Financial Economics has made significant progress in asset management, the coordination between firms cash inflows with cash outflows by matching the maturity of income generated by assets with the maturity of interest incurring debts. People now little about the maturity structure of firm’s assets and liabilities, because willingly obtainable and thorough information regarding a firm’s liabilities and liabilities like commitment were not easy and time overwhelming to gather in our country, while many papers had explained how imbalances in the maturity period of asset and liability structure could be the main reason of currency and financial crises in the emerging markets, the factors that create such imbalances in the first place have established comparatively little attention so far. The agency costs can be reduced if firms issue short-term debt and, thus, are evaluated periodically. Information asymmetry and conflict between shareholders and debt holders can be intensified in transition economies for three reasons: (i) lack of shareholder and creditor protection owing to the imperfect legal system; (ii) the high level of uncertainty enables firms with overdue debt to switch to high-risk assets, which increases flotation and/or transaction costs; and (iii) the ownership structure of companies in emerging markets creates potentially higher agency costs because managers dominate the board of directors and have comparatively greater control rights (Harvey, Lins and Roper (2004). Smith and Warner (1979) argue that riskier and smaller companies have higher agency related costs because managers of small companies have mutual interests with the shareholders since they are holding a larger proportion of the equity. The managers are interested in increasing the equity value even if doing so reduces the firm’s total value, behavior that obviously conflicts with the creditors’ objectives. The objective of this study was to contribute and filling the gap of maturity mismatch between firm’s assets and liabilities, and firms can employ to reduce agency costs is to match the duration of assets and liabilities. Study showed theoretically how mismatch may lead to and exacerbate maturity mismatch due to market uncertainty, and how maturity mismatch increased output instability on the non/financial firms. Second, research provided empirical results that support the predictions that firm’s debt maturity was positively related to maturity of its assets to test this prediction the study made the model which depended on the following variable like debt maturity ratio, asset maturity ratio, market to book value ratio, and firm size. A common recommendation was that a firm would compare the maturity period of its assets to that of its long term liabilities. If long term liabilities had less maturity period with respect to assets, then there may not be sufficient cash on hand to pay back the principal when it was outstanding. On the other hand, if debt has a greater maturity period with respect to assets, then cash flows from assets come to an end, whereas debt expenses stay outstanding. Maturity matching could lessen these risks and then structure of corporate hedging that decreases predictable expenditure of financial distress. In a related element, Myers (1977) dispute that maturity matching could control agency conflicts between equity holders and debt holders by ensuring that debt reimbursements were planned to communicate with the reduction in the worth of assets. In a model of this fact, Chang (1989) revealed that maturity matching can reduce organization expenditure of debt financing. Hoven and Mauer (1996) study also reveals well-built support for the standard textbook recommendations that firms should compare the maturity period of their assets to that of their liabilities. Research investigation specified that asset maturity was an important aspect in explaining distinction in debt maturity structure. The sample of firms were taken from non/financial firms listed on the Kse-100 index and their financial data consisting from year 2004 to 2008 and those firms were used to analyze the distinctive financial characteristics. The reasons for choosing non-financial firms because it played significant role in the economy of our country and the measurement of maturity matching of assets and liabilities and reduction in agency cost would help these firms to avoid risks like liquidation and changing in interest rates. For example, if the duration of the maturity of assets was larger than the maturity period of its liabilities, then the maturity structure was at risk to growing interest rates. This was because the higher maturity period assets were more responsive to interest rates than the lower maturity period liabilities. If interest rates go up then the assets were turned down in value more rapidly than the liabilities were. If interest rates remain constant, there may be a deficit in supporting the liabilities. One way to diminish this problem was to rebalance the assets such that the maturity period of the assets were equal to the maturity period of the liabilities, then any interest rate modify has a minor outcome. If in the above case, the asset maturity period was too high, the maturity period must be shortened. This short fall may be achieved by either rebalancing the structure with shorter maturity period assets or by shorting longer maturity period assets, and if the firm’s debts and debt like obligations are larger then its assets in amount then this mismatch between the maturity period of assets and liabilities can lead it towards liquidation so to keep away from that liquidation the firms should keep up matching between the amount of its assets and liabilities, and companies that have a greater reliance on external finance face a comparatively weaker agency problem. De Haas and Peeters (2006) agency cost issue can be alleviated by the higher variability of firm value, which can interfere with the firm’s ability to payoff its obligations. This was a key pattern of the advantage that Non-Financial firms listed on KSE-100 Index can acquire from this study by matching the maturity period of its assets to that of its debts and by reducing the agency cost problem.
