DOES MALAYSIAN FIRMS' CORPORATE CAPITAL STRUCTURE CHANGE HAVE AN IMPACT ON ITS CORPORATE PERFORMANCE?

Teoh Ker Li

Bachelor of Finance (Honours) 2012

Pusat Khidmat Maklumat Akademik VNIVERSm MALAYSIA SARAWAK

ADAKAH PERUBAHAN STRUKTUR MODAL KOPORAT FIRMA-FIRMA DI MALAYSIA MEMBERI KESAN KEATAS PRESTASI KOPORATNYA?

FI.KHICMAT MAKLUMAT AKACI!MIK

11111 III1Ifiill111111111 1000245041

TEOHKERLI

Projek ini merupakan salah satu keperluan untuk Ijazah Sajarna Muda Kewangan dengan Kepujian

Fakulti Ekonomi dan Perniagaan UNIVERSITI MALAYSIA SARA W AK

2012

I

-

DOES MALAYSIAN FIRMS' CORPORATE CAPITAL STRUCTURE CHANGE HAVE AN IMPACT ON ITS CORPORATE PERFORMANCE'!

TEOH KERLI

This project is submitted in partial fulfilment of the requirements for the degree of Bachelor of Finance with Honours

(Finance)

Faculty of Economics and Business UNIVERSITI MALAYSIA SARAWAK

2012

I PENGESAHAN PELAJAR

Saya mengakui bahawa Projek Tahun Akhir bertajuk Adakah Perubaham Struktur Modal Koporat Firma-Firma di Malaysia

Memberi Kesao ke atas Prestasi Koporatoya? ini adalah hasil kerja saya sendiri kecuali nukilan, petikan, huraian dan ringkasan

yang tiap-tiap satunya telah saya nyatakan sumbernya.

7 (Tarikh Serahan) (Tandatangan Pelajar)

TeohKerLi 25699

ST ATEMENT OF ORIGINALITY

This work described in this Final Year Project, entitled Does Malaysian Firms' Corporate Capital Structure Change Have an Impact

on Its Corporate Performance? is to the best of the author's knowledge that of the author except where due reference

is made.

.lr1 (Date Submitted) (Student'S Signature)

Teoh Ker Li 25699

ABSTRAK

ADAKAH PERUBAHAN STRUKTUR MODAL KOPORAT FIRMA-FIRMA

01 MALAYSIA MEMBERI KESAN KEAT AS PRESTASI KOPORATNY A?

oleh

Teoh Ker Li

Kajian ini bertujuan mengkaji hubungan yang wujud dalam tahun-tahun yang

berlainan di antara struktur modal dan prestasi koporat dengan menggunakan 505

buah firma yang tersenarai di Bursa Malaysia. Kajian ini telah dijalankan dengan

menganalisasikan kesan nisbah corak perubahan hutang dan ekuiti dalam 505 buah

firma yang terpilih dari tahun 2005 hingga 2010 dan menentukan hubungan tersebut

sarna ada menyokong teori Static Trade-ofJatau teori Pecking Order. Tempoh kajian

ini adalah dijalankan dalam bentuk keseluruhan serta dalam keadaan ekonomi yang

berbeza, terutamanya dalam keadaan ekonomi yang mengalami krisis. Perubahan

jumlah hutang, jumlah hutang jangka panjang, jumlah hutang jangka pendek dan

jumlah ekuiti digunakan sebagai proksi stuktur modal manakala pasaran nilai buku,

margin untung bersih serta pulangan ekuiti telah digunakan sebagai pengukuran

prestasi koporat. Keputusan kajian menunj~kkan hanya jumlah ekuiti didapati

mempunyai hubungan positif yang kukuh terhadap semua ukuran prestasi koporat.

Pada masa yang sarna, hubungan antara semua jenis perubahan hutang dengan

petunjuk-petunjuk prestasi kQPorat adalah dalam bentuk yang bercampuran. Secara

keseluruhan, kebanyakkan hubungan antara perubahan struktur modal firma dengan

perubahan prestasi koporat didapati mengikuti teori Static Trade-off.

