EU Corporate Response to the Current Economic Downturn - Research Paper Example

Dissertation Proposal EU corporate response to the current economic downturn: their strategic finance policy shift of raising more debt to pay off existing debt Abstract The current global economic downturn has been significantly impacting on almost every economy in the world irrespective of its degree of autarky and size. In this backdrop corporate entities tend to res0pond to economic outcomes such as recessions with a skewed policy shift in which existing corp0orate debt is paid off with new debt. EU corporate response is underlined by a similar strategic response to the current global economic crisis. However the real significance of this policy shift in the EU corporate context is marked by a dichotomy of approaches. High- leveraged firms in the EU do not respond to economic crises in the same way that low-leveraged firms do. The former responds by adopting a more debt more repayment policy while the latter responds by adopting a less debt more equity policy. This strategic policy dichotomy underlies the very nature of EU corporate culture too. Invariably strategic policy responses of this nature are characterized by paradigm shifts that both primarily and immediately presume corporate governance and sustainability issues. 1. Introduction 1.1. Research problem/question EU companies operate in a highly regulated competitive environment that gives them little, if any, freedom to achieve organizational goals, both short term and long term (Spedding, 2004). In this backdrop leveraging decisions of firms are basically determined by long term organizational goals related outcomes as much as they are determined by theoretical conceptual frameworks. A set of endogenous and exogenous variables that impact on these outcomes has been studied with greater emphasis on organizational outcomes related to leverage in general (DeMarzo and Duffie, 1991). However a series of questions as to what, why, when, where and how have not been properly answered concerning the significance of more debt and less equity in order to settle existing debt against the backdrop of the current economic downturn (Cooper, 2008). 1.2. Research objectives/aims The objectives of this research effort can be divided into two broader categories: (a) Strategic objectives and (b) Theoretical objectives. (a) Strategic objectives To establish a series of positive and negative correlations among a set of predetermined endogenous and exogenous variables impacting on the EU corporate response to the current economic downturn. To determine the extent and depth of strategic corporate response to economic downturns by using company debt policy. To examine what policy choices are made by EU firms in deciding between more debt and less equity such as between long term and short term loans. (b). Theoretical objectives To establish a theoretical conceptual framework of analysis for the strategic competitive and operational environments of the EU corporate sector concerning raising more debt to pay off existing debt. To set up a contingency model for conceptualization of research outcomes in this paper. 2. Literature review Strategic finance policy shifts in the EU corporate sector against the backdrop of the current global economic downturn have been marked by more debt to pay existing debt (Pettit, 2007). This kind of leveraging practice has a very far reaching impact on the overall capital structure of the firm as well (Lele, 1992). Issuing more debt in order to settle existing debt is a strategic financial initiative adopted by EU firms thus obviating the need for issuing equity (O’Conner and Jen, 2002). However the strategic financial policy on leveraging in the EU corporate sector has acquired a new dimension, i.e. while exiting debt might accumulate indefinitely due to interest payment obligations there is very little freedom available to the manager to manipulate the overall capital structure despite the sustained efforts to raise more debt to pay exiting debt (Militello and Schwalberg, 2002). The authors suggest a more cautious approach to leverage decisions. The existing theoretical constructs including those governing the determination of firm’s capital structure such as Modigliani & Miller Theorem (M&M) have been over-utilized to construct theoretical and conceptual contingency models that have very little relevance and appropriateness to the context (Grinblatt, 2006). Conceptual framework building efforts have been of very little success against the backdrop of economic downturns (Sturr and Vesudevan, 2007). This is particularly so since firms don’t always behave predictably in times of crises (Davenport, 2006). These authors reiterate the importance of strategic innovation in the face of difficult financial decisions due to market uncertainty (Charan, 2008 and Oxelheim, 2006). While many researchers have examined the causal factors of raising more debt to pay off existing debt in companies which are highly leveraged, there is very little research carried out into the associated links between such leverage decisions and impending global economic crises (Bhimar, 2005). The author places emphasis on cost management in leveraging though some incisive insights have been developed in connection with strategic financing options in critical contexts (Jacobs and Chew, 2003). Some researchers have invariably focused attention on causal factors ranging from agency costs to information asymmetry in leverage decisions. However their efforts have been less focused on the diverse and dynamic causes associated with economic downturns (Megginson, 2008 and Talbott, 2009). Debt and equity in the capital structure of the firm is not necessarily determined by these causal factors alone. In the same vein associated outcomes have received much less attention except that there is a paradigm shift in analytical interpretations from endogenous variables to exogenous variables (Ghosh and Ariff, Ediotrs, 2004). Thus in this literature review determination of causes and outcomes would assume a multidimensional approach including corporate governance and sustainability issues. 3. Methodology 3.1. Primary research 3.1.1. Interviewing Data collection is one of the central challenges in any research project. It is the process through which the opinion of people are collected and categorised. There are many methods of collecting data such as interviews; questionnaires; documents and observations provide invaluable information that is used for policy decisions, marketing strategies, and academic studies etc (Miller and Salkind, 2002). Interviews are suitable when in-depth information is desired and this type of information is required in order to fulfil the purpose of this research. Therefore the interviewing research method will be followed in this paper. 3.1.2. Preparation of questionnaire This is the most important part in the planning of a sample survey, because a poorly designed questionnaire may ruin an otherwise well conducted survey. At this stage it is always advantageous to think in advance what variables and tabulations would be required for later analysis (Ganguin and Bilardello, 2004). It is advisable that a dummy tabulation plan should have been prepared in advance, if possible. This would ensure the inclusion of the information, which would be needed for the questionnaire. 