Effect of Bond Financing on the Enterprise Performance in Chinese Listed Firms - Research Paper Example

Effect of Bond Financing on the Enterprise Performance in Chinese Listed Firms Number Department Research Method Used The research study methods which have been chosen for this study is quantitate research and performance-based evaluation method. In this investigation, the primary characteristic that tries to explain a phenomenon were being observed and recorded after which an SPSS analysis of the data collected was done before a conclusion was passed. In this case, the primary characteristic was the ability of bond financing to affect Chinese listed firms by affecting their performance. Data Analysis In the analysis, this paper adopted three major accounting based performance indicators; earnings per share (EPS), return on asset (ROA) as well as return on equity (ROE). These measurements were used as dependent variables in ascertaining the firms` performance against the independent variables which were bond asset rate (BAR), proportion of first stock holders (F1), total assets turnover (Size) and current ratio (CR). The above dependent variables are more regularly used performance indicator proxies. Their ratios computation worked out from income statements items and balance sheets. Furthermore, I opted for more than one indicator proxy for measuring performance because this dissertation wanted to investigate the null hypothesis (Ho); there is a positive correlation between bond financing and the performance of enterprises when proportion of bond financing is low or whether the alternative hypothesis (H1) is true (Ho is false). According to (Wang, 2012, pg. 108), return to equity ratio can actually measure investment return of shareholders. This ratio reveals how efficiently management works to produce more earnings for the shareholders of an enterprise. In simple words, it may be claimed firm profitability is actually measured by the gain earned from the shareholders` invested money. Return on assets is actually a better internal management ratio since it measures the profit against every asset a division utilizes to create those earnings. Therefore, it is one way of evaluating the profitability, performance, and efficiency of the division. Moreover, EPS (earnings per share) was also used as an accounting ratio because it indicates a clear view of enterprise performance. It signposts how much profit of an enterprise can be accredited to every ordinary share within the enterprise. The higher the EPS figure, the stronger the financial position of an enterprise and, thus, a reliable enterprise to make investment (Yang & Mallick, 2011, pg. 214). The table presented below displays the results of the regression analysis on these variables including EPS. Table A 1. Regression analysis of the variables ROE NPM EPS ROA CR NPR F1 BAR Size BAR2 Mean .0810 .0854 .4027 .5887 1.4246 3.7370 41.1202 .0809 3.0599 .0083 Maximum .4947 .4760 4.0700 3.3030 6.7265 1174.5016 86.3500 .2136 7.6819 .0456 Median .0836 .0706 .3081 .4329 1.1960 .0000 40.5700 .0771 3.1042 .0059 Minimum -.4921 -.2342 -1.4610 .0727 .0936 -257.8916 3.6200 .0040 -.6644 .0000 Mode -.4921 -.2342 .0200 .0727 .0936 .0000 16.8500 .0040 -.6644 .0000 Range .9868 .7103 5.5310 3.2303 6.6330 1432.3932 82.7300 .2096 8.3464 .0456 Standard Deviation .0992 .0965 .5211 .4850 .9455 72.7965 18.1923 .0418 1.2832 .0079 Variance .0098 .0093 .2715 .2352 .8940 5299.3289 330.9592 .0018 1.6466 .0001 Standard Error of Mean .0059 .0057 .0309 .0287 .0560 4.3121 1.0776 .0025 .0760 .0005 In table A 1 above, the regression results shows a clear scenario where bond financing actually affects enterprise performance. The average earning per share (EPS) is minimum (-1.4610) when the proportion of first stock holder is low (F1=3.6200). However, average EPS figure is maximum (4.0700) when the proportion of first stock holder (F1=86.3500) is highest. The same case applies with the bond asset rate (BAR) and return on equity; return on equity (ROE) is highest (0.0810) when BAR is also highest (0.0809). These results prove that the null hypothesis, Ho is actually true. In table A 2 below, the results shows the correlation between the dependent variables and bond asset rate (BAR), total assets turnover per 1 billion (Size) and the proportion of first stock holder (F1). This table result was obtained after rigorously carrying out a regression analysis using the data from listed companies in China stock exchange. Table A 2. Correlations of the variables Correlations coefficients F1 BAR1 Size BAR2 CR NPR ROE Pearson Correlation .373 .597** .770** .196** .073 .090 Sig. (2-tailed) .000 .000 .001 .219 .127 N 285 285 285 285 285 285 NPM Pearson Correlation .597** .481 .403** -.341** .314** .038 Sig. (2-tailed) .000 .000 .000 .000 .519 N 285 285 285 285 285 285 EPS Pearson Correlation .770** .403** 391 .305** .063 .049 Sig. (2-tailed) .0232 .140 329 .254 .287 .414 N 285 285 285 285 285 285 ATR Pearson Correlation .196** -.341** .305** 287 -.207** -.037 Sig. (2-tailed) .001 .000 .000 .000 .535 N 285 285 285 285 285 285 CR Pearson Correlation .073 .314** .063 -.207** 201 -.044 Sig. (2-tailed) .219 .000 .287 .000 .457 N 285 285 285 285 285 285 NPR Pearson Correlation .090 .038 .049 -.037 -.044 .21 Sig. (2-tailed) .127 .519 .414 .535 .457 N 285 285 285 285 285 285 **. Significant level, 0.01 (2-tailed). From the outcome above, we can clearly observe that the there is a strong positive correlation between total assets turnover (size) and ROE (return on equity) as witnessed in the correlation co-efficient of 0.770. Again, there is also a significant positive relation between EPS and both proportion of first asset holder and total asset turnover as shown in the coefficients of 0.196 and 0.305 respectively. In this case, the cash flow from all the enterprise`s operations may have been inclusive of all the actual coupons that paid to be the bond holder throughout the specific accounting period. Given these might be bonds that had been sold at discount, it was beneficial to engage smaller coupons than was presently stated as an interest expense. In this light, the amortized portion of the bond discount is supposed to be included in cash flow from financing. In summary, the above results also confirms the validity of the null hypothesis, Ho (Ho is true). Further analysis was done using the standardized and unstandardized coefficients to ascertain the nature of relation between the independent variables and return on equity (lower and upper bound figures). As such, the result of this regression analysis is displayed in table B 1 below. Table B 1. Standardized and unstandardized Coefficients Model Unstandardized Coefficients Standardized Coefficients 95.0% Confidence Interval for B Correlations B Std. Error Beta Lower Bound ROE Upper Bound ROE Zero-order Partial Part 1 (Constant) -.098 .027 -.151 -.045 CR .031 .005 .301 .021 .041 .314 .339 .265 Size .014 .005 .192 .005 .024 .061 .179 .134 BAR 1.164 .399 .505 .378 1.950 .038 .172 .128 Bonds Payable Unit CNY -1.014E-012 .000 -.152 .000 .000 -.031 -.156 -.116 BAR2 -4.824 2.087 -.397 -8.933 -.715 .043 -.137 -.102 a. Dependent Variable: NPM From the above table results, at 95% confidence interval, there is a positive relationship that is statistically significant between ROE and total assets turnover and bond asset rate after standardizing the variables. For instance, total assets turnover (Size) showed a higher positive correlation coefficient (0.024) between it and upper bound ROE with a standardized coefficient (0.192) and a lower correlation coefficient (0.005) between it and lower bound ROE. Finally, the analysis to confirm the null hypothesis (Ho) as per the industrial sector is presented in table B 2 below. The frequency with which listed enterprises recorded the highest profits (measured in terms of return on equity, earning per share, and return on assets) after the period of high bond financing was recorded. Both the cumulative and valid percentages were then calculated as per the sectors. From the table results below, the manufacturing sector recorded the highest frequency (150) in terms of the profits gained after the period of high bond financing. The lowest frequency appeared on mining sector with only 30 cases which was 10.5% of the total profit recorded after high bond financing. This was 89.5% less than the cumulative percentage of manufacturing, real estate and mining sectors. However, the profit gain was relative high in periods after high bond financing than period of low bond financing. sector data Frequency Percent Valid Percent Cumulative Percent Valid Manufacturing 150 52.6 52.6 52.6 Real Estate 63 22.1 22.1 74.7 Utility 42 14.7 14.7 89.5 Mining 30 10.5 10.5 100.0 Total 285 100.0 100.0 Discussion In a closely related wavelength, it is also true that trading in bond financing has redefined the drawing of the income statement or the trading profit and loss. Because of the trading in bond financing, one has to identify top products which had brought about profit within an organization’s fiscal year. Because of the need to account for trading in bonds, there was the need to account for and calculate net income by deducting expenses from revenues. What informs this development is the fact that bond trading and transactions impact income statement through two accounts: the amortization expense accounts and the interest expense. The same will apply to equity statements. The equity statement is inclusive of elements of financial elements such as dividends, accumulated profits, preferred shares and common stock. This is because bond issuance had tremendous effect on financial synopsis through amortization expenses and interest rates. These flow into the retained earnings account which is chief among the equity item. Thus, the statement of cash flows will also be factored in this development. There will be the operation of the cash flows alongside outgoing and incoming cash that has been accrued from fundraising initiatives, investments and lending. Zhao, Wan and Xu (2013, pp. 158- 160) contend