The two asset types supported borrowing through different mechanisms, He finds. Tangible assets were more closely associated with asset-based borrowing, in which loans are secured by collateral that creditors could potentially liquidate if the borrower were to default. A key factor in this type of lending is redeployability, or whether an asset can be transferred to another user without losing much value. Intangible assets, by contrast, were mainly associated with cash flow–based borrowing. Because these assets are difficult to pledge or resell, lenders instead rely on the company’s ability to generate stable operating cash flows over time.
Intangibles that can reduce cash-flow volatility are especially valuable for debt-financing purposes, He argues. To this end, she makes a distinction between production-based intangibles (such as patents, software, trade secrets, and licenses), which help support a company’s operations and productivity, and demand-shifter intangibles (brands and trademarks, franchise agreements, domain names, and customer lists), which directly affect customer demand for a company’s products and services. The latter do more to stabilize cash flow, which reduces the likelihood and severity of financial distress, according to the study. She finds that a $1 increase in demand-shifter intangibles was associated with an increase of 45 cents in long-term debt, compared with a rise of 15 cents for production-based intangibles.
Using a court ruling that resulted in a quasi-natural experiment—as a consequence of the ruling, distressed companies were pushed toward formal bankruptcy rather than out-of-court restructuring—He then extended her analysis to look at how companies can borrow against assets that are difficult to pledge as collateral. The key, she says, is in the legal infrastructure that allows financially distressed companies to restructure and preserve their operations as a going concern, through Chapter 11 reorganization, for example. While physical assets can be sold to repay creditors, intangibles generate most of their value within a functioning business. The amount that intangible-intensive companies can borrow, then, depends on lenders’ confidence that the companies’ operations—and the cash flows produced—can be preserved during distress.
The study demonstrates that when the restructuring process becomes even slightly less reliable, as happened in the ruling she studied, it becomes harder for intangible-intensive companies to borrow. Formal bankruptcy tends to be slower, more disruptive, and more public, which can erode a company’s going-concern value.
As the value of intangibles continue to grow, policymakers should consider keeping up with the evolving economy by strengthening the legal framework that governs corporate distress and restructuring, He argues. Systems that resolve distress while preserving going-concern value would help protect companies and keep credit flowing to intangible-rich ones, particularly in the technology and service industries, that she sees as “driving modern innovation and growth.”
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