Emploi corporate finance

Abstract

This paper investigates the link between financial structure and employment growth and the link between financial structure and inventory growth, among incorporated Canadian manufacturers over the period 1988 to 1997. It. finds that financially vulnerable firms-smaller firms and those with higher leverage-tend to shed more labour than healthier firms for an equal sized drop in product demand. When a demand shock occurs, a firm with high leverage sheds nearly 10% more employment for than a firm with average leverage. The influence was larger during the recession of 1990-1992 and more significant in sectors that were hit hardest by the recession. This is as one would expect given that credit constraints become more binding during recessions. The influence was also larger in sectors that experienced larger cyclical fluctuations. On average, firms with high leverage also tend to cut inventories more (+5%) when a shock in demand occurs.

Résumé

Cette étude porte sur le lien entre la structure financière et la croissance de l'emploi et des inventaires des fabricants canadiens constitués en société au cours de la période allant de 1988 à 1997. On observe que pour une certaine baisse dans la demande de produits, les entreprises financièrement vulnérables-c'est-à-dire celles qui sont de petite taille ou qui ont un ratio de levier financier élevé-ont tendance à réduire davantage leurs effectifs que les entreprises en meilleure santé financière. Lorsqu 'un choc à la baisse survient dans la demande de produits, les coupures d'emploi sont près de 10 % plus élevées dans les entreprises avec un ratio de levier financier élevé, en comparaison avec les entreprises dont le ratio se situe dans la moyenne. Cette influence était plus marquée durant la récession de 1990 à 1992, et était plus significative dans les industries qui ont été plus durement touchées par la récession. Ce résultat n'est pas surprenant dans la mesure où les conditions de crédit sont plus contraignantes en période de récession. Enfin, les entreprises avec un ratio de levier financier élevé tendent à réduire davantage leurs inventaires (dans une proportion de 5 %) lorsque survient un choc de la demande.

During recent decades, Canadian businesses increasingly financed themselves by raising their level of debt with respect to assets, commonly referred to as leverage. Between 1961 and 1996, the share of Canadian firms' capital held in debt increased by nearly 50%.1 In the 1990s, the level of aggregate corporate leverage tended to fall slightly, but still remained high by historical standards. Does this increase in leverage matter? Capital structure theory beginning with Modigliani and Miller (1958) argues that the choice of capital structure does not matter to the net value of the firm or the cost of available capital. Divergences from this theorem, described by Donaldson (1963), Jensen and Meckling (1976), Myers (1977, 1984), Myers and Majluf (1984), and Fama and French (2002) emphasize the role of informational asymmetries and agency costs which differentiate the cost of external and internal finance, making capital structure choice important for the firm's value and for the cost of capital available to the firm. This has implications for the real side activity of the firm, including employment and investment in inventories.

In this paper we examine the relationship between firm leverage and stability in employment and inventories using Canadian data for the manufacturing sector. Recent empirical studies focusing on the U.S. manufacturing sector have shown that highly leveraged firms have more volatile inventory and employment patterns. In the event of a negative demand shock, firms must find new funds to finance variable inputs. A firm with a healthy balance sheet position may have the cash on hand, or easy access to external finance, to smooth production by building up inventories (Blinder & Maccini, 1991) and avoid the large adjustment costs associated with the firing (and hiring when demand picks up later) of employees (Nickell, 1986; Oi, 1962). On the other hand, if a firm has difficulty obtaining outside finance, its employment and inventories should be more sensitive to the availability of internal funds. Cash flows at highly leveraged firms tend to be committed to principal and interest payments, and lenders may see the firm as having reached its maximum debt capacity. Hence, the cost of additional debt to a financially distressed firm is likely to be high. As a result, leveraged firms will tend to lay off workers (Sharpe, 1994) and allow inventories to decline (Carpenter, Fazzari, & Petersen, 1994; Kashyap, Lamont, & Stein, 1994). Alternatively, firm owners may prefer higher debt to force firm managers to respond quickly to changes in the economic environment (Jensen, 1986, 1988). In either case, employment and inventory instability is the outcome.

Similar arguments have been put forth regarding small firms. Small firms also face capital market constraints since they often do not have access to equity markets and often need to finance their operations with more expensive bank loans. Thus, small firms are often also seen as financially constrained and more sensitive to demand shocks than large firms (Gertler & Gilchrist, 1994; Gertler & Hubbard, 1988).

Interestingly, there is reason to believe that the impact of financial vulnerability on employment and inventory may be larger during recessions. A substantial literature has arisen to describe the so-called "financial accelerator", which is summarized in Bernanke, Gertler, and Gilchrist (1996). The basic implications of the financial accelerator can be described as follows. The first is that small firms and firms with unhealthy balance sheets will bear the brunt of deteriorating credit market conditions following a real or monetary shock, because lenders flee from firms that face significant agency costs of borrowing, a phenomenon referred to as the "flight to quality". Agency costs refer to the higher return necessary for external financing compared to internal financing required to compensate for conflicting incentives facing managers and owners, and the costly monitoring of managerial action. Other things being equal, agency costs should be higher when leverage is high and when the firm is small.2 Reduction in credit available to these firms will exacerbate the problems related to reduced net worth at the firm, causing them to reduce output and investment more than otherwise for a similar demand shock. The second implication is that the reduction in spending and production of credit-constrained firms will spread to other firms, propagating and amplifying the downturn. This suggests a route by which increased debt in the corporate sector may lead to higher macro-economic instability. It is also hypothesized that the influence of financial vulnerability should be greater the deeper the recession (Gertler & Hubbard, 1988; Kashyap et al., 1994).

Bernanke and Gertler (1989) and Calomiris, Orphanides, and Sharpe (1994) describe this same phenomenon in terms of "debt deflation". When a shock provokes an unanticipated fall in the general price level, the ensuing reduction in the collateral value of assets decreases the capacity of the firm to raise external funds, or "debt overhang". Firms tend to run up debt during expansions, and are more vulnerable to the effects of debt overhang at cyclical peaks as a result of their high leverage. The literature also raises the possibility that if the macroeconomic shock was the result of a monetary policy to raise the interest rate, this may have an effect on the cost of a leveraged firms' outstanding debt (Bernanke & Blinder, 1988). Higher interest rates also affect the cost a firm incurs in carrying inventory (Kashyap et al., 1994). Finally, the literature suggests that inflation might be lower than expected during a recession, increasing the real cost of external capital (Bernanke & Campbell, 1988; Bernanke & Gertler, 1989).