Two essays on financial contracting

Abstract

This thesis studies the effect of financial contracting on two major corporate activities - trade credit finance and mergers and acquisitions. Chapter 1 examines when a borrowing firm violates loan covenant, how bank interventions in this borrower affect the borrower's trade credit. Trade credit declines when banks obtain additional control rights following debt covenant violations. Interventions that are likely to result in acceleration of loan repayments lead to larger reductions in trade credit. In addition, dependent suppliers that have made customer-specific investments are adversely affected by bank interventions. Ex ante, firms take into account the effect of bank control on dependent suppliers and accordingly offer less restrictive debt contracts. These results suggest that debt covenant violations have large negative externalities for dependent suppliers and firms take these externalities into account when designing loan contracts. In Chapter 2, we find that differences in the compensation of acquirer and target firms' management teams negatively affect the outcomes of mergers. Larger differences in top management pay are associated with lower returns to the acquiring firm after the announcement of the merger and negative combined wealth effects. Larger pay differences also increase the likelihood of employee layoffs. Overall, our results suggest that differences in executive compensation are indicators of integration problems at merging firms, which in turn negatively affect merger outcomes.

Date of Award	2015
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology