EBITDA and Managers' Investment and Leverage Choices

Abstract

EBITDA is a commonly used performance measure for (i) valuation, (ii) debt contracting, and (iii) executive compensation. The widespread use of EBITDA by stakeholders may induce managers to focus their attention on EBITDA. Since EBITDA excludes various expenses, managers who fixate on EBITDA may underweight the excluded expenses when determining their firms' investments in capital and leverage levels. I find that managers who fixate on EBITDA overinvest in capital and overlever their firm relative to their industry peers. These results are robust to alternative proxies for managers' focus on EBITDA and alternative specifications. I also find that firms whose managers focus on EBITDA have weaker operating performance, which is attributed to higher depreciation expense. My primary proxy for managers' focus on EBITDA is whether they choose to disclose EBITDA in annual earnings announcements. I find that the use of EBITDA in setting executive compensation, the prevalence of EBITDA estimates by analysts, and the use of EBITDA-based covenants in firms' debt contracts are all positively associated with the propensity to disclose EBITDA in earnings announcements. I find weaker evidence of opportunistic motives explaining EBITDA disclosure. These results are consistent with managers disclosing EBITDA to portray to investors that it is a metric they seek to maximize. Overall, this study suggests that while EBITDA is a widely used metric, there is a systematic cost to using this measure-it provides managers with incentives to overinvest in capital and to acquire excessive debt.principale variable de substitution à la concentration des gestionnaires sur le BAIIA est le choix de publier ou non le BAIIA dans les annonces des résultats annuels. L'auteur note que l'utilisation du BAIIA dans la détermination de la rémunération des cadres, la prévalence des estimations du BAIIA proposées par les analystes et l'utilisation de clauses restrictives basées sur le BAIIA dans les contrats d'emprunt des sociétés affichent toutes un lien positif avec la propension à publier le BAIIA dans les annonces de résultats. Il relève des données moins probantes quant aux motivations opportunistes qui pourraient expliquer la publication du BAIIA. Ces résultats tendent à confirmer que les gestionnaires publieraient le BAIIA afin de signaler aux investisseurs leurs efforts pour maximiser cet indicateur. Dans l'ensemble, l'étude semble indiquer que, même si le BAIIA est un indicateur largement utilisé, son usage présente un coût systématique : il incite les gestionnaires à surinvestir dans les immobilisations et à abuser de l'emprunt.

The association between EBITDA reconciliation quality and opportunistic disclosure

“…Prior studies that have focused on EBITDA include the studies by Cormier, Demaria, and Magnan (2017), Rozenbaum (2019), and Verriest, Bouwens, and De Kok (2019).…”

“…Rozenbaum 2019also found evidence which suggests that companies disclose EBITDA for informational, rather than opportunistic purposes. From a sample of 18 082 press releases of US-listed companies over the period 2003 to 2011, Rozenbaum (2019) investigated whether managers that fixate on EBITDA as performance measure were more likely to over-invest and over-leverage their companies. Since EBITDA excludes interest, depreciation and amortization, management that fixates on EBITDA may put less weight on the real costs involved when making financing and investment decisions, resulting in over-investment or over-leveraging companies.…”

“…In validating his proxy for management's fixation on EBITDA, i.e. whether EBITDA was reported in a press release, Rozenbaum (2019) found that the choice to disclose EBITDA was more consistent with management disclosing EBITDA to inform investors and debt holders, and less consistent with opportunistic disclosure.…”

Opportunity Motivation and Growth Aspirations of Mexican Entrepreneurs: The Moderating Role of the Household Income

“…A key motivating factor in the decision to follow an entrepreneurial career is a desire for independence and control over one´s working life [21,64]. Independence may be understood as the individual's intention to start a new venture that is primarily expected to make independent entrepreneurs while providing income and EBITDA (earnings before interests, taxes, depreciation, and amortization) capable of achieving the financial aspirations of the firm, although it allows for managers with incentives to overinvest in capital and to acquire excessive debt [65]. When digital transformations accompany innovations, they enhance value creation in products and services offered in the market to create digital dividends and foster entrepreneurship [66].…”

Optimal Information Design and Incentive Contracts with Performance Measure Manipulation

“…14 Examples of real earnings management include over-production (Roychowdhury 2006), R&D cuts (Baber, Fairfield, and Haggard 1991;Rozenbaum 2017), advertising decreases (Cohen, Mashruwala, and Zach 2010) and compromises in workplace safety (Caskey and Ozel 2017). These activities diminish the firm value (Bhojraj, Hribar, Picconi, and McInnis 2009;Cohen and Zarowin 2010).…”