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Analysis of the determinants of funding policies of companies listed on the stock

market in Romania

Author: Grasu Ana-Georgiana

Coordinator: Ingrid Dragot

Abstract

This study examines the importance of six factors in funding policy decisions of

companies listed on the Bucharest Stock Exchange, analysis useful for Romanian and foreign

investors and companies, especially since the study is positioned as the 2008-2012 time being a

sensitive period in terms of economy. The main conclusion of the research was that the listed

firms in Romania finances its assets through equity, debt and short term trade and long-term debt

or financial, in the order specified.

Key words: capital structure, trade-off theory, pecking order theory, Romanian

companies.

Introduction

The study tried to investigate the determinants of the capital structure in the emerging

countries particularly the Romanian companies listed on BSE and highlight important factors

that influence a company's capital structure. The aim was to determine these factors for

companies operating on the Romanian market especially in the last five years, given the current

global economic situation, namely the economic crisis and recent financial years 2008-2012 debt

crisis. Theories of debt financing have been growing over the past two decades.

The Theoretical Framework and Previous Research

The capital structure has long been examined in the corporate finance literature of

developed countries; few studies emerged to examine the capital structure in developing markets.

Since the classic paper of the Modigliani and Miller (1958), many theories embarked a number

of determinants that affect the capital structure of the firms, the most well-known theory are the

trade-off theory and the pecking order theory where a variety of variables that are potentially

responsible for determining capital structure decisions in companies can be found in the

literature. Modern finance theory and empirical work have been trying to give answers to what

are the factors that affect the decisions to change firms capital structure. Change in capital

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structure brings about changes in the relative position of capital providers (e.g., stockholders and

debtors). The trade-off theory assumed that the firms sets a target debt-equity ratio and

eventually move toward achieving this target. The financing decision is based on cost benefit

analysis of debt financing versus equity financing, the cost associate with each choice is the key

determinants of the financing decision. The theory suggests the existence of a target optimal

capital structure within the firm tries to reach by balancing its investment and financing plans.

The pecking order theory states that firms follow a hierarchy of financial decision when

establishing its capital structure. Initially firms prefer to finance their projects through internal

financing i.e. retained earnings. In case they need external financing, first they apply for a bank

loan then for public debt. As a last resort, the firm will issue equity to finance its project. Thus

according to pecking order theory the profitable firms are less likely to incur debt for new

projects because they have available internal funds for this purpose. The reason firms are

reluctant to issue equity is because of asymmetric information between the management and the

new stockholders. Another theory is the asymmetrical information phenomenon is present in a

developed country and more or less in a developing one: some investors are more informed than

others, and, in this case, the market efficiency hypothesis is put under questions. Also the

financial literature developed signalling theory which sustain that managers know the true

distribution of firm returns, but investors do not. Managers will gain if the securities of the firm

are higher valued by the market, but are penalized if the company goes bankrupt. Investors take

larger debt levels as a signal of higher quality.

Data Base

The paper employed different measure of the capital structure such as leverage,

indebtedness and coverage of interest in operating profit. In this study, the selection of

explanatory variables is based on the alternative capital structure theories and previous empirical

work. The choice was limited because of lack of relevant data. As a result, the final set of

explanatory variables includes: tangibility, profitability, market to book ratio, size, capital

intensity and the financial crisis for 29 Romanian companies.

All information has been obtained from:

Internet sites providing information on companies listed on BSE, such as

www.bvb.ro. www.ktd.ro.

The Financial Statements published on the company website.

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In the following I present the media of these indicators that represent the capitl structure

of our companies for the five years.

Table no. 1 Median capital structure indicators

An Levier

(DAT/CPR) Datorii totale/AT

Grad de ndatorare (DTS/DT+CPR)

2008 45.70% 36.36% 33.40%

2009 28.26% 22.08% 29.18%

2010 31.42% 21.24% 33.74%

2011 36.70% 22.51% 29.18%

2012 34.06% 22.29% 33.57%

The conclusions would be likely to notice are that the main source of financing for

Romanian companies domestic financing remains closely watched by foreign financing through

bank loans. Romanian companies prefer private financing in exchange for the public.

