Make Financing Decisions Research Articles

Analysis of capital structure stability of listed firms in China

PurposeThe purpose of this paper is to analyze the corporate capital structure stability of listed firms in China during the period 1990–2013.Design/methodology/approachThe study uses panel data from a sample of 716 firms that have been listed in China for at least 15 years. A fixed-effects panel data regression model with time effects is used in the estimation.FindingsThe findings show that size, profitability and investment opportunities have a significant influence on capital structure, whereas the tangibility of assets is not found to be significant. Few industries show significance in explaining differences and variation in leverage ratios.Social implicationsIt is recommended by this study that corporate managers of listed firms in China should consider leverage ratios variation while choosing the capital structure.Originality/valueThis study can be helpful in assisting companies to make financing decisions and setting up strategies relevant in their growth and profitability. The study will also have a significant assistance to bring to light corporate issues to policy makers, especially in the areas of both equity and debt financing, particularly the bond market. To the society, this study will show the nature of Chinese-listed companies, and it can assist individual investors in making decisions regarding companies in which they hold investments and in making meaningful comparisons with other companies. The paper also aims at contributing to the existing literature on the empirical study on capital structure.

Do environmentally sustainable practices lead to financially less constrained firms? International evidence

In this study, we utilise a comprehensive dataset from 41 countries spanning 2002–2013 and show that environmentally sustainable practices (ESP) are negatively associated with financial constraints of firms. We refine ESP into three components: emission reduction, product innovation and resource reduction, and show that firms which are more innovative and efficient in reducing wastage of resources are most benefited by ESP. The findings are even stronger for firms operating in countries with high institutional qualities, in high emission and highly competitive industries. These results are important to lending institutions for making financing decisions. Policymakers and investors could also utilise ESP as a key distinguishing factor for firms to benefit from lower financial constraints. Appropriate support and initiatives from local and national regulators could motivate firms to be more environmentally friendly.

Personalized financing decision support with health evolution model for elder care

The burden of elder care is increasing rapidly due to an aging society. Elder care services are expensive and becoming more so in the US. Financing elder care services with available financial products is an important task in healthcare management. In this article, a Continuous-Time Markov Chain (CTMC) model is proposed to capture health risk transitions. The transition probabilities among care stages and length of stay (LOS) at each care stage are estimated using historical data for elders with a specific health condition. Financial decision support is formulated as an optimization problem with maximum service-level fulfillment rate of an elder given his/her health profile and financing options. A case study is conducted using a heart transplant monitoring dataset. The patterns of optimal financing decisions are investigated. The results show a clear advantage to making financing decisions based on an elderly person’s personal health profile.

Capital Structure and a Firm's Workforce

While businesses require funding to start and grow, they also rely on human capital, which affects how they raise funds. Labor market frictions make financing labor different than financing capital. Unlike capital, labor cannot be owned and can act strategically. Workers face unemployment costs, can negotiate for higher wages, are protected by employment regulations, and face retirement risk. I propose using these frictions as a framework for understanding the unique impact of a firm's workforce on its capital structure. For instance, high leverage often makes managing labor more difficult by undermining employees’ job security and increasing the need for costly workforce reductions. But firms can also use leverage to their advantage, such as in labor negotiations and defined benefit pensions. This research can help firms account for the needs and management of their workforce when making financing decisions.

The determinants of Islamic bank capital decisions

We report new evidence on the bank and institutional determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia'a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize managers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

Determinants of Bank Capital in Dual Banking Systems

We report new evidence on the bank and country-level determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia’a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize mangers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

Determinants of Bank Capital in Dual Banking Systems

We report new evidence on the bank and country-level determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia’a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize mangers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

The determinants of leasing decisions: an empirical analysis from Chinese listed SMEs

Purpose – The purpose of this paper is to investigate the determinants of leasing decisions for a sample of China’s non-financial small and medium-sized enterprises (SMEs). Design/methodology/approach – Pooled ordinary least squares and Tobit models are used to analyze five years of data (2009-2013) on the sample units, to find the determinants of leasing decisions after controlling for industry. In order to assess the robust of the results, the authors further apply instrumental variables methods. Findings – The results suggest that CEO ownership, tax rate, financial distress potential, and firm size are positively related to the operating lease share, whereas debt ratio, profitability, and tangibility are negatively linked to the operating lease share. In contrast, capital lease share increases with debt ratio, profitability, firm size, and strong corporate governance; it decreases with CEO ownership and financial distress potential. Research limitations/implications – Using a small sample might not be enough capture industry effects. Future research may gain more insights using sufficient sample and considering the types of leases as well as leased assets. Practical implications – This study offers evidences to the policy-makers who may adopt the practices to promote the development of leasing market. Furthermore, these results provide important implications to lessors in making operating strategy decisions and to potential lessees in making financing decisions. Originality/value – To the authors’ limited knowledge, this is the first study on leasing relies on publicly traded Chinese SMEs. The results of this study enrich the literature on the determinants of leasing in several ways.