ABSTRACT

DOES MALAYSIAN FIRMS' CORPORATE CAPITAL STRUCTURE

CHANGE HAVE AN IMPACT ON ITS CORPORATE PERFORMANCE?

by

Teoh Ker Li

This study aims to examine the relationship that exists to be varying year by

year between the corporate financial structure in debt and equity ratio change pattern

of movement that affects the performance of the selected 505 public listed firms in

Malaysia from year 2005 to 2010 and determines its consistency in related to either

static trade-off theory or pecking order theory. It is tested in overall and also

different economic period mainly the crisis period by using change of total debt, long

term-debt, short-term debt and total equity as the proxy corporate financial structure.

Whereas for the measurement of corporate performance will be using Market to

Book Value, Net Profit Margin and Return on Equity. Results show that only change

in total equity had a consistent positive significant relationship with the change of all

corporate performance indicators, whereas a mix relationship was found between all

kinds of change in debts with the change of all corporate performance indicators. In

overall, majority of the relationships between changes in corporate financial

structure with change of corporate performance was found consistent with the Static

Trade-off Theory.

ACKNOWLEDGEMENT

First of all, I would like to offer my sincerest gratitude to my thesis's

supervisor, Madam Josephine Yau wholehearted guidance, invaluable help,

encouragement, advises and patience for all aspect from this thesis progress. Her

numerous comments and suggestion during the preparation of this project are

gratefully praised. Especially for her patience and unconditional willingness in help

when encountering problem no matter big or small during the thesis progress is

invaluable and truthfully well appreciated. I attribute the level of my degree to her

encouragement and effort and without her this thesis, too, would not have been

completed. One simply could not wish for a better or friendlier supervisor.

Upon completion of this thesis, I would also want to thanks my mother and

family for their constant support mentally and financially from the beginning of the

thesis progress. Finally, I would like to thanks to my thesis group mates, house mates

that helped and supported me a lot especially Bong Hui Hian and Chua Su Yen who

happily cooperated as thesis group mates in solving all problems that occurred

during the thesis program especially in the process of collecting data. Lastly, I would

like to thank my house mates and friends who helped and supported me throughout

the thesis progress.

Pusat Khidmat Maklumat Akademik UNIVERSm MALAYSIA SARAWAK

TABLE OF CONTENT

LIST OF TABLE xv

LIST OF FIGURE xvi

CHAPTER ONE INTRODUCTION 1-26

1.0 Introduction .............. .... ........... .. ............... ... ................................................ ··················-1

1.1 Theoretical Framework·· ································ ··················································· ···· ········-5

1.1.1 Modigliani and Miller (MM) Theorem (1958)············································-5

1.1.2 Agency Cost Theory (1976)-·· ····················· ································· ·················7

1.1.3 Static Trade-off Theory (1977)· ··························· ·.··· ... ···· ..... ·..·········· ············9

1.1.4 Signalling Theory (1977) ............................. .. ....................... ·······················10

1.1.5 Pecking Order Theory (1984 ) .................... .......................... ... .... ················-12

1.2 Background of Studies·············· ············· ···· ··:········· ····· ················· ······························· -15

1.3 Problem Statement························ ··· ················· · ........................... ........................... ···-21

1.4 Research Objectives··············· ····························· ...................................................... ·· -24

Vlll

1.5 Rational Significance of Research·---------------------- -------------------------------------------------------25

1.6 Scope of Research ------------------------------------- ------------ -------------------------------------------------------26

1.7 Conclusion -- ------ ------------- ---------------------------- --- ---------------------------- ----- ------------------ ------------26

CHAPTER TWO: LITERATURE REVIEW 27-60

2.0 Introduction------------------------------------------------------------------------------------------------------------------27

2.1 Capital Structure Theories------------------------------------------------------------------------------------------28

2.1.1 Static Trade-off Theory------------------------------------------------------------------------------- 28

2.1.1.1 Evidence from developed countries---------------------------------------------29

2.1.1.2 Evidence from emerging countries---------------------------------------------29

2.1.1.3 Evidence from Malaysia--------------------------------------------------------------31

2.1.2 Pecking Order Theory----------------------------------------------------------------------------------33

2.1.2.1 Evidence from developed countries---------------------------------------------33

2.1.2.2 Evidence from emerging countries ---------------------------------------------34

2. ] .2.3 Evidence from Ma1aysia--------------------------------------------------------------35

IX

---------------------------------------------------------------------------~

2.2Capital Structure and Corporate Perfonnance-······························· ·· ··· ·············· ·· ·······-37

2.2.1 Evidence from developed countries···························· ··· ····· ··········· ...... · ...... 37

2.2.2 Evidence from emerging countries······················· ······································-39

2.2.3 Evidence from Malaysia······· ·································· ····· ··············· ·· ········· ·· ···42

2.3 Debt and Corporate Perfonnance ...................................................... ···················· ···-43

2.3.1 Evidence from developed countries················· ···········································44

2.3.2 Evidence from emerging countries················· ····································· ··· ····45

2.3.3 Evidence from Malaysia ................................. ..................... ·······················48

2.4 Equity and Corporate Perfonnance························································· ·············· ·····49

2.4.1 Evidence from developed countries-·····························································49

2.4.2 Evidence from emerging countries······ ························································50

2.4.3 Evidence from Malaysia························································ ·····················-51

2.5 Conclusion ..................................................... ............ ........................................... ······-51

x

61-76CHAPTER THREE: DATA AND METHODOLOGY

3.0 Introduction.......... ·.. · ...... ·· ..· .... ·.. ··· .... ·... ··· .. ··· ... ·· .... ·· ... ·· .............................................. ·61

3.1 Sample Data··· ..···· ....·..·.. ············ .. ··· .............. ·..·· ..··········· ..············· ..·· .. ····· .... ·· ..···· .... ····61

3.2 Conceptual Framework··· .. · ...... · .. ···· .. ·········· ..·········· .. ------ -- .. · .... --······ ....·.. ·..···· ...... ······· ·62

3.2.1 Change in Corporate Performance ........ · ...... · .................. ----· ........ ----· .......... 63

3.2.2 Change in Debt Financing ..................................................... __ .......... __ .. ____ ..65

3.2.2.1 Change in Total Debt .............. ·.. · .... --· ....------·--· .. -- ............ ·.. · .... -- .. ·66

3.2.2.2 Change in Long-term Debt .... ------ .................... --·-- .. -- .. ·.. ·.. ---- ...... ·{)7

3.2.2.3 Change in Short-term Debt-­ ........ -- ........ · ...... ·--.... .... --·--................67

3.2.3 Change in Equity Financing .... -- ..·.. -- ............ -- ...... --·-- .. ·.. ----·--.... ...... ·--.. -- ..·--68

3.3 Hypothesis Development .. ······················· -- ... -- ...... -- .............................. --,.'" -- ............. ·69

3.4 Data Analysis ..···· ...... -- ....................... "--""""" -- .... " ---- ..... -- .... -- ...............--.-- ..... ---- ...... ·73

3.4.1 Descriptive Statistic .... · .-- ........... -- ......... .. -- ........... -- .......... -- ............ .... ----.-- ...73

3.4.2 Correlation Coeffi cient········ -­ ...................... ---- .... --. -- ---- ......... . --. -- --······ ..······74

Xl

3.4.3 Multiple Regression Analysis············································· ········ ···· ·············75

3.5 Conclusion······································· ····· ...................................................... ·················78

CHAPTER FOUR: EMPIRICAL RESULTS 79-108

4.0 Introduction·········································· ................................... .. ................. ···················79

4.1 Preliminary Debt to Equity Employment Patterns····································· ............... 79

4.2 Evolution of Changes in Corporate Financial Structure in Malaysia············· ··········81

4.3 Descriptive Statistic········································· ···· ..... ................................................. ·· ·84

4.4 The Correlation Matrix ........................ .............. ... ............. ································· ······-85

4.5 Multiple Regression Analysis ....... ............................................... ·······························86

4.5.1 Change of Corporate Financial Structure vs. Corporate Performance

(Market to Book Value)····················· ········· ················ ·········· ··············· ·······86

4.5.2 Change of Corporate Financial Structure vs. Corporate Performance (Net

Profit Margin)····································:·························· ·························· ·····90

4.5.2.1 Pre-Crisis Period (2005-2006}············· ·········· ······ ······················· ·93

4.5.2.2 During Crisis Period (2007-2008}············ ·· ································94

Xll

4.5.2.3 Post Crisis Period (2009-201 0) ···················································95

4.5.2.4 Pre-Crisis Period (2005-2006}·····················································96

4.5.2.5 During Crisis Period (2007-2008}··············································97

4.5.2.6 Post Crisis Period (2009-201 0)······························· ·····················98

4.5.3 Change of Corporate Financial Structure vs. Corporate Perfonnance

(Return on Equity)····· ···················································································99

