Marketing Issues in Transitional Economies

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Economies in Transition

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Transition economies

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This positive association confirms the trade-off and free cash flow theories of capital structure. The evidence presented in the preceding discussion suggests that most firms in both developed and developing countries follow a pecking order in their financing decisions. These findings confirm the predictions of Myers and Majluf The general consensus among researchers is that asset tangibility is directly related to leverage.


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Jensen and Meckling point out the possibility of risk shifting strategies whereby managers may shift to riskier investments at the expense of the bondholders. These agency costs of debt can be mitigated if the collateral value of assets is high. Hence, asset tangibility is likely to be positively associated with leverage. Furthermore, in the event of bankruptcy, a higher proportion of tangible assets could enhance the salvage value of the firm's assets. The lenders of finance are thus willing to advance loans to firms with a high proportion of tangible assets.

Harris and Raviv observe that non-debt tax shields and firm assets are usually regarded as proxies for asset tangibility.

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Bradley, Jarrell and Kim use non-debt tax shields as a proxy for asset tangibility, and they find a statistically significant positive relationship between firm leverage and non-debt tax shields. Alternatively, Friend and Lang use the ratio of net property, plant and equipment to total assets and they report a strong positive relationship between leverage and asset tangibility for both closely held and public corporations. On the other hand, Titman and Wessels incorporate the ratio of inventory plus gross plant and equipment to total assets and they confirm a positive association between collateral value and leverage.

Rajan and Zingales use both the book and market values of leverage and they report a positive and significant relationship between leverage and asset tangibility for firms in most of their sampled countries. In contrast, Mutenheri and Green examine the determinants of capital structure for firms in Zimbabwe. They observe a strong negative association between asset tangibility and leverage for the pre reform period However, a strong positive association is detected for the post reform period Therefore, asset tangibility may not be used actively as a criterion for advancing loans.

Abor and Biekpe report a negative and significant relationship between asset tangibility and leverage for Ghanaian firms. They attribute this observation to the higher operating risk associated with a higher proportion of fixed assets. Huang and Song perform robustness analyses by examining, inter alia, first difference regressions for Chinese firms and a strong positive correlation is observed between asset tangibility and leverage.

Gwatidzo and Ojah use fixed and random effects models and confirm a statistically significant positive relationship for firms in Nigeria and South Africa 4 suggesting that financiers in these countries require collateral to issue long term debt. Contrary to the predictions of the theory, Sheikh and Wang document a strong negative correlation between book leverage and asset tangibility for listed manufacturing firms in Pakistan.

The authors note that the negative association could be due to the tendency for managers to 'empire build' at the expense of collateralised assets. Overall, the empirical evidence discussed so far provides strong support for the positive association between asset tangibility and leverage predicted by capital structure theorists.

A negative association is observed only in exceptional circumstances. Capital structure theories suggest that growth opportunities are correlated to firm-financing behaviour. However, the effect of growth is dependent on the measure used to capture growth. Gupta uses the annual compounded growth rate in sales and finds that growth firms tend to have higher leverage than non-growth firms. This is partly due to their ability to access external finance in a relatively unconstrained manner. Titman and Wessels use the percentage change in total assets and they arrive at a similar conclusion for the ratio of long term debt to the book value of equity.

This evidence is consistent with the prediction that growth firms add value to the firm and hence increase the firm's debt capacity. Delcoure pools data for firms in western European transition economies and fails to find a statistically significant association between firm growth prospects and leverage. A contrary view is pointed out by Myers who argues that firms with growth potential will tend to have lower leverage.


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  • This is because firms with intangible growth prospects will generally avoid debt to mitigate the potential underinvestment problem associated with financial distress. Eriotis et al. Larger variations are therefore interpreted as high risk. This presents a significant hurdle for growth firms to raise capital with more favourable terms. Rajan and Zingales use the market-to-book ratio of total assets to proxy growth opportunities and they find evidence supporting Myers' prediction. Barclay and Smith and Ngugi reach the same conclusion for a sample of firms covered by Compustat and Kenyan firms respectively.

    On the contrary, Al Najjar finds a positive relationship between leverage and growth opportunities measured by the market-to-book ratio for Jordanian firms. This finding is contrary to the predictions of Myers suggesting that growth firms in Jordan prefer to finance investments with debt.

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    The preceding evidence shows that most studies that use the growth rate of assets as a proxy for firm growth opportunities tend to exhibit strong positive correlations. On the other hand, most studies that use some form of a market-to-book value of assets ratio reveal negative associations between growth and leverage.

    This is because growth in the asset base of a company provides an incentive for creditors to advance loans to growth firms. Conversely, the market-to-book ratio reveals intangible growth opportunities which may not easily be collateralised. The introduction of taxes to the Modigliani and Miller irrelevance model suggests that corporate taxes are a vital element in the determination of firm leverage.

    Modigliani and Miller demonstrate that the tax savings associated with interest tax shields induce firms to take on more debt. Therefore, a positive association between tax and leverage should be observed. The bone of contention, however, has been to determine a reliable proxy for the tax rate. Most studies use the ratio of taxes paid to total taxable income, and the empirical evidence has, at most, been conflicting. Homaifar, Zietz and Benkato utilise a general autoregressive distributed lag model to test Modigliani and Miller's tax relevance predictions for both the short run and the long run.

    Entering the market for financial services in transitional economies | Emerald Insight

    They document a long-run positive relationship between leverage and corporate tax. However, no significant relationship is observed in the short run. Graham uses a sophisticated simulation technique in an attempt to derive a more accurate measure of the effective tax rate and concludes that taxes affect leverage in a positive manner. Negash argues that, where there is a change in the tax regime, the use of simulation to estimate the effective tax rate may not be appropriate. In his study of firms operating in a tax regime where firms are not progressively taxed, he finds that taxes are negatively associated with leverage.

    This finding is confirmed by Abor and Biekpe for Ghana. However, Ngugi and Gwatidzo and Ojah find insignificant correlations for Kenya and South Africa respectively.

    soethiemonou.tk Likewise, Frank and Goyal confirm strong negative correlations for the book value measures of leverage.