Managerial entrenchment, financial constraints, and investment choice in unlisted firms

Abstract

This paper examines how internally generated cash is allocated for investment in unlisted firms in the post‐global financial crisis period. We estimate models using a panel data set from unlisted firms in the United Kingdom from 2009 to 2014. With the use of a commercially available credit rating and a widely used index in the literature to proxy for external financial constraints, the paper concludes that less financially constrained firms display a higher investment‐cash flow sensitivity. This association has been consistent across the post‐global financial crisis period. We find some evidence to suggest that investment inefficiencies reduce investment‐cash flow sensitivity, and this is intensified in the presence of external financial constraints. We extend the investment choice literature in the presence of financial constraints using evidence from unlisted firms. We also enhance the investment choice literature by incorporating the managerial entrenchment effect along with financial constraints. Provision of financial support for private entities is a crucial policy focus for any government. We call for policymakers to enhance microfinancing options for unlisted firms to reduce the impact from external financial frictions.

Capital structure revisited. Do crisis and competition matter in a Keiretsu corporate structure?

“…We also observed that tangibility ( TAN ) and leverage ( BLev ) are positively and significantly related at the 1% level. This underscores the importance of asset base as an added security in reducing a lender's risk (Danso & Adomako, 2014; De Jong et al, 2008; Nicodano & Regis, 2019; Ranasinghe, 2019; Williamson, 1988). This tends to support both the pecking order and the trade‐off theories.…”

“…Following this, a review of the capital structure literature identifies various theories that that have been at the forefront of the debate on how various firm‐level characteristics affect firms' debt‐equity choice decisions (Frank & Shen, 2019; Grosse‐Rueschkamp et al, 2019). For example, arising out of discussion of the irrelevance theory is the trade‐off theory, which argues that an optimal capital structure is determined by the costs and benefits associated with the use of debt as against equity (Nicodano & Regis, 2019; Ranasinghe, 2019). Thus, there is either an optimal debt‐equity ratio, or a range for this ratio, whereby a firm's average cost of capital can be minimised (Bartholdy, Mateus, & Olson, 2015; Brown, Dutordoir, Veld, & Veld‐Merkoulova, 2019; Scott, 1977).…”

“…Despite their differences, the afore‐mentioned theoretical positions have received significant empirical support, suggesting that various firm‐level factors can drive firm financing decisions in both local and international business contexts (Inderst & Vladimirov, 2019; Ji et al, 2019; Lemmon & Zender, 2019; Nicodano & Regis, 2019; Ranasinghe, 2019; Wang et al, 2019). These factors include firm size, profitability, asset tangibility, non‐debt tax shield, liquidity, volatility and growth (Antill & Grenadier, 2019; Asad et al, 2019).…”

“…Of the empirical studies that evaluate the relationship between firm‐level factors and leverage, the majority find evidence that earnings volatility (a proxy for firm risk) and leverage are negatively related (e.g., Chen, 2004; De Jong et al, 2008; Ranasinghe, 2019). This relationship is based on the logic that firms with volatile earnings have a greater risk of default, which impacts negatively on their ability to secure external finance or makes external financing costly (De Angelo & Masulis, 1980; Ji et al, 2019).…”

“…These subsequent theoretical developments suggest that the choice of capital structure is not random (Inderst & Vladimirov, 2019; Ji, Mauer, & Zhang, 2019; Lemmon & Zender, 2019). Whilst this claim has received support from a large body of literature suggesting that firms' characteristics affect their capital structure decisions (e.g., Ahmed & Hla, 2019; Asad, Gulzar, Bangassa, & Khan, 2019; Céspedes, González, & Molina, 2010; Danso & Adomako, 2014; De Jong, Kabir, & Nguyen, 2008; Fosu, 2013; Muradoğlu & Sivaprasad, 2012; Ranasinghe, 2019; Wang, Manry, & Rosa, 2019), it is reasonable to argue that other, unexplored, factors, such as financial crisis and product market characteristics may also influence capital structure (Alexandridis & Hasan, 2019; Elmagrhi, Ntim, Malagila, Fosu, & Tunyi, 2018; Harris & Roark, 2019). This naturally raises some questions: (a) Would the traditional capital structure determinants remain important in product markets in which firms traditionally enjoy special lending relationships with large major banks; and (b) Would the traditional capital structure determinants remain important, where firms belong to large industrial groupings and are subject, largely, to effective monitoring?…”