The Firm’s Trade Credit Policy Effects on Debt and Capital Structure under Trade-Off and Pecking Order Predictions – A Panel Data Static Model Analysis, from European Western Countries

Abstract

Listen

Translate article

The aim of this paper is to analyze the conditions under which firm’s both book leverage and capital structure may be explained with the scholar explanatory variable sets constituted by financing, profitability and return volatilities. Innovative tangibility represented by a new assets flexibility as another explanatory variable and trade credit policy defined by trade credit duration gap and trade credit risk taking ratios as innovative control variables as well. Results show that leverage and capital structure models confirm pecking order and trade-off predictions, where a conjunct negative profitability and positive financial costs influence seems to correspond to a kind of compromise between profits and financial costs, in line with trade-off theory giving priority to internal generation of funds over debt. The innovative effort on this investigation is based on the replacement of firm’s tangible assets by firm’s assets structure that may represent a solution to avoid interest conflicts by achieving an under and over-investment trade-off. But the greater innovative contribution was centered on firm’s trade credit policy effects: trade credit duration gap and three trade credit risk taking ratios. Results also shows that the traditional explanatory variable sets have the impact evidenced in leverage and capital structure literature on confirming pecking order and trade-off. Contrary to our predictions firm’s trade credit duration gap doesn’t influence nor leverage neither capital structure levels but trade credit risk taking effects carry out an influence to increase leverage and deteriorate capital structure levels if they are closely related to the firm’s coverage ratio (coverage of financial costs by earnings before interest and taxes). In turn, trade credit risk taking related to gross and net coverage ratios (closer to core business) present results significant and relevant to reduce leverage level, while only trade credit risk taking related to net coverage ratio improves capital structure ratio. In the meantime, all the firm’s trade credit risk taking related to the three different coverage ratios never put in question the significant and relevant effects of return volatilities as risk variables on the increase/decrease of leverage and on the deterioration (or improvement) of capital structure ratio and may be considered reliable risk variables. For further investigations each, another countries or geographic groups of countries and sectoral basis must be investigated to confirm our results or using another explained variables like total debt, capital structure in relation with total debt and market-to-book ratios to reinforce all explanatory aspects related to market-timing perspectives and institutional characteristics. Final recommendations must oriented to further investigation related to leverage and/or capital structure as effective signs of financial distress and/or bankruptcy caused by other risk taking decisions, capital insufficiencies or unsteady capital structures. At last, a very useful recommendation to alleviate possible financial distress and/or bankruptcy consequences of excessive debt must be driven by proposals of research involving sustainability solutions based on interacted dependent variables as new adjustment models instruments.