dragota m and semenescu a article for finance india

7/27/2019 Dragota M and Semenescu a Article for Finance India

1/20

1

Debt-equity choice in Romania: The role of firm specific determinants

Mihaela Dragot, PhD

Andreea Semenescu

Bucharest University of Economics

JEL code: G32 Financing policy, capital and ownership structure

Abstract

This paper contributes to the capital structure literature by investigating the firm specific determinantsoperating in one of the most unstudied countries from the Central and Eastern Europe. The database used toprovide evidence about the capital structure characteristics and to investigate whether and to what extent the main

capital structure theories can explain capital structure choice contains accounting and market information aboutRomanian-listed companies. One of the main conclusions for capital structure analysis was that Romanian listed

companies financed their assets, in order, through equity, commercial debt and, finally, through financial debt.Furthermore, some of the firm characteristics identified by previous studies as correlated in a cross-sectionanalysis with capital structure in developing markets are similarly correlated for the present sample of companies.The four variables used in the regression model are significant, but some of them only for one type of debt, or onlyfor the accounting values and not for the market ones or vice versa. The pecking order theory seems to be more

appropriate for the Romanian capital market, but the signalling theory is not entirely rejected.

1. Introduction

This paper investigates the firm specific determinants for the Romanian listed companies, taking intoaccount the fact that Romania is one of the most unstudied East European countries, first of all due to the un-transparency of financial data. Expressly, we try to answer to the following two questions:

1. Are the financial decisions of the Romanian-listed companies different from those taken by firms whichact in economies where market mechanisms lead for a long period of time? It was taking intoconsideration the fact that Romania has a transitional economy, from a command to a market economy.

2. Do the factors which affect the changes in capital structure, identified through empirical research fordifferent other developing or developed countries, have a similar effect for the Romanian listedcompanies?

Due to the fact that Romanian listed and non-listed companies and the banks, too, are not anymore state owned, but the state remain the collector of the tax, factors such as size (as a proxy for bankruptcy costs), tangibleassets (as a proxy for collateral) or profitability might have an impact on capital structure. Moreover, due to the

fact that, after the year 1990, Romania declared that it had not a command economy, the tax can influence thecapital structure, opposite the Modigliani and Miller (1958) theory, in a world without taxes.

Modigliani and Miller (1958) model predicts that in a perfect financial market the value of a firm isindependent of its combination debt-equity and these resources are perfect substitutes for each other. In a realeconomy, this mix is often very important for firm value and for the cost of capital analysis, and some importantalternative financial theories were developed. Firm and country characteristics became more and more importantand a lot of empirical studies were published especially for the developed countries and for the US in the firstplace. Among the theoretical approaches, could be mentioned here the surveys realised by Harris and Raviv (1991)and, more recently, Myers (2001).

In a general classification, the theories about the capital structure can be structured in: (i) the main stream

in capital structure theory, founded by Modigliani and Miller (MM) (1958), stating the neutrality of capitalstructure on the cost of capital and the value of the firm, corrected in time with taxes (Modigliani and Miller, 1963;Miller, 1977); (ii) the static trade-off theory; (iii) the signalling theory applied in capital structure decision; (iv) thepecking order theory.

The critics for the Modigliani and Millers model were numerous, its main weaknesses being the

hypothesis of the efficient market, a world without taxes and the hypothesis of a constant interest rate. Yet,managers do believe in optimal capital structure due to the debt tax shields. In their opinion, a reliable capital

structure must ensure profitability, solvency, flexibility and effective control. The Net Income Approach1, under

certain assumptions, postulates an inverse relationship between the weighted average cost of capital and the totalvalue of the firm.

Merton Miller (1977) added personal taxes into the analysis and demonstrated that optimal debt usageoccurs on a macro-level, but it does not exist at the firm level. In his article, he pointed out that the tax advantage

1 In contrast to the Net Operating Income Approach, this theory concludes that the capital structure has a major

influence on the value of the organization. Therefore, the use of leverage will change both the cost of capital andthe value of the firm. Net Income is capitalized to reach the market value of the firm (http://www.exinfm.com).


2/20

2

of corporate debt might be mostly if not completely illusory. In his paper, Miller showed that under specificconditions the only feasible equilibrium is the one in which the after-tax cost of debt equals the after-tax cost ofequity2.

Other researchers have added imperfections3, such as bankruptcy costs (Baxter (1967), Stiglitz (1972),Kim (1978)), agency costs (Jensen and Meckling (1976)) and gains from leverage-induced tax shields (DeAngelo

and Masulis (1980)). For instance, DeAngelo and Masulis (1980) demonstrated that each firm will have a uniqueinterior optimum leverage decision with or without leverage related costs.

