Expert answer:increase in external financing among euro countrie
Solved by verified expert:you should read the article that I attach it then answer the questions down 1. Bris et al. (2014) find an increase in external financing among euro countries. Name four explanations given in the article for this finding: 1. 2. 3. 4.2. Name one weak euro country according to the article: and one strong euro country according to the article:
article_euro_and_corporate_financing_before_the_crisis.pdf
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The Euro and Corporate Financing before the Crisis*
Arturo Bris
IMD and ECGI
Yrjö Koskinen
The Wharton School,
University of Pennsylvania
Mattias Nilsson**
University of Colorado,
Boulder
Forthcoming in the Journal of Financial Economics
July 10, 2014
Abstract
We study the financing policies of European public corporations prior to the euro crisis. Using data from
11 euro countries and a control group of five other European countries over 1991–2006, we show that
nonfinancial firms from euro countries with previously weak currencies considerably increased their debt
financing after the introduction of the euro. The results are stronger for large firms, firms dependent on
external financing, and for the latter part of the post-euro time period. Overall, the results support the
hypothesis that the supply of capital increased following the introduction of the euro.
JEL classification: F33, F36, G32
Keywords: euro, financial integration, external financing, debt financing, supply of capital,
financial dependence.
*The authors would like thank Henrik Cronqvist, Eric Hughson, Matthias Kahl, Pedro Matos, Raghu Rau, Josef
Zechner, Toni Whited, François Derrien, Buhui Qiu, and seminar participants at Bank of Finland, Claremont
McKenna College, Hanken/Helsinki School Economics, Boston University, and NHH Bergen for helpful comments.
We are also grateful for comments from participants at European Winter Finance Summit in Hermagor, Austria,
conference on Financial Intermediation and the Real Economy in Paris, and EFA in Cambridge. An earlier version
of the paper was circulated under the title “The Euro and Corporate Financing.” The project was initiated when
Koskinen was visiting the Bank of Finland, he is grateful for the Bank’s hospitality. All remaining errors are our
responsibility. Contact information: Arturo Bris, arturo.bris@imd.ch ; Yrjö Koskinen, yrjo@wharton.upenn.edu;
Mattias Nilsson, mattias.nilsson@colorado.edu.
**Corresponding author.
Electronic copy available at: http://ssrn.com/abstract=2687284
1.
Introduction
In 2009, the European Union celebrated the tenth anniversary of the introduction of the euro as its
common currency. In a report published in 2008, the European Commission claimed that the first decade
of the Economic and Monetary Union was a “resounding success” (European Commission, 2008). Those
words turned out to be premature. Soon after the celebrations were over, the euro area was tossed into a
severe crisis from which it has yet to fully emerge from.
The extant macroeconomics literature has identified a private sector credit boom and related current
account deficits as major causes for the crisis (Lane, 2012). This paper aims to participate in this debate on
the roots of the crisis by providing firm-level evidence on corporate financing choices before the onset of
the crisis. In particular, we examine if the euro has led to an increase in the use of debt financing for
companies hailing from the euro area compared to other European companies.
Previous research by Bris, Koskinen, and Nilsson (2006, 2009) shows that the introduction of the
euro resulted in increases in corporate valuations and investments for euro area firms compared to other
European firms. Bris et al. attribute these findings mainly to a decrease in cost of equity and debt capital.
As a result of decreased cost of capital, the demand for external financing is expected to have increased in
the euro area compared to other comparable European countries. The supply of capital may have also
increased in the euro area. For example, euro area financial markets have become less segmented since the
introduction of the euro, as manifested by the increase in cross-border portfolio investments, in particular
for bonds (see, e.g., De Santis and Gerard, 2006; Lane, 2006; Lane and Milesi-Ferretti, 2007). Thus, firms
have become less dependent on domestic investors when raising external financing. In addition, the
implementation of the ambitious legislation known as the Financial Services Action Plan (FSAP) during
the first half of the 2000s has made it easier to provide financial services throughout the European Union
and thus could have facilitated cross-border financial intermediation (Kalemli-Ozcan, Papaioannou, and
Peydró, 2010). The euro countries may have been particularly well positioned to take advantage of this
regulatory integration by already sharing a common currency.
