Impact of Corporate Financing Decision on Performance of Firms Listed in Kuwait Stock Exchange - Research Paper Example

Impact of Corporate financing decision on performance of firms listed in Kuwait Stock Exchange-Summary Report Department Abstract This published journal explored the relationship between financing performance of corporates and financial decisions like capital budgeting, capital structure techniques and dividend policy. It used a panel data from 80 listed firms in Kuwait. The outcome of this research revealed that, unlike the capital structure`s Trade-off Theory, there is a negative relationship between the degree of debt and firms` financial performance. This could be accredited to high cost of borrowing that prevailed between 2000 and 2008 and the underdeveloped debt market in Kuwait. The empirical outcomes also revealed that short-term debt depicted a substantial and negative link to all the accounting measure of performance, whereas no impact was realized in long-term dept. Since there was a sluggish and underdeveloped bond market, companies appeared to involve in short-term loans instead of long-term loans, something that lead to the danger of refinancing individual debt. Introduction Every financial decision regarding capital budgeting, capital structure, and dividend policy associate with corporate performance. For example, decision on optimal investment maximizes shareholders` the present value of wealth by adopting capital budgeting procedures. Huge companies appear to make significant amounts of expenditures when building new plant and acquiring equipment that might call for the use of extra capital budgeting procedures. Little consensus exist among researchers regarding whether the decisions involving dividend policy can influence performance of firms. In a closely related wavelength, it is also true that decision to trade 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 financial decisions 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. Literature Review Historical, most literature empirically explored the determination of accounting decisions with only few studies emphasizing on their link to the firm performance. Contend and divulge that the issuance of and engaging in bond financing has 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 cash flow and income statements 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. 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 Kuwait 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. The matter has also complicated government’s involvement in bond financing and the Kuwait financial market. Research Objective The objective of the investigation was to examine the impact of corporate financial decisions on performance of corporates in Kuwait. There is inadequate empirical evidence concerning the impact of corporate financial decisions on the firms` performance from both developing and developed nations. Most work on corporate financial decisions emphasized on the causes of capital budgeting procedures, corporate leverage and dividend policy. As such, a gap exists in the literature with regard the effect of corporate financial decisions on firms` performance. Therefore, investigation aimed at filling the gap by examining the impact of corporate financial choices on firms` performance among Kuwait companies. Research Questions The research questions were formulated in form of hypotheses as follows: H1: A company’s capital structure is anticipated to have a negative impact on its performance. H2: A company’s short-term debt reduces its performance. H3: A company’s dividend policy impacts its performance positively. H4: A company’s capital budgeting procedures is anticipated to have a positive impact on its performance. H5: A company’s size is anticipated to have a positive impact on its performance. H6: There is a positive association between corporate performance and risk. H7: Growth opportunities improve corporate performance. H8: Industrial sectors influence corporate performance. Research Methodology 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. The data employed for this research were gathered from different resources alongside KSE (Kuwait Stock Exchange), Reuters, database of EMIS (Emerging Markets Information Service), and Global Investment House. The data set were inclusive of all publicly traded companies listed in the KSE for a specific time period (from 2000-2008). The sample selected for this research was based on the obtainability of the data for that particular period of interest. All firms were required to provide their financial statements for each year for the time period. The data set enclosed detailed information regarding each company. The dataset sample consisted of 80 listed companies in Kuwait and the sample gathered had 14 sectors, inclusive of both non-financial and financial firms. The information regarding all accounting-linked variables were gathered and calculated from yearly financial reports, specifically, the income statements and the balance sheets, for every listed company in Kuwait. Every financial statement adhered to the international standards` requirement. Data Analysis In the analysis, this paper adopted major accounting based performance indicators; earnings per share (EPS), return on asset (ROA), Tobin`s Q as well as return on equity (ROE). These measurements were used as dependent variables in ascertaining the firms` performance against the independent variables such as capital structure decisions (CSDs), the capital budgeting procedures dummy variable (CBDum), DIVID (choice of dividend policy), Size, Growth, Risk, Tangibility and Liquidity. Dividend yield (DY) was used as a measure for dividend policy while the standard deviation of return divided by total assets was used as measure of risk in the study. The other variables that affected the companies` performance were assets structure, which were measured by liquidity and tangibility. Tangibility was defined as a ratio of total assets to fixed assets (TANGB), while liquidity was a ratio of total assets to current assets (LIQUID). The above dependent variables are more regularly used performance indicator proxies. Their ratios computation worked out from income statements items and balance sheets. Furthermore, the research opted for more than one indicator proxy for measuring performance because the paper wanted to investigate the above hypotheses. According to the study, 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. 