Three essays in financial economics

Abstract

Corporate liabilities have rich heterogeneity in many dimensions, such as debt types, maturity structure, covenant terms, and syndication structure. Existing literature mainly studies corporate liabilities from a corporate finance perspectives. Their macroeconomic and asset pricing implications are relatively less explored. This dissertation seeks to investigate the asset pricing and macroeconomic implications of three important elements of non-financial firms’ liabilities: the usage of undrawn credit lines, the loan covenants in debt contracts, and leasing. In the first essay, I study the cross-sectional relationship between corporate undrawn credit line holdings and expected returns. I document that firms with more undrawn credit lines earn 3.88−5.74% higher returns than firms with fewer undrawn credit lines. To rationalize this finding, I incorporate the major features of credit line contracts into the investment-based asset pricing framework to illustrate a novel risk-based mechanism: firms with larger idiosyncratic liquidity needs endogenously hold more undrawn credit lines to preserve flexible and cheap liquidity. However, due to credit line revocations that strongly correlate with aggregate economic conditions, they become more exposed to aggregate shocks, yielding the positive undrawn credit line premium. In the second essay (with Emilio Bisetti and Kai Li), we study the quantitative impact of lender control rights on firm investment, asset prices, and the aggregate economy. We build a general equilibrium model with endogenous loan covenants, in which the breaching of a covenant (technical default) entails a switch in investment control rights from borrowers to lenders. Lenders optimally choose low-risk projects, thus mitigating borrowers’ risk-taking incentives and reducing their cost of equity. Such a mechanism mitigates the financial accelerator effect (29), and generates a technical default spread such that firms closer to technical default earn 4% lower average returns than those further away from it. In the third essay (with Kai Li), we document that leased capital accounts for about 20% of total physical productive assets used by US public firms, and its proportion is more than 40% among small and financially constrained firms. The leased capital ratio exhibits a strong counter-cyclical pattern over business cycles and a positive correlation with cross-sectional idiosyncratic uncertainty. We argue that existing macro models with financial frictions assume that firms can not rent capital and overlook the effects of leasing activities on business cycle dynamics. We explicitly introduce a buy-versus-lease decision into the Bernanke-Gertler-Gilchrist financial accelerator model setting to demonstrate a novel and quantitatively important economic mechanism: that the increased use of leased capital when financial constraints become tighter in bad states significantly mitigates the financial accelerator mechanism and thus also mitigates the response of macroeconomic variables to negative TFP shocks and risk shocks. We provide strong empirical evidence to support our mechanism.

Date of Award	2023
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology
Supervisor	Byoungchan LEE (Supervisor)