Table no. 2 Descriptive statistics of the independent and dependent variables of listed companies

in Romania

Levier DAT_AT Grad_Indat Tang Profitab Size Oprt_Crest Intenst_Capit

Mean 0.6846 0.7063 0.3865 0.5783 0.3932 2.7338 2.7753 0.6219

Median 0.3664 0.3929 0.3171 0.5878 0.7083 2.7569 2.4275 0.4213

Standard

Deviation

0.1622 0.1756 0.1923 0.0258 0.1783 0.0551 0.0575 0.0885

Minimum 0.0022 0.0045 0.0012 0.0028 -0.9987 2.3263 0.8109 -1.0095

Maximum 1.2117 1.3680 0.9925 0.9879 0.8762 3.0063 1.9168 0.9987

Sum 147.6889 45.9444 57.9762 86.7467 34.1619 385.4707 391.3199 66.4721

Count 141 141 141 141 141 141 141 141

These values emphasize the application of corporate financing policy in Romania based

on equity in most of them followed by foreign loans are the loans of the bank and the suppliers.

We remark the median of 58.80% for tangibility suggesting that our businesses can opt for bank

loans with what vouch for them. But profitability is present in a relatively high 90.83% which

marks its use funding policy, specifically companies in Romania will opt to reinvest in various

investment projects.

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It can be noticed that for the three dependent variables differences between minimum and

maximum values lead to the idea of different capital structures in Romanian companies. But

between variables such as maximum and minimum values are close, with some proportionality in

the use of each debt category. The explanatory variables except the company size differences

leading to the conclusion that the listed companies in our country have different financial

situations. The small difference can be seen in company size indicator suggesting no matter large

and small companies as in other states, where small businesses are dominated by large

corporations.

Table no. 3 Correlation matrix of the independent and dependent variables listed companies in

Romania

Levier DAT_AT Grad_Indat Tang Profitab Size Oprt_Crest Intenst_Capit

Levier 1

DAT/AT 0.07491 1

Grad de indatorare 0.09399 0.10881 1

Tang 0.27333 -0.18735 -0.28427 1

Profitab -0.47018 -0.28600 -0.35376 0.12435 1

Size 0.35127 0.17517 0.34930 0.08147 0.14858 1

Oprt_Crest -0.33178 -0.35537 -0.29621 -0.09176 -0.10761 0.0187 1

Intenst_Capit -0.21206 -0.28627 0.18356 0.05149 0.09375 -0.2287 -0.01858 1

The matrix is used to detect any multicollinearity between the independent and dependent

variables. From the correlation matrix of the variables used can be seen that between dependent

and independent variables are an acceptable degree of association so there is the influence of

explanatory variables on the dependent. Among the independent variables is remarkable that

capital intensity has a weak correlation with the degree of leverage and indebtedness, the total

indebtedness influence.

It may also be noted that as between the independent variables and the correlation

between the dependent variables is weak or ineffective. Thus, they do not influence one another,

and by the inclusion / exclusion of a variable in the model group, the remaining variables can

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provide significant information, which was not the case if they were highly correlated with each

other.

Research Methodology

Dependent indicators used in this model are leverage, interest of coverage ratio of

operating profit and borrow capital structure related to total active.

Leverage indicates the proportion of equity and debt to finance long-term assets of the

company, being an indicator of the company's risk.

Leverage = DAT/CPR

Indebtedness can be explained in principle as leverage, but in this case short-term debt

relative to total capital of the company (owned and borrowed).

Grad de ndatorare = DTS/(DT+AT)

Operating profit debt coverage is an indicator that can be covered cost of debt of its

operating activities. This indicator is directly linked to profitability and its high value will lead to

better profitability. If a company has a lower value than its value in a company issues debt

management that will be unable to meet payments to creditors.