4.5.3.1 Pre-Crisis Period (2005-2006}···················································102

4.5.3.2 During Crisis Period (2007-2008}························· ············ ·······103

4.5.3.3 Post Crisis Period (2009-201 0) ·················································104

4.5.3.4 Pre-Crisis Period (2005-2006}·· ·················································105

4.5.3.5 During Crisis Period (2007-2008}············································1 06

4.5.2.6 Post Crisis Period (2009-2010) ······ ··· ·········································107

4.6 Conclusion .... .... .. .... ............................................... ... ....................................... ..... ·····108

X III

CHAPTER FIVE: EMPIRICAL FINDINGS AND IMPLICATIONS 109-122

5.0 Introduction·····------------------------------------------------------------------------ ------------------------------------109

5_1 Findings from Preliminary Debt to Equity Employment Patterns--------------------------1 09

5.2 Findings from Evolution of Changes in Corporate Financial Structure in

Malaysia--- ------------------ --- -- ---- -.--------------------------- -------- --------------------- ---------------- ------------·11 0

5.3 Findings from Change of Corporate Financial Structure vs. Corporate

Performance---· -·-·------------------------ --------------- --.. ---------------------------------------------------.--.---- III

53.1 Change of Corporate Financial Structure vs_ Market to Book

Value-------- ------------------------------------------------- ..-----.---------- --------------------- .. -.------111

5.3.2 Change of Corporate Financial Structure vs_ Net Profit Margin---- ·--·----113

5.3.3 Change of Corporate Financial Structure vs. Return on Equity·-------------118

5.4 Conclusion ---------------- -- -------------------- ------ ------------- .. -------------------------.------- -- ------------------ ·122

CHAPTER SIX: CONCLUSIONS AND RECOMMENDATION 123-129

6_0 Introduction------------- -------------------------------------- -- ---------------------------- -------------------------- -----123

6.1 Summary of Discussion and Conclusion of the Research Study and Theoretical

Implications .--- -- --------------------------------------------------------------------------------------------------------124

XIV

6.2 Recommendations--------------- -- ------------------------ --- -- --------------------------------------------------------126

6.3 Future Research Directions----------------- -- ------------------------·--------------------------------------------128

6.4 Conclusion ----- --------------------------------------------- --- --------------------------- .------------------------ ----- -- ·129

APPENDICES

REFERENCES 128-134

LIST OF TABLE

Table 1.1: Components of financial structure in a non-financial firm ----------------------------4

Table 2.1: Summary of Literature Review----------- ----- --------------------- ----- --------------------------- -53

Table 3.1: Variables, proxy measurement and the expected relationship based on the

selected theory and based on this study---------·------------------------------------------ ----72

Table 3.2: Correlation coefficient value and it relationship between the

variables------------------------- ---- ------- -----------:-------- -- ---------------------------------- -- ------------74

Table 4.1: Evolution of Changes in Capital Structure of Malaysian Public Listed

Firms---···-----------------------------··---------------------------------------------------------------------------81

xv

Table 4.2: Summary of Descriptive Analysis·---- -------- ....----- .. ---------------------- .......... -----------84

Table 4.3 : The Correlation Matrix----------- ----------------------- -- -------------------------------------------------85

Table 4.4: The Regression of Market to Book Value as the Dependent Variable -- -----87

Table 4.5: The Regression of Net Profit Margin as the Dependent Variable-----------------91

Table 4.6: The Regression of Return on Equity as the Dependent Variable------ ---------- l 00

Table 5.1: Summary of Hypotheses in the Study-------------------- --- -------------------- -- -------------122

Table 6.1: Summary Result of the Study according to the Theory------------------- ----------- 124

LIST OF FIGURE

Figure 1.1: Summary on Theoretical Framework------------ --- ------------- ------ ------------------------- 14

Figure 1.2: The Total Number of Listed Firms' in Bursa Malaysia since 1990 till

201 0- -------------- -------------------------------------------------- ----------- ------------ ----------------------- --17

Figure 1.3: The Number of Listed Firms in Bursa Malaysia and the Total Debt

Employed from Year 1990 till 201 0------------------------------------- ----- --- ----------------18