The static trade-off theory of capital structure states that the optimal combination between debt andequity is obtained when the net tax advantage of debt financing balances leverage related costs such as financialdistress and bankruptcy, holding firms assets and investment decisions constant (e.g. Baxter (1967); Altman(1984), (2002)). According to this theory, issuing equity means moving away from the optimum and should beconsidered bad news.

Another approach to explain the capital structure of firms is to consider the differences in the level of

information, available for the outsiders, about the investment opportunities and income distribution of the firm.Asymmetric information theory assumes that managers or other insiders possess private information about the

characteristics of the firms return streams or investment opportunities. Information asymmetry may result in twodifferent approaches to set up the capital structure. Acording to Rosss model (1977), investors understand largerdebt levels as a signal of managements confidence in the firm. The main empirical implication of this model isthat the firm value (or profitability), debt level and banckruptcy probability are all positively related4. However,any firm attemting to convince the market that it is of a type other than its true type will gain from overvaluation

of one security and lose from undervaluation of the other (Heinkel, 1982). In equilibrium, the amounts issued ofdebt and equity are such that the gains and losses balance at the margin. In cases that involve competition betweenan incumbent firm and an entrant, low cost entrants signal this fact by issuing debt while the incumbent and highcost entrants issue only equity. The main result is that issuance of debt is good news to the financial market(Poitevin, 1989).

According to the pecking order theory (Myers and Majluf, 1984, etc.), the capital structure is built insuch a manner to allow reducing the distortions of investment decisions, due to informational asymmetry. Lelandand Pyle (1977) built a model based on the fact that a leveraged company allows for the manager to hold an

important fraction of the equity of the company. Rendleman (1980) emphasized that companies with undervaluedshares on the market will prefer borrowing resources, but he didnt build a model of the market answer to the

demand of the company, compared to that to new shares issuing. According to the pecking order theory, thecompany will never issue shares if there is a possibility for it to borrow resources, no matter if the shares of thecompany are over or undervalued on the market.

Jensen and Meckling (1976) show that, under the agency theory assumptions, increasing the leveragewill allow for shareholders to benefit from creditors by rising the volatility of the cash-flows of the company, evenif this behaviour may affect the owners gains, which may be less than in the case of a less leveraged firm. Based

on Jensen and Mekling model, other authors took into account the agency costs (determined by the stakeholdersconflicts) as determinants of the capital structure. Authors like Narayanan (1987), Hougan and Senbet (1987),

Brander and Poitevin (1989), Dybvig and Zender (1989) supported the theory of avoiding or limiting agencyproblems by using certain schemes of managers rewards and/or by issuing more complex financial assets, such asconvertible debts. Diamond (1989) sustains the conclusion that longer is the period during which the companyengaged debt and paid it in time, more solid is its present reputation and less its cost of capital. Therefore, bigcompanies, with a certain reputation, prefer to invest in non-risky projects in order to keep up this reputation.Smaller companies, not yet mature, will choose risky projects and if they survive without bankruptcy, they canprobably choose safer projects in the future. For starting, creditors will consider them risky and require higher

interest rates because expecting a risky behaviour in choosing their investments. Marsh (1982) noticed that

companies will issue long term debt, if their value is under the target value, considered as the last ten yearsaverage. It has been also noticed that the market conditions have a significant influence on this policy; companiesprefer debts if it is expected that other companies will do the same and shares issues will be preferred if the returnon equity of the company is higher then the return of market portfolio.

2 When this equilibrium obtains, Proposition I MM holds in the presence of taxes and no firm has a financialincentive to alter its mix of debt and equity even though interest payments on debt are tax deductible. Debt and

Taxes clarified that the perfect-markets assumptions are sufficient, but not necessary conditions for leverage to beirrelevant. Showing that the assumptions required for Proposition I do not hold is not enough to conclude thatleverage matters, rather it must also be the case that clever arbitrageurs cannot profit from the situation (Stulz, R.,"Merton Miller" (April 2006), http://ssrn.com).3 Dragot, M., Dragot, V., Pele, D.T., Semenescu, A., 2008, Capital structure: An Unconventional Approach,

the 42nd Conference of Euro Working Group of Financial Modelling , Stockholm University School of Business,15-17 May.4

Chen, L., Lensink, R., Sterken, E., 1998, The Determinants of Capital Structure: Evidence from Dutch PanelData, Working paper.


3/20

3

The access of the companies on the financial markets to be financed is determined by many factors suchas informational asymmetry, limited access to the resources (a difficult access to new credits due to a highlyimposed leveragerestrictions), corporate governance problems due to different conflicts between the stakeholdersof the company (managers shareholders, managers creditors or shareholders shareholders). For dissimilarfirms, this influence will not be homogenous, due to their characteristics and sizes. In the case of big companies,

the possibility of an arbitrage between alternative financing sources will be higher than in the case of smallcompanies, because of an easier access on the financial market.

The majority of empirical studies on capital structure, such as Bradley et al. (1984), Titman and Wessels(1988), Rajan and Zingales (1995), Wald (1999), De Miguel and Pindado (2001), Hatzinikolau, Katsimbris andNoulas (2002), Lf (2004), Bancel and Mittoo (2004), Brounen et al. (2006), Vos, Yeh and Tagg (2007) employdata from developed countries to analyse the determinants of capital structure. Studies on emerging markets, suchas Wiwattanakantang (1999), Booth et al. (2001), Deesomsak, Paudyal and Pescetto (2004), Huang and Song(2006), Chang, Lee and Lee (2007), Delcoure (2007) only appeared in the recent years.

The rest of the paper is organised as follows. In the next Section some of the theoretical literatureconcerning the determinants and effects of leverage is reviewed. Section 3 introduces some considerations

regarding the Romanian capital and credit markets. Section 4 contains the some descriptive statistics about thecapital structure for the Romanian listed companies. In section 5 we justify the choice of the variables used in ouranalysis. Section 6 contains the database, the methodology. Section 7 discusses the empirical results of our study.Section 8 concludes the paper.

2. International empirical studies for signalling theories through capital structure

The previous empirical research of corporate capital structure considered as reference study in this field,Rajan and Zingales (1995), has been mainly focused on G7 countries and has found the following variables asbeing most consistently related to the corporate capital structure: tangibility, size, profitability and growthopportunities.

Ever since Myers (1984) article on the determinants of corporate borrowing, the literature on thedeterminants of capital structure has grown steadily. Titman and Wessels (1988) took several attributes of firms as

asset structure, non-debt tax shields, growth, uniqueness, industries classification, size, earnings, volatility andprofitability, but found only uniqueness (indicators of uniqueness include expenditures on research and

development over revenues, and selling expenses over sales) as highly significant. However, Harris and Raviv(1991) pointed out that the consensus among financial economists was that leverage increased with fixed costs,non-debt tax shields, investment opportunities and firm size. Leverage will decrease with volatility, advertising

expenditure, and the probability of bankruptcy, profitability and uniqueness of the product. Moh'd, Perry, andRimbey (1998) employed an extensive time-series and cross-sectional analysis to analyse the impact of agencycosts and ownership concentration on the capital structure of the firm. Results indicated that the distribution of

equity ownership is important in explaining overall capital structure and that is the reason why managers willreduce the level of debt as their own wealth is increasingly tied-to the firm5.

In more recent articles, it seemed that financial decisions in the developing countries were somehowdifferent (Mayer, 1990

6). The first empirical studies in the area of capital structure take into consideration the case

of developed economies and less of them used cross-country comparisons to test theories of corporate financialleverage. Rajan and Zingales (1995) is a notable exception in this area. Booth, Aivazian, Demirguc-Kunt, andMaksimovic (2001) took tax rate, business risk, asset tangibility, firm size, profitability, and market-to-book ratioas determinants of capital structure across ten developing countries. They found that long-term debt ratiosdecreased with higher tax rates, size, and profitability, but increased with tangibility of assets. Again the influence

of the market-to-book ratio and the business-risk variables tended to be subsumed within the country dummies.

The overall importance and signs of the coefficients for size, tangibility and profitability are similar to those inRajan and Zingales (1995), except that the evidence in favour of a negative relation between profitability andleverage is much stronger. The business risk proxy continues to have the same mixed effect. They also observethat some institutional factors in developing countries influence the leverage of large and small firms differently.Several recent studies in the field have indicated that even among developed economies like the US and European

countries, the financing policies and managers behaviour are influenced by the institutional environment andinternational operations (see, for example, Graham and Harvey, 2001 for US firms; Bancel and Mittoo, 2004for

large European publicly listed firms; and Brounen et al., 2006 in four European countries: the UK, theNetherlands, Germany and France).

Numerous studies identified two categories of capital structure determinants: firm-specific factors such ascollateral value of assets, size and risk of the companies, their growth opportunities, profitability or nondebt tax

5

Pao, H.T., Pikas, B., Lee, T., 2003, The determinants of capital structure choice using linear models: hightechnology vs. traditional corporations, Journal of the Academy of Business and Economics.6

Mayer, C., 1990, Financial Systems, Corporate Finance and Economic Development, in G. Hubbard (ed.),Asymmetric Information, Corporate Finance and Investment. Chicago: The University of Chicago Press.


4/20

4

shield and country-specific factors among which economic development, banking sector and financial markets. Amilestone in the study of firm- and country-specific determinants of capital structure can be considered the articleof de Jong, Kabir and Nguyen (2008) demonstrating that financial structure of companies is influenced by firm-and country-specific determinants, but the latter ones have both a direct and indirect effect. The indirect effect ismeasured by their significance as determinants of the coefficients of firm-specific factors in the regression. This

result is extremely important to understand the differences between different countries in term of financialstructures of the companies, but it also limit the use of pool data analysis for explaining the capital structure.

The majority of previous empirical works analyse the capital structure of firms in economies with highlydeveloped stock markets7. Others studies take into consideration firms that are listed on non-developed stockmarkets

8. The following papers analyse the determinants of capital structure of the most representative firms from

developing economies, taking into account that they have severe constrains to access stock market for funding andthe access to information is, in general, only available for this elite of firms listed on the stock market. For thisreason the empirical evidence faces to a trade-off between availability of information and accuracy of the sample.

The study of Munyo (2004) analyzes the determinants of the sources of funding for the firms from Uruguaythrough cross section econometric models. The analysis casts out that size, tangibility and profitability are

influencing variables for the financial structure. The less profitable firms are those mainly financed throughexternal funding. The firms with a bigger proportion of tangible assets have easier access to long-term bankingcredit. On the other hand, the firms which do not possess these features or the ones which present a smallerrelative proportion of this type of assets will tend to be financed through trade credit lines. Comparing to previousresults for Uruguay, in Bentancors work (1999) it was not found any statistic significance regarding the influence

of size. Guimaraes and de Castro (2003), through the analysis of small and mid-size Brazilian companies, showthat size is directly associated with leverage level. The same relationship is observed in Huang and Song (2002)

for Chinese firms9.

Deesomsak, Paudyal and Pescetto (2004) consider a range of companies in four countries of Asia Pacificregion, Thailand, Malaysia, Singapore and Australia and using cross-country analysis demonstrates that firm-specific characteristics (firm size, growth opportunities, non-debt tax shield, liquidity, share price performance)influence the capital structure of companies, but country-specific factors (stock market activity and the level ofinterest rates) are also extremely important. Furthermore, the idea of an indirect influence of the country factors by

the firm-specific ones on the leverage is also advanced.Delcoure (2007) analyses the determinants of capital structure in transitional economies (Poland, Russian

federation, Czech Republic and Slovakia). She founds out that companies are mainly equity capital financed, andbanks provide short-term debt rather than long-term resources. Size, assets tangibility, tax rate and non-debt taxshield have a positive influence on the leverage, while profitability has a significant negative influence. Hence, the

determinants of financial structure in transitional economies are the same as in the developed ones, the mainpattern applying for transitional economy being the new modified pecking order theory retained earnings, equitycapital, short-term debt, long-term debt. Chen (2004) analyses the determinants of capital structure of Chinese

listed companies on the basis of a panel data and shows that the capital structure choice accords to the newmodified pecking order theory. Huang and Song (2006) analyses the capital structure determinants for Chinese

listed companies and notices that they tend to have much lower long-term debt that in other developing countries.Nevertheless, size and fixed assets have a positive influence on the leverage, profitability, non-debt tax shield,growth opportunities and managerial shareholdings have a negative influence on leverage, which also correlateswith industries and is influenced by taxation. Wu and Yue (2008) analyse a particular circumstance resulting in theincrease of corporate tax rate of Chinese firms that had previously received local government tax reimbursementand demonstrate that in such a circumstance the companies increased their leverage in order to benefit from fiscalsavings, although the Chinese companies are known to have very low leverages. Analysing the debt-maturity of

Chinese companies, Cai, Fairchild and Guney (2008) demonstrate that size, assets maturity, liquidity, amount of

collateralized assets and growth opportunities are important in determining the extension of debt maturity, whilefirms quality and effective tax rate report mixed results. Finally, debt and equity market conditions and equityownership structure also influence debt maturity. Fattouh, Scaramozzino and Harris (2005) analyse the capitalstructure on South Korean companies through a quintile regression approach and find out that variables associatedto asymmetric information costs are significant in explaining the leverage, but their influence is different

depending on the quintile in which the company is included.In the following section we will make a short presentation of the Romanian characteristics with regard to

credit market and capital one in order to have a better understanding of the Romanian transitional economy.