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 Tobin`s Q EPS ROA CSD CBDum DY TANGB Size LIQUID 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 financial decisions actually affects corporate performance. The summary figures for the variables were reported in Table A 1. The average ROE was 12.3% for the entire sample, whereas the average ROA was only 7.2%. The reported accounting performance measures showed that Kuwaiti companies have low accounting performance. These measures of market performance depicted high proportions of performance that were being compared with the accounting measures. The high percentages for the measures of market performance could be due to the increase in the companies share price and equity devoid of any upsurge in the real performance activities of the company. The lower accounting earnings may also be influenced by the companies leverage. The average total asset to total debt for the sample, in general, was about 115 %. To inspect the correlation amongst the explanatory variables, Table A 2 described the correlation matrix for the variables. The findings revealed that a strong negative association existed between leverage and growth, whereas size had a strong negative association with all the leverage pointers with the exclusion of TDTE and TDTC. Moreover, a positive association between growth and size was observed. This indicated that bigger companies with greater growth opportunities appeared to have greater leverage ratio. The findings also have revealed that most Kuwaiti firms with greater leverage ratios were likely to have greater level of risk as opposed to the firms with lower leverage ratio. This indicated that leveraged companies have higher risks since debt holders have tendencies to take control of the company. Table A 2. Correlations of the variables Correlations coefficients TDTA LTDTA Size STDTA DY Growth ROE Pearson Correlation .373 .597** .770** .196** .073 .090 Sig. (2-tailed) .000 .000 .001 .219 .127 N 285 285 285 285 285 285 LTDTA 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 STDTA Pearson Correlation .196** -.341** .305** 287 -.207** -.037 Sig. (2-tailed) .001 .000 .000 .000 .535 N 285 285 285 285 285 285 CSD Pearson Correlation .073 .314** .063 -.207** 201 -.044 Sig. (2-tailed) .219 .000 .287 .000 .457 N 285 285 285 285 285 285 CBDum 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. 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. 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 DY .031 .005 .301 .021 .041 .314 .339 .265 Size .014 .005 .192 .005 .024 .061 .179 .134 LTDTA 1.164 .399 .505 .378 1.950 .038 .172 .128 STDTA -1.014E-012 .000 -.152 .000 .000 -.031 -.156 -.116 Mcap -4.824 2.087 -.397 -8.933 -.715 .043 -.137 -.102 a. Dependent Variable: ROA 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. Conclusion In conclusion, it is clear that corporate financial decision has both positive and negative effects in Kuwait 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, all hypotheses were confirmed to be true. A sensible panel data of 80 firms (720 observations) were examined in this research. The empirical outcome gave the evidence that capital structure significantly and negatively has a linear relationship with both marketing and accounting measures of performance. The finding postulated that firms prefer in-house funding to debt to equity. Companies with greater profitability appear to employ greater retained earnings but less debt. In the contrary, the outcome in the case of Kuwait opposed the argument put forward by trade-off theory on capital structure. Conversely, this could again be accredited to the inflated cost of borrowing as well as the underdeveloped debt market in Kuwait. Additional, given the inimitable tax atmosphere in Kuwait (no corporate tax rate) suggests that debt never benefit from the tax shield within Kuwait as is the case in western countries. Therefore, at that time, it made less sense for firms in Kuwaiti to use a high degree of debt in their individual capital structure. This would have not been a prudent strategy since doing so would have not confer tax merits as was the case in western nations. From this perspective, the researchers considered that manager could operate companies effectively minus going into debt since incurring high level of debts within capital market is normally fraught with risks. Part of the finding revealed that STDTA was discovered to have substantial and negative impact on ROA while there was no effect of LTDTA. Probable explanations of that outcome showed that short-term debt-vulnerable firms have to tackle the risk of refinance. The need for a reflection on the significant role of financial institutions in providing companies with extra short-term loans instead of involving them with long-term debt was a necessity. This significant fact shed more lights on the main exceptionality in the Kuwait setting, in which mutual funds and the bond markets are still inactive and undersized to begin long-term bonds. Reference Al Mutairi, M., Hasan, H.,M. & Risik, E. A. (2011). The Impact of Corporate Financing Decision on Corporate Performance in the Absence of Tax: Panel data from Kuwait Stock Market. II World Finance Conference (pg.1-27). Greece:SSRN. http://ro.uow.edu.au/cgi/viewcontent.cgi?article=2590&context=commpapers Read More