Factors affecting firm long-term operating performance following straight bond issuance

Abstract

This project aims at investigating whether a relationship exists between long term operating performance following straight debt issuance and a number of independent variables namely debt rating, firm’s debt ratio, underwriter reputation, and the governance index of the firm. We attempt to analyze this relationship within the context of the predictive ability of these four variables of firm long term operating performance after a debt issue. Indeed we find that the bond rating and the governance index may be good indicators of firm long term operating performance following straight debt issuance. To test this relationship, we carry a regression on 484 instances of straight bond issuances between 1990 and 2009. To measure long term operating performance, three ratios are used, the operating return on assets, the profit margin and the return on assets. The abnormal performance of these ratios over those of the industry for one year, three years, and five years after the issuance were used in the regression. We find that the regression coefficient is significantly negative for the bond rating, insignificant for the optimal debt ratio and the underwriter reputation and significantly positive for the governance index. We also conclude that measuring operating performance for the one year time horizon is inconclusive as the effects of issuing debt had not taken effect and that measuring the performance for the five year time horizon is also inconclusive as these effects would have faded away. Finally, we note that the operating return on assets ratio may not fully incorporate the effects of issuing debt and that the profit margin and the return on assets ratios may dilute the effects of such issuances. Accordingly these ratios would not be suitable when it comes to measuring operating performance following straight debt issuance.