

Results demonstrate a negative relationship between IR quality and the cost of debt, showing that firms that provide higher quality integrated reports benefit from access to third party financial resources at better conditions.

Research limitations/implications

The results of this study offer important implications for managers and policymakers. The capacity of IR quality to allow a cost of debt reduction should push managers to a greater propensity towards transparency and the dissemination of high quality integrated reports. In addition, in light of the benefits connected to the IR quality, policymakers should push towards the adoption of IR as a solution to fulfil the regulatory obligations deriving from Directive 2014/95/EU.

Practical implications

Results show the goodness of IR as an ideal solution to fulfil the obligations imposed by Directive 2014/95/EU. The important financial benefits associated with IR quality make the high quality integrated report an ideal tool capable of fulfilling regulatory obligations and at the same time guaranteeing a reduction in the cost of debt.

Originality/value

To the best of the authors’ knowledge, this is the first work that analyses the relationship between IR quality and cost of debt.

Details

Journal of Applied Accounting Research, vol. 23 no. 1
Type: Research Article
ISSN: 0967-5426

Keywords

Article
Publication date: 7 December 2020

Olanike Akinwunmi Adeoye, Sardar MN Islam and Adeshina Israel Adekunle

Determining the optimal capital structure becomes more complicated by the presence of an agency problem. The issuance of debt as a corporate governance mechanism…

Abstract

Purpose

Determining the optimal capital structure becomes more complicated by the presence of an agency problem. The issuance of debt as a corporate governance mechanism introduces the asset substitution problem – the agency cost of debt. Thus, there is a recognized need for models that can resolve the agency problem between the debtholder and the manager who acts on behalf of the shareholder, leading to optimal capital structure choice, and enhanced firm value. The purpose of this paper is to model the debtholder-manager agency problem as a dynamic game, resolve the conflicts of interests and determine the optimal capital structure.

Design/methodology/approach

As there is no satisfactory model for dealing with the above issues, this paper uses a differential game framework to analyze the incongruity of interests between the debtholder and the manager as a non-cooperative dynamic game and further resolves the conflicts of interests as a cooperative game via a Pareto-efficient outcome.

Findings

The optimal capital structure required to minimize the marginal cost of the agency problem is a higher use of debt, lower cost of equity and withheld capital distributions. The debtholder is also able to enforce cooperation from the manager by providing a lower and stable cost of debt and a greater debt facility in the overtime framework.

Originality/value

The study develops a new dynamic contract theory model based on the integrated issues of capital structure, corporate governance and agency problems and applies the differential game approach to minimize the agency problem between the debtholder and the manager.

Details

Journal of Modelling in Management, vol. 16 no. 4
Type: Research Article
ISSN: 1746-5664

Keywords

Article
Publication date: 24 November 2020

Sami Bacha, Aymen Ajina and Sourour Ben Saad

This study aims to shed light on the effect of corporate social responsibility (CSR) on the cost of debt. It also investigates whether audit quality affects the cost of

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Abstract

Purpose

This study aims to shed light on the effect of corporate social responsibility (CSR) on the cost of debt. It also investigates whether audit quality affects the cost of debt incurred by socially responsible firms.

Design/methodology/approach

Based on a sample of French non-financial companies over the period 2005 to 2016, this paper uses panel data regressions. This paper re-estimates the model using Newey-West standard errors and the weighted-least-squares method. For further robustness, this paper runs instrumental variable regressions using the two-stage instrument variable method (two-stage least square).

Findings

The results show a negative relationship between CSR performance and the cost of debt, suggesting that financial institutions are likely to apply preferential costs for socially responsible firms. Financial institutions reward socially responsible companies as they recognize the potentiality of CSR to reduce firm risk and enhance its reputation. The findings also show that the perceived audit quality, along with CSR performance, are relevant to banks in the pricing of debt. The incremental audit quality, attributable to audits by the Big 4 auditors, decreases the cost of debt for CSR firms. Big 4 auditors are expected to, simultaneously, play information and insurance roles, thereby enhancing the firm risk profile. The results are robust to alternative audit quality measures (i.e. audit fees).

Practical implications

This study has important implications for managers and banks. Managers will be able to understand the effect of CSR on financing costs with relevant implications for strategic financing planning. Firms are also encouraged to signal their commitment to maintain a high-level quality reporting and reduce agency costs through their expenditure in auditing (i.e. hiring a large well-known audit firm). Moreover, this study sensitizes banking institutions to encourage the concept of socially responsible finance and consider soft information (i.e. involvement in societal issues, corporate citizen, trustworthiness, integrity and non-opportunistic behavior), as part of the credit decision-making and debt pricing process.

Originality/value

This study extends the literature on CSR and the cost of debt. Unlike prior studies, this paper focuses on the debt-pricing effects of audit quality for CSR firms. Audit quality is deemed to be an important governance feature that is likely to constraint opportunistic behaviors (i.e. CSR diversion) and play information and insurance roles to lenders. Audit quality (perceived or real), along with CSR performance, are associated with lower costs of debt.

Details

Corporate Governance: The International Journal of Business in Society, vol. 21 no. 1
Type: Research Article
ISSN: 1472-0701

Keywords

Article
Publication date: 19 February 2021

Quoc Trung Tran

This paper aims to investigate the effect of foreign ownership on cost of debt financing in an emerging stock market.