1.2 Statement of Problem
The objective of my study is to contribute to filling the gap of maturity mismatch between firm’s assets and liabilities, and the importance of agency cost, which shows theoretically how mismatch may lead to and exacerbate maturity mismatch due to market uncertainty, and how maturity mismatch increases output instability in the Non-Financial firms listed on KSE-100 Index. The purpose of the study is to notice whether the debt maturity structure described by Shah and khan (2005); Myers (1977); Titman (1992); Diamond (1991); Barnea, Haugen, and Senbet (1980); Jalilvand and Harris, (1984); Ozkan, 2000, Yi, 2005 and Whited, (1992); Warner (1979); Hoven and Mauer (1996); Barclay and Smith (1995); Barnea, Haugen, and Senbet (1980, 1985); and Hart and Moore (1995) present the detail regarding the debt maturity structure. The scope of study is to analyze the maturity matching structure between firm’s assets and liabilities, and agency cost problem. 1.3 Hypotheses H0: There is a positive relationship between Debt maturity and asset maturity. H1: There is a positive relationship between Debt maturity and Firm Size. H2: There is an inverse relationship between Debt maturity and Market to Book Ratio.
1.4 Outline of the Study
The outline of the study processed as follows. Chapter one based on the introduction of the thesis, which consists of the some introduction of debt maturity structure by different researchers, the statement of problem, scope and objectives hypothesis etc. Chapter two consists of literature review given by different researchers, theories on debt maturity structure, and factors affecting the debt maturity structure. In chapter three, research methods were described, which contained method of data collection, sampling technique, sample size, research model developed, and statistical technique. Chapter four consists on the findings and interpretation of the results which were taken after the data collection process. Chapter five contained the conclusion, discussions, implications, recommendations, and future research.
The literature included two types of theories about the debt maturity structure: agency cost theory, and maturity matching theory.
2.1 Agency Cost Theory
Myers (1977) discussed that risky debt financing caused low investment benefits when a firm’s investment had chances to look for growth option. Financial Analysts worked to represent equity holders failed to accomplish profitable investment options because risky debt control a part of equity holders’ incentive in the form of a decrease in the probability of default. Myers represented that low investment benefits can be assured by providing short-term debt to mature before the growth options utilized. The hypothesis was that the firm’s assets had a greater ratio of growth options were used shorter-term debt. Titman (1992) presented that if growing firms have both the greater chances of bankruptcy and positive future-outlook then got incentive from borrowing short-term debt and going for a constant-rate contract. Briefly, there was an acceptance in the literature that growth (market-to-book ratio of assets) should be inversely correlated to debt maturity in the agency/contracting costs perspective. Williamson (1988) firms with more tangible assets should find asset substitution (risk shifting) more difficult, which lowers debt agency costs and thus raises optimal leverage. Hart and Moore (1995) defined the role of long-term debt in controlling management’s capability in increasing funds for future projects. It was analyzed that long-term debt may restrict self-interested managers from financing non-profitable investments entails a direct variation of long-term debt with market-to-book ratio. Therefore, the relationship between growth options and debt maturity structure had an experimental issue. Diamond (1991) focused on the relationship between debt maturity and the credit value of a firm. Diamond defined liquidity risk as the risk that a debtor will lose control rents because creditors do not want to refinance, and therefore choose to liquidate the firm. Because short-term debt was seen by Diamond as being debt that matures before the profits of an investment were received, it was necessary to refinance short-term debt. For firms with high credit worthiness, the liquidity risk was not relevant. A decreased in credit worthiness did not lead to a ‘crunch’ of credit to the firm. For this reason, firms with a high credit rating were expected to borrow on the short term. For firms with a medium credit rating, the liquidity risk can be of importance. Firms with a low credit rating also interested to borrow on the long term. Firms with a low credit rating were therefore forced to borrow on the short term. Firms with comparatively greater ratio of future investment opportunities tend to be littler. Barnea, Haugen, and Senbet (1980) found that organization conflicts, similar to Myers’s (1977) underinvestment problem, could be restrained by reducing the maturity of debt. Therefore, smaller firms which faced additional harsh agency conflicts than larger well-maintained firms may use shorter-term debt to mitigate these conflicts. In