Explicit and Implicit Contracts with Non-Financial Stakeholders and Corporate Capital Structure: The Case of Product Warranties

50 Pages Posted: 29 Apr 2010

See all articles by Jayant R. Kale

Jayant R. Kale

Georgia State University

Costanza Meneghetti

Colorado State University, Fort Collins - Department of Finance & Real Estate

Husayn K. Shahrur

Bentley University - Department of Finance

Date Written: January 18, 2010

Abstract

We use a unique dataset of product warranty offerings by firms to investigate the effect of a firm’s warranty reserve levels on its capital structure decisions. Our sample consists of firms that (i) offer explicit warranties, (ii) likely offer implicit product warranties, and (iii) are in non-warranty-offering industries. For the whole sample, we find that leverage relates negatively to the firm’s warranty level. Further, we find that firms that offer implicit warranties have lower debt levels than firms in non-warranty industries and that, conditional on operating in a warranty-offering industry, firms that issue explicit warranties tend to have even lower debt levels. We also investigate the determinants of the product warranty decision, and find that firms offer explicit warranties when products are more differentiated, when uncertainty about product quality is high, and when sellers have private information on product quality. We then show that the negative relation between firm’s debt and warranty levels continues to hold even after we control for self-selection by firms into offering explicit warranties. Our research contributes to the literature that examines how contracting with non-financial stakeholders such as customers affects the firm’s financing decision.

Keywords: Capital Structure, Leverage, Product Warranties, Explicit and Implicit Contracts

JEL Classification: G22, G32

Suggested Citation

Kale, Jayant Raghunath and Meneghetti, Costanza and Shahrur, Husayn K., Explicit and Implicit Contracts with Non-Financial Stakeholders and Corporate Capital Structure: The Case of Product Warranties (January 18, 2010). Available at SSRN: https://ssrn.com/abstract=1539217 or http://dx.doi.org/10.2139/ssrn.1539217

Jayant Raghunath Kale (Contact Author)

Georgia State University ( email )

Robinson College of Business
University Plaza
Atlanta, GA 30303-3083
United States
404-413-7345 (Phone)
404-413-7312 (Fax)

Costanza Meneghetti

Colorado State University, Fort Collins - Department of Finance & Real Estate ( email )

Fort Collins, CO 80523
United States

Husayn K. Shahrur

Bentley University - Department of Finance ( email )

175 Forest Street
Waltham, MA 02154
United States

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