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Article

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…

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

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Article

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

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Article

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. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1746-5664

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Book part

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

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Article

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

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

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Article

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

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Article

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. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0144-3585

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Article

Chwee Ming Tee

The purpose of this paper is to examine whether the relationship between politically connected firms (PCFs) and the cost of debt is moderated by board attributes such as…

Abstract

Purpose

The purpose of this paper is to examine whether the relationship between politically connected firms (PCFs) and the cost of debt is moderated by board attributes such as audit committee independence, ethnic board diversity, gender board diversity and family controlling ownership.

Design/methodology/approach

This study employs ordinary least squares model to examine the moderating effect of audit committee independence on the association between PCFs and the cost of debt; moderating effect of ethnic board diversity on the association between PCFs and the cost of debt; moderating effect of gender board diversity on the association between PCFs and the cost of debt; and moderating effect of family-controlled boards on the association between PCFs and the cost of debt.

Findings

The results show that PCFs are associated with lower cost of debt, consistent with crony capitalism theory. Furthermore, board attributes are shown to have significant moderating effect on the association between PCFs and the cost of debt. Specifically, the cost of debt in PCFs can be further reduced, provided the boards have higher audit committee independence, are ethnically diverse, have higher proportion of female directors in the board and audit committee and are controlled by family shareholders.

Originality/value

This study reveals evidence on the impact of board attributes on the cost of debt in PCFs. All findings suggest that concerns on PCFs’ severe agency problems can be alleviated through effective monitoring. The significant board attributes that facilitate effective monitoring are audit committee independence, ethnic board diversity, gender board diversity and family ownership.

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Article

Ben Le

This paper aims to examine the impact of government ownership on the cost of debt and firm valuation in listed Vietnamese companies for the period 2007 to 2016.

Abstract

Purpose

This paper aims to examine the impact of government ownership on the cost of debt and firm valuation in listed Vietnamese companies for the period 2007 to 2016.

Design/methodology/approach

The authors use both the generalised methods of the moment (GMM) and the ordinary least squares (OLS) regressions to analyse a panel data spanning over the period 2007 to 2016 in the markets of Vietnam. Further, the instrumental variable is used in the paper.

Findings

The authors find that firms with relative higher government stockholdings or state-owned companies where the government owns 50 per cent or more of shares outstanding enjoy a lower cost of debt compared to the other firms. Consequently, these firms have higher firm valuation and profitability. The results are robust for both the GMM and the OLS regressions. Further, firms that no longer retain government ownership have a higher cost of debt than the other firms. The results of the paper imply the importance of political connections in businesses in the market of Vietnam.

Originality/value

This paper connects the relationship between government ownership and the cost of debt with the relationship between government ownership and firm valuation. The paper tests the relationship between the cost of debt and government ownership using both OLS and GMM specifications and the results are robust for both approaches. The manuscript uses an instrumental variable to show that government ownership has a positive impact on higher firm performance through reducing cost of debt. Further, this paper addresses the possible issue of endogeneity.

Details

Pacific Accounting Review, vol. 32 no. 2
Type: Research Article
ISSN: 0114-0582

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Article

Amal Hamrouni, Ali Uyar and Rim Boussaada

The purpose of this paper is to test whether or not CSR disclosure (i.e. aggregate as well as its three sub-indicators) reduces the cost of debt for French corporations…

Abstract

Purpose

The purpose of this paper is to test whether or not CSR disclosure (i.e. aggregate as well as its three sub-indicators) reduces the cost of debt for French corporations listed in the SBF 120 index between 2010 and 2015.

Design/methodology/approach

CSR disclosure ratings of firms were collected from the Bloomberg database under three dimensions such as environmental, social and governance (ESG). Then, a pooled regression analysis was run.

Findings

The results indicate that overall CSR disclosure score as a combination of ESG disclosure scores has a negative effect on the cost of debt (i.e. lowers the cost of debt). While environmental disclosure is negatively associated with the cost of debt, social disclosure is unexpectedly positively associated, and governance disclosure has an insignificant association with the cost of debt.

Research limitations/implications

The study has two main limitations. First, the analysis does not consider contractual constraints and obligations that might exist in debt contracts (Jung et al., 2018). Second, the analyses cover a specific time period (i.e. between 2010 and 2015) for a specific country (i.e. France) excluding utilities and the financial sector.

Practical implications

Overall, it is inferred from the results that financial markets for lenders take into account CSR disclosure when assessing the creditworthiness of borrowers. Specifically, environmental disclosure is the only subdimension of CSR that is influential on creditors’ decisions to offer favorable interest rates. In line with this outcome, companies can assess their processes and be more aligned with eco-friendly practices, and investors are particularly advised to invest in those types of firms.

Originality/value

This study extends scant literature on the association between CSR and the cost of debt by exploring how creditors treat CSR dimensions dissimilarly in granting loans to firms. The findings of this study have particular importance as financial debt is one of the most predominant forms of external financing.

Details

Management Decision, vol. 58 no. 2
Type: Research Article
ISSN: 0025-1747

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