and divulge that the issuance of and engaging in bond financing has also had tremendous effects on debt issuance. All these issuances of debt finance may be divided into three categories: the bonds that have been issued at par; bonds that have been issued at a discount; and bonds that have been issued at a premium. As for the bonds that have been issued at par, bond financing has had tremendous effect on income statement, cash flow statement and balance sheet. As touching the income statement, there is an inclusion of an interest expense that is equal to the bond’s coupon payment that is attributable to a particular and stipulated accounting period. Similarly, there is a tremendous effect on the cash flow statements. In this case, cash flow from operations is inclusive of interest expenses records that feature in the income statement. As touching the date of issuance, the company or the industry is to account for cash flow that emanate from financing the total amount that had been received for the bond. There are also effects that spiral into the balance sheet. The balance sheet is to perennially include long-term liabilities that are concomitant with the face value of the bonds, up to the point of redemption or maturity (Eang, 2009, p. 60). As touching the bonds that are issued at a discount, there are effects on income statement, the cash flow statement and balance sheet. Concerning the balance sheet, there is the inclusion of long-term liability that is equal to the carrying value, at all times. At the point of initiation, the carrying value is to be held as being equal to the bond`s face value when the unamortized discount has been subtracted. Annually, the bond value that has been recorded on the balance sheet is to be increased up to the point at which the bond matures and the value that is displayed on the balance sheet equals that of the bond’s face value. There are also effects that are experienced on the income statement. In this case, the income statement is to include income expenditure that is equal to the payments on the bond’s coupon. This includes the amortized portion of the discount that had been received and registered during a specific accounting period. In regard to the development immediately above, it is interesting to note that the People’s Republic of China has tried vehemently to balance the price at which investors purchase bonds. This usually happens when they are first made with a typically approximate amount that is equal to the nominal amount. The net then follows that the issuer receives the issued price and less issuance fees. In this regard, the market price of the bond may vary according to different circumstances: the market price of the bond may be traded at a premium; or at a discount. When the market price is traded at a specific premium, it will be above par normally for the simple reason that the market interest rates have gone down, following their issuance. Conversely, if the market price of the bond varies at a discount, then it is most likely that it is below par, given that the market rates will have risen or there will be a high likelihood of the default of the bond (Wang, Zhang, Zhang and Zhao, 2011, pp. 2975 – 2998). The matter has also complicated government’s involvement in bond financing and the Chinese financial market. For instance, on 21 August 2014, Beijing granted 10.5 billion Yuans in its municipal government debt, and thus making Beijing become the eighth Chinese region to grant its own local government bonds, among the other 10 that had been scheduled for the same. According to Zhu (2013, pp. 119- 122), the move above is a culmination of the initiatives that had been launched by China’s Ministry of Finance in May 2014 to grant the 10 local governments the chance to repay and issue bonds in their own bid, so as to tackle looming crises in public finances and to check the shadowy banking sector which municipal authorities heavily depend on for funding. It is in this light that Beijing set its fixed rate municipal bonds that were granted in three branches of 10, 7 and 5-year terms. The returns that were accrued from this development ranged from 4 to 4.23%. This is a figure that is slightly below market expectation of the higher cost that had been associated with loans that the local governments have secured from times past through the financing of vehicles and/or state-owned firms. The funds and gains gained therefrom are thus used to facilitate affordable housing, transportation and transport infrastructure and environmental projects. It is also for the simple reason above that the authorities in China have sought to establish municipal bond market that is meant for the local governments and are meant to raise funds for the development of the infrastructure. This is the case since, the back-door financing is widely expended by local governments over the past decades and has therefore informed fears that unregulated activity has the potential to cause the systematic risk of/for China’s financial system. In a