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Electronic copy available at: http://ssrn.com/abstract=2687284
We provide evidence that the introduction of the euro has led to an increase in external financing,
especially debt financing, for firms hailing from euro countries. Based on our sample of public firms,
nonfinancial firms are likely to have significantly contributed towards current account deficits among the
crisis countries by borrowing more. Our results are stronger for firms from those euro countries that
previously had weak currencies, consistent with the idea that increased external financing is due to higher
demand for financing. However, there is clear evidence that increased supply has also been a major
contributing factor. Large firms, who have better access to foreign banks and investors, have increased their
debt financing more, despite the fact that previous research shows that their valuations increased less than
the valuations for smaller firms [see Bris, Koskinen, and Nilsson (2009) for relative valuations]. Moreover,
firms in industries that are more dependent on external financing have increased their debt financing more.
Finally, results are stronger during the second half of our time period, partially due to the implementation
of FSAP. These findings support the idea that improved supply of capital has led to increased use of external
financing among the euro countries.
We estimate regressions where the change in total external financing, the change in debt, or the
change in external equity, all normalized by lagged assets, are the dependent variables. As explanatory
variables we use measures of size, profitability, collateral, a proxy for industry-level growth opportunities
(corresponding to US industry Tobin’s Q), together with dummies indicating firms in the euro area for the
time the common currency has been in use. Our sample consists of 2,486 firms from 16 European countries
in the period 1991–2006. In particular, we use corporate-level data from the 11 original countries that
adopted the euro in 1999, and as our control sample we use the three EU countries that did not adopt the
euro (Denmark, Sweden, and the UK) as well as Norway and Switzerland. Using a control sample allows
us to compute differences-in-differences estimators to measure the impact of the euro both cross-sectionally
and in the time-series domain.
We show that the introduction of the euro has on average lead to a 1.9% annual increase in external
financing relative to assets for companies from the euro area compared to companies from our control
countries. When we split the sample of euro firms between firms in weak euro countries (i.e., countries that
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suffered a currency crisis in the years before the introduction of the euro) and strong euro countries, we find
that for the weak euro countries the annual increase in external financing is 4.2% of assets, composed of
2.6% increase in debt financing and 1.4% increase in external equity financing. For strong euro countries
there is no increase in external financing, but equity issuance increases by 0.8% annually.
We also estimate individual country results, using firms from the UK as the benchmark. Among
the individual euro countries, the results are the strongest for firms from the now-troubled countries of Italy,
Portugal, and Spain, as well as for firms from the currently financially more solid northern euro countries
of France, Netherlands, and Finland.1 Among the non-euro countries, Denmark stands out as the only
country in which firms on average significantly increased their external financing, in particular debt
financing, after 1999.
Among industries, the results are the strongest for basic industries (agriculture, mining, and
construction) and for service industries among the weak euro countries. Since construction is part of basic
industries, the results for that industry are not surprising in view of the real estate boom in some euro
countries. However, we should bear in mind that our results are relative to the control group, which is
dominated by firms from the UK, and that the UK also experienced a real estate boom.
The results showing that firms from weak euro countries have on average raised more external
financing than firms from strong euro countries is consistent with the explanation that demand for financing
has increased, since Bris, Koskinen, and Nilsson (2006, 2009) show that the weak euro firms experienced
higher increases in Q and investment levels after the introduction of the euro. In order to examine if supply
of financing is also a major contributing factor for the increase in external financing in the euro area, we
classify industries to be dependent on external financing by measuring the fraction of investments financed
by external finance in corresponding industries in the US between 1991 and 1997 [following the procedure
of Rajan and Zingales (1998)]. We then show that industries that are dependent on external financing have
significantly increased their debt and equity financing compared to the control group after the introduction
1
Note that Finland is classified as a weak euro-country in our analysis as it was hit by a significant currency crisis
in the early 1990s.