The determinants of exchange rate risk management in developing countries: evidence from Indonesia

Studies on exchange-rate risk management in developing countries are still very rarely addressed. This study investigates determinants of exchange rate risk management (hedging) in Indonesian firms. Using 276 samples of listed firms in the Indonesia Stock Exchange and employing a Logit regression model, we found that only firm size is associated with a hedging in the listed companies. The findings are not consistent with the study proposed in the developed countries. It suggests that most of the large Indonesian companies are conglomerates with controlling shareholders who have the authority for hedging and making financing decisions. The finding also suggests that the hedging market in Indonesia is not yet mature. Furthermore, firms are either not familiar with the hedging instruments or may not be big enough to hire professionals to deal with the complicated and costly hedging instruments.

Does Financial Leverage Influence Investment Decisions? Empirical Evidence From KSE-30 Index of Pakistan

Purpose: The present study investigates the impact of the financial leverage on the investment decisions of the listed companies in KSE-30 Index of Pakistan. It identifies the most important factor that influences investment decision of the company and which causes the bankruptcy of Pakistani listed firms. Methodology: The study uses descriptive statistics, correlation analysis and pooled ordinary least square regression model for the analysis of 30 (financial & non-financial) companies of Pakistan. Results: The empirical findings of the study reported that the financial leverage has a negative and significant impact on the investment decisions. Policy Implications: The outcomes of the study help the strategic management to make financing decisions about leverage whether to take long term debt or not.

What determine firms’ capital structure in China?

Purpose – The purpose of this paper is to investigate the determinants of capital structure using a cross-section sample of 1,481 non-financial firms listed on the Chinese stock exchanges in 2011. Design/methodology/approach – Employing four leverage measures (total leverage and long-term leverage in terms of both book value and market value, respectively) this study examines the effects of factors with proven influences on capital structure in literature, along with industry effect and ownership effect. Findings – The authors find that large firms favour debt financing while profitable firms rely more on internal capital accumulation. Intangibility and business risk increase the level of debt financing but tax has little impact on capital structure. The authors also observe strong industrial effect and ownership effect. Real estate firms borrow considerably more and firms from utility and manufacturing industries use more long-term debt despite compared with commercial firms. On the other hand, firms with state ownership tend to borrow more, while firms with foreign ownership choose more equity financing. Research limitations/implications – The study uses cross-section data to avoid any potential time effects, which allows the authors to focus on their main research question – to identify the determinants of capital structure for Chinese firms. Future research may gain more insights using panel data and considering other factors such as crisis and financial reforms. Practical implications – These results may provide important implications to investors in making investment decision and to firms in making financing decisions. Originality/value – This paper uses by far the largest and latest cross-section sample from the Chinese stock markets, offering a more complete picture of the financing behaviours in the Chinese firms, with known characters and the impact of ownerships.

The Detection and Dynamics of Financial Distress*

ABSTRACTUsing samples of US firms, we examine the efficacy of six risk‐proxy variables to forecast 5‐year failure: year‐end t‐values of stock return volatility, firm size, recent profitability, market leverage (LEV), book‐to‐market equity ratio (BM), and recent stock return. Logistic regression results indicate that firm size is most powerful, while LEV and BM are weakest. We then identify distressed firms and analyze the effect of year t+1 operating and financing cash flows on 5‐year failure rates for these firms using a new methodology, failure risk surprise. Results explain why LEV and BM are weak forecasters of 5‐year failure rates: Low‐LEV and low‐BM (high‐LEV and high‐BM) distressed firms are less (more) likely to have a profit in year t+1, and are also more likely to issue equity (retire debt) in year t+1, interactions which tend to moderate failure risk. We also find that failure risk sensitivity to year t+1 operating result increases with both LEV and BM, while failure risk sensitivity to future macroeconomic conditions is significant only for high‐LEV firms. Many results are consistent with the tradeoff theory of capital structure, while other results indicate that managers make financing decisions to take advantage of mispricing.

