Capital structure and performance of Middle East and North Africa (MENA) banks: an assessment of credit rating

Ahmed A El-Masry

doi:10.21511/bbs.11(1).2016.09

Abstract

The firm’s credit rating is an important communication tool and previous research has shown that many companies consider it important in capital structure decisions. This study examines the determinants of capital structure in MENA banks. In addition, it investigates the determinants of credit rating. Further, the impact of credit rating and capital structure on banks’ performance is examined. Therefore, this study is an attempt to answer the following questions: 1) what are the main determinants of capital structure? 2) how does credit rating affect capital structure? 3) what are the main determinants of credit rating? and 4) what is the effect of capital structure and credit rating on bank performance? The sample covers 169 banks and is divided into two sub-samples: rated (79) and non-rated banks (90). The results indicate that credit rating directly affects the capital structure decisions as rated banks use more debts than non-rated banks. Banks’ performance is positively associated with credit rating and negatively with the capital structure. This study has an implication on investors in their decisions to invest in the banking industry. It also helpful for policy makers to understand how bank’s capital structure behaves so they could take it into consideration when issuing new regulations such as Basel

Highlights

Capital structure is one of the most intriguing corporate issues and continues to motivate top management and academics to determine the optimal combination of debt and equity that will maximize firm value and increase investors’ pecuniary benefits
Kisgen (2006) found that credit rating directly affects capital structure decisions on the US market in the period from 1986 to 2001. He found that companies near a credit rating upgrade or downgrade issued less debt relative to net equity as a percentage of total assets than firms not near a credit rating change, a finding which is inconsistent with the traditional capital structure theories, as their predictions do not include the impact of credit rating on capital structure decisions
Asgharian (2005) identifies the motives for companies to get higher credit rating 1) high credit rating increases the ability of the company to issue debt and facilitates its access to the capital market, 2) new companies can make the best use of high credit rating through building up their market reputation, and 3) lower cost of fund as credit rating can be seen as a competitive advantage that distinguishes one company from another company, especially, in industries characterized by a limited number of competing companies

Summary

Introduction

Capital structure is one of the most intriguing corporate issues and continues to motivate top management and academics to determine the optimal combination of debt and equity that will maximize firm value and increase investors’ pecuniary benefits. Kisgen (2006) found that credit rating directly affects capital structure decisions on the US market in the period from 1986 to 2001 In his study, he found that companies near a credit rating upgrade or downgrade issued less debt relative to net equity as a percentage of total assets than firms not near a credit rating change, a finding which is inconsistent with the traditional capital structure theories, as their predictions do not include the impact of credit rating on capital structure decisions. The theory holds that a firm, in order to achieve an optimal capital structure that maximizes the total market value, seeks debt levels that balance the value of interest tax shields against the various costs of bankruptcy or financial distress. Firms far away from an upgrade or downgrade will be in better position to increase their debt levels if they are below their target, since they will be less concerned about a change in rating”

Objectives

Methods

Findings

Conclusion