Long-term Debt Financing Research Articles

Capital structure and the profitability of listed retail firms

The South African retail sector continues to experience a decline in sales and returns amidst growing external competition and a drop in consumer confidence stemming from the recent credit downgrades in the country. Yet, firms in this sector appear to maintain high debt to equity levels. This study investigated whether the capital structure practices of these firms influence their profitability. A Panel data methodology, using three regression estimators, is applied to a balanced sample of 16 retail firms listed on the Johannesburg Securities Exchange (JSE) during the period 2008-2016. The analysis estimates functions relating capital structure composition with the return on assets (ROA). Results reveal a statistically significant but negative relationship between all measures of debt (short-term, long-term, total debt) with profitability, suggesting a possible inclination towards the pecking order theory of financing behaviour, for listed retail firms. Additionally, retail firms are highly leveraged yet over 75% of this debt is short-term in nature. Policy interventions need to investigate the current restrictions on long-term debt financing which offers longerterm and affordable financing, to boost returns. While this study’s methodology differs slightly from earlier studies, it incorporates vital aspects from these studies, and simultaneously specifies a possible model fit. This helps to capture unique but salient characteristics like the transitional effects of debt financing on firm profitability. It therefore delivers some unique findings on the financing behaviour of retail firms that both in form policy change, while stimulating further research on the phenomenon.

The Moderating Effect of Firm Size on the Relationship Between Capital Structure and Financial Distress of Non-Financial Companies Listed in Kenya

This paper sought to establish the moderating effect of firm size on the relationship between capital structure and financial distress of listed non-financial firms in Kenya. Firm size was measured using the natural logarithm of total assets while capital structure was operationalized by total debt, long-term debt and short term debt financing. The degree of financial distress was measured using the Altman’s Z-score index as reviewed for the emerging markets. Secondary data from audited and published financial statements was collected on the 40 listed non-financial firms between year 2006 and 2015. The study estimated the specified panel regression model for fixed effects as supported by the Hausman test results. Feasible Generalized Least Squares (FGLS) regression results revealed that firm size has a significant moderating effect on the relationship between capital structure and financial distress of non-financial firms. Specifically, the study found that although generally debt has a negative and significant effect on financial distress of the studied companies, this effect becomes positive and significant as the size of the firm increases. The study further found that use of long term debt has a positive and significant effect among large-scale firms while short term debt is significantly detrimental. On the basis of these empirical findings, the study recommended that managers of listed non-financial companies should always consider the size of the firm in making leverage choice decisions for their entities.

An Assessment and Measurement of Risks in the International Airline Industry: A Study of the ICAO Carriers Over the Period, 1990-2013

A prior study by one of the authors (Gritta, et. al. 2006) published in the Journal of the Transportation Research Forum, examined the extent of operating, financial, and total leverage facing the major U.S airlines, those carriers with total revenues of $1.0 billion or more. The study found that the vast majority of the carriers were highly leveraged at both the operating and financial levels and that this resulted in highly unstable profitability and increased the dangers of bankruptcy. The global airline industry has always been highly cyclical and somewhat fixed-cost driven. Airlines are thus high in what financial analysts refer to as operating leverage. In addition, the many airlines have followed aggressive debt strategies; that is, they have chosen to use large amounts of long-term debt finance to purchase assets. This results in a high degree of financial leverage. In the past, the resulting combined leverage has created severe financial problems for major carriers, both domestically and internationally.The current study seeks to examine a sample of foreign carriers in order to measure the extent of risks on the international level. In doing so, comparisons will be made to the large U.S. carriers. If possible, the authors will use the same time horizon as in the published paper, although in some cases carriers are too new to have such a history.

Are credit rating agencies still relevant? Evidence on certification from Moody's credit watches

We show that a rating agency can provide certification for corporate borrowers through the mechanism of a credit watch with direction downgrade. We find that firms with watch-preceded rating confirmations (firms for which original ratings are confirmed after a credit watch warning) experience an increase in their long-term debt financing and ramp up their investment activities following the credit watch period. These firms are able to maintain their profitability from before to after the watch period, while we find no such evidence for firms with watch-preceded rating downgrades. Among firms with confirmed ratings, those with less access to credit markets obtain more long-term debt financing at a lower cost of debt capital only in the post-watch period, indicating that rating agencies can help alleviate firm capital constraints. The certification effects persist after controlling for potential endogeneity bias.

The shadow costs of repos and bank liability structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank׳s financing structure. In our model the bank׳s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long-term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank׳s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long-term debt financing. These shadow costs limit the bank׳s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank׳s financing choices and show that all these tools are able to curb the bank׳s reliance on repos.