XVI

Figure 1.4: Semi Annual FTSE Bursa Malaysia KLCI Price Index from year 2000 till

20 1 0---------------- ------------------------- ------- ----------------------------------------------------------------23

Figure 3.1: The Conceptual Framework of the Relationship between the Independent

Variables and the Dependent Variables--------------------------------------------------------63

Figure 4.1: Debt to Equity Ratio in Malaysian Public Listed Firms from year 2005 till

2010------ -- ----------------- ------- ----------------- ---- ------- --- -------------------------- ------------ ------- ----.s 0

Figure 4.2: Changes of total debt, long-term debt, short-term debt and total equity of

Malaysian Public Listed Firms from year 2005 till 2010----------------------------81

XVll

CHAPTER ONE

INTRODUCTION

1.0 Introduction

Financial structure can be defined as the mixture or the combination of debts

and equity which are used to support and finances the firm's total assets where it

usually determined by the financial manager in an organization. Financial structure is

usually consists of long-term debt, short-term debt and also the total equity of a firm

(Brealey, Myers, & Allen, 2008), and can be found in the right hand side of a firm's

balance sheet to financed the usage oftota[ assets in a firm which can be found in the

left hand side of the balance sheet (Ross, Randolph, & Jeffrey, 1999).

Capital structure, another similar term for financial structure, yet there are

many differences found between both. Actually, capital structure is somehow a

subset of financial structure as it is only the summation of the total long-term sources

of capital, which consist of many different type of long-term debt, and at least two

type of equity(common and preferred stock) and also hybrid(convertible bonds)

(Saad, 2010). Since the term of financial structure and capital structure are more or

less having the same meaning in most research paper, therefore in this research paper

tenns financial structure and capital structure will be assume as the same definition.

Over half of the century, it had been a favourite and popular topic among the

academicians and practitioners in the finance field to discussed and begin their

researches based on the scope of capital structure and corporate performance which

is the fundamental topic of corporate finance ever since the path breaking

1

contribution by Modigliani and Miller (MM) in developing the irrelevance

proposition of the modern capital structure theory (Chou, et.al. 2010; Cheng, Liu, &

Chien, 2010). Modigliani and Miller (1958) popularly known as the MM theorem or

also known as the irrelevance theory of capital structure is the origin theory of

capital structure that is broadly accepted and in used by many researchers which

implies that capital structure or the financing decision of a firm give no effect to

firm's value in a perfect market (Ong & Teh, 2011).

For years in many studies around the world tried to find out an ideal way to

achieved optimal capital structure where firm's weighted average cost of capital is

minimized and maximizing the corporate performance on the other hand (Tian &

Zeitun, 2007). Just like the probability chart, a large scale of distinct securities in

uncountable combination can be issued by the firm's financial manager based on the

principle of a firm's most basic objective, maximizing the corporate profitability

(Brealey, Myers, & Allen, 2008).

Profit alone had no longer a significant meaning to firm albeit it is tried to be

maximized all the time. Many financial managers thought that it is not a well defined

tool for firm objective anymore. Now in modem days, most of the time financial

manager attempt to obtain a particular combin~tion that can contribute to increase

the firm's overall market value (Altan & Arkan, 2011) as increasing the corporate

performance had gradually become the main focus of firms' value. Hence, it is

important for a financial manager to decide how the firm finances its overall

functions and growth by using different source of funds (Ong & Teh, 2011).

2

However, in today's rapidly growing capital market it is difficult for financial

manager to distinguish a perfect ratio of optimal capital structure for a firm. In fact,

there is no definite way or formula in determining optimal firm's capital structure

neither in a perfect market nor imperfect market (Dhankar & Boora, 1996). Since the

market in reality are imperfect, then there is a possibility that capital structure that a

finn used might cause corporate performance to be vary from time to time as capital

structure does has a closed link with corporate performance (Tian & Zeitun, 2007;

Ong & Teh, 2011).

The following table presented the formation of a firm's financial structure in

the balance sheet of a firm. Where on the left hand side, comprise from the type of

long lived assets that a firm should invest, known as capital budget. While on the

right hand side is the method of a firm obtained to raise cash for required capital

expenditures in whole, known as capital structure. This is where many finance

managers are trying to seek for a balance or optimum capital structure between debt

fmancing and equity financing in order to achieve the objective of corporate

performance maximization.

