Asset Tangibility and Capital Allocation
Journal of Corporate Finance,
Firms comprise divisions that often differ with respect to the degree of asset tangibility. As the strength of borrowing constraints depends on the liquidation value of assets, these firms influence their debt capacity by allocating funds across divisions. We argue that a company whose capital allocation is not verifiable suffers from a dynamic inconsistency problem, as it tends to allocate resources in favor of divisions with fewer tangible assets, leading to a tight borrowing constraint. When capital allocation is verifiable, committing to invest only little there eases this constraint, although it implies a deviation from a return maximizing allocation.
Asset Tangibility and Capital Allocation within Multinational Corporations
IWH Discussion Papers,
We investigate capital allocation across a firm's divisions that differ with respect to the degree of asset tangibility. We adopt an incomplete contracting approach where the outcome of potential debt renegotiations depends on the liquidation value of assets. However, with diversity in terms of asset tangibility, liquidation proceeds depend on how funds have been allocated across divisions. As diversity can be traced back to institutional differences between countries, we provide a rationale for multidivisional decision- making in an international context. A main finding is that multinationals may be bound to go to certain countries when financiers cannot control the capital allocation.
Rating Agency Actions and the Pricing of Debt and Equity of European Banks: What Can we Infer About Private Sector Monitoring of Bank Soundness?
The recent consultative papers by the Basel Committee on Banking Supervision has raised the possibility of an explicit role for external rating agencies in the assessment of the credit risk of banks’ assets, including interbank claims. Any judgement on the merits of this proposal calls for an assessment of the information contained in credit ratings and its relationship to other publicly available information on the financial health of banks and borrowers. We assess this issue via an event study of rating change announcements by leading international rating agencies, focusing on rating changes for European banks for which data on bond and equity prices are available. We find little evidence of announcement effects on bond prices, which may reflect the lack of liquidity in bond markets in Europe during much of our sample period. For equity prices, we find strong effects of ratings changes, although some of our results may suffer from contamination by contemporaneous news events. We also test for pre-announcement and post-announcement effects, but find little evidence of either. Overall, our results suggest that ratings agencies may perform a useful role in summarizing and obtaining non-public information on banks and that monitoring of banks’ risk through bond holders appears to be relatively limited in Europe. The relatively weak monitoring by bondholders casts some doubt on the effectiveness of a subordinated debt requirement as a supervisory tool in the European context, at least until bond markets are more developed.