Financing Investment: The Choice Between Bonds and Bank Loans

Abstract

We build a model of investment and financing decisions to study the choice between bonds and bank loans in a firm's marginal financing decision and its effects on corporate investment. We show that firms with more growth options, higher bargaining power in default, operating in more competitive product markets, and facing lower credit supply are more likely to issue bonds. We also demonstrate that, by changing the cost of financing, these characteristics affect the timing of investment. We test these predictions using a sample of U.S. firms and present new evidence that supports our theory.

Credit market frictions and capital structure dynamics

“…Choi, Getmansky, Henderson, and Tookes [9] show that the issuance of convertible bonds is positively related to a number of capital supply measures. Morellec, Valta, and Zhdanov [52] show that capital supply uncertainty in debt markets has first order effects on firms' investment and financing decisions. Finally, a number of surveys indicate that financing decisions are generally governed by the preferences of the suppliers of capital rather than by the demands of the users of capital (see Graham and Harvey [27]).…”

Operating Leverage and Underinvestment

“…Then, we carry out the empirical tests using a large panel covering 16,169 publicly traded firms from 1966 to 2016. Following Leary and Roberts (), Whited (), and Morellec, Valta, and Zhdanov (), we estimate a mixed proportional hazard model and find that a one‐standard‐deviation rise in operating leverage decreases the investment hazard rate by approximately 4.1%. The evidence suggests that operating leverage can mitigate the negative relation between financial leverage and investment.…”

“…Our empirical test focuses on relatively large and lump‐sum projects. Following Whited () and Morellec, Valta, and Zhdanov (), we adopt an investment spike measure as our primary dependent variable. An investment spike occurs if the ratio of the investment to net property, plant, and equipment (PP&E) is two times greater than the firm median.…”

Trade credit contract in the presence of retailer investment opportunity

“…First, recall that min r denotes the retailer's outside opportunity profit, implying that the retailer would not accept the contract if his expected profit is lower than min r . Then, the profits of the retailer and the supplier under symmetric information case are 9 This is a common assumption in the finance literature, as exemplified by Garleanu and Zwiebel (2008) and Morellec, Valta, and Zhdanov (2014). 10 Although it is difficult for the supplier to know the investment rate of the retailer, she can estimate based on the observation of historical data, for instance, the annual reports of listed companies and assessment of third-party evaluation agencies.…”