Taming polysemous signals: The role of marketing intensity on the relationship between financial leverage and firm performance

• Author: Hannah Oh,John Bae,Sang‐Joon Kim
• DOI: http://doi.org/10.1016/j.rfe.2016.12.002
• Published date: 01 April 2017
• Date: 01 April 2017

Taming polysemous signals: The role of marketing intensity on the

relationship between financial leverage and firm performance

John Bae

a,

⁎,Sang-JoonKim

b

, Hannah Oh

c

a

Financeat Elon University, NC27244, United States

b

Managementat Ewha School of Business,Ewha Womans University,South Korea

c

Marketingat the College of BusinessAdministration, Universityof Nebraska Omaha,NE 68182, United States

abstractarticle info

Articlehistory:

Received23 February 2016

Receivedin revised form 9 December2016

Accepted18 December 2016

Availableonline 23 December 2016

This studyattempts to reconcile the two strandsof research on the impactsof financial leverage on firm valua-

tion. The prior literaturehas shown that financial leveragehas a polysemous effect. In other words,it provides

two opposingsignals of firm performance (i.e., financialdistress vs. a driver of positive changein a firm's pros -

pects). Given that the effects of financial leverage are contradictory,we specify how these divergentsignals ap-

pear and propose that there is a non-monotonic effect of financial leverage on firm valuation. The study also

shows that marketingactivities can be strategicallyimplemented to tame thesepolysemous signals. Marketing

activities are costly actions for a firm, especially one in an adverse environment with high le verage, and are

rewardedin terms of firm valuation.Therefore, marketingactivities can help reinforcethe driver signaland alle-

viatethe distress signal of financialleverage, thus increasingfirm valuation.This study finds a U-shapedrelation-

ship between financial leverage and Tobin's q and a positive moderating effect of marketing intensity on the

curvilinearrelationship.

© 2016 ElsevierInc. All rights reserved.

Keywords:

Firm financialleverage

Marketingintensity

Firm valuation

Signaling

1. Introduction

Since the seminal work on debt by Modigliani and Miller (1958),

debt, as a means to finance, has been studiedin terms of how it can af-

fect the capital structureof a firm (Myers, 1984; Kraus & Litzenberger,

1973;Frank & Goyal, 2003). Basically, Modigliani and Miller (1958) the-

orized that capitalstructure does not affect the marketvalue of a firm.

However, since the conception of corporate income tax was added to

the capital-structure-irrelevancethesis, the role of debt has been exten-

sively exploredand its monetarybenefits and costs have been specified

(Myers, 1984; Kraus & Litzenberger, 1973; Frank & Goyal, 2005;

Graham, 2003). For example, Kraus and Litzenberger (197 3) argued

that debt is beneficial in that it can shield earnings from corporatein-

come taxes, butthat it can also lead firms to the dangerof bankruptcy.

That is, as the level of debt increases, the marginalbenefit of debt de-

clines, while the marginal cost increases. A firm that is optimizing its

overall value will focus on this tra de-off when choosing how much

debt and equity to use for financing (Frank & Goyal, 2005). Thus, the

conflictbetween benefitand cost of debt can yielda curvilinearrelation-

ship betweendebt and performance(specifically,an inverted U-shaped

relationship).

While thetrade-off theory has providedtheoretical contributions to

our understanding of capitalstructure, its empiricalrelevance has often

beenquestioned. In addition,our knowledgeof the impact of debt,char-

acterizedby multiple meaningswithin a firm, on firm performance,has

not been fully specified. The empirical findings reported have been in-

conclusive. Some scholars havefound a positive relationship between

debt and firm performance (Jensen, 1986; McConnell & Servaes,

1990), while others have found a negative relationship (Goddard,

Tavakoli & Wilson, 2005; Myers, 1977; Mar garitis & Psillaki, 2010;

Yazdanfar & Ohman, 2015). Stulz (1990) found both a positive and a

negative effect of debt based on Myers (197 7) and Jensen (1986).

Scholars have not reached an agree ment about the relationship be-

tween financial distress and corporate performance (Opler & Titman,

1994) and the empiricalevidence based on the agencycosts hypothesis

is mixed (Campello, 2006a, b; Mesquita & La ra, 2003; Titman, 2000;

Myers, 2001;Harris & Raviv, 1991; Weill,2008). See Table 1 for a sum-

mary of previousliterature.

Variousconclusions exist in the literature regardingthe relationship

between financialleverage and firm performance.Consideringpotential

causes for these inconsistentresults, such as different sample periods,

sample regions, model specifications, and hypothesized relationships

between various researches, we attem pt to reconcile these findings

through the use of a very comprehensive data set that covers a time

span of 30 years under a non-linear model specificationthat properly

accounts for other firm and industry effects. Furthermore, we provide

Reviewof Financial Economics 33 (2017)29–40

⁎Correspondingauthor.

E-mailaddresses: jbae@elon.edu(J. Bae), s.kim@ewha.ac.kr (S.-J.Kim),

hoh@unomaha.edu(H. Oh).

http://dx.doi.org/10.1016/j.rfe.2016.12.002

1058-3300/©2016 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe