Flexibility

MSc in Finance and International Business
Aarhus School of Business

University of Aarhus
Master thesis
July 2009
Financial flexibility and investment:
Evidence from the Warsaw Stock Exchange
Author:
Iweta Gdala, MSc student
Academic supervisor:
Tom Aabo, Associate Professor, PhD
July 2009
Declaration of independent work
Hereby I confirm that I composed this work on my
own, and that I did not use any other than the quoted
material and resources.
(IWETA GDALA)
Aarhus, 12 July 2009
ABSTRACT
Market imperfections establish a link between financing and investment decisions.
Financial flexibility can be viewed as the link that through accumulated internal funds and
external borrowing capacity enables a company an execution of growth options and
implementation of good NPV projects in a timely and competitive manner.
In this paper the relation between real and potential investment on one side and financial
flexibility and its components on the other side are investigated. Four hypotheses are
formulated and tested with the use of correlation analyses and a panel data methodology on
a balanced sample of 102 public companies traded on the Warsaw Stock Exchange in the
period between the year 2003 and 2008. Several interesting findings have been concluded.
Firstly, the results indicate no significant relationship between leverage ex ante and growth
opportunities or net capital expenditures ex post. Secondly, cash-rich companies are
perceived as having better growth prospects but it does not translate into higher investment
outlays in the following period. Thirdly, there is a mixed evidence on financial flexibility
building in high-growth states and before major real investment. Last but not least, debt
maturity is not negatively related to growth opportunities and net capital expenditures,
indicating that the contracting cost theory is not supported in the sample.
TABLE OF CONTENTS
ABSTRACT...................................................................................................................................... 4
TABLE OF CONTENTS................................................................................................................. 5
SUMMARY OF TABLES............................................................................................................... 7
CHAPTER 1 INTRODUCTION................................................................................................. 8
CHAPTER 2 LITERATURE FRAMEWORK........................................................................ 11
2.1 THEORY OVERVIEW................................................................................................... 11
2.1.1 IRRELEVANCE THEOREM...................................................................................................... 11
2.1.2 TRADE-OFF THEORY............................................................................................................. 11
2.1.3 FREE CASH FLOWS THEORY.................................................................................................. 12
2.1.4 THE MODIFIED PECKING ORDER THEORY............................................................................. 13
2.1.5 CONTRACTING COSTS THEORY AND DEBT MATURITY-RELATED PROPOSITIONS ................. 15
2.1.6 DEMAND FOR LIQUIDITY VS. FINANCIAL FLEXIBILITY......................................................... 16
2.1.7 FINANCIAL FLEXIBILITY EMERGENCE IN THE THEORETICAL LITERATURE .......................... 17
2.1.7.1 Survey findings .............................................................................................................. 17
2.1.7.2 DeAngelo and DeAngelos contribution........................................................................ 17
2.1.7.1 Gamba and Triantis contribution .................................................................................. 18
2.1.7.1 Other views on financial flexibility................................................................................ 19
2.1.8 SUMMARY OF THE THEORIES ............................................................................................... 20
2.2 EMPIRICAL STUDIES OVERVIEW................................................................................ 22
2.2.1 LEVERAGE AND GROWTH OPPORTUNITIES........................................................................... 22
2.2.2 LEVERAGE AND INVESTMENT EX POST................................................................................ 24
2.2.3 DEBT MATURITY AND GROWTH OPPORTUNITIES ................................................................. 25
2.2.4 DEBT MATURITY AND INVESTMENT EX POST....................................................................... 26
2.2.5 LIQUIDITY VERSUS GROWTH OPPORTUNITIES AND INVESTMENT EX POST .......................... 27
2.2.5.1 Sensitivities of investment to cash flows ....................................................................... 28
2.2.6 FINANCIAL FLEXIBILITY....................................................................................................... 30
2.2.7 SUMMARY OF EMPIRICAL STUDIES....................................................................................... 32
CHAPTER 3 EMPIRICAL ANALYSIS................................................................................... 34
3.1 RESEARCH CONTEXT AND HYPOTHESES DEVELOPMENT.......................................... 34
3.2 DATA........................................................................................................................... 35
3.3 VARIABLES ................................................................................................................. 36
3.3.1 DEPENDENT VARIABLES....................................................................................................... 36
3.3.1.1 Measuring real investment ............................................................................................. 37
3.3.1.2 Measuring potential investment ..................................................................................... 37
3.3.2 EXPLANATORY VARIABLES.................................................................................................. 39
3.3.2.1 Measuring leverage ........................................................................................................ 39