Abstract

Purpose

This paper aims to investigate the effect of foreign ownership on cost of debt financing in an emerging stock market.

Design/methodology/approach

Cost of debt is a function of foreign ownership. Control variables include state ownership, firm profitability, financial leverage, Tobin's Q, asset growth, firm size and asset tangibility. The research sample includes 3,263 observations from 405 firms listed in Vietnamese stock market during the period 2009–2017.

Findings

The authors find that foreign ownership negatively affects cost of debt and this effect is stronger in non-state-owned enterprises and financially constrained firms.

Originality/value

Prior research shows that ownership structure is a key determinant of debt financing cost in many developed markets. This paper contributes to the literature of emerging market finance by showing that foreign ownership reduces cost of debt financing.

Details

International Journal of Emerging Markets, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1746-8809

Keywords

Article
Publication date: 19 October 2020

Kanyarat (Lek) Sanoran

This study aims to examine whether audit partner public-client specialization and busyness impact the cost of debt.

Abstract

Purpose

This study aims to examine whether audit partner public-client specialization and busyness impact the cost of debt.

Design/methodology/approach

This paper uses data from companies in Thailand for the 1998–2016 period. To measure the cost of debt, this study uses the realized interest cost, measured as the total interest expense for the one year ahead divided by the average value of total debt outstanding during that year.

Findings

The results show a positive association between the cost of debt and two measures of public-client specialization and busyness, which are the number of public clients audited by an individual audit partner in each year and the proportion of the number of public clients divided by the number of total clients in an individual audit partner’s portfolio.

Originality/value

In the literature, there is a lack of research on whether a higher number of public clients in an audit partner’s portfolio leads to better or worse perceived audit quality. This study extends prior literature by examining whether creditors’ perception of audit quality depends on the audit partner specialization or busyness and specifically, on the number of public clients of the auditor. The findings indicate that public-client busyness of a particular audit partner, rather than the audit partner public-client specialization, matters in the cost of debt.

Details

Managerial Auditing Journal, vol. 35 no. 9
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 29 September 2020

Darush Yazdanfar and Peter Öhman

The main purpose of this study is to describe and analyse the relationship between the 2008–2009 global financial crisis and small and medium-sized enterprises' cost of

Abstract

Purpose

The main purpose of this study is to describe and analyse the relationship between the 2008–2009 global financial crisis and small and medium-sized enterprises' cost of debt capital.

Design/methodology/approach

Statistical methods, including multiple OLS and dynamic panel data, were used to analyse a longitudinal cross-sectional panel dataset of 3865 Swedish SMEs operating in five industry sectors over the 2008–2015 period.

Findings

The results suggest that the cost of debt was influenced by the financial crisis and another macroeconomic factor, i.e. the interbank interest rate, and by firm-specific factors such as firm size and lagged cost of debt.

Originality/value

To the authors' best knowledge, this is one of few studies to examine the cost of debt among SMEs during the crisis and post-crisis periods using data from a large-scale, longitudinal, cross-sectional database.

Details

Journal of Economic Studies, vol. 48 no. 6
Type: Research Article
ISSN: 0144-3585

Keywords

Article
Publication date: 11 November 2014

Achraf Guidara, Hichem Khlif and Anis Jarboui

– The aim of this study is to investigate the effect of voluntary and timely disclosure on the cost of debt for the South African setting.

Abstract

Purpose

The aim of this study is to investigate the effect of voluntary and timely disclosure on the cost of debt for the South African setting.

Design/methodology/approach

The sample of this paper consists of 20 South African listed non-financial companies for the period 2008-2011. A content analysis is used to measure the extent of voluntary disclosure. Timely disclosure is proxied by earnings reporting lag.

Findings

Results show that the extent of voluntary disclosure is negatively and significantly associated with the cost of debt. In contrast, timely disclosure exerts a trivial effect on the cost of debt. When testing for the moderating effect of timely disclosure on the association between the extent of voluntary disclosure and the cost of debt, this paper documents that this association is only negative and significant for the shorter earnings announcement lag group.

Originality/value

The findings of this paper have policy implications for managers in the South African setting and other developing economies similar to South Africa, given the crucial role played by debt as an important source of external financing for publicly traded companies.

Details

Meditari Accountancy Research, vol. 22 no. 2
Type: Research Article
ISSN: 2049-372X

Keywords

Article
Publication date: 1 February 1986

Raymond F. Gorman

Since Jensen and Meckling [1976] first introduced the concept of an agency cost of debt, most research on the agency cost of debt has centered on who bears these costs

Abstract

Since Jensen and Meckling [1976] first introduced the concept of an agency cost of debt, most research on the agency cost of debt has centered on who bears these costs. Jensen and Meckling's original contention was that if bondholders have rational expectations, then the owner‐manager should bear the agency costs of debt. The alternative to this explanation was first offered by Barnea, Haugen and Senbet [1981] who claimed that because of the effects of agency costs on the supply of debt, these costs would be borne by the bondholders. Roberts and Viscione [1984] extend the analysis of Barnea, Haugen, and Senbet by including costly tax avoidance on personal and corporate levels to show that the agency costs of debt are shared by bondholders and owner‐managers.

Details

Studies in Economics and Finance, vol. 10 no. 2
Type: Research Article
ISSN: 1086-7376

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