Testing capital structure models on Philippine listed firms

Abstract

This study examines the ability of the Trade-Off (TO) model and the Pecking Order (PO) model to explain the financing behaviour of Philippine listed firms from 1990 to 2001. Using panel data regression techniques, the firms’ leverage ratios move towards their optimal level, holding up the TO model. The results, however, show better support for the PO model, as leverage and profitability are negatively related, while financing deficit mostly explains the annual change in total liabilities. Furthermore, in joint tests, only the fitted values from the PO model equation continue to have additional explanatory power over fitted values from the TO model. Firms issued more equity than debt from 1990 to 1996 when stock market prices were increasing rapidly, but this still fits the more complex version of the PO model.

Notes

¹The target debt ratio has been defined as the sample mean over the period of study (Shyam-Sunder and Myers, 1999), as a 3-year moving average (Javilvand and Harris, 1984), or as deviation from their industry means (Hovakimian et al., 2002).

²A positive relationship appeared, however, when Fama and French used market value of assets over book value of assets to measure market opportunities. Booth et al. (2001) commented that a ‘spurious correlation’ would occur if leverage is measured as debt over market value of equity while market opportunity is measured as market value of equity over book value of equity. This would apply to both Rajan and Zingales (1995) and Fama and French studies which use market leverage.

³The Philippine Corporate Handbook does not cover this period and complete company annual reports in the PSE library are limited to only about 80 firms.

⁴See Titman and Wessels (1988), Booth et al. (2001), Bhaduri (2002) and Gaud et al. (2005). Some studies have suggested that larger firms tend to have better access to capital markets, and that they have better economies of scale in issuing debt. In the Philippines, however, these advantages do not quite hold since the corporate bond market is quite thin.

⁵An alternative measure for growth opportunities, growth in book value of total assets, also shows a positive effect on leverage when inserted into the standard leverage equation.

⁶In their study of Spanish firms, de Miguel and Pindado (2001) used a similar approach.

⁷Foreign debt as a proportion of total debt in 1996 ranged from 34% (Allayanis et al., 2001, Table 1) to 40% (Claessens et al., 1998).

⁸As proposed by Davidson and MacKinnon (1981). The test is implemented by initially regressing the variable in question against instrument variables, and collecting the residuals from the regression. A second regression that includes the residuals as one of the independent variables in the original regression model (i.e. test of pecking order using the financial deficit) is then performed.

⁹As described in Stock and Watson, 2003, pp. 353–354.

¹⁰Scaling the value of financing deficit by dividing it by total assets makes the financing deficit variable insignificant. The use of total assets to scale financing deficit seems to change its relationship with the total liabilities to total assets ratio (i.e.,TLA).