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The profit versus loss heuristic and firm financing decisions

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  • Pinnuck, Matt
  • Shekhar, Chander

Abstract

This paper examines the extent to which the profit versus loss heuristic directly affects debt issuance decisions. We hypothesize that reporting a loss and its use as a heuristic rather than firms’ economic fundamentals has an impact both on the decision to raise external debt finance and on the choice between debt and equity financing. The results are consistent with the hypothesis. We find that there is a sharp and economically-significant discontinuity around the zero-earnings threshold in the level of debt issues. Firms reporting small losses issue significantly less debt than firms reporting small profits. We also find that the loss heuristic has an impact on the choice between debt and equity in that loss firms issue less debt relative to equity. Taken together the results are consistent with the notion that profit versus loss heuristic impacts the debt issuance decision and provide explanations that add to those offered by the traditional theories.

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  • Pinnuck, Matt & Shekhar, Chander, 2013. "The profit versus loss heuristic and firm financing decisions," Accounting, Organizations and Society, Elsevier, vol. 38(6), pages 420-439.
    • Handle: RePEc:eee:aosoci:v:38:y:2013:i:6:p:420-439
    DOI: 10.1016/j.aos.2013.09.003
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    2. Papanastasopoulos, Georgios A., 2017. "Asset growth anomaly in Europe: Do profits and losses matter?," Economics Letters, Elsevier, vol. 156(C), pages 106-109.
    3. Naser Makarem & Frank Hong Liu & Lei Chen, 2023. "Evidence that financing decisions contribute to the zero-earnings discontinuity," Review of Quantitative Finance and Accounting, Springer, vol. 60(1), pages 231-257, January.
    4. Dellaportas, Steven & Xu, Lina & Yang, Zhiqiang, 2022. "The level of cross-disciplinarity in cross-disciplinary accounting research: analysis and suggestions for improvement," CRITICAL PERSPECTIVES ON ACCOUNTING, Elsevier, vol. 85(C).
    5. Kettunen, Jukka & Martikainen, Minna & Voulgaris, Georgios, 2021. "Employment policies in private loss firms: Return to profitability and the role of family CEOs," Journal of Business Research, Elsevier, vol. 135(C), pages 373-390.

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