No abstract

We examine whether debt covenant design (threshold tightness, covenants frequency, covenant interdependence, and overall covenant strictness) reduces the adverse effect of poor accounting quality on the cost of debt in the private lending market. We predict and find that when borrowing firms exhibit low accounting quality, lenders tend to increase debt contract strictness through debt covenant design (e.g., increasing the number of covenants, decreasing covenant interdependence or including covenants with greater threshold tightness). Moreover, our results indicate that the cost of debt for borrowers with low accounting quality is significantly influenced by the covenant strictness. Further evidence shows that, although debt covenant designs help mitigate adverse information risk, financial reporting quality is more important than strict debt covenants in lowering the cost of debt, a matter of concern for firm managers and lenders.

Using a sample from 1980 to 2018, we find evidence consistent with banks and insurers in the United States diversifying financial risk through their equity holdings. They tend to offset the risk of increased leverage by lowering the leverage of the non-financial firms in which they take an equity stake.We attribute this finding to the impact of risk-based capital regulations. Facing the high cost of equity, financial institutions are well incentivized to comply with increased capital requirements by reducing asset risk. Our results demonstrate that the scope of the induced de-risking activities of these institutions is not limited to their credit portfolios but extends to their equity exposure as well. We also show that non-financial firms that are concerned about being dropped from the portfolios of financial institutions could de-leverage to deviate from their theoretically optimal capital structures. These novel regularities need to be included in debates about capital regulations for banks and insurance companies.

This study examines the role of information transparency in facilitating peer firms' investment in follow‐on innovation. We capture information transparency with both textual and numerical information disclosed in 10‐Ks. Using patent citations to proxy for investment in follow‐on innovation, we predict and find a positive association between transparency at the knowledge source and follow‐on innovation. We further show that the effect of information transparency varies with the degree of uncertainty around technological innovation. Thus, the evidence suggests that information transparency facilitates investment in follow‐on innovation by resolving uncertainty associated with investment in technological innovation. An analysis using the cited firms' going‐private decision as a negative shock to information transparency confirms the significant effect of a cited firm's disclosure on its decision to invest in follow‐on innovation. Our study contributes to the literature on the positive externalities of peer‐firm disclosures and highlights the important role of information transparency in shaping innovation investment decisions.

This study investigates how pre‐grant patent disclosures required by the American Inventors Protection Act (AIPA) affect the value of innovation. The accelerated disclosures instituted by the AIPA may benefit innovative firms by either reducing duplicative R&D projects or by facilitating prompt, beneficial knowledge spillovers among firms. However, early innovation disclosures may result in proprietary costs and reduce competitive advantages. Our results indicate that when firms engage in quality innovation as captured by patent citations or originality, they have more efficient innovation output after the passage of the AIPA, and their innovation output is more strongly associated with future earnings.