The effect of financial factors on firms’ financial and tax reporting decisions

Purpose – The purpose of this paper is to investigate the effect of financial factors on firms’ financial and tax reporting decisions. Firms often face the difficulties of accomplishing both financial and reporting goals. The extent to which reporting they put more value depends on the differential weighting of firms’ financial reporting and tax costs. The authors incorporate various financial factors as a source of cross-sectional differences in the weighing of both financial reporting and tax costs. Design/methodology/approach – To examine firms’ decisions when fulfilling both the purposes of financial and tax reporting is difficult, the authors use a large set of firms in Korea, where book-tax conformity is high and aggressive tax shelters are restricted. The authors develop a new measure that can specify firms’ decision making between financial and tax reporting by considering both earnings management and tax avoidance. Findings – The findings show that debt ratio affects firms’ financial and tax reporting decisions non-monotonically depending on the level of the debt ratio. The authors also find that firms with more long-term debt financing are more likely to be aggressive in financial reporting, while firms with higher financing deficit or better access to the capital market are more likely to be aggressive in tax reporting. Research limitations/implications – Thus, the findings provide more compelling evidence of firms’ decision making between two conflicting strategies, particularly when fulfilling both the purposes of financial and tax reporting is difficult. The authors expect that the results provide practical implications to standard setters, auditors and financial statement users who are interested in the ongoing debate over book-tax tradeoffs. Originality/value – This paper fulfills an identified need to study how firms’ decision making between two conflicting reporting strategies are affected by the various financial factors, which are closely linked to a firm’s financial reporting and tax costs.

Debt maturity, financial crisis and corporate performance in GCC countries: a dynamic-GMM approach

This study investigates the effect of debt financing and debt maturity on corporate performance, using evidence from Gulf Cooperation Council countries (GCC): Qatar, Oman, Kuwait, Kingdom of Saudi Arabia, United Arab Emirates, and Bahrain. The study uses a dynamic GMM approach for an unbalanced sample of 400 firms for the period 2004-2012. The study also investigates the effects of the financial crisis on the significance of long-term and short-term debt financing as determinants of firms' performance. Our findings indicate that the long-term and short-term debt financing affect firms' performance negatively. The results also show that the economic importance of short-term debt increases as a determinant of firms' performance after crisis, while the effect of long-term debt decreases.

Cash Holdings, Use of Debt and Dividend Structure of Family Firms

In this study we examine the relation between firm’s financial structure and family ownership. We develop a theoretical model of the precautionary cash holdings. Our empirical results show that the fraction of a company’s shares that are held by the founding family members or their descendants influences the use of cash and equivalents, dividend policy and debt structure of a firm. Our results are robust to different estimation methods and alternative model specifications. We find that family firms tend to rely less on long-term debt financing, pay fewer dividends and carry higher precautionary cash balances.

The Agency Credit Spread

We study the impact of agency frictions on the price of defaultable debt in the context of a structural model of corporate decisions. Our model features dynamic investment and long-term debt financing, thus allowing us to analyze many types of possible agency distortions: under- and over-investment, debt claim dilution and excess dividend distributions. We show that shareholders’ incentives to deviate from firm (i.e., equity plus debt) value optimizing policies contribute a significant part of a firm’s credit spread, which we refer to as the agency credit spread. As deviations from firm value maximizing policies are most significant when the firm approaches financial distress, typically in economic downturns, the agency credit spread is large. We find that the mismatch in the maturity of assets and liabilities, the liquidation cost of assets, and the operating leverage of the firm are positively associated with the theoretical agency credit spread. We confirm those predictions in a sample of large S&P500 firms.

