Creditor Control Rights and Firm Investment Policy by Greg Nini, Amir Sufi, and David Smith

1. Creditor Control Rights and Firm Investment Policyby Greg Nini, Amir Sufi, and David Smith Comments by Carlos D. Ramirez

2. The Story • Empirical literature appears to have largely overlooked the importance of contractual restrictions on capital expenditures. • These restrictions appear to be a very big deal--about 40% of all loan contracts in the sample contain an explicit restriction provision.

3. The Story, part 2: • These restrictions appear to bind! A firm that experiences a deterioration in its financial health (a downgrade), also experiences a 52 percent increase in the likelihood of being imposed a capital expenditure restriction in its loan contract.

4. Main Comment VERY GOOD PAPER!

5. Another motivation point: • Paper can form part of investment-cash flow sensitivity debate– FHP (and others) vs. KZ (and others) • In a nutshell: KZ claim that cash flow sensitivities do not appear to increase monotonically with measures of liquidity constraints. • These results can offer an explanation of why this monotonic relationship may not show up in the data…

7. Main Concern: • Authors recognize a serious difficulty: CAUSALITY • Sequence of events: 1. A firm’s financial health decreases 2. New loan contracts contain capital expenditure restrictions 3. Capital expenditures decline

8. What’s the problem? • You can go from 1 to 3, without 2! • Example: Exogenous (macro, industry) shock

9. How to deal with this?--1st Test: • Look at a plot of the actual restriction relative to investment spending. • Result: Most of the actual spending concentrates around the restriction. • Authors argue that this is too much of a coincidence.

10. 1st Test problem? • Loan amounts are about 40 percent of assets. (Table 2 of paper) Thus, these loans are large! • Given that they are so large, firms have a significant incentive to negotiate these loan contracts, including the restriction amount. • Banks have an incentive to monitor the firms, hence they offer contracts that force firm managers to release more information. • If so, the kink is not coincidental.

11. 2nd Test: Regression analysis • Regress Capital Expenditures changes on whether the firm had a loan restriction imposed, controlling for year effects and firm performance.

12. Main Results

13. 2nd Test Problem: • The capital expenditure coefficient appears to be “fragile” -- sometimes insignificant or significant at the 10 percent. • Hence it is important to do more robustness checks.

14. Suggestion for Robustness Checks: • Include other measures of performance as controls. (Examples:1.Change in revenues (accelerator theories of investment); 2. The stock of liquid assets to total assets (liquidity constrained)). • Look at a subsample of firms that received a downgrade. (This constrains the sample to those firms that are likely to reduce investment spending, regardless of restriction imposition.) • Split this subsample by the existence of a capital restriction.

15. Last Comment: A great paper for $10,000!!