3.3.2.2 Measuring liquidity ........................................................................................................ 41
3.3.2.1 Measuring debt maturity ................................................................................................ 42
3.3.2.2 Financial flexibility........................................................................................................ 43
3.3.2.3 Control variables ............................................................................................................ 44
3.3.2.4 Descriptive statistics of the variables ............................................................................. 45
3.4 METHODOLOGY ......................................................................................................... 47
3.4.1 CORRELATION ANALYSES.................................................................................................... 47
3.4.2 PANEL DATA ANALYSIS........................................................................................................ 48
3.5 EMPIRICAL RESULTS.................................................................................................. 51
3.5.1 CORRELATION ANALYSES.................................................................................................... 51
3.5.2 GENERALIZED ESTIMATING EQUATIONS ............................................................................. 61
3.5.2.1 Leverage and real investment......................................................................................... 61
3.5.2.2 Leverage and growth opportunities................................................................................ 64
CHAPTER 4 CONCLUSIONS.................................................................................................. 67
4.1 INTERPRETATION OF THE RESULTS ........................................................................... 67
4.2 LIMITATION OF THE THESIS....................................................................................... 70
4.3 SUGGESTIONS FOR FURTHER RESEARCH................................................................... 71
BIBLIOGRAPHY.......................................................................................................................... 72
APPENDICES................................................................................................................................ 78
APPENDIX 1 - DESCRIPTION OF THE SAMPLE COMPANIES................................................................ 78
APPENDIX 2 - KEY FINANCIALS OF THE SAMPLE COMPANIES OVER THE PERIOD2003-2008 .......... 78
SUMMARY OF TABLES
Table I Summary of relevant theory implications ................................................................. 21
Table II Summary of relevant empirical results ..................................................................... 33
Table III Summary statistics for the variables ......................................................................... 46
Table IV Matrix of Pearsons correlations for the unadjusted sample..................................... 53
Table V Matrix of Spearmans correlations for the unadjusted sample.................................. 54
Table VI Matrix of Pearsons correlations for the industry-adjusted sample........................... 55
Table VII Matrix of Spearmans correlations for the industry-adjusted sample ....................... 56
Table VIII Matrix of Pearsons correlations for the individual-effect-adjusted sample............. 57
Table IX Matrix of Spearmans correlations for the individual-effect-adjusted sample .......... 58
Table X Partial correlations for the unadjusted sample .......................................................... 59
Table XI Partial correlations for the industry-adjusted sample ................................................ 60
Table XII Partial correlations for the individual effect-adjusted sample................................... 60
Table XIII GEE models with Leverage 1 and Leverage 2.......................................................... 62
Table XIV GEE Leverage 1 and 2 model for two growth groups (I classification).................... 64
Table XV GEE Leverage 1 and 2 model for two growth groups (II classification) .................. 65
Financial flexibility and investment: Evidence from the Warsaw Stock Exchange Page 8 of 87
Iweta Gdala
Finance and International Business
Aarhus University
CHAPTER1 INTRODUCTION
Financial flexibility is receiving a growing attention of academics and authors,
following survey results, which showed that the most important item affecting corporate
debt decisions is management's desire for financial flexibility (Graham and Harvey, 2001,
p. 218). Ranked higher by practitioners than corporate finance theory had predicted,
financial flexibility is gradually becoming the focus of theoretical and empirical studies.
Several issues have been examined in relation to financial flexibility: its impact on firms
capital structure, its function in the agency theory, its companys value enhancement
characteristics, interactions with growth opportunities, investment decisions, and real
options.
Depending on its definition, financial flexibility seems to play an important role in
explaining a few corporate finance casualties. For capital structure researchers, financial
flexibility (i.e. debt capacity preservation) emerges as a dominant force driving corporate
leverage decisions. According to De Angelo and De Angelo, for example, it is the critical
missing link for an empirically viable [capital structure] theory (2006, p. 1). Behavioral
financiers look at the agency costs of under- and overinvestment and see the financial
flexibility (i.e. ability to dynamically adjust capital structure in the future) as a way to
attenuate the principal agent conflict. Additionally, companys value may be enhanced if
it is able both to alter the leverage level in response to changing market or individual
conditions and investment distortions can be mitigated. Financial flexibility may increase
the value of real options in that it improves managements ability to capture growth
opportunities. Higher real options value may also translate into increased companys
worth, if investors expectations about the future growth are well perceived and reflected in
the stock price.
The term financial flexibility requires a clear definition, as several
interpretations have been used in the literature. The definition adopted in this thesis has its
roots in the modified pecking order theory and combines stockpiling of financial slack and
reserving borrowing power (Myers, 1984b, pp. 589), that is debt capacity, in anticipation
of future growth.
Financial flexibility and/or its components can be related to firms investment
activities if capital markets have frictions, external financing is costly or agency costs are
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present. This linkage between corporate financing and investment activities is investigated
in the thesis. The investing activity of companies refers to its two dimensions: real and
potential investment. Potential investment is defined as a growth opportunities set available
to a company at the beginning of a year (ex ante). Real investment is delineated as capital
expenditures incurred by a company in the following year (ex post) and directed at
growing firms asset base (in contrast to investment outlays intended to maintain firms
current asset base).
The intertemporal settings of the research are important as they designate the
direction of the cause and effect relationship between financing and investment decisions.
The design of the following thesis is aimed at investigating the impact of financing
decisions related to financial flexibility and its elements on investment decisions.
Companies that face future growth opportunities are expected to increase their financial
flexibility ex ante in order to meet the financial needs created by the capital expenditures.
The following hypotheses are the central focus of the paper:
1. Leverage ex ante is negatively related to real and potential investment ex post.
2. Liquidity ex ante is positively related to real and potential investment ex post.
3. Firms build financial flexibility to meet major real investment. Financial flexibility
changes are positively related to growth opportunities.
4. Debt maturity is negatively related to real and potential investment.
The research contributes to the existing financial literature in a several ways.
Firstly, to examine interactions between financial and investment decisions the study uses
an independent sample of companies. The large body of empirical work focuses on
developed markets, so inclusion of observations from different macroeconomic and
institutional environment such as that of Eastern Europe can bring new insights into the
problem or reinforce conclusions stated elsewhere. Secondly, the thesis attempts to tie
research on capital structure, cash holdings, investment and the recent literature on
financial flexibility. It provides a broad review of theories and empirical studies related to
the topic of financial flexibility. Thirdly, it undertakes the effort to formulate and test a
financial flexibility per se and its impact on real and potential investment
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The thesis proceeds as follows. Chapter 2 covers the theoretical background and
reviews relevant literature on the subject. In the next section an analytical work is
described in detail and statistical analyses are implemented. Chapter 4 summarizes the
results, identifies shortcomings of the work and sets possible future research directions.
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CHAPTER2 LITERATURE FRAMEWORK
2.1 Theory overview
2.1.1 Irrelevance theorem
Interactions between investment and financing decisions have been the central
issue of corporate finance studies since Modigliani and Miller (MM). In their seminal
article Modigliani and Miller (1958, pp. 291) attained that under perfect capital market
assumptions the capital structure of a firm is a matter of indifference. In other words,
financial and investment decision of companies are completely separable and changing the
financing mix will have no effect on firms value.
2.1.2 Trade-off theory
Since in the reality the MM assumptions do not hold, market imperfections
establish a linkage between financing and investment decisions and their interactions have
been studied at both theoretical and empirical level in the financial literature.
One set of such market imperfections contributing to importance of financing
decisions are debt characteristics, that is tax savings of interests on one hand and
bankruptcy and other borrowing restrictions costs on the other hand. As already noticed by
Modigliani and Miller (1958, 1963), despite the tax advantage of debt firms may prefer
other forms of financing because of costs associated with leverage, such as strict
limitations imposed by lenders on the maximum amount a firm can borrow relative to its
equity and the need for an emergency reserve of unused borrowing power (Modigliani and
Miller, 1963, pp.441). A company has a target debt ratio the long-run debt ratios around
which its actual debt ratio will fluctuate as it "alternately" floats debt issues and retires
them with internal or external equity (MM, 1963, pp. 441) and corporate financing
decisions are motivated by adjustments leading to the optimal financing mix.
The view that companies strive to maintain the optimal relation between the two
good and bad facets of debt is known as the trade-off theory of capital structure. It
states that companies weigh tax shields provided by debt interests against costs of leverage
and, as a result, there is an optimal capital structure for each firm.
