How Important is Capital Structure Policy to Firm Survival?

Chung, Y. Peter; Na, Hyun Seung; Smith, Richard L.

doi:10.2139/ssrn.1952199

Cited by 12 publications

(7 citation statements)

References 28 publications

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“…Dynamic TOT explains that being at the target will allow firms to generate substantially more net cash flow thus be able to engage with new profitable investment opportunities and eventually maximizes the firms' value. Whereas firms failing to be at the target will suffer from lower risk-adjusted return and not be able to sustain profitable operations (Chung et al, 2013). Realising the implication and benefit of being at the target leverage is substantially higher than being off the target, firms in Indonesia thus rebalance instantaneously.…”

Section: Correlationmentioning

confidence: 99%

Do Indonesian firms practice target capital structure? A dynamic approach

Haron

2016

JABS

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Purpose This study aims to investigate the dynamic aspects in the capital structure decisions of firms in Indonesia, offering an extension to the existing literature on Indonesia via a dynamic model, including the existence of target capital structure, the influencing factors, the speed of adjustments and the supporting theories to explain the findings. Design/methodology/approach This study uses a dynamic partial adjustment model estimated based on a generalized method of moments. Findings Indonesian firms do practice target capital structure and are influenced by firm-specific factors like profitability, business risk, firm size, liquidity and share price performance due to time-varying factors. A rapid adjustment toward target leverage is detected, thus supporting the existence of the dynamic trade-off theory (TOT). The pecking order theory (POT) also has significant influence, particularly after the new reformation of financing policy, where retained earnings are also preferred as a source of financing apart from merely external financing through bank loans. There are also traces of market timing influences where firms also seem to time their equity issuance. Research limitations/implications Despite relatively utilizing recent data and bigger sample firms compared to the previous limited studies on Indonesia, the results of this study, however, need to be cautiously interpreted. First, the sample chosen focused on listed firms, hence may not be generalized to all Indonesian firms, listed and unlisted. Second, the study does not separate firms by sectors and their leverage positions, that is under-levered and over-levered, so as to note that financial decisions may also be affected by the sector in which the firms operate and their leverage positions. These are to be considered in future research. Practical implications There is strong evidence that the corporate financing behavior of Indonesian firms is governed by the POT and TOT. Both are dealing with the function of debt. The financial sector reformation does have a positive impact on the banking sector, but not the local corporate bond market. Therefore, regulators and policymakers should bear in mind that banking as well as private bond market in Indonesia must be tailored in such a way that both could act as intermediaries of debt financing, as bond market represents an important component of a diversified financial sector. Originality/value This study fills the gap by providing an extension to the existing literature and a deeper insight of the capital structure of Indonesian firms using a more robust dynamic model.

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Section: Correlationmentioning

confidence: 99%

Do Indonesian firms practice target capital structure? A dynamic approach

Haron

2016

JABS

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“…In addition, the lower information asymmetry between the larger firm and the capital markets may make it easy for these large firms to go for equity financing compared to smaller firms where an outsider may have less information than insiders. As mentioned earlier, we define firm size as log of total assets as has been used by several researchers (Chung, Na & Smith, 2013;Wald, 1999). We divided our subsamples into quantiles so as to have adequate number of observations in each subgroup (Kadapakkam, Kumar & Riddick, 1998) and estimated the regression equation for both the groups separately.…”

Section: Small Versus Large Firmsmentioning

confidence: 99%

Do Board Characteristics Impact Firm Performance? An Agency and Resource Dependency Theory Perspective

Bhatt

Bhattacharya

2015

Asia-Pacific Journal of Management Research and Innovation

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This article, from the perspective of agency and resource dependency theory, investigates the relationship between the various board characteristic measures, such as, board composition, board size, leadership structure and board activity, and accounting measures of performance in a sample of listed firms of Indian information technology (IT) sector. Panel data analysis was carried out on the sample. Our study, after controlling for firm-specific factors, found that the non-duality has a positive effect on performance only when the chairman is independent especially in the case of the larger firms. However, it failed to give evidence to the aspect of agency theory linked to board independence and firm performance. A significant and positive relationship was found between board size and firm performance. Board meeting and board attendance were not found to be associated with firm performance. Our study lends new insights specific to Indian markets as we find results contrary to the popular belief that smaller boards and boards with more independent directors lead to better firm performance.

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“…Allen and Gale (1999), Herring and Wachter (1999) and Pavlov and Wachter (2004, 2006, 2011) find significant evidence of risk-shifting in real estate markets and document the implication of this behaviour for the underlying markets. Furthermore, Chung, Na, and Smith (2013) document that firms appear to increase leverage when they face attractive growth opportunities or when poor operating performance undermines equity value. This paper extends the above literature in a specific way.…”

Section: Related Literaturementioning

confidence: 99%

REIT Financing Choices: Preparation Matters

2016

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Sun, Titman, and Twite (2014) find that risky capital structure characteristics, such as high leverage, a high share of debt due in the near future and a high share of variable-rate debt, significantly reduce the cumulative total returns of US REITs over the 2007-2009 financial crisis. In this paper we show that preparing ahead of the crisis significantly improved the cumulative return over the crisis period even after controlling for the levels of the relevant capital structure characteristics at the start of the crisis. Specifically, we document that REITs which reduced leverage and increased maturity prior to the crisis fared better during the crisis. For instance, a one standard deviation reduction in leverage generated a five percent higher cumulative return during the crisis. We further find that US REITs with the highest capital structure risk (high leverage and short maturities) were more likely to prepare for the crisis ahead by reducing leverage and extending maturity. This effect is especially large for REITs with strong governance. We also document that none of our findings hold for European REITs. This suggests that since European firms did not experience or observe the levels of market excess that occurred in the US before the crisis, whether or not they prepared for the crisis had no impact on their returns during the crisis. (2014) find that risky capital structure characteristics, such as high leverage, a high share of debt due in the near future and a high share of variable-rate debt, significantly reduce the cumulative total returns of US REITs over the 2007-2009 financial crisis. In this paper we show that preparing ahead of the crisis significantly improved the cumulative return over the crisis period even after controlling for the levels of the relevant capital structure characteristics at the start of the crisis. Specifically, we document that REITs which reduced leverage and increased maturity prior to the crisis fared better during the crisis. For instance, a one standard deviation reduction in leverage generated a five percent higher cumulative return during the crisis. We further find that US REITs with the highest capital structure risk (high leverage and short maturities) were more likely to prepare for the crisis ahead by reducing leverage and extending maturity. This effect is especially large for REITs with strong governance. We also document that none of our findings hold for European REITs. This suggests that since European firms did not experience or observe the levels of market excess that occurred in the US before the crisis, whether or not they prepared for the crisis had no impact on their returns during the crisis. WORK IN PROGRESS -DO NOT CITE OR QUOTE WITHOUT PERMISSION

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How Important is Capital Structure Policy to Firm Survival?

Cited by 12 publications

References 28 publications

Do Indonesian firms practice target capital structure? A dynamic approach

Do Indonesian firms practice target capital structure? A dynamic approach

Do Board Characteristics Impact Firm Performance? An Agency and Resource Dependency Theory Perspective

REIT Financing Choices: Preparation Matters

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