most cases, the issuing costs of a public debt issue were fixed, and these costs were therefore self-determining of the size of the debt. Because public debt has a longer maturity than private debt, a positive relation between the size of a firm and the maturity of debt was proposed. However, those reasoning did not apply to small unlisted firms, because these firms make very little use of public debt. The present study also included leverage and industry affiliation as determinants of debt maturity. Arguably, larger firms have lower asymmetric information and agency problems, higher tangible assets relative to future investment opportunities, and thus, easier access to long-term debt markets. The reasons why small firms were forced to use short-term debt include higher failure rates and the lack of economies of scale in raising long-term public debt. It was further argued that larger firms tend to use more long-term debt due to firms remaining financial needs (Jalilvand and Harris, 1984). Agency problems (risk shifting, claim dilution) between shareholders and lenders may be particularly severe for small firms. Then, bondholders attempt to control the risk of lending to small firms by restricting the length of debt maturity. Large (small) firms, thus expected to had more long (short)-term debt in capital structure. Consequently, these arguments imply a positive relationship between firm size and debt maturity. It was widely accepted by the current literature that larger firms have lower agency costs of the debt (Ozkan, 2000, Yi, 2005 and Whited, 1992), because these larger firms were believed to have an easier access to capital markets (firms can more easily overcome the transaction costs) and a stronger negotiation power (firms have a stronger position in the debt negotiation than smaller firms). Hence both these arguments favor larger firms for issuing more long-term debt compared to smaller firms. In addition to it Smith and Warner (1979) argued that smaller firms were more likely to face higher agency costs in terms of a conflict of the interest between shareholders and debt holders. Hoven and Mauer (1996) found out only little evidence for the agency cost aspect that debt maturity used to restrict the conflicts of interest between share holders and debt holders. Although smaller firms in the sample lead to used short term debt, findings also suggested that firms with big amounts of growth options have small leverage, and hence small to moderate incentive of debt maturity structure to reduce the conflicts of interest above the utilization of those options. Barclay and Smith (1995 ) test of the determinants of corporate debt maturity accepted the hypothesis that firms with greater growth choices in investment opportunity sets issued large amount of short-term debt. Study also found that firms issue large amount of long-term debt. The findings were robust to surrogate measures of the investment opportunity set. Technique as well propose to growth options in the firm’s investment opportunities be key in discussing both the time-series and cross-sectional fluctuation in the firm’s maturity structure. Study also supported strong relationship among firm size and debt maturity: superior firms issue a considerably bigger proportion of long-term debt. This was uniformed with the observance that small firms dependent more heavily on bank debt that traditionally had shorter maturity than public debt. Smaller firms had large growth options, which were indicating to employ shorter-term debt to reduce the agency conflicts; these indications assume debt as uncertain. Though, the capital structure theory suggested that these firms employ moderate amounts of leverage to mitigate the risk of financial loss. As such, firms with low leverage and low chances of financial loss would likely be unbiased to employ debt maturity structure to restrict agency conflicts, all other matters remain constant. Agency cost theory also proposed that smaller to medium size firms have relatively higher agency costs because the possible divergence of risk shifting and reducing the concentration between equity holders and managers (Smith and Warner, 1979). To overcome the issue and to control the agency cost short-term debts were recommended Barnea, Haugen, and Senbet (1980, 1985). The large constant flotation cost of constant securities comparative to the small size of the firm had an additional barrier that stops all small firms’ access to the capital market. Smith (1986) argues that managers of regulated firms have less discretion over investment decisions, which reduces debt agency costs and increases optimal leverage. Shah and khan (2005) evidenced the blended support for the agency cost, Study findings showed that smaller firms employ more shorter term debt then longer term debt; even there was no evidence that growing firms employ more of short-term debt as assumed by (Myers, 1977) that debt maturity varies inversely to proxies for firm’s growth options in investment opportunities, The implication of firm size variable also verify the information asymmetry hypothesis, established it costly to access capital market for long term liabilities.
