Essays on Corporate Growth and Corporate Credit Risk
Abstract: This doctoral dissertation contributes to research on financial economics. It consists of an overall introduction and three independent papers. The first paper, “A Theory of Gazelle Growth: Competition, Venture Capital Finance, and Policy,” examines how young fast-growing small firms, called gazelles, develop. The paper investigates under which circumstances gazelles grow by establishing a new facility organically or by acquiring another firm. The paper proposes a theoretical model in which a gazelle firm competes against an incumbent firm that is a market leader in an oligopolistic market. The paper shows that a lower cost of organic growth can increase the gazelles’ incentives for acquisition growth. This is because the incumbent cannot in this situation protect its market from the gazelle’s entry and therefore does not acquire the target firm for entry-deterring purposes. Therefore, the gazelle firm can acquire the target firm at such a low price that it prefers growth by acquisition over organic growth. This effect implies that regulators’ financial policies customized to support the gazelles’ organic growth may, instead, spur gazelles to grow through acquisitions. The second paper, “Tracing Credit Risk in the Equity Market,” analyzes empirically how the illiquidity of a firm’s stock in the equity market affects the firm’s credit risk in the debt market. The paper measures credit risk via credit default swap (CDS) spreads. According to the Efficient Market Hypothesis, the stock price should reflect all available information. Similar to stock return or stock return volatility, stock liquidity is another aspect of stock price that provides information to the market about a firm’s value and future performance. This paper hypothesizes that stronger information asymmetry about the firm’s value will manifest itself as a higher illiquidity of the firm’s stock in the equity market. The CDS market will interpret higher illiquidity as a higher credit risk of the firm, and this will increase the CDS spread for the firm. The paper uses a sample of publicly owned large North American non-financial firms and shows that the higher the illiquidity of a firm’s stock, the higher the CDS spread of the firm in the next fiscal quarter. The third paper, “How Does Debt Composition Influence Credit Risk?,” investigates how different types of debt in a firm’s capital structure affect its credit risk. This paper uses CDS spreads to measure firms’ credit risk and decomposes debt according to two classifications: account type and debt maturity. Every debt type has its characteristics and implies a different level of information asymmetry in the credit relationship between the firm and its lender. Therefore, this paper hypothesizes that the CDS market attributes a different level of credit risk to each debt type. Empirically, the study finds that debt to financial markets is the most influential in terms of economic magnitude on next quarter’s CDS spread among all debt types by account type classification. Regarding debt maturity classification, the paper concludes that the CDS market attributes more credit risk to long-term than short-term debt.
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