3
of the euro. The result holds for all euro firms, but it is much stronger for firms from weak euro countries
(annual increase is 3.9% of assets in debt financing and 1.6% in equity financing). Interestingly, the results
for debt financing are also stronger for large firms (defined as having above sample median average sales
in the pre-euro period). For example, large firms from weak euro countries have increased their debt
financing by 3.2% of assets annually, whereas the increase for smaller firms is 2.2%. One possible
explanation is that larger firms have the most to gain from financial market integration, as international
investors and banks have a preference for larger, more well-established firms. Consistent with this view,
Gozzi, Levine, and Schmukler (2010) show that large firms dominate financing from international capital
markets.
We further show that external financing has increased more in the 2003–2006 time period than in
the 1999–2002 period, even though a significant increase in valuations occurred already in the earlier time
period (Bris, Koskinen, and Nilsson, 2009). If demand for financing were the sole factor contributing to
greater use for external financing, firms should have raised more financing already in 1999–2002. One
mechanism that has contributed to stronger results in the latter half of our sample is the adoption of the
Financial Services Action Plan (FSAP). FSAP is an EU-wide legislative program whose purpose is to
facilitate cross-border provision of financial services. Our result for euro countries is partially explained by
including an index that reflects when the actual legislation was implemented in different member countries.
Next, we analyze the use of external financing by looking at the effect of the euro on changes in
non-cash assets, changes in cash holdings, changes in dividend payments, and changes in total payouts.
Consistent with the corporate investment results in Bris, Koskinen, and Nilsson (2006), we find that euro
firms have significantly increased their non-cash assets relative to other firms. Interestingly, cash holdings,
dividends, or total payouts have not grown compared to our control group. Firms that belong to industries
that are more dependent on external financing have experienced higher growth in non-cash assets. Better
access to financing has thus had real consequences. Consistent with the external financing results, the
growth in non-cash assets has been faster after 2002. Even though valuations increased immediately when
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the euro was introduced, it seems to have taken some time before the institutional framework was ready to
support increased firm growth.
The next section reviews the literature. Section 3 describes the data sources and the variables used
in the paper. Section 4 discusses the methods and main results. Section 5 studies how dependence on
external financing affects financing. Section 6 provides evidence on the importance of deepening financial
integration and regulatory harmonization over time. Section 7 focuses on asset growth. Finally, Section 8
concludes.
2.
Related literature
The extant macroeconomics literature on the euro crisis has started to emphasize private sector credit
booms and related current account deficits as perhaps the most important explanatory factors for the euro
crisis. For example, Lane (2012) documents the dramatic increase in private sector credit and current
account deficits that occurred for those euro countries that are now engulfed in severe recessions. Lane
(2013) shows that capital flows in the euro area were dominated by debt and that the increase in net foreign
debt is positively correlated with growth in private credit for euro countries before the crisis. We
complement these aggregate results by providing firm-level evidence for significant increases in external
financing, in particular debt financing, in the euro area. Consistent with the macroeconomics literature, our
results are stronger for firms hailing from the crisis countries.2
Some of our results are consistent with the view that the cost of capital has decreased in the euro area,
leading to a surge in that demand for external financing. There is strong evidence for the decline in cost of
capital in the euro area. Bartram and Karolyi (2006) show that systematic risk has been significantly reduced
due to the introduction of the euro. Hardouvelis, Malliaropulos, and Priestley (2007) find evidence that the
cost of equity has decreased in the euro area since the introduction of the euro, and that there is no similar
reduction in cost of capital for those EU countries that chose not to adopt the euro as their currency. Bris,
2
For a pre-crisis overview of the macroeconomic effects of the euro, see Beetsma and Giuliodori (2010).