7Such Gupta (1969), Nadiri (1969), Herbst (1974), Taub, J. (1975), Titman and Wessels (1988), MacKie-Mason

(1989), Barclay and Smith (1995), Cantillo and Wright (1995), Rajan and Zingales (1995), Peterson andRajan(1997), Caprio and Demirg-Kunt (1998), Bevan and Danbolt (2000), Chen and Jiang (2001), Fisman and

Love (2001), Denis and Mihov (2002), Mateut and Mizen (2002).8 Such Singh and Hamid (1992), Schiantarelli and Srivastava (1996), Bentancor (1999), Booth et al. (2001), Finotti

and Fama (2001), Prasad et al. (2001), Green et al. (2002), Huang and Song (2006).9 Dragot, M., 2008, op.cit.


5/20

5

3. Some characteristics of credit and capital markets in Romania

Since the Anti-Communist Revolutions, from the end of XX Century, the East European emergentmarkets are in a transition process to a functional market economy. Even through most of these countries became

members of European Union, the financial markets regulation still remain a main issue for the capital marketsdevelopment. Traditionally, according to the classical work of Coase (1960) and Stigler (1964), the optimal

government policy is to leave securities markets unregulated. From this point of view, issuers have an incentive todisclose all available information in order to obtain higher issuing prices, simply because failure to disclose wouldcause investors to assume the worst (see also Grossman and Stiglitz, 1980; Grossman, 1981; Milgrom andRoberts, 1986). More recently, the alternative hypothesis - that regulation really matters was accepted by themost part of the specialists10.

Historically, in December 1989, the moment of Romanian anti-communist revolution, individuals were

not familiar with market economy mechanisms, due to more than seventy years of command economy. Thus,before the Second World War, Romania was under a royal (1938-1940) and, after that, a fascist (1940-1941)

dictatorship. Between 1941 and 1945, Romania fought in the Second World War, and beginning with 1945 wasunder the influence of the Union of Soviet Socialist Republics. During this period the information related toanything that was in association to the market economy doctrine was practically unavailable for the most part ofRomanian population. Moreover, even after 1989, the mechanisms of market economy were not enforced sosoon11.

In the last 10 years, the Romanian credit market was characterised by high interest rates and relativerestrictive conditions. As an example, we present the evolution of interest rate on the period 2003-2007, based onthe Romanian Central Bank monthly bulletin (December 2007).

Source: Romanian Central Bank monthly bulletin, December 2007

The credit was inaccessible for many Romanian firms or was considered only in a small proportion assource of financing. The proportion of the credits varied between 8.52% and 18.93% of GDP between the period1997 and 2007. The companies accessed mainly short-term credits as data from the Table no.1 suggest.

Table no.1The importance of credit market in the Romanian economy (%)

10 Dragot, V. et al., 2008, Minority Shareholders Protection in Romania: Does Regulation Have an Impact onthe Development of Capital Market?, the 42nd Conference of Euro Working Group of Financial Modelling,Stockholm University School of Business, 15-17 May.11

Romania has a different situation comparatively to the other European Communist Countries and maybe similaronly to Bulgaria. For instance, in Poland, the pressure of labour unions revealed the interest of the people for thevalues of democracy. The East Germany was, somehow, for cultural reasons, close to the market economydoctrine due to the West German influence. Yugoslavia benefits from a certain amount of capitalist issues. Albaniachose a particular type of communism, oriented to isolationism, which created a totally different state of affairs. In

these circumstances, for Europe, Romania may be the best study case about the relevance of the regulations on thecapital market development. Hence, from a scientific point of view, this study benefits from the advantage that

there are not initial perturbing factors of influence that can affect the relevance of the analysis (Dragot , V. et al.,2008).


6/20

6

Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Credits forfirms/PIB 13,41% 14,69% 9,75% 8,52% 9,15% 9,88% 10,57% 10,94% 12,37% 14,28% 18,93%

Short term

credits forfirms/PIB 7,53% 8,42% 6,75% 6,32% 6,76% 7,19% 6,79% 6,37% 6,89% 8,47% 9,05%

Long term

credits forfirms/PIB 5,88% 6,28% 3,00% 2,20% 2,39% 2,69% 3,78% 4,58% 5,48% 5,81% 9,88%

Source: www.insse.ro

Hence, the conditions and the cost of the credits are restrictive especially for small companies, but theycould affect also the financing decision for the listed ones, too. Moreover, as Delcoure (2007) suggested, in atransition economy the companies realize a quasi-free financing by equity, which determines them to adopt amodified pecking-order theory retained earnings, equity, short term financing, long term financing.

