Loan Financing and Cost Management

Abstract

This paper examines how, if at all, managers engage in cost management around periods of loan financing. Compared with matched benchmark firms, loan financing firms report lower operating costs prior to financing, while the difference in costs is insignificant post-financing. Loan financing firms experiencing a sales decline manage costs downward to a greater extent than those experiencing a sales increase. The increase in operating costs post-financing is attenuated by the intensity of earnings-based covenants. This cost reversion cannot be explained by increases in working capital or investment. Overall, the evidence suggests that loan financing affects managers’ operating decisions both before and after the event. Downward cost management prior to loan initiation helps financing firms report higher operating cash flows and does not make future performance inferior to benchmark firms post-financing.

Keywords: loan financing, cost management, asymmetric cost behavior

JEL Classification: M41, G21, G32