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Koskinen, and Nilsson (2009) find evidence for cost of equity reduction using Tobin’s Q-ratios: valuations
measured using Q-ratios have increased after the introduction of the euro, especially for countries that
devalued their currencies during the European Monetary System (EMS) crisis of 1992–1993. Hassan (2013)
shows that the cost of equity has decreased in the euro area for the non-tradable sector and that real interest
rates have declined, because bonds denominated in euros provide better insurance against consumption
shocks than bonds issued in the legacy currencies would have provided. Based on this literature, we would
expect firms in the euro area to increase their external financing, and this is indeed what we find.3
Some of our results cannot be explained by a decrease in the cost of capital. For example, large firms
have increased their external financing more despite the fact that their valuations have increased less than
the valuations for smaller firms. One reason for this is that large firms are better positioned to benefit from
financial integration. There is plenty of evidence that financial markets have become less segmented and
more integrated in the euro area. For example, Hardouvelis, Malliaropulos, and Priestley (2006) show that
excess stock returns in the euro area have become more sensitive to common euro risk at the expense of
country-specific risks. Cappiello, Kadareja, and Manganelli (2010) show that co-movements between
European stock market returns have increased since 1999, which implies increased stock market integration.
Corporate bond markets have also become more integrated and credit spreads have converged across the
euro area. Baele, Ferrando, Hördahl, Krylova, and Monnet (2004) show that since the adoption of the euro,
the impact of country-factors in explaining credit spreads has become economically small and that credit
spreads are more influenced by fundamental factors like ratings and maturity.
Transactions costs for buying euro area assets have declined significantly since the introduction of
the euro. Coeurdacier and Martin (2009) provide evidence that the costs for buying euro area bonds and
stocks have decreased significantly. Lower transactions costs, elimination of intra-euro area exchange rate
risk, and currency matching rules for assets and liabilities becoming irrelevant within the euro area, have
3
Contrary to the prevailing evidence, Bekaert, Harvey, Lundblad, and Siegel (2013) find no evidence for a euro
effect. Bekaert et al. (2013) study valuation differentials and they show that there is a strong European Union effect:
bilateral valuation differentials are significantly lower for EU members than for non-members.
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resulted in a dramatic increase in cross-border portfolio investments between euro countries. The increase
is portfolio investments is more pronounced for bonds (see, e.g., Lane, 2006; De Santis and Gerard, 2006),
but cross-border holdings within the euro area have also increased significantly for equities (see, e.g., De
Santis and Gerard, 2006; Lane and Milesi-Ferretti, 2007). Finally, Kalemli-Ozcan, Papaioannou, and
Peydró (2010) show that bilateral bank holdings have also increased between euro countries by 25–30%
compared to other EU members.
Increased cross-border portfolio investments imply that firms in the euro area are less dependent
on domestic markets for their financing needs and in particular, that firms that were previously financially
constrained due to underdeveloped domestic financial markets would be expected to increase their external
financing more than other firms. Consistent with this, we find that firms from industries that are more
dependent on external financing have increased their debt financing more than firms that are less dependent
on external financing.
We are not the first ones to emphasize that changes in the supply of capital matter for firms’
financing choices. Faulkender and Petersen (2006) compare firms that have bond ratings—and thus access
to bond markets—to firms that do not. They show that firms with bond ratings have 35% more debt in their
capital structures. Like Faulkender and Petersen (2006), we show that even large corporations may face
financing constraints and that access to credit markets is a significant determinant in firms’ financing
choices. Papers by Leary (2009), Sufi (2009), and Lemmon and Roberts (2010) identify exogenous shocks
that have led to a change in the supply of capital. Leary (2009) finds that the emergence of a market for
certificates of deposit in 1961 and the resulting expansion in bank credit led to increased leverage for firms.
Sufi (2009) shows that the introduction of syndicated loan ratings in 1995 led to increased borrowing by
firms that obtained a rating. Lemmon and Roberts (2010) study the collapse of Drexel Burnham Lambert
and the resulting decrease in high-yield bond financing and show that this led to a decrease in financing
and investments for those firms that were using high-yield debt financing. The introduction of the euro is
also an exogenous event, implemented partially for political reasons [as argued by Bris, Koskinen, and
Nilsson (2009)]. However, since the euro is likely to have affected both the demand for and supply of
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capital, its introduction alone cannot provide direct evidence that an increase in supply of capital is a major
cause for the observed increase in external financing. For that purpose, we utilize the implementation of the
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