Review of Quantitative Finance and Accounting

Abstract We propose a refined dynamic programming model based on a hidden Markov chain formulation and a nonlinear filtering technique to calculate the optimal debt ratio for public and private sectors for different scenarios. We then conduct the empirical analysis of the U.S. markets in real estate and equities during 1991.Q1 and 2020.Q1, comparing them with the theoretical results. It indicates that U.S. households and governments spent more than they can afford. While households reduced their debt ratio during times of economic distress, the public sector hiked its debt ratio to stimulate the economy. The policy effect took a long time to accumulate, and the outcome was lower than expected to revitalize the economy in time.

Abstract We examine how turnovers of provincial officials in China correspond to changes in corporate working capital. We find that during periods of turnover in government, working capital tends to increase as cash and long-term investments decrease, while total assets remain stable. Firms increase their working capital more for promotion of government officials. In addition, a firm obtains more short-term debts from banks and may be more willing to provide trade credit to its customers during political uncertainty period. We find that government policy uncertainty and intervention uncertainty factors coexist and interact with firms’ working capital during periods of provincial officials’ turnover in China.

Abstract The paper provides insights into how debt overhang issues related to transfers of value to creditors can impact target firms’ financial policy after an acquisition. The later are natural events which introduce new prospects of value creation and possibilities of undue transfer of value to the incumbent creditors. We examine changes in leverage at the target firm before and after it is acquired in a sample of US, Canadian, and European firms over the 2000–2016 period. We find that the target’s pre-acquisition financial leverage predicts changes in its leverage after the acquisition, consistent with target firms increasing their leverage after the acquisition to avoid wealth transfer to creditors. Changes in financing structure are implemented shortly after the acquisition. The more long-term indebted the target firm, the more releveraging develops. Our results support the releveraging hypothesis as suggested by the creditors’ holdup mechanism.

Abstract Prior studies document that SG&A expenditure (exclusive of R&D and advertising expenditure) creates an intangible asset value despite that U.S. GAAP requires SG&A to be expensed immediately as a period cost. In this paper, we investigate whether the credit default swap (CDS) market recognizes the intangible asset value of SG&A expenditure. Our findings show that although the CDS market views contemporaneous SG&A expenditure as a risk factor on average, it does recognize the intangible asset value created by SG&A. Specifically, the positive association between CDS spread and SG&A expenditure is weaker for firms with higher SG&A intangible asset value. This suggests that SG&A’s intangible asset value helps mitigate credit risk. We also document that such mitigation effect is stronger when the accounting information of the reference entity is more transparent and when the reference entity is more financially constrained. Our inferences remain when we: (1) examine the short window CDS market reaction to SG&A information around SEC filing dates, and (2) use total SG&A expenditure including R&D and advertising in our analysis. Overall, this study shows that the credit market differentiates between the expense and the asset components of SG&A expenditure and lowers the risk assessment of firms with higher intangible asset values.