3

Table 1.1: Components of financial structure in a non-fmancial firm

From the table here, it is clearly shown that the total debt and equity of a finn from the left side of the balance sheet are used to finance the total assets of the finn from the right side of the balance sheet.

Firm's Balance Sheet

Assets:

Fixed Assets

Buildings Land Machinery and Equipment

Liabilities and Equity:

Long-Term Liabilities

Long-term notes Long-term bonds Long-term bank loans Debentures Pension Obligation Lease Obligation

Total Fixed Assets 1

Current Assets

Inventories Cash in hand Cash in Bank Account Receivables Prepaid Expenses Marketable Securities

Total Current Assets 2

Other Assets

Patents Copyrights Investments Goodwill

Total Other Assets 3

Total Long ­ term Liabilities· Short-Term Liabilities

Short-term Notes Overdraft Account Payables Accrued Expenses Other Payables Deferred Tax Unearned revenues, Deposits

Total Short ­ Term Liabilities5

Equity:

Common Stock (Par value + Paid in Capital - Treasury Stock) Preferred Stock Capital Reserves Retained Earnings

Total Equity6

SUM: 1+2+3= Total Assets

SUM: 4+5+6= Total Debt and Equity

Source: Above table was an example of balance sheet adapted and modified from the Corporate Finance McGraw-Hill International Edition, pp.2 and also from the Financial Management: Principles and Applications Pearson Prentice Hall International Edition, pp.35

4

Pusat Khidmat Maklumat Akademik W\1VERSm MALAYSIA SARAWAK

1.1 Theoretical Framework

The relationship between financial structure and corporate perfonnance can be

tested based on various theories. Modigliani and Miller's (1958) MM Theorem, the

first modem theory of capital structure which also the elemental theory of capital

structure. Another theory is the static-trade off theory which is use to detennine the

capital structure value by a trade-off between tax shield and bankruptcy cost. While

the Pecking Order Theory by Myers and Majluf (1984) will be the choice of testing

the capital structure of using the internal financing when the finn internal financing

is inadequate. A Signalling theory of capital structure can also be used to explain the

relationship between capital structure and corporate perfonnance. Lastly the theory

can be related in testing the link between the capital structure and finn perfonnance

will be the Agency theory.

1.1.1 Modigliani and Miner (MM) Theorem (1958)

Since 1958, Modigliani and Miller had developed a theory pertaining

the finn capital structure and corporate perfonnance which known as the

Modigliani and Miller theorem, in short MM theorem. MM theorem is

someway been said that it is a foundation of modem corporate finance. The

starting point of the theory for capital structure having the basic concept

where finn which are operate in a well-function market, its financial

decisions do not give any effect to corporate perfonnance (Villamil, 2008).

From the studies had done by Modigliani and Miller, there are four

different outcomes that can found from their papers in 1958, 1961 and 1963

5

where there are four propositions established based on their studies

(Villamil, 2008). The first proposition of the MM theorem was about under

a certain conditions, the pattern of consumption on debt and equity of a firm

does not give an effect to the firm's market value. While the second

proposition of MM Theorem stated that a firm's leverage will not affect the

firm's weighted average cost of capital (Pagano, 2005). The third

proposition of MM Theorem was focused on the firm market value stated

that it will not be affected by its dividend policy. And the fourth proposition

of the MM theorem found that the reaction of the equity-holders is

unresponsive towards the firm's financial policy. MM theorem had been

characterized as one of the first formal theories that use the concept of a no

arbitrage case where the thought of "law of one price" is venerable

(Villamil, 2008).

This theory is function under a perfect market where it is operates

under a few assumptions applied by Modigliani and Miller (1958). The

assumptions are in a perfect market which means there will be neutral taxes,

no capital market frictions, no asymmetric privilege for the investors and

the borrowers, and firm financial policy provides no information where the

market is efficient (Modigliani & Miller, 1958). This is why the MM

theorem is somehow structured a debate on why it had been known as the

capital structure irrelevance theory as the market in the modern days are no

long perfect (Jensen & Meckling, 1976; Modigliani & Miller, 1963; Myers,

1984; Myers & Majluf, 1984).

6