Ebook Capital Structure and Sustainability: An Empirical Study of Microfinance Institutions
The capital structure of lending institutions has become an increasingly prominent issue in the world of finance, particularly in the wake of the 2008 banking collapse and the ensuing government bailouts and institutional restructuring efforts. During any time of financial or banking crisis, when bailout funding/aid is available, questions of capital structure become more salient. What is the best mix of debt, equity, and grant funding which will ensure solvency and self-sufficiency? The question of optimal capital structure for lending institutions, particularly ones with access to grant funding, is an open and weighty question.
Within the academy, the issue of optimal capital structure has been studied intensely since Modigliani and Miller published their seminal 1958 paper, “The Cost of Capital, Corporate Finance and the Theory of Investment”. There is a considerable amount of literature with respect to the optimal capital structure of corporate firms (See for example, Faulkender and Petersen (2006); Harris and Raviv (1991); Titman and Wessels (1988); Bradley, Jarrell, and Kim (1984)). Depending on the relevant considerations (tax advantages, bankruptcy costs, agency costs, transaction costs, asymmetric information, or corporate control), one can point to an optimal capital structure in terms of a corporate firm’s value.
Yet, the application of the Modigliani-Miller (MM) theorem and other corporate finance theorems to lending institutions is less straight-forward. The basic MM principles are applicable to lending institutions, but only after accounting for the fundamental differences in how lenders and corporations operate (Cohen, 2003). The relationship between the levered and unlevered betas, the manner in which revenues are generated, and the nature of regulation for a lending institution are markedly different from that of a corporate firm. As Froot and Stein (1998) and Cebenoyan and Strahan (2004) have shown, risk management objectives also influence the capital structure of lending institutions. Consequently, the theoretical notion of an optimal capital structure for a lending institution is not very well-defined. The issue of grant money adds another layer of complication to the capital structure question for lending institutions. Does grant money create moral hazard or incentive issues with respect to banking operations? Thus, within the context of the lending institution capital structure discussion, one is required to consider issues similar to the grant versus concessional loan debate in the foreign aid literature (For example, see Gupta et al. (2003), Schmidt (1964)). This paper attempts to shed light on these issues through a study of Microfinance Institutions (MFIs).
As in Garmaise and Natividad (2008), which examines the effects of asymmetric information on lending using MFIs, this paper provides an empirical analysis of the effects of capital structure on self-sufficiency and efficiency through a study of MFIs. I take an empirical approach to examining MFI capital structures in order to identify those with the strongest record of performance. Presumably, any findings with respect to microfinance institutions could be relevant for other types of lending institutions. Given Booth et al. (2001) demonstrate that many capital structure choices are affected by the same variables in developed and developing countries, lessons learned here also could be applied to our knowledge of optimal capital structure for lending institutions in general; especially during times of crisis when grant money is available.
The remainder of the paper proceeds as follows: Section 2 describes MFIs and the evolution of microfinance funding sources. Section 3 describes the data used. Section 4 analyzes the relationship between funding sources, sustainability, efficiency, and outreach. Section 5 concludes.
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