Heitor Almeida

Financing Frictions and the Substitution Between Internal and External Funds

Ample evidence points to a negative relation between internal funds (profitability) and the demand for external funds (debt issuance). This relation has been interpreted as evidence supporting the pecking order theory. We show, however, that the negative effect of internal funds on the demand for external financing is concentrated among firms that are least likely to face high external financing costs (firms that distribute large amounts of dividends, that are large, and whose debt is rated). For firms on the other end of the spectrum (low payout, small, and unrated), external financing is insensitive to internal funds. These cross-firm differences hold separately for debt and equity, and they are magnified in the aftermath of macroeconomic movements that tighten financing constraints. We argue that the greater complementarity between internal funds and external financing for constrained firms is a consequence of the interdependence of their financing and investment decisions.

Internal Capital Markets in Business Groups: Evidence from the Asian Financial Crisis

This paper examines capital reallocation among firms in Korean business groups (chaebol) in the aftermath of the 1997 Asian financial crisis, and the consequences of this capital reallocation for investment and performance of chaebol firms. We show that chaebol transferred cash from low growth to high growth member firms after the crisis, using cross-firm equity investments. This capital reallocation allowed chaebol firms with greater investment opportunities to invest significantly more than control firms in the aftermath of the crisis. Chaebol firms with greater investment opportunities also showed higher profitability and lower declines in valuation than control firms following the Asian crisis. Our results suggest that Korean chaebol used their internal capital markets to mitigate the negative effects of the Asian crisis on their investment and performance.

Optimal state-dependent rules, credibility, and inflation inertia☆

Abstract We use a state-dependent model where pricing rules are optimal to examine the costs of a money-based disinflation under various assumptions about the credibility of the policy change. Our analysis allows us to relate actual credibility and future inflation inertia to the asymmetry of the price deviation distribution. An important implication of our state-dependent setting is that disinflation can be attained without substantial cost even in a situation of low credibility, provided that a mechanism of price alignment eliminates the asymmetry of the price deviation distribution. We also develop an analytical framework for analyzing intermediate imperfect credibility cases.

The Effect of Internal Capital Markets on Corporate Investment: Evidence from the Asian Financial Crisis

This paper provides new evidence on the relationship between internal capital markets and corporate investment by exploiting an exogenous event and an unique empirical setting. We do so by comparing the investment behavior of Korean business group (chaebol) firms with non-chaebol Korean firms in the aftermath of the 1997 Asian financial crisis. Our empirical methodology employs a difference-in-differences matching estimator to ensure that chaebol and non-chaebol firms in the control group are as similar as possible along observable dimensions other than chaebol membership. The matching estimator also accounts for time-invariant, firm-specific effects. In addition, we conduct a battery of placebo and other related tests to evaluate alternative explanations that rely on endogenous selection of firms into chaebol, and demand effects that may differentially affect chaebol and control firms following the crisis. The results show that chaebol firms invest significantly more than non-chaebol firms in the control group in the aftermath of the crisis. This difference in investment behavior does not hold for normal periods, including a recession year. Chaebol firm post-crisis investment is positively associated with variables that proxy for the availability of internal capital markets, including industry diversification within a chaebol and chaebol liquidity. Chaebol firms with greater investment opportunities increased investment the most in the aftermath of the crisis, a pattern that is not observed in the control group. Finally, we find that chaebol firm profitability increased relative to control firms in the years following the crisis. Overall, our results suggest that Korean chaebol were able to use their internal capital markets to mitigate negative effects of the Asian crisis on corporate investment.

More Cash, Less Innovation: The Effect of the American Jobs Creation Act on Patent Value

Firms can become less innovative following a sudden “inflow” of cash. Specifically, multinational firms that were eligible to repatriate (and indeed repatriated) cash to the U.S. under the American Jobs Creation Act generate less valuable patents than otherwise similar firms. They also conduct more exploratory activities. This effect only exists among firms in less competitive industries, firms with lower institutional ownership, and firms with overconfident CEOs, and is mainly driven by the reduction in the value of U.S.-originated patents. Our evidence suggests that, without appropriate governance, a cash windfall may lead managers to engage in riskier innovation strategy that can destroy value.

More on the Performance of Higher Order Moment Estimators in Investment Equations

Almeida, Campello, and Galvao (2010) [ACG] use Monte Carlo simulations and real data to assess the performance of estimators that deal with measurement errors in investment models. ACG are the first to provide an independent assessment of alternative methods, showing when they work properly and discussing the assumptions embedded in them. Erickson and Whited (2010) review ACGs study focusing exclusively on tests involving the Erickson and Whited (2000, 2002) [EW] estimator. While casting doubt on the usefulness of the ACG analysis, Erickson and Whited (2010) develop a number of ex-post fixes for the problems uncovered by ACG. The authors argue that the ACG tests would place the EW estimator in a more positive light had they used those fixes. This paper evaluates the new fixes proposed by Erickson and Whited and clarifies their implications for the debate about measurement error. The analysis provides further support for ACGs main conclusion: the presence of measurement error does not justify the use of the EW estimator in lieu of more robust, simpler alternatives.

Understanding the Credit Multiplier: The Working Capital Channel

We provide novel evidence that frictions in the financing of working capital can limit firms’ production capacity, leading to the amplification and propagation of liquidity problems over time. We propose a new approach to identify this firm credit multiplier that compares how a same firm responds to permanent shocks differently when these shocks are initiated in the period in which they are predicted to be most profitable (their “main quarter”). Our analysis implements this test with oil price shocks and provides extensive evidence supporting our identification strategy. Our results suggest that the financing of working capital can be an important channel for understanding the real effects and determinants of short-term funding problems faced by firms.

Bank Lines of Credit as Contingent Liquidity: Covenant Violations and Their Implications

We examine the relation between the financial health of banks and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the Asset Backed Commercial Paper market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Looking at the broader period of the financial crisis (2007-2010), we find that a worsening in financial health at banks led to a lower probability of waivers, following a covenant violation on a credit line. Our paper suggests that a worsening in financial conditions of lenders can bear financial implications for firms that use credit lines as an instrument of liquidity management.

Assessing the performance of estimators dealing with measurement errors

We describe different procedures to deal with measurement error in linear models and assess their performance in finite samples using Monte Carlo simulations and data on corporate investment. We consider the standard instrumental variable approach proposed by Griliches and Hausman (Journal of Econometrics 31:93–118, 1986) as extended by Biorn (Econometric Reviews 19:391–424, 2000) [OLS-IV], the Arellano and Bond (Review of Economic Studies 58:277–297, 1991) instrumental variable estimator, and the higher-order moment estimator proposed by Erickson and Whited (Journal of Political Economy 108:1027–1057, 2000, Econometric Theory 18:776–799, 2002). Our analysis focuses on characterizing the conditions under which each of these estimators produce unbiased and efficient estimates in a standard “errors-invariables” setting. In the presence of fixed effects, under heteroscedasticity, or in the absence of a very high degree of skewness in the data, the EW estimator is inefficient and returns biased estimates for mismeasured and perfectly measured regressors. In contrast to the EW estimator, IV-type estimators (OLS-IV and AB-GMM) easily handle individual effects, heteroscedastic errors, and different degrees of data skewness. The IV approach, however, requires assumptions about the autocorrelation structure of the mismeasured regressor and the measurement error. We illustrate the application of the different estimators using empirical investment models. Our results show that the EW estimator produces inconsistent results when applied to real-world investment data, while the IV estimators tend to return results that are consistent with theoretical priors.