2.2 Maturity Matching Theory
A frequent recommendation in the literature discussed that a firm should go with the maturity structure of its assets to that of its debt. Maturity matching can concentrate these threats and thus a structure of corporate hedging that decreased projected expenses of financial suffering. In a related element, Myers (1977) explained that maturity matching could control agency conflicts between equity holders and debt holders by ensuring that debt repayments had planned to match up with the decrease in the worth of assets in place. At the closing stages of an asset’s life, the firm encountered a reinvestment judgment. Concerning to debt that matures at that time assists to restore the suitable investment benefits as soon as new investments were needed. Though, this analysis specifies that the maturity of a firm’s assets did not the only determinant of its debt maturity. Its growth options play a vital role as well. Chang (1989) revealed that maturity matching could reduce organization expenses of debt financing. Stohs and Maurer (1996) and Morris (1976) argued that a firm can face risk of not having sufficient cash in case the maturity of the debt had shorter than the maturity of the assets or even vice versa in case the maturity of the debt was greater than asset maturity (the cash flow from assets necessary for the debt repayment terminates). Following these arguments, the maturity matching principle belongs to the determinants of the corporate debt maturity structure. Emery (2001) argued that firms avoid the term premium by matching the maturity of firm’s liabilities and assets. Hart and Moore (1994) confirmed matching principle by showing that slower asset depreciation means longer debt maturity. Therefore, this study expected a positive relationship between debt maturity and asset maturity. Gapenski (1999) differentiated two strategies of maturity matching namely the accounting and financing approach. The accounting approach considers the assets as current and fixed ones and calls for the financing of the current assets by short-term liabilities and of the fixed assets by long-term liabilities and equity. The financing approach considers the assets as permanent and temporary. In these terms the fixed assets were definitely permanent ones and some stable part of the fluctuating current assets was also taken as permanent. This approach then suggests financing the permanent assets by long-term funds (long-term liabilities and equity) and temporary assets by short-term liabilities. Consequently, the financing approach generally employs ceteris paribus more long-term liabilities than the accounting approach does. Firms also consider asset maturity as an essential determinant of the debt structure. In contrast, companies that have a greater reliance on external finance face a comparatively weaker agency problem. The related agency costs are lower because the higher income variability of these firms erodes their capacity to cover their interest and credit payments. Hoven and Mauer (1996) come across with well-built support for the regular textbook recommendations that firms should compare the maturity period of firm’s liabilities to that of firm’s assets. Study results were indicating asset maturity a key aspect in discussing instability in debt maturity structure. Shah and khan (2005) found unambiguous support for maturity matching hypothesis. Study findings reveal that the fixed assets vary directly with debt maturity structure. Myers (1977) argues that maturity matching of firm assets and liabilities can also partially serve as a tool for mitigation of the underinvestment problem, which was discussed in the agency costs theory section. Here the maturity matching principle ensures that the debt repayments should be due according to the decrease of the asset worth. Comparing maturities as an effort to list debt repayments to match up with the decrease in expected worth of assets now in place. Gapenski (1999) differentiates two strategies of maturity matching namely the accounting and financing approach. The accounting approach considers the assets as current and fixed ones and calls for the financing of the current assets by short-term liabilities and of the fixed assets by long-term liabilities and equity. The financing approach considers the assets as permanent and temporary. In these terms the fixed assets are definitely permanent ones and some stable part of the fluctuating current assets is also taken as permanent. This approach then suggests financing the permanent assets by long-term funds (long-term liabilities and equity) and temporary assets by short-term liabilities. Consequently, the financing approach generally employs ceteris paribus more long-term liabilities than the accounting approach does. The financing approach (borrowing more on long-term basis) brings more stable interest costs than the accounting approach; but as the yield curve is usually upward sloped, the