Datorii totale/Active totale = DT/AT

Indicators used as explanatory variables to the dependent variables are the following.

A. Tangibilitatea activelor = AF/AT

Structure of assets has a direct impact on capital structure, gives tangible more likely to

receive bank loans or issuing shares realization. Lenders require assets to be used as collateral to

offset the chance to deal with the problem of asset substitution. For companies that can not offer

collateral, lenders may require higher credit terms. Therefore, external financing is more costly

than internal financing. Moreover asset substitution problem is less likely to occur when firms

have more assets in place. If the banks do not have sufficient information on companies who

offer loans, they will give less credit to those who have more intangible assets. Therefore, a

positive correlation between tangible and leverage will reveal the presence of information

asymmetry. However, if there is collateral, the debtor could be put on hold to invest in risky

projects or ineffective. Accordingly, the theory of "pecking order" identified a positive

correlation between the percentage of these assets in total assets and leverage of studies showing

this correlation can include Brinkhuis and Maeneseire (2009), Psilaki and Daskalakis (2008),

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Sinan (2010). But studies in Romania provides a negative correlation Dragot and Semenescu

(2008).

B. Profitabilitatea = EBIT(1-)/AE

Regarding profitability indicator, the theory of "pecking order" suggests that profitable

firms first use internal funds and then will turn to external funding. This highlights that

companies with high profits should have a lower debt ratio., Leading to a negative relationship

supported by De Haas & Peters (2004), Sinan (2010), Viet (2010) on the United Britain. In

another prospective lenders prefer to lend to firms with high cash flow stream. Thus capital

structure is a tool signaling performance and prospects of the company, and this is why a positive

value of the correlation coefficient between the two variables can be expected. Profitability is the

indicator that will highlight and emphasize the efficiency of company assets, correlation and

Hennessy and Whited observed (2006) Strebulaev (2007), Rafiu and Akinlolu (2010).

C. Mrimea companiei = Ln(CA)

Most studies argue that large companies tend to be more diversified and therefore have a

lower risk before the bankruptcy. Therefore large firms tend to provide more information to

lenders than smaller firms and the cost of monitoring is lower for large companies. This

argument supports a positive relationship between the information provided and the size of

companies and Zongjum Nadeem (2011). But although the size of the company can be inversely

proportional to the level of asymmetric information between investors within the company and

outsiders, large companies can support equity financing, which implies a negative relationship.

D. Oportunitile de cretere = PER =Pre de inchidere/EPS12

In general literature provides a negative relationship between leverage and growth

opportunities (Jong et.al, 2008). If a company's management objectives tend to increase the

interests of managers and shareholders are the same for those companies with strong investment

opportunities. For companies without growth opportunities, debt serve to limit agency costs.

According to the trade-off theory, firms with growth opportunities tend to borrow less,

opportunities are considered intangible assets compared to those who hold tangible assets as

growth opportunities can not be colaterizate.

E. Intensitatea capitalului = AT/CA

Thus, increasing capital intensity implies future growth of income fluctuation risk. Top

managers want to have control of the company and the main concern of creditors is to limit the

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risk of default of the company's debts, which could be achieved through a low debt companies

choosing its automation instead of manual labor. On the other hand the conservative argument is

that the higher capital intensity in a company greater the need for more long-term debt to meet

financial requirements and will also have access to assets that will become collateral damage. So

capital intensity is negatively correlated with total debt and short-term and positively correlated

with long-term debt.

F. Criza financiar variabil dummy

The financial crisis may affect leverage both directly and indirectly, through the

emergence of this global economic event all banks and lenders to cover unforeseen

circumstances require collateral and interest to a much higher level. By "more expensive" loans

increasingly fewer companies will be able to meet the requirements and therefore will give up

this method of financing. On the other side with the arrival of this unwanted phenomenon more

companies will need financial resources not only to make certain investments but also to

maintain operating activities and in extreme cases will resort to these external sources even at a

much higher price than would have been expected.

