The Determinants of Foreign Currency Debt Financing: Borrower Incentives or Lender Incentives?

• DOI: http://doi.org/10.1111/ajfs.12197
• Published date: 01 December 2017
• Date: 01 December 2017
• Author: Hyeon Sook Kim,Sung C. Bae,Taek Ho Kwon

The Determinants of Foreign Currency Debt

Financing: Borrower Incentives or Lender

Incentives?*

Sung C. Bae**

Department of Finance, College of Business, Bowling Green State University, United States

Hyeon Sook Kim

School of Business, Chungnam National University, Republic of Korea

Taek Ho Kwon

School of Business, Chungnam National University, Republic of Korea

Received 27 October 2016; Accepted 11 July 2017

Abstract

We offer new evidence that firm-level determinants of foreign currency (FC) and local cur-

rency (LC) debt financing differ significantly. While LC debt financing is affected mainly by

demand-side borrower incentives, such as operating profitability, financing deficit, and depre-

ciation expenses that reflect borrowers’ capital needs, FC debt financing is affected mostly by

supply-side lender incentives, such as tangible assets, firm size, asset growth, and R&D

expenses, which FC debt lenders consider in assessing the potential value of collateral, in

addition to the widely-reported export ratio. Our results remain robust in the presence of

macro-level factors.

Keywords Foreign currency debt financing; Determinants; Borrower incentives; Lender incen-

tives; Korean firms; Global financial crisis

JEL Classification: F31, G15

*The authors acknowledge helpful comments from Kang Baek, Anthony Loviscek, Seungjoon

Oh, session participants at the 2016 CAFM meeting in Seoul, Korea, and an anonymous ref-

eree of the Journal on the earlier version of the paper. Bae gratefully acknowledges research

support from the CBA Summer Research Grant Program at Bowling Green State University.

This work was supported by the Korea Grant of the National Research Foundation funded

by the Korean Government (NRF-2011-327-1300258). The usual disclaimer applies.

**Corresponding author: Sung C. Bae, Department of Finance, College of Business, Bowling

Green State University, Bowling Green, OH, USA. Tel: +1-419-372-8714, Fax: +1-419-372-

2527, e-mail: bae@bgsu.edu.

Asia-Pacific Journal of Financial Studies (2017) 46, 824–852 doi:10.1111/ajfs.12197

824 ©2017 Korean Securities Association

1. Introduction

Business firms around the world, especially those in the emerging economies,

often raise foreign currency (FC, hereafter) debt for various reasons, which differ

from the reasons for raising domestic or local currency (LC, hereafter) debt.

Gozzi et al. (2012) demonstrate that domestic and international bond markets

provide different financial services and thus debt issues in these two markets have

different attributes, which are not explained by differences across firms or their

country of origin. In this paper, we attempt to unveil the potentially different

characteristicsoffirmsusingFCdebt,relativetofirmsusingLCdebt,andthe

firm-specific factors that determine firms’ usage of FC debt, relative to LC debt.

Our paper focuses on Korean manufacturing firms. Considering that Korea has

experienced one of the most volatile exchange rate changes in Asia since the Asian

financial crisis and that Korean firms frequently resort to FC debt in various

forms, Korean firm s are an excellent exp erimental labora tory to examine iss ues

on FC debt financing.

Several earlier studies have examined the underlying rationale of FC debt financ-

ing.

1

These include: to circumvent legal restrictions imposed by domestic govern-

ments (Shapiro, 1984; Rhee et al., 1985); to overcome segmented local capital

markets (Jorion and Schwartz, 1986; Campbell and Hamao, 1992); and to arbitrage

differences in tax rates across the world (Smith and Stulz, 1985; DeMarzo and Duf-

fie, 1996). Using aggregate cross-country data, a few subsequent studies show that a

firm’s usage of FC debt is related to macro factors such as international funding,

exchange rate volatility, domestic inflation (Basso et al., 2007), and FC domestic

deposits (Luca and Petrova, 2008). A number of other studies also document that

FC debt helps firms hedge foreign exchange risk associated with their exporting

activities (Allayannis and Ofek, 2001; Keloharju and Niskanen, 2001; Kedia and

Mozumdar, 2003; Bae and Kwon, 2013; Mora et al., 2013). Other recent studies

show that banks’ financing issues surrounding financial crises, such as the 2007 glo-

bal financial crisis and the 2011 European shock, explain the contraction on dollar

lending as a supply side driver (Correa et al., 2012; Acharya et al., 2013; Ivashina

et al., 2015).

More research is, however, warranted in order to shed empirical light on several

key issues unanswered in the existing studies. First, while most reasons for FC debt

financing documented in the literature are macro- and market-oriented factors, little

is known about the internal, firm-specific characteristics that affect firms’ financing

of FC debt versus LC debt. In a study of FC debt by small firms in the 25 transition

1

Another group of existing studies investigates the effects of FC debt financing on firm per-

formance and value with mixed evidence (see, e.g. Allayannis et al., 2003; Harvey et al., 2004;

Bleakley and Cowan, 2008; Clark and Judge, 2009; Endr

esz and Harasztosi, 2014). In a study

of Korean firms, Bae et al. (2016) show that firms with FC debt have lower firm values than

firms with LC debt, the evidence of which is mainly attributed to inefficient usages of cur-

rency derivatives by firms with FC debt.

Determinants of Foreign Currency Debt

©2017 Korean Securities Association 825