Pecking-Order or Static Trade-off Theory in Family Firms? Evidence from Belgium

Abstract

The purpose of this paper is to investigate whether a difference can be stated in the family firms' financial choices. Using the Shyam-Sunder and Myers model, our research focus on the financial behaviour of family and non-family privately held firms in Belgium. Out of a sample of 210 privately held firms for the period 2002-2010, panel data methodology is employed to estimate Pecking-Order and Static Trade-off models. Our results show that although neither Pecking Order nor Static Trade-off Theory seems to apply to non-family firms, family firms are more likely to adopt an indebtedness target ratio. Moreover, the introduction of an allowance for corporate equity on the Belgian market is also taken into account. Our results indicate that such a mechanism seems to have an influence on the family firms funding choices.Keywords: family firm, debt, financial structure, capital structure, financial behavior, allowance for corporate equity IntroductionIn the literature relative to the financial structure of the firm, two theories are regularly confronted. The theory of Modigliani and Miller (1958) revealed the neutrality of the financial structure under the hypothesis of a perfect market. By introducing corporate income tax, Modigliani and Miller (1963) demonstrated the superiority of firms using debts, since the take advantage of the deductibility of interest expenses. Nevertheless, this model was criticized because it did not take into account the costs of distress within the firm. In order to fill this gap, Static Trade-off Theory was built to develop a model based on a costs-profits analysis resulting from the issuance of debt (Krauss & Litzenberger, 1973). This theory assumes the existence of a target indebtedness ratio equalling the profits of the deductibility of interest expenses and the costs of distress of the firm. Besides, an alternative theory was proposed by Myers and Majluf (1984): the Pecking-Order Theory. Under this theory, due to information asymmetry between managers and external investors, self-financing would be preferred to debts and stocks issuance by the managers.

Cost of Debt and Corporate Profitability

“…A method which is frequently used for testing the POT is based on the analysis of a firm's net debt issued to finance the "funds flow deficit", given by adding dividend payments, capital expenditure, the net increase in working capital, the current portion of long-term debt and by subtracting the operating cash flows after interest and taxes (Shyam-Sunder & Myers, 1999). In addition to this method used by several studies (e.g., Chirinko & Singha, 2000;Frank & Goyal, 2003;Bauweraerts & Colot, 2012), the POT has been tested on the basis of the relationship between profitability and firm's leverage (e.g., Titman & Wessels, 1988;Baskin, 1989;Allen, 1993). The negative correlation between profitability and leverage is a factor that validates the theory since only profitable firms have the opportunity to finance new investments with retained earnings rather than through a new debt and/or equity issuance.…”

Capital Structure Determinants in Family Firms: An Empirical Analysis in Context of Crisis

“…Existing research suggests that family firms would target their debt level to maintain the family control of the business. Moreover, other existing empirical research highlights that family firms seem to pursue indebtedness target ratio (Bauweraerts & Colot, 2012) and can approach their debt target ratio more quickly than non-family firms (Lopez-Gracia & Sanchez-Andujar,2007). …”

Preference Order of Responses to Economic Distress in Italian Listed Firms

“…Without going into a detailed analysis of the research literature, it is nevertheless worth noting the funds flow deficit computed by adding dividend payments, capital expenditures, net increase in working capital, current portion of long-term debt and subtracting the operating cash flows, after interest and taxes (Shyam-Sunder & Myers, 1999;Chirinko & Singha, 2000;Bauweraerts & Colot, 2012) and the numerous indices that are used to measure a firm's level of debt or its degree of profitability (Fama & French, 2002;Frank & Goyal, 2003;Leary & Roberts, 2005;Panno, 2003;Lemmon & Zender, 2006;Bharath, Pasquariello, & Wu, 2009;Mazen, 2012). From the analysis of these indicators the studies have tried to delineate the order of preference followed by firms for their financing.…”

“…Al Manaseer et al (2011) provided evidence for the POT against target capital structure theory in the UK market. Bauweraerts and Colot (2012) revealed that neither POT nor Static Trade-off Theory can explain why family rather than non-family firms are more likely to adopt an indebtedness target ratio. In his examination of a sample of French companies, Mazen (2012) confirmed the explanatory power of the POT.…”