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One of the papers that contributed to the discussion on the trade-off theory and the
same time laid foundation for deviations from it was Determinants of corporate
borrowing by Myers (1977). Myers started off with the assumption that a company is
valued as a going-concern and as such it is expected to keep engaging in new investments.
He divided firms value into two components: the value of assets already in place and the
present value of future growth opportunities. The assets-in place are more heavily financed
with debt than growth opportunities, as their nature gives creditors better protection than
the intangible value of discretionary future investments. Consequently, firms with many
growth opportunities and a modest assets base are expected to carry less debt than mature
low-growth companies.
2.1.3 Free cash flows theory
Another market friction that distorts MM irrelevance theorem is information
asymmetry. One way to incorporate its impact into capital structure decisions was
proposed by Jensen and Mecking (1974) in the so-called free cash flow theorem. They
discerned that corporate managers interests might not always be fully aligned to owners
interests if both groups were to maximize their utilities. The discrepancy of interests
combined with agents ability to directly influence companies operations can lead to
corporate actions that do not necessarily maximize firms value. Considering the superior
information of corporate management, Jensen and Mecking concluded that there was a
conflict inherited in the relationships between agents (managers) and principals
(shareholders and/or bondholders). The conflict which they called agency problem can
result in a loss to the corporate organization as compared to a sole ownership entity. The
loss known as agency costs include additional costs the principals must incur to
establish appropriate initiatives and to monitor the agents and the residual welfare
reduction caused by unrestricted divergence of agents decisions from those that would
maximize value to the principals.
As a consequence of the problems associated with separation of ownership and
control, investment and financing decisions are influenced.
In a corporation with potential agency issues debt is a means for disciplining
managers through reducing residual cash flows that are subject to their discretionary
disposal. Debt covenants also limit agents flexibility in reallocating companys wealth in
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their own or shareholders interests and allow to monitor managers actions. The agency
costs of debt will eventually be borne by corporations, as debtholders take them into
account and incorporate into the price for the financing provided. Managers anticipate the
costs and have initiative to minimize them in advance through e.g. providing detailed
financial statements to the public, hiring an independent auditor or through transparent
disclosure practices. Only then, the agency costs are lowest possible. Such prudent
managers behavior can also be awarded by increased confidence of investors who
perceive debt as a catalyst for agency problem.
The controlling role of debt can be interpreted in the context of investment
activities of a corporation. Companies with few investment opportunities and ample free
cash flows, which are subject to the above mentioned agency costs, may seek to overcome
the agency issue by employing more debt. Leverage may reduce investment activity of
corporations. This phenomenon has been labeled overinvestment problem and indicates the
positive relationship between leverage and firms value. Through the presence of debt in
companys capital structure managers are refrained from investing in projects that might be
detrimental to existing shareholders and bondholders but please agents empire building
ambition.
2.1.4 The modified pecking order theory
An alternative view on the impact of information asymmetry frictions of the
market on financing investment decisions has been proposed by Myers (1984b)
1
in his
modified pecking order theory. According to Myers (1984b) and Myers and Majluf (1984)
if the managers have superior information to investors and they act in shareholders best
interest then firms have good reasons to avoid issuing common stock. By avoiding equity
they prevent the dilemma of either passing by positive net present value projects or issuing
stock at price they think is too low. So if internally generated funds are insufficient and the
need for external financing arises managers would rather cover investment outlays with
1
The original pecking order hypothesis stems from the study by Donaldson in 1961 on financing practices of
a sample of large corporations, of which management had a string preference for internal resources as new
funds even to exclusion of external funds (after Myers, 1984b, pp. 581)
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new borrowing than issue new shares. Thus, in the world of imperfect information between
managers and shareholders companies preference for funds is the following: first internal
cash, then debt and at last equity. The assumption underlying the theory is that managers
goal is to maximize the wealth of shareholders and the shareholders-managers conflict is
not addressed in the pecking order theory.
There are a few important conclusions that can be drawn from the modified
pecking order. Firstly, an announcement of new equity issue indicates that the
management thinks the current price of company stock is overvalued and, thus, it would be
a negative sign to the market resulting in the stock price decline. Secondly, companies
build up financial slack or reserve borrowing power (Myers, 1984b, pp. 589), that is debt
capacity, in anticipation of future growth. Thirdly, companies whose investment
opportunities outstrip operating cash flows may forgo profitable projects rather than issue
equity or debt.