Historically, the stock market exchange activity in Romania began in 1839 and during its existence, thestock markets activity was influenced by the socio-political events of the time, being even closed during the FirstWorld War. The activity of the stock market is interrupted in 1948 following the nationalization. At the moment ofits closing, there were listed shares of 93 companies and 77 fix income assets (bonds) (www.kmarket.ro). Afteralmost 50 years of break, BSE was reopened at November 20th 1995. Presently, it offers the possibility to invest in

equity securities (shares and allocation rights), debt securities (municipal bonds, corporate bonds and, soon, Statebonds), securities issued by mutual funds (shares and fund units) and futures contracts. Shares, rights andcorporate bonds are traded in three tiers, depending on how they fulfil the NSC requirements.

The year 2002 brought changes for the capital market regulations. Among the effects of the newregulations we can mention: rising the standards of transparency, investors protection, improving the activity ofthe market intermediaries and the growth of the market activity. The change of investors perception made thecapital market a viable alternative to place money, 2002 being a year of growths both in quotations and in indexes(BET, BET-C and BET-FI), considered the highest increase among the first 57 largest stock exchanges all overthe world (www.bvb.ro). The year 2005 represented a new international recognition for the BSE as, together with

the Vienna Stock Exchange Market, it launched the ROTX index, built according to the principles of the IndexFamily of Central Europe. For this period, may be mentioned: a successful bond issue of the European InvestmentBank, the futures on gold at the Sibiu Monetary Financial and Commodities Exchange and the transactionplatform for derivatives at BSE

12. The Romanian capital market is still a developing one, its importance as

instrument of financial resources allocation being smaller than that of the credit market (see data from the tablebelow).

Table no. 2The importance of capital market in the Romanian economy

Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Capitalization/GDP 2.00% 1.05% 1.05% 1.33% 3.30% 6.05% 6.17% 13.85% 19.46% 21.42% 24.18%

Turnover/GDP 0.77% 0.49% 0.25% 0.23% 0.33% 0.47% 0.51% 0.98% 2.71% 2.89% 3.88%

Source: www.bvb.ro

Modigliani and Perotti (1997) consider that the essential conditions for capital market development are:(i) the existence of proper legislation, (ii) the appropriate enforcement of the law and (iii) the guarantee of free

trade. Romania, having a small capital market, may be included in the class of countries with low protection ofminority shareholders. In this context, Dragot et al. (2007) estimated a control premium for Romanian listed

shares in the period 2002-2004, with a median of 44.62% and an average of 82.44%. The seminal literaturedealing with the protection of the minority shareholders in ex communist countries is represented by Pistor, Raiserand Gelfer (2000) and Pajuste (2002). In Romania, companies with major shareholders owning a large percentageof the capital set dividend ratios lower than the others (Dragot, 2006). The average stake owned by the largershareholder is very large (the average first shareholder control percentage is 53%, and for the second is 16.6%).

Also, the control premium for the companies listed on the Romanian capital market is higher than the worldaverage (Dragot et al., 2007). The study of Dragot V. et al. (2007) for the period 1996-2007 revealed, regardingthe minority shareholders protection in Romania, that this index improves from 13 (January 1996) to 17.25 (March2008) which was proved to have a positive influence on capital market development.

Generally, the development of any capital market, but especially for Romania, as a transitional economydepends on a lot of variables, one of them being the investors behaviour when they choose their investments onthe capital market, in banks, in the insurance policies etc. Most of the classic models in finance take intoconsideration the hypothesis that investors are rational and risk adverse. Recent studies proved that investors have

a tendency to be more likely irrational. In that sense, modern theories were developed, such as behavioural

12 Dragot, V., et al. (2008).


7/20

7

finance, looking for the correct answer to the question if the investors are truly risk adverse or rational when theychoose their investments. International studies made in this area revealed that investors tend to allocate in a wrongmanner their capital. Individual investors tend to accept a great probability of a small lose (as for a lottery game)instead of small probability for a big lose caused, for example, from equity investment, despite the big returns inthe future13.