Financial Management in SMEs

1. Introduction Many people who start to run a business do not engage themselves in financial matters. The reason may be because they do not have enough knowledge or interest in recording transactions, preparation and analysis of financial statements and secondary they are extremely involved in other aspects of business like managing people, sales purchasing and production. These entrepreneurs rely on their accountants to run the financial side of their business. While financial management is a critical element of the management of a business as a whole, within this function the management of its assets is perhaps the most important. In the long term, the purchase of assets directs the course that the business will take during the life of these assets, but the business will never see the long term if it cannot plan an appropriate policy to effectively manage its working capital. In effect the poor financial management of owner-managers or lack of financial management altogether is the main cause underlying the problems in SME financial management. A great many small businesses fail not because the owner does a poor job or provides an inferior service, but because their firm is not run like a business. Most small business people only know one-half of what it takes to succeed. The part they are missing is how to manage and grow their business. Small business owners that succeed in this part learn these issues while working or they already have the knowledge. 2. Previous literature on finance in small business Literature on small firms' financial management is quite voluminous and it concentrates on different aspects of firm's management. For this research paper we have selected just a few studies from the recent period concentrating predominantly on various issues of financial management and small firms' strategy. The following table summarizes studies across the globe and points out the main point of interest. 2.1. Studies on causes of financial failure Prediction of Financial Failure Some researchers tried to predict small enterprise failure to mitigate the collapse of small businesses. McNamara et al. (1988) developed a model to predict small enterprise failures giving the following four reasons: a) to enable management to respond quickly to changing conditions, b) to train lenders in recognising the important factors involved in determining an enterprise's likelihood of failing, c) to assist lending organisations in their marketing by identifying their customer's financial needs more effectively, d) to act as a filter in the credit evaluation process. The authors argued that small enterprises are very different from large ones in the area of borrowing by small enterprises, lack of long-term debt finance and different taxation provisions. Involuntary liquidation Hall and Young (1991) performed UK a study of 3 samples of 100 small enterprises that were subject to involuntary liquidation in 1973, 1978 and 1983. The authors have found that the reasons given for failure were of financial nature in 49.8%. In the study of perceptions of official receivers interviewed for the same small enterprises, 86.6% of the 247 reasons given were of a financial nature. The positive correlation between poor or non-existent financial management (including basic accounting) and business failure has well been documented in western countries according to Peacock (1985, 2004). Default behaviours of SMEs and the credit characteristics of their owners Bhunia (2012) examined relationship between default behaviours of SMEs and the credit facets of their owners. Identifying and measuring credit risk of SMEs should be different from that of large firms, for SMEs appear to be influenced by their owners more directly and significantly, so that a more appropriate and effective way of credit management of SMEs could be applied in practice. …

Long-term debt maturity and financing constraints of SMEs during the Global Financial Crisis

We use the recent financial crisis to investigate financing constraints of private small and medium-sized enterprises (SMEs) in Belgium. We hypothesize that SMEs with a large proportion of long-term debt maturing at the start of the crisis had difficulties to renew their loans due to the negative credit supply shock, and hence could invest less. We find a substantial variation in the maturity structure of long-term debt. Firms which at the start of the crisis had a larger part of their long-term debt maturing within the next year experienced a significantly larger drop in investments in 2009. This effect is driven by firms which are ex ante more likely to be financially constrained. Consistent with a causal effect of a credit supply shock to corporate investments, we find no effect in “placebo” periods without a negative credit supply shock.

Financial Constraints and Firm-Level Investment in Asia: Dynamic Panel Smooth Threshold Regression Approach

This paper provides evidence on the impact of internal finance constraints, growth opportunities and debt overhang on the firm-level investment in 14 Asian countries over the period of 1990-2010. We used Panel Smooth Threshold Regression (PSTR) which relaxes the assumption of the a priori splitting of firms into constrained and unconstrained firms. We provide large-sample evidence that shows, for firms with low cash flow and low growth opportunities, investment is not sensitive to the availability of internal finance, and that these firms rely more on the long-term debt finance than external equity. Our results indicate that for firms with high cash flow and high growth opportunities, equity finance dominate the long-term debt finance. On the other hand, for high leveraged firms, debt overhang reduces investment through a ‘liquidity’ effect. We find that firms with concentrated ownership are not financially constrained, and that they use more equity finance than long-term debt to finance investment. Overall, our findings indicate the availability and access to sources of external finance is critical for firm investment in Asia.

Operating, Financial and Total Leverage and the Effects on U.S. Carrier Returns, 1990-2003

The U.S. airline industry has always been highly cyclical and somewhat fixed cost driven. The carriers are thus high in what financial analysts refer to as operating leverage. In addition, the majority of the airlines have followed aggressive debt strategies; that is, they have chosen to use large amounts of long-term debt finance to purchase assets. This results in a high degree of financial leverage. In the past, the resulting combined leverage has created severe financial problems for many in the industry. This paper will examine these different levels of leverage using elasticity measures borrowed from economic theory. The purpose is to examine the effects of this leverage during the years in which the carriers saw unprecedented growth and a return to profitability. It will also compare and contrast several carriers (such as Southwest) which have avoided the "boom and bust" cycle of this industry as well as the effects of 9/11. The sample will consist of the major U.S airlines and several of the group referred to as "nationals."

Managers’ Self-Serving Attribution Bias and Corporate Financial Policies

The self-serving attribution bias (SAB) refers to individuals taking responsibility for good outcomes and blaming others for bad outcomes. Consistent with the existence of managerial SAB, I find that managers tend to use more first-person pronouns (relative to second- and third-person pronouns) in the Management Discussions and Analysis Section of the 10-K filings when firm performance is better. A consequence of SAB is overconfidence (i.e., overestimating the mean and underestimating the variance of future cash flows). Consistent with this argument, managers with more SAB are more likely to issue forward-looking statements and make earnings forecasts, the tone (e.g., positive versus negative) of their forward-looking discussions has smaller variation, and their earnings forecasts tend to be overly optimistic. Firms whose managers have more SAB have higher investment-cash flow sensitivity and experience more negative market reactions around acquisition announcements. These firms also tend to have higher leverage, rely more on long-term debt financing, are more likely to repurchase stocks, and are less likely to issue dividends. Collectively, the evidence suggests that managers have self-serving attribution bias and this bias has implications for corporate policies.

