Asset Tangibility and Corporate Performance under External Financing

Asset values often fall sharply once assets are placed outside of the …rm. When this happens, investors have fewer incentives to enforce their right to liquidate or reorganize the …rm. Instead, they may allow an underperforming business to continue and may even re…nance it under its current management. The problem that this creates is that …rm insiders then have fewer incentives to implement value-enhancing policies. Continuation is less likely to occur, however, when assets can fetch high values outside of the …rm. This paper looks at moral hazard in …rm performance under external …nancing. The testing strategy I implement sidesteps the issue of endogeneity between …nancial contracting and economic outcomes by using “asset tangibility”(i.e., the resale value or ease of redeployment of the …rm’s assets) as a state variable. I show novel evidence that the performance of externally-funded investment is driven by the post-…nancing value/redeployability of the …rm’s assets outside of the …rm. More precisely, I show that the component of investment that is explained by external …nancing is associated with superior …rm product market performance, valuation, and accounting returns when, subsequently to …nancing, asset tangibility turns out to be high. In contrast, economic outcomes associated with external funding are markedly poorer when asset tangibility is ex post low. Crucially, these dynamics are not observed for internally-funded investment. Inferences that the …rm observes superior business performance under external …nancing when assets are more tangible hold for both new outside equity and debt …nancing. Key words: Asset tangibility, external …nancing, product market competition, endogeneity. JEL classi…cation: G31. *Department of Finance, College of Business Administration, University of Illinois at Urbana-Champaign, Champaign, IL 61820. E-mail: [email protected]. I thank Bo Becker, Long Chen, Diemo Dietrich, Zsuzsanna Fluck, Sendhil Mullainathan, and Michael Weisbach for helpful suggestions. Evangelos Benos, Reza Etebari, and Sherlyn Lim provided excellent research assistance. The usual disclaimer applies.