The role of macroeconomic and institutional factors in creating corporate financial flexibility

Abstract

Purpose The purpose of this paper is to investigate the role of macroeconomic factors and the institutional environment on corporate financial flexibility (FF). Most studies focus on well-developed financial markets and very little is known about corporate FF in less developed financial markets and emerging markets (Buvanendra et al., 2016). The present study contributes to filling this gap in the literature and provides a more practical and functional framework to assess the FF of firms located in emerging economies. Design/methodology/approach The study used annual data for the period from 1991 to 2018. To examine the relationship between macroeconomic indicators, institutional environment and corporate FF, hypotheses were tested using an unbalanced panel logistic regression model. Findings The paper provides empirical insights into the relationships between macroeconomic factors, institutional environment and corporate FF. The results suggest a substantial change in FF across firms. Inflation, institutional quality and banking sector development negatively affect FF, while equity market development has a significant positive impact. Gross domestic product growth was found to be an insignificant predictor of FF. Practical implications This study has practical implications for corporate finance managers, regulators and investors, who must consider the significant factors of this study when making economic decisions. Finance managers can thus make appropriate decisions regarding capital structure and FF. Regulators of the banking sector can take appropriate measures to enhance competition and increase the development of the banking sector. Further, regulators of the equity market can enhance the development of the market to enhance the supply of capital. Originality/value This study adds to the literature showing that not only firm-specific factors affect corporate FF, but country-specific macroeconomic and institutional factors also have a significant effect. It also adds to the literature in the area of corporate FF; this field is in its initial stage, even in developed countries, while, in developing countries, little work has been done.

Do selected board governance mechanisms strengthen the link between institutional and macroeconomic variables and the financial flexibility of corporations? Empirical evidence from an emerging economy

“…The average inflation rate in Sri Lanka stands at 4.01%, a figure in line with the average inflation rate in the Philippines (Chow et al, 2018). Nevertheless, the levels of EMD and BSD in Sri Lanka appear to be relatively low compared to the evidence in the literature from other emerging countries (Mahmood et al, 2019b).…”

“…The results of the study reveal that uncertainty in macroeconomic circumstances, together with the interaction impact of corporate governance, has a negative impact on a firm’s capital structure. Certain studies have incorporated FLEV as a measure of CFF (Mahmood et al , 2019a; Mahmood et al , 2019b). FLEV is influenced by corporate governance mechanisms during times of significant economic uncertainty (Chow et al , 2018).…”

“…In terms of determinants, research indicates that CFF could be affected by a number of institutional and macroeconomic factors (Booth et al, 2001), including profitability (PRF) (Hooshyar et al, 2017), tangibility (TAN) (i.e. the collateral value of fixed assets) (Mahmood et al, 2019a), financial leverage (FLEV) (Byoun, 2007), insider corporate ownership and quality of earnings (Estwick, 2015;Islam et al, 2020), firm age (Jang, 2017), inflation (Hanousek and Shamshur, 2011;Sett and Sarkhel, 2010;Gajurel, 2006), the growth rate of GDP (Cho et al, 2014;Gajurel, 2006), equity market development (EMD) and banking sector development (BSD) and concentration (Mahmood et al, 2019a;Mahmood et al, 2019b). Extant studies indicate that these factors are significant determinants of the CFF of firms in both developing and emerging countries.…”

Do banking sector concentration, banking sector development and equity market development influence firms’ financial flexibility? Evidence from Pakistan

“…An important feature of the fixed effect model is its ability to account for the individual effects of each firm, but the slope coefficients are supposed to be persistent for all of the sample units. The main assumption of the random effect model is that there is no relationship between groups or individual effects with explanatory variables (Mahmood et al , 2019). The Hausman specification test (1978) was employed to identify whether the random effect or fixed effect model is better.…”

Do corporate financial flexibility, financial sector development and regulatory environment affect corporate investment decisions?

“…Equity market and banking sector are relatively developed. Although the banking sector of Pakistan is highly concentrated (Mahmood et al , 2019a, b), it plays an important role in economic development of the country. On the other hand, the bond market is relatively small and less developed in Pakistan (Nasir and Farooq, 2017).…”