Corporate Financial Policies in Overvalued Debt Markets

58 Pages Posted: 13 Jan 2013 Last revised: 21 Aug 2015

See all articles by Jarrad Harford

Jarrad Harford

University of Washington; European Corporate Governance Institute (ECGI)

Marc Martos-Vila

London Business School - Department of Finance; University of California, Los Angeles (UCLA) - Finance Area

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Date Written: June 24, 2015

Abstract

We investigate the repercussions of credit market mistakes for a firm's borrowing and investment decisions. When credit ratings are relatively optimistic, we find evidence that firms take advantage of inaccuracies by issuing more debt, increasing leverage, rolling over more debt and lengthening maturities. The result goes beyond a wealth transfer and has real investment implications: approximately 75% of the funds raised from debt issuance related to credit rating mistakes was used for capital expenditures and cash acquisitions. In the cross section, credit rating mistakes affect financially constrained firms the most, suggesting that debt overvaluation loosens financial constraints.

Keywords: Debt Misvaluation, Capital Structure, Cash Holdings, Credit Ratings, Debt Issuance, Financial Constraints, Investment, Mergers and Acquisitions, Moody's, Moral Hazard

JEL Classification: G31, G32, G34

Suggested Citation

Harford, Jarrad and Martos-Vila, Marc and Rhodes-Kropf, Matthew, Corporate Financial Policies in Overvalued Debt Markets (June 24, 2015). Available at SSRN: https://ssrn.com/abstract=2200093 or http://dx.doi.org/10.2139/ssrn.2200093

Jarrad Harford

University of Washington ( email )

Box 353226
Seattle, WA 98195-3226
United States
206-543-4796 (Phone)
206-543-7472 (Fax)

HOME PAGE: http://faculty.washington.edu/jarrad/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Marc Martos-Vila (Contact Author)

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit ( email )

Soldiers Field Road
Rock Center 312
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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