In his preceding paper on corporate borrowing Myers (1977) concluded that
companies that faced a material possibility of financial distress were likely to find it hard
to raise capital to fund promising new investments and a threat of underinvestment was
likely to limit the use of debt usage. The phenomenon of giving up good investments,
extended to information asymmetry settings in the pecking order theory, has been labeled
underinvestment problem of debt financing. The underinvestment problem implies a
negative relation between leverage and growth opportunities. The more debt overhang a
company is exposed to, the more profitable projects it will have to give up. It is important
to note, however, that this theory does not formulate conclusions for companies with poor
investment prospects.
Despite the early emphasis by Modigliani and Miller (1963) and recogntion as
important determinant of capital structure by the pecking order theory (Myers and Majluf
(1984)), financial flexibility had not been as vastly discussed as leverage in the financial
literature until recently. Modigliani and Miller used the terms an emergency reserve of
unused borrowing power (1963, pp.441) and the need for preserving flexibility (1963,
pp.442) for spare debt capacity and with no regard to cash. They viewed the unused
borrowing power as additional considerations while deciding on the optimal capital
structure that account for investment opportunities. Myers in his modified pecking order
theory included liquid assets into reserve borrowing power means (1984, pp. 589) and
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the so-called financial slack has become the first choice for managers deciding on project
financing. According to Myers and Majluf (1984, pp.14) the conventional rationale for
holding financial slack cash, liquid assets, or unused borrowing power is that the firm
doesn't want to have to issue stock on short notice in order to pursue a valuable investment
opportunity.
2.1.5 Contracting costs theory and debt maturity-related propositions
One more dimension of financial flexibility has paved its way in the literature that
is of significance for investment-financial flexibility interactions considerations of the
thesis. It is the view that financial flexibility matters not only because it meets the need to
raise funds but also because it allows to reduce leverage in future states of the world.
The link between investment decisions and the length of debt obligations is rooted
in the theory of agency costs. Myers (1977) recognized the importance of debt maturity in
the light of shareholders-bondholders conflict, known as the contracting costs theory.
Shortening debt maturing is a way to reduce agency costs that are responsible for
underinvestment. It implies that limiting the length of a debt contract and, as a
consequence, introducing a platform for contract terms renegotiations, may stimulate
investment activity. Another argument that amplifies the positive relation between short-
term debt and investment is that shareholders prefer short debt maturities so that they can
more fully capture investment benefits rather than pay them out to bondholders in the form
of interests.
Childs, Mauer and Ott (2005) extended Myers theory by introduction of financial
flexibility considerations. They defined financial flexibility as the ability to dynamically
adjust capital structure in the future (2005, pp. 668). By examining the interactions
between flexible financing and investment decisions in a model with stockholder
bondholder conflicts over investment policy they find that the financial flexibility
encourages the choice of short-term debt thereby dramatically reducing the agency costs
of under- and overinvestment (2005, pp. 667). According to Childs et al. both under- and
overinvestment is reduced with short-term debt and, therefore, the sign of the relation
between short-term debt and investments is not clear. Additionally, it is ambiguous how
maturity impacts leverage as it depends on the type of growth options available in the
firms investment opportunity set. If equity-value maximizing management faces the
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growth option that replaces assets-in-place with an underlying riskier asset, a firm with
dynamic debt will choose a larger initial debt level than a firm with static leverage because
the former has the flexibility to later reduce leverage. In contrast, when exercising the
growth option expands assets-in-place, a firm with dynamic debt is less aggressive with its
initial leverage choice because it has the flexibility to increase the debt level when the
growth option is exercised and its larger asset base can support a higher level of leverage.
(2005, pp.670). The authors conclude that overall financial flexibility significantly
increases firm value.
2.1.6 Demand for liquidity vs. financial flexibility
Keynes in his book The General Theory of Employment, Interest and Money in
1936 (pp. 153) distinguished three motives that lead for liquidity preference: (i) the
transactions-motive, i.e. the need of cash for the current transaction of personal and
business exchanges; (ii) the precautionary-motive, i.e. the desire for security as to the
future cash equivalent of a certain proportion of total resources; and (iii) the speculative-
motive, i.e. the object of securing profit from knowing better than the market what the
future will bring forth. The precautionary and the speculative motives resemble in fact
Modigliani and Millers need for preserving flexibility (1963, pp.442) but relate to liquid
assets rather than to reserve of untapped borrowing