3.1.3. Administration of Questionnaire Once the questionnaire is prepared it may be administered by three different methods. (i) Direct personal interviews. (ii) Email inquiry (iii) Telephonic conversation. In this case study all three methods were used. Most of the respondents were educated and co-operative and they realised the significance and importance of such a sample survey. The problem of non-response due to carelessness on the part of respondents is expected to be very large, though in the current survey such negligence was minimal. 3.1.4. Survey While statistical surveys are often carried out to collect quantitative information about items in a population sample, political and government related surveys of people and establishments are too common in health, social sciences and marketing. They are carried out with a particular purpose on mind, i.e. to investigate some facts or information. In the current research methodology, the researcher carried out a few surveys among the target audiences in order to determine the correlations, variances, co-variances and regressions. 3.2. Secondary research Secondary data was collected through an extensive research effort conducted both online and in libraries. The researcher extensively used the books written on the topic and also studied research journals, reports, graphs, articles, newspaper articles and so on. References were taken from most of the research material available in the field. This study depends mainly on the secondary material though. Correlations, regressions, variances and co-variances have been done with a significant emphasis on the associated risk factor of leveraging by EU companies in times of economic downturns. 4. Analysis or reflections In the EU both private and public sector firms are faced with the same amount of competition and regulation (Aliginger and Hutschrneiter, 2003). In other words any firm deciding to change the composition or the structure of its capital would have to face the same degree of competition in the environment where it operates irrespective of other external factors. On the other hand the current global economic downturn has quite a lot of implications for the firm’s decision making process (Mercado, Welford and Prescott, 2001). Highly leveraged firms tend to take greater risks by focusing on debt financing of its capital stock as against those less-leveraged high equity firms which prefer to be safe-players (Ceroin, 2007). Debt capital as against equity capital of the firm if correctly managed brings in fortunes by way of higher returns. This is probably the best alternative in times of an economic downturn (Weiner, 2005). The significance of borrowing more in order to finance the existing debt is nothing new but in the face of a global downturn it is more significant because there is a more radical set of exogenous variables that has a telling impact on the firm’s decision making concerning capital structure (Schmidheiny, 1998). EU corporate culture unlike the North American variety has been exposed to a highly regulated environment (Kim and Kim, 2006). Thus the significance associated with this regulatory environment’s impact on leverage decisions of the management cannot be played down. While many researchers have argued for a historically divided or phased out approach to the delineation of the evolutionary process of the capital structure’s growth, others have concentrated on the EU’s expansionary cycle (Moser and Schips, Eds, 2000). Either way there is much less said about the associated outcomes in respect of the environmental constraints (Krugam, 2008). For instance EU corporate response to the current economic downturn essentially impacts on the leverage decisions. Yet there are no established market metrics on the degree of response and its impact on the policy decision making process (Marvikakis, 2009). Further there is no clear idea about the degree of collectivity in responding to this external threat by EU firms. An aggregation of individual responses to determine the extent of convergence at different levels would be more feasible though. While a degree of divergence too has been noticed by this researcher there is no proper metric to decide on the level of its intensity either (Sharma, Starik and Husted, Eds, 2007). For instance, that not that all firms collectively respond to external stimuli in an equally collective fashion, is true. This tendency to respond to external stimuli in adopting individual strategic policy initiatives is not a new approach either (Cnossen, 2004). Recent EU statistics show that there is a clear divergence between those firms in the West and those in the East in responding to external economic stimuli (Tricker, 2009). The fear of risk and therefore debt is greater among East European managers while Western managers have a preference for risk which is associated with high returns (Laidi, 2008). In times of a recession which is characterized by two consecutive quarters of negative GDP growth in a year, high leveraging helps the management to pass some of the risk to third parties, viz. debt holders (Brealey, Myers and Marcus, 2002). Unlike shareholders they do not show any interest in the business except its performance and profitability. In this context, EU corporate response to economic recessions and leveraging decisions has something in common with organizational goals (Knoop, 2004). This researcher’s position as an independent freelancer in the field of research has a very little bearing on the outcomes though the position adopted by this researcher reflects on the work to a greater extent. Conclusion In strategic finance and leverage related decision making process of the EU corporate environment, there is very little certainty and still much less clarity as to overall outcomes (Smit and Kiekbeld, 2008). It’s against this backdrop that the EU corporate response to economic downturns has to be posited against the leverage decisions of firms (Mayer, 2004). Such leverage decisions tend to be biased in favor of more debt to pay off existing debt and all the more time and resource constrained in the face of burgeoning risk element. Coupled with the significance of the regulatory environment, the organizational outcomes along with corporate governance and sustainability issues play a very important role in determining the level convergence and divergence (Blewit, 2008). While convergence might not be collectively determined for a number of corporate entities, there is no gainsaying the fact that EU corporate culture is determined by its regulatory regime’s rigor (Wilson, 2009). Finally the macroeconomic environment of the average ERU firm is decidedly one in which its operational independence determines organizational outcomes so much (Basci, Togan and Hagen, 2007). REFERENCES 1. Aiginger, K. & Hutschrneiter, G. (2003) Economic Policy Issues for the Next Decades New York, Springer Publishing 2. Balling, M. & Lierman, F. & Mullinex, A. (2009) Competition and Profitability in European Financial Services, New York, Routledge. 3. Basci, E. (ed) & Togan, S. (ed) & Hagen, J.H. 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