financing approach is also more costly. The financing approach versus accounting approach decision making is thus a classical risk return trade-off relationship. In praxis, the corporate commonly favor the accounting approach before the finance approach, the same holds for our consideration of maturity matching for the empirical evidence of the debt maturity structure. Based on these Maturity matching arguments, we will consider the impact of balance sheet liquidity immunization on the corporate debt maturity structure. The financing approach compared with accounting approach decision making had a classical risk return trade-off relationship. In praxis, the corporate commonly favor the accounting approach before the finance approach, the same holds for our consideration of maturity matching for the empirical evidence of the debt maturity structure. Based on these Maturity matching arguments, this study considered the impact of balance sheet liquidity immunization on the corporate debt maturity structure. Guedes and Opler (1996) stated that the mean of estimation of asset maturity did not appear to be vary much between firms, those issue debt (term of one to nine years) and firms that issued debt up to twenty nine years term. But firms that issue debt for greater than thirty years term had assets with significantly long lives. Assumptions expect that firms will compare the maturity of assets and liabilities show that partially correct. Morris (1976) argues that such a strategy allows firms to decrease uncertainty both over interest costs over the asset’s life as well as over the net income that will be derived from the assets. (Emery (2001) the higher the term premium, the stronger should be the firm’s incentive for maturity matching. CHAPTER: 3 RESEARCH METHODS 3.1 Method of Data Collection Secondary data is comprised on non-financial firms listed on KSE-100 Index for year 2003-2008, collected from the different sources i.e. Karachi Stock Market, Balance sheet analysis report published by State Bank of Pakistan and other internet sources. The data is comprised on following variables: Dependent variable Debt Maturity Independent Variables Asset Maturity, Firm Size, Market to Book Ratio,
3.2 Sampling Technique & Procedure
All the non-financial firms listed on the Karachi stock Exchange KSE-100 index selected for the purpose of conducting the research study.
3.3 Sample Size
Sample for this study has been taken from “Balance Sheet Analysis of non-financial companies listed on the Karachi Stock Exchange (2003-2008)”, a publication of Statistics Department of State Bank of Pakistan. The book contains six years data of balance sheets and income statements of non financial firms. 3.4 Research Model Developed Following model was determined the impact of different variables on the debt maturity and to test the hypothesis that the variables that impact on debt maturity were studied in this thesis, like: Asset Maturity, Firm Size, and Market to Book Ratio, by using multiple linear regression. DEBMAT = AŽA± + ASSETMAT (AŽA²1) + SIZE (AŽA²2) + MV/BV (AŽA²3) + AŽA¼ Where DEBMAT is Firm’s Debt Maturity (Debt maturing more then one year / Total Debt) ASSETMAT is Firm’s Asset maturity (Fixed Assets / Depreciation) SIZE is Firm Size (Log (natural) of total assets) MV/BV is Market-to-Book Ratio (Market value of firm’s assets / Book Value of firm’s assets) Aµ is error term AŽA± is the Constant 3.5 Statistical Technique After collecting the data from the selected population, it was analyzed by using SPSS software to study the impact of independent variables on the dependent variables.
The statistical technique “Multiple Linear Regression” was used to identify the variables that impact the debt maturity.
CHAPTER: 4 RESULTS 4.1 FINDINGS AND INTERPRETATION OF THE RESULT: Multiple linear regression technique applied through SPPS software by using the Enter method, which is highly recommended for this type of analysis. Following results appeared:
TABLE 1: MODEL SUMMARY FOR DEBT MATURITY
Std. Error of the Estimate
.624 .389 .336 .16521 1.884 A. Predictors: (Constant), ln_assmt, ln_mkttobv, FIRM size B. Dependent Variable: sqrt_dema This table displays R, R squared, adjusted R squared, the standard error, and Durbin- Watson. R, the multiple correlation coefficients, is the correlation between the observed and predicted values of the dependent variable. Larger values of R indicate stronger relationships. R squared showed the percentage of deviation in the dependent variable explained by the regression model. Small values specify that the model did not in shape with the data well. Dependent variable (Debt maturity) and two independent variables (asset maturity, and market to book value ratio) were transformed to make the data normally distributed. It shows that 38.9 % variation in dependent variable (square root of debt maturity) was due to independent variables (log of asset maturity, firm size, and log of market to book value ratio).