Results

First I made a table used for modeling the determinants of capital structure to see later if

we get the same answers. The results are obtain in most studies.

Table no.4 Expected signs of the independent variables

Factor determinant Formula Efect asupra structurii

capitalurilor

Tangibilitate Active Fixe/Active Totale ( - )

Profitabilitate EBIT(1-)/AE ( - )

Mrimea companiei Ln(CA) (+)

Oportunitatea de cretere PER ( + )/( - )

Intensitatea capitalului AT/CA ( + )

Criza financiar dummy ( + )

After running the regressions we pooled all the data in the following table to provide an

overview of the three models made. A pattern in which the six independent variables are

included in the pattern B includes all of the variables except for the financial and C The intensity

excluding capital.

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Table no. 5 Results of regression models A, B, C including the three dependent variables

Varibile dependente

Variabile independente Levier Datorii totale/Active Toatel Grad de ndatorare

Model A Model B Model C Model A Model B Model C Model A Model

B

Model C

Tangibilitate 0.3514* 0.4624* 0.3571* -0.6325* -0.1288* -0.4333* -0.4251* -0.1241* -0.0229*

Profitabilitate -0.4530* -0.3246* -0.2472* -0.5347* -0.1349* -0.2354* -0.2594* -0.1595* -0.2571*

Mrimea Companiei 0.3379* 0.3379* 0.3313* 0.1216* 0.1122* 0.3207* 0.3485* 0.1460* 0.1511*

Oportunitatea de cretere -0.1743* -0.3687* -0.1358* -0.1561* -0.0341* -0.1211* -0.1382* -0.1983* -0.2031*

Intensitatea Capitalului 0.1026* 0.0127** n/a -0.4358* -0.2387** n/a -0.1110* -0.1025** n/a

Criza Financiar -0.1737* n/a -0.1741** -0.2714* n/a -0.7713**

-0.4191* n/a -0.3193**

Variable in the model showed that company size is positively correlated with the three

dependent variables, and tangibility, profitability, growth opportunities and the financial crisis

are negatively correlated with capital intensity. This variable presents a mix of signs is

influenced by the form of debt. Regarding this tangibility is positively correlated with leverage,

but negatively with total debt and short term. This is conclusive with the literature mentioned in

the first two chapters. Tangible assets sustain a negative correlation between them and dependent

variables, the result is logical, because this is how the companies finance the investments in

current assets, while the financial debt is used to finance the fixed assets. The profitability is

negative correlated; this sustains the conclusion of pecking order theory. Size is positively

correlated big firms sent a more direct signal to the creditors and could obtain a credit more

easily, especially in the context where a bigger turnover is associated to a smaller risk exposure.

The correlation of market-to-book-ratio is negative which sustain that the companies with good

growth opportunities will offer greater gains to shareholders than to creditors, fact that sustained

the hypotheses of the pecking order theory. Capital intensity is negatively correlated with total

debt and short-term and positively correlated with long-term debt. Last financial crisis indicator

is showing a negative relationship with all categories of debt which indicates that this

phenomenon does not allow unwanted economic entities to seek external resources due to risk

aversion creditors. Therefore companies will not have the internal resources you need to plan

their great investments and current activity to avoid bankruptcy costs. Therefore, in these

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difficult financial terms many companies having a policy of long-term funding made arrived in

bankruptcy situations.

The financing decision at micro-economic level is strongly influenced by the evolution of

macroeconomic indicators (inflation, interest rate, economic growth), as well as by corporate

governance problems that Romania, practically has not solve yet, although the regulation can be

a starting point in this direction.

Conclusions

The overall conclusion is that Romanian companies face the problem of information

asymmetry and a more analytical perspective we can say that companies are funding policy

based on pecking order theory. Factors influencing capital structure shows that the

macroeconomic level you can influence on the microeconomic level. An underlying problem is

given financing and corporate governance in Romania which is at an early stage and therefore

management does not take the best decisions in this matter.

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