Can Signaling Theory Help Agency and Resource Scarcity Theories Explain Franchisee Failure? Predicting SBA-Backed Loan Defaults

This study examines the use of analytic techniques to develop a model that predicts the potential default of Small Business Administration (SBA) backed loans issued to American franchisees. Data collected by World Franchising (WF) in their 2008 survey and by SBA from 2000-2008, covering 271 diverse US franchise chains, on the reported failure rates and charge off percentages of SBA backed loans was used to explore associations between franchisor characteristics and franchisee loan performances. The predictive capability of the derived model was assessed using a data mining technique in which the original data set is split into two different subsets: one for estimation and one for validation. KXEN’s (Knowledge Extraction Engines) predictive modeling was used to associate default rates with franchise characteristics. Earnings claims, the requirement for franchisee’s industry specific knowledge, total units growth rate, and franchise experience were found as significant predictors linking franchise theories; agency, resource scarcity, and signaling to franchisee failure (default). This study can be used as an important policy tool that will aid franchisors, franchisees, lenders, the SBA, and other stakeholders in making financing decisions.

Do Peer Firms Affect Corporate Financial Policy?

We show that corporate financial policies are highly interdependent; firms make financing decisions in large part by responding to the financing decisions of their peers, as opposed to changes in firm-specific characteristics. On average, a one standard deviation change in peer firms' leverage ratios is associated with an 11% change in own firm leverage ratios --- a marginal effect that is significantly larger than that of any other observable determinant and one that is driven by interdependencies among debt and equity issuance decisions. Consistent with information-based theories of learning and reputation, we find that smaller, more financially constrained firms with lower paid and less experienced CEOs are more likely to mimic their peers. Additionally, we quantify the externalities engendered by these peer effects, which can amplify the impact of changes in exogenous determinants on leverage by almost 70%.

Financing decisions as a source of conflict in venture boards

Governance scholarship has suggested that venture boards should be structured so as to stimulate internal conflict. However, structure is a weak predictor of board effectiveness. Moreover, conflict can be dysfunctional, especially when it is focused on relationships rather than tasks. We show that venture boards experience more relationship conflict when they make financing decisions that involve devaluation of the venture and that this effect is moderated by whether the CEO is a founder. Our findings should prompt venture governance scholars to reconsider the importance of board structure, the value of board conflict and the behavior of founder- versus non-founder CEOs.

Corporate boards and the leverage and debt maturity choices

Debt, and in particular, short-term debt have the potential to discipline managers. We examine the role of the board in making financing decisions that provide this discipline. Specifically, given a firm's characteristics, we predict that stronger boards will force the firm to hold more debt and more short-term debt. Employing a rich dataset of board characteristics and controlling for other aspects of a firm's corporate governance, we find support for these hypotheses. Our simple measure of director power is a robust and promising measure of internal governance.

Corporate Boards and the Leverage and Debt Maturity Choices

Debt, and in particular, short-term debt have the potential to discipline managers. We examine the role of the board in making financing decisions that provide this discipline. Specifically, given a firm's characteristics, we predict that stronger boards will force the firm to hold more debt and more short-term debt. Employing a rich dataset of board characteristics and controlling for other aspects of a firm's corporate governance, we find support for these hypotheses. Our simple measure of director power is a robust and promising measure of internal governance.

A Contribution to the Theory and Practice of Rational Financial Contracting

This paper presents a theory of corporate finance from the perspective of bondholders. Towards this end an equilibrium model of a debt and equity financed firm is developed that motivates the need for an upfront bond contract that solves an agency problem between bondholders and stockholders. This bond contract guides the firm towards a no arbitrage equilibrium by directing managers to make investment decisions conforming to the risk aversion of their shareholders and then make financing decisions that preserve the investment quality of their bonds. Empirical evidence on the investment and financing of nonfinancial corporations conform to the predictions of the model.

Firm Financing Decisions

We examine whether firms make financing decisions to correct deviations from target ratios, as predicted by the tradeoff theory with transaction costs. We find that while the theory can well explain debt reduction activities, it does a poor job in explaining the issuance decisions - the choices among the use of internal funds, debt issuance, and equity issuance. The key variables of the theory - deviation-from-target, past leverage ratios, marginal corporate tax rate, and transaction costs - all predict the issuance decisions in the wrong direction. We further show that incorporating transaction costs into the tradeoff theory is unlikely to provide the main interpretation for the empirical patterns documented in Baker and Wurgler (2002) and Welch (2004).

What managers think of capital structure: the evidence from Hong Kong

This paper studies Hong Kong managers’ financing decisions, using the results of two surveys, one conducted in 1994 and other in 1999. The pecking order principle was found to be preferred to maintaining a target financing mix. Tax benefits were not important criterion. No signaling motivation was found on the part of the managers. The Asian financial crisis led managers to prefer equity to debt. Managers did not follow a set of principles mechanically in making financing decisions, but also considered the current market conditions. Post crisis data suggest that managers behaved in a manner consistent with their survey responses.