A Study on Financing Preference of China Electric Power Industry

This paper is an analysis of the financing preference of China electric power industry through an empirical analysis method. Through a detailed study using the data of listed electric power companies from 2004-2006, which belongs to the security markets of Shanghai and Shenzhen, We grasp the fact that debt financing is the main method widely used in listed electric power companies, especially long-term debt financing method. This find is very useful for further research on financing effects of to electric power industry, as well as to investors and creditors of the listed electric power companies.

Modeling capital structure decisions in a transition market: empirical analysis of firms in Egypt

It has been realized that none of the three basic theories of capital structure presents a complete answer to the actual determinants of corporate financing decisions. This study attempts to model the practice of capital structure decisions according to the basic premises of each theory of capital structure: trade-off theory, pecking-order theory and free cash flow theory. The methodology addresses modeling long-term and short-term debt financing decisions based on ten different statistical criteria using data from Egypt stock market. The empirical evidence indicates that four models of corporate financing are influenced by the trade-off theory relatively. The contributions of this paper are as follows. First, this study offers a more refined and comprehensive methodology for modeling firms’ capital structure decisions. Second, the results of this study compare to those of previous studies of other developing countries and thus add an element of external validity.

Geographic diversification and agency costs of debt of multinational firms

This paper examines the agency conflicts between shareholders and bondholders of multinational and non-multinational firms and provides an explanation for the puzzle that multinational firms use less long-term debt, but more short-term debt than domestic firms. Using a sample of 6951 firm–year observations for multinational and domestic firms over the 1988–1994 period, we find that alternative measures of agency costs have statistically significant negative effects on the firm's long-term leverage. The results, however, also show that the negative effects of agency costs of debt on long-term leverage are significantly greater for multinational than non-multinational firms. It is documented that the effect of the agency costs of debt on leverage are increased by the firm's degree of foreign involvement. The evidence shows that firm's increasing foreign involvement exacerbates agency costs of debt leading to lower (greater) use of long-term (short-term) debt financing. This result is also confirmed using alternative measures of foreign involvement. The evidence is consistent with the view that multinational corporations (MNCs) are susceptible to higher agency costs of debt than domestic corporations because geographic diversity renders active monitoring more difficult and expensive in comparison to domestic firms. The results fail to support the view that MNCs' lower long-term debt ratios are due to the advantages of the internal capital markets.

The determinants of capital structure: Evidence from China

Abstract This paper employs a new database containing the market and accounting data (from 1994 to 2003) from more than 1200 Chinese-listed companies to document their capital structure characteristics. As in other countries, leverage in Chinese firms increases with firm size and fixed assets, and decreases with profitability, non-debt tax shields, growth opportunity, managerial shareholdings and correlates with industries. We also find that state ownership or institutional ownership has no significant impact on capital structure and Chinese companies consider tax effect in long-term debt financing. Different from those in other countries, Chinese firms tend to have much lower long-term debt.

CAPITAL STRUCTURES IN EMERGING STOCK MARKETS: THE CASE OF HUNGARY

This paper studies developments in the Hungarian capital markets during 1992–95 and investigates the determinants of the capital structures of companies listed on the Budapest Stock Exchange. Hungarian companies had very low leverage ratios. Empirical findings indicate that the negative relationship between leverage and proportion of tangible assets was primarily caused by the lack of long‐term debt financing. The relationship between leverage and the size of the company provides some indication of the importance of trade credits for the companies. The more profitable companies had less debt than less profitable ones. This is attributed to the firms’financial incentives aggravated by the segmentation of Hungarian credit markets and credit rationing within the financial environment. Manufacturing firms and firms with the state among their major shareholders enjoyed higher levels of debt financing relative to other companies.

Economic exposure and debt financing choice

In recent years, firms in several industrialized economies have globalized. In this paper, it is shown that the economic exposure of such non-financial firms plays an important role in their long-term debt financing choice. When firms face positive economic exposure, eurocurrency debt denominated in foreign currency dominates foreign debt as well as domestic debt. However, when firms face negative economic exposure, foreign debt dominates other forms of debt financing as the value-maximizing choice for the shareholders of the firm. If firms are not exposed, domestic debt, foreign-currency debt, and eurocurrency debt are equivalent financing alternatives, in the absence of bankruptcy costs.