A research made in the year 2000 by a specialised institute before one of the big crises on the Romaniancapital market (the bankruptcy of one of the most important mutual fond at that time, National Investment Fund)

brought into light the fact that, from 3.76 millions of households, only 376.000 of them had a monthly incomegreater than 6 millions RON (approximately 220 euros at that time). Only 20% of them had usual savings, 62%had sporadic savings and 18% had no savings. Among those who had regular savings, 25% from their income wasassigned for investment in commercial banks (51%) in insurance policies (38%), currency investments (17%) andthe rest in other investments. At that time, only 16% of the households from the sample had intended to invest instocks. Moreover, only 9% from the sample usual brought up to date, 52% followed occasionally the information

from the Stock Exchange and 39% never kept informed. Investments in stocks on capital market had a greatpotential, only in part actually used, due to the lack of information and transparency and for macroeconomic

reasons (poverty, unstable financial environment, great inflation rate etc.).Another interesting aspect revealed by this survey was the reasons why the interviewed persons made the

choice for one stock or another: based on the firms reputation, maybe the geographical location and onlyresidually the performances of the shares on the capital market.

A more recent study realised by Pun, Braoveanu and Muetescu (2007) provides evidence about

absolute risk aversion on the Romanian capital market, using the formula of risk aversion used previously byKihlstrom (1981), Pratt and Zeckhauser (1987), Kimball (1993), Gollier and Pratt (1996)14. The empiricalevidence indicates a decreasing risk aversion from a level of 92.1 in the year 2004, to 20.9 in the year 2007 (for thefirst 6 month) (see Table no.3). This evolution could be explained by a higher efficiency of this market (especiallyat institutional and regulatory level), a higher experience of the Romanian investors and increasing investmentopportunities, an increase in the income level that generated a higher interest for risky assets and a differentattitude towards risks.

Table no. 3

Absolute risk aversion of the Romanian investors (2004 2007)15

Year Absolute Risk Aversion (ARA)

2004 92.1

2005 79.3

2006 25.5

2007 (6 month) 20.9

4. The capital structure analysis for the Romanian listed companies

Rajan and Zingales (1995) used five alternative definitions for leverage. Subsequent studies accepted,

totally or partially, this approach, for developed or developing economies (Wald, (1999), Booth et al. (2001),Drobetz and Fix (2003), Ferri and Jones (1979), Munyo (2004), Devic and Krstic (2001); Deesomsak et al. (2004)etc.).

Rajan and Zingales (1995) for the G-7 countries revealed a certain variability of the results depending onthe leverage measurement; there were differences according to the use of the short time leverage or of the longtime leverage. Taking into account the relevant literature, but also the available data, we used as proxy forfinancial structure three variables to measure leverage: (1) total debt/total assets; (2) long term debt/ total assets;

(3) commercial debt/total assets. The first measure was also used by Rajan and Zingales (1995), Deesomsak et al.(2004), Wald (1999), Chui, Lloyd and Kwok (2002), Delcoure (2007), McKnight and Weir (2008) etc..

It can be mentioned that the alternative measures, such asEquity

debtTotal_ , can be easily derived from the

first measure (see Rajan and Zingales (1995), Chen, Lensink and Sterken (1998), Devic and Krstic (2001),

Driffield, Mahambare and Pal (2005), etc.).

13 Dancy J., 2001, Are most individuals too risk averse as investors?, Market Noise (www.markets-

noize.com).14 Pun C., Braoveanu, I., Muetescu, R, Absolute risk aversion on the Romanian capital market, Romanian

Journal of Forecasting, no. 4, pp. 77-87.15 Pun et al., 2007.


8/20

8

Measures such asassetsTotal

debttermLong

_

__ were used by Titman and Wessels (1988), Demirguc-Kunt and

Maksimovic (1999), Booth et al. (2001), Devic and Krstic (2001), Wald (1999), Delcoure (2007), De Jong, Kabir

and Nguyen (2008) etc.), orassetsTotal

debtCommercial

_

_ (Titman and Wessels's (1988)) were analysed in this section, too.

All three variables were measured to be used in the regression model both in book and market values,by using market capitalization instead of book equity.

The following analysis was based on median values for three variables (in book values):

1. equity/total assets (E/AT);2. financial debt (with interest expenses associated)/total assets (DFIN/AT);3. commercial debt/total assets (DCOM/AT).