different wavelength, it is important to note that bond financing has compelled the Beijing Administration to place sanctions on the use of bond financing or bond trading. Specifically, the Chinese municipal and provincial governments placed restrictions that forbade the borrowing of money outside the separate pilot scheme that had been launched as early as 2009. The pilot scheme had been launched under the auspices of the central government which had taken to issuing the bonds on their behalf. The government would then also assume responsibility for the repayments that were to be made. Just as Mazumdar and Chen (2011, pp. 15-20) observe, it is also true that the advent of the development immediately above has paved way for a considerable degree of friction between the municipal and the national government in China. This is seen in the fact that over time, the local government has made several attempts at circumventing the ban mentioned immediately above through the setting up of companies that are famously known as local government finance vehicles (LGFVs). These companies were to take loans or issue bonds, on behalf of local authorities. Due to this, the 2013 local audit that was released accurately, showing that local governments were under a debt obligation of 10.88 trillion Yuans. Because of this, it was realized that 40% of the debt had been raised through the use of LGFVs. Nevertheless, it is also true that the central government has attempted several occasions to shut down the selling of bonds and bank borrowing by LGFVs over the recent years. On the contrary, this development has only encouraged many of these organizations to resort to short-spanned maturity shadow banking sector and high-interest banking in an attempt to stay afloat or remain solvent. The cash flow is to be inclusive of the actual coupon that has been duly paid to the debt holder at the time of the specified accounting period. As bond that is sold at a premium, it pays out larger coupons than is being currently quoted as an interest rate expense that is on the income statement. Resultantly, the CFO is to be understated relative to the company (or companies) that have sold its bond at par. The amortized portion of the aforementioned bond premium is to be included in the cash flow from financing. This causes the reported cash flow from finance to be overstated, relative to the bonds of a company that has sold its bond at par. Bond financing has also by far affected computation. Computation is used to determine the value of the bond that a firm will have made after a given period. Conclusion In conclusion, it is clear that the use of bond financing has both positive and negative effects in China listed firms. As shown in the result of data analysis, bond asset rates, total asset turnover and the proportion of first stock holder all affect the firms` performance by positively affecting their performance indicators (EPS, ROE, and ROA). Hence, the null hypothesis was confirmed to be true. However, it is worth noting that in itself, bond financing may be amoral. One of the drawbacks of bond financing is the friction between local and national governments and the attempt by the former to sidestep the bans on financial practices that had been placed by the national government. According to Yang and Mallick (2011, pp. 221-5), the ability of the 10 local governments to repay and issue bonds in their own bid, so as to tackle looming crises in public finances and to check the shadowy banking sector which municipal authorities heavily depend on for funding is one of the advantages that has graced the use of bond financing in China. The import of this is that the onus is upon China to make legislation that would reverse the aforementioned drawbacks that accost bond financing while magnifying the accruals that characterize the use of bond financing. The discussion above clearly demonstrates the fact that bond financing can be highly beneficial to China’s or any other country’s industry. Therefore, the balancing of the merits against the demerits of the bond financing and the amplification of the former against the latter is the responsibility of stakeholders (the government through the legislature and the ministry of finance and trade, investors, corporations, firms and their leaders). China can therefore make legislations that would reverse the drawbacks of bond financing while furthering the gains that characterize bond financing. References DIDIER, T. AND SCHMUKLER, S. L., (2013). The financing and growth of firms in China and India: evidence from capital markets. Journal of International Money and Finance, 39 (2), pp. 111 – 137. EANG, A., (2009). Influence of Capital Structure on Firm Performance: Evidence from Indonesian Listed Companies. FIRTH, M., MALATESTA, P. H., XIN, Q. & XU, L., (2012). Corporate investment, government control, and financing channels: Evidence from Chinas Listed Companies. Journal of Corporate Finance, 18 (3), pp. 433 - 450 FONSEKA, M. 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