Ebook Capital Structure, Unleveraged Equity Beta, Profitability and other Corporate Characteristics: Evidence from Australia
Being one of the few developed economies providing full credits of corporate income tax to shareholder distributions, Australia provides an interesting ground for studying firm characteristics associated with cross-firm capital structure variations. Twite (2001) finds that corporate debt financing has reduced after Australian adopted the tax imputation system in 1987. This is expected as the tax incentive for using debt is largely reduced due to the elimination of double taxation on shareholder income. Therefore, it is reasonable to expect that bankruptcy cost, signaling effect and agency cost considerations dominate the tax benefit consideration when Australian corporations make capital structure decisions.
Previous literature has identified a number of firm characteristic variables correlated with cross-sectional capital structure variations, although none of these variables can be used to test any specific capital structure theory. The Harris and Raviv (1991) literature review finds that financial leverage is generally positively related to firm size, asset tangibility and growth opportunity but negatively correlated with risk and profitability of the firm. Rajan and Zingales (1995) report that factors identified by the US studies also affect capital structures of firms in other major industrialized countries.
In the handful of studies been published using Australian data, some evidence contradicts the US findings. Twite (2001), for example, reports that debt ratio increases with profitability. Deesomsak, Paudyal and Pescetto (2004), on the other hand, find that firm risk, growth opportunity and profitability do not have a significant impact on financial leverage of Australian firms. What puzzles us about this study are the findings of the insignificant effects that profitability, growth and firm risk have on the capital structure differences among the firms. The Twite study, on the other hand, does not offer evidence on the role of risk. In previous studies which do examine the effects of risk, most of them take accounting measurements of risk, usually volatilities or coefficient of variations in profit, ROA, ROE, or sales revenue. We argue that these measures of risk may not be the primary concerns of corporations in making the long term financing decisions about capital structures. As shareholders have the liberty to diversify their investments, they are likely to be concerned only about the systematic risk of equity of the firms. As risk, growth and profitability are factors predicted to affect debt ratios by various theories, we decide to reinvestigate their roles using a two dimension data set to carry out both cross-sectional and longitudinal studies.
Using the longitudinal cross-section data set gives us an edge to overcome one possible limitation of the previous Australian studies which examine either static models or models restricting on time-invariant relationships between capital structure and firm characteristics. Allen (1993), for example, is an example of static model research. Deesomsak, Paudyal and Pescetto (2004), on the other hand, use average values of dependent and independent variables observed over multi-years. Twite (2001) uses panel data regressions on multi-year observations but imposes fixed time effects. Since the financial environment in which corporations operate change from time to time, we argue that financial leverage and firm characteristic relationships, if they are there, may not necessarily be stable over time. Taking average values or restricting time-fixed effects risk losing the rich information contained in the panel data. To overcome this potential problem, this study uses Fama-Macbeth regression which allows us to examine the time-varying dependence that capital structure has on firm-specific characteristics in Australia.
This study proxies firm risk by unleveraged equity beta. We estimate equity beta from stock price and unleverage the beta using the Hamada equation to reverse the financial leverage impact on equity risk. In contrast to the previous Australian studies but consistent with the US evidence, we find that risk and profitability of Australian firm have significant negative impacts on their choices of financial leverage level. We also find that growth expectations are significantly negatively correlated with debt ratios; a result that contradicts previous studies in both Australia and the US. Our finding of positive relationships between financial leverage and firm size and asset tangibility are consistent with the broad literature. While the signs of estimated coefficients for individual determinant variables are generally stable over time, the magnitudes of the coefficient estimates exhibit significant variations over time. In general, our findings are most consistent with the predictions of the signaling theory and provide mixed evidence for predictions of other capital structure theories.
The structure of this study is as follows. We start with a brief discussion of capital structure theories and their implications. We then present our test regression, variable specification and discuss the data and research methodology, followed by the findings and discussion section. Conclusions about the findings are presented at the end of the paper.
Posted in :