TABLE 3: ANOVA FOR DEBT MATURITY
Sum of Squares
Regression .592 3 .197 7.228 .001* Residual .928 34 .027 Total 1.520 37 A. Predictors: (Constant), ln_assmt, ln_mkttobv, FIRM size B. Dependent Variable: sqrt_dema This table summarizes the results of an analysis of variance. If the significance value of the F statistic is small (smaller than say 0.05) then the independent variables did a fine work to clarify the deviation in the dependent variable. If the significance value of F is greater than 0.05 then the independent variables didn’t clarify the deviation in the dependent variable. In this model the significance value of the F statistic is less then 0.05, thus the independent variables did a fine work to clarify the deviation in the dependent variable.
TABLE 5: COEFFICIENT FOR DEBT MATURITY
B Std. Error Beta Tolerance VIF
1 (Constant) -.733 .301 -2.434 .020 ln_assmt .266 .065 .559 4.063 .000 .948 1.055 FIRM size .041 .020 .288 2.097 .043 .954 1.048 ln_mkttobv -.055 .042 -.180 -1.311 .198 .957 1.045
Sqrt_dema = -0.733 + 0.266*ln_assmt + 0.041* Firm size – 0.055*ln_mkttobv + Aµ In this model square root of Debt Maturity was the dependant variable and the independent variables include Asset Maturity, Firm Size, and Market to Book Ratio, Aµ is the error term. If debt maturity changed by 1 unit then asset maturity increased by 0.266, firm size increased by 0.041, and market to book value ratio decreased by 0.055. 4.2 HYPOTHESES ASSESMENT SUMMARY The hypotheses of the study were distinctive financial characteristics have significant impact on debt maturity. These financial characteristics were asset maturity, firm size, and market to book value ratio. In this study each the financial characteristic tested and concluded the results.
TABLE 4.3 : Hypotheses Assessment Summary
S.NO. Hypotheses R Square Coefficients SIG. > 0.05 RESULT H1 There is a positive relationship between Debt maturity and asset maturity. 0.389 0.266 0.000 Accepted H2 There is a positive relationship between Debt maturity and Firm Size. 0.389 0.041 0.043 Accepted H3 There is an inverse relationship between Debt maturity and Market to Book Ratio. 0.389 -0.055 0.198 Accepted
FUTURE RESEARCH AND CONCLUSIONS
In this study, multiple linear regression analysis is exercised to examine data collected from listed Pakistani non-financial firms for period 2003-08. Regression analysis is used to measure the long term debt used by firms. Debt maturity is taken as a dependent variable in the study where as asset maturity, firm size, and market to book value ratio are independent variables to measure their effect on debt maturity.
The study concludes that the most important variables are debt maturity, and asset maturity. According to this study, these variables are most important in the prediction/ anticipation of maturity structure of firms’ asset and liabilities. According to study, asset maturity is very important for the model to predict the debt maturity structure. Asset maturity is positively related to debt maturity. This study confirmed matching principle by showing that slower asset depreciation means longer debt maturity. These results were also supported by Hart and Moore (1994). Firm size is also one of the important variables for this study. This study found out only little evidence for the agency cost aspect that debt maturity used to restrict the conflicts of interest between share holders and debt holders, these results were matching with the study conducted by Hoven and Mauer (1996). These results were varied in various countries, because there have been difference in environments and circumstances and firms make decision accordingly, it also showed that smaller firms employ more shorter term debt then longer term debt, which was supported by Shah and khan (2005). There was an acceptance of growth (market-to-book ratio of assets) should be inversely correlated to debt maturity in the agency/contracting costs perspective in this study, these results were supported by Titman (1992).
All variables were considered to be in line with the literature, however, based on regression coefficients shown by many variables along with dependency problem, the final model comprised of independent variables; asset maturity, and firm size had significant value of less than 0.05 which suggests that these variables have significant impact on the debt maturity of non-financial firms listed on KSE-100 index. On the other hand, results also revealed that market to book value ratio had significant value greater than 0.05 therefore it may not necessarily lead to an impact on non-financial firms listed on KSE-100 index.
5.3 Implications and Recommendations
This research was limited to the non-financial firms listed on Karachi Stock Exchange. The data taken from 58 firms are taken through various sectors for the year 2003-08. It was suggested that such type of study should be carried out in other countries of Asia as well, as to have comprehensive idea about the debt maturity structure. Moreover, it is also suggested that other factors except ones examined in this study should be researched as to have perfect idea about the debt maturity structure. Besides that, this study can also be replicated in other developing countries.
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