The sample contained companies listed on Bucharest Stock Exchange for the period 1997-2007. Thenumber of firms considered in the database was different from one year to another, because of the aspects we dealtwith in applying the working principles financial, accounting and statistics characterizing the testing methods

applied (see Table no. 4).Firstly, all the companies included in the category banks and financial services were eliminated

(according to the classification in the monthly bulletins of the BSE) because of the specific regulation regardingtheir activity, the leverage of these companies being strongly influenced by exogenous factors, and we focusedexclusively on the companies considered non-financial. Secondly, we eliminated the companies for which we

didnt have enough information to perform the study rigorously. All the information was obtained from thefollowing sources:

the internet sites providing stock exchange information such as www.bvb.ro and www.kmarket.ro, formarket capitalization of the companies listed on BSE (number of shares, moments when the modifications of

equity took place, mergers etc.), but also to get a part of the financial and accounting information necessary(balance sheets, incomes and expenses account for the years 2000 and 2001);

the database provided by Reuters Press Agency regarding the market prices of the companies from thesample to determine the market capitalizations;

the financial and accounting information obtained from the site of the Romanian Ministry of Finance.The median values, for the period 1997-2007 are presented below.

Table no. 4Total assets financing for the Romanian listed companies for the period 1997-2007

The most important conclusion is that the main financial resources for the Romanian listed companies,

remain the equity. These data sustain the pecking order theory, their own resources being the most importantfinancial resource in the capital structure architecture

16. Other argument for this first conclusion is the result which

revealed that over 45% of the Romanian listed firms didnt make any equity issue, through capital market and,until the beginning of 2006, only two companies made public offerings from the moment of their listing.

These results are consistent with Booth et al. (2001)17 study for 10 developing countries. This studyrevealed that, without the South Korea case (considered the most developed country from all the ten countriesanalyzed), all had less leverage (both in market and in book value) than the median values for the G-7 countries

16

Dragot, M., Semenescu, A., 2008, A Dynamic Analysis of Capital Structure Determinants Empirical Resultsfor Romanian Capital Market, Theoretical and Applied Economics Journal, no.4 (521).17

Booth, L., Aivazian, V., Demirguc Kunt, A., Maksimovic, V., 2001, Capital Structures in DevelopingCountries,Journal of Finance, vol.LVI, no.1.

MEDIAN VALUESYEAR Number offirms in the

sample

E/AT DFIN/AT DCOM/AT TOTAL DEBT

1997 22 60,79% 0,44% 13,90% 14,34%

1998 49 69,93% 6,24% 22,46% 28,70%

1999 53 59,70% 7,51% 24,64% 32,15%

2000 52 60,84% 5,00% 25,60% 30,60%

2001 52 66,81% 2,96% 22,14% 25,10%

2002 53 60,87% 7,25% 22,26% 29,51%

2003 53 67,96% 7,54% 18,82% 29,36%

2004 35 63,16% 1,91% 28,81% 36,84%

2005 36 69,93% 2,25% 27,79% 30,07%

2006 43 60,50% 6,09% 31,00% 37,09%2007 45 63,40% 5,67% 30,47% 36,14%s


9/20

9

considered in the study of Rajan and Zingales (1995). Moreover, the study underlined the fact that the differencesbetween total debt and long term debt were more important in the developing countries than in the developed ones.The developing countries had medium and long term leverage much lower than the developed ones.

The Romanian firms prefer private financing instead of the public one and we could find al least twopossible explanations for this trend:

The Romanian capital market remains an emergent one, insufficiently developed to support theinvestment project financing. The most important role of this market is still the speculative one, to have

high capital gains in short time, if it is possible; The ownership structure for the most part of the Romanian listed companies reflects the presence of

significant shareholders, and they are not very interested in supporting the investments by equity issue. Ifthey must choose an external source of financing, the bank loans are, in many cases, preffered.Dragot V. (2005) identified this trend for the Romanian listed firms: as long as these companies had

significant shareholders, the dividend ratio had low values, even if the same study stated that Romania made

important steps for the minority shareholder protection. According to La Porta, Lopez-de-Silanes, Shleifer andVishny (1998) index, Romania had a level of 2.75. The author appreciated that the investors education is very

important in the sense of knowing their rights and their interest in their protection.The Romanian companies adopt external financial support only in a proportion varying between 14%-

37%, and the most important sources are bank and commercial loans, because the bond market is insufficientlydeveloped18. Since financial debt had interest expenses associated, and the fiscal argument could influence thecompanies capital structure decision, it is appropriate to analyse the fiscal changes for this period:

On the 1st

of January 1997, the total deductibility for interest expenses was adopted. Until this moment,the regulation permitted only limited interest expenses deductibility

19. This change in fiscal regulations

did not appear to influence the level of debt, only if the analysis was made with 1 lag, since in 1998 theproportion of financial debt in total assets had risen significantly;

Starting with the year 2002, the fiscal regulations reintroduced the limited deductibility for theseexpenses, taking into consideration the level for leverage20: more or less 100%:

Leverage =

10

10

EquityEquity

DebtDebt

+

+

( )

>+

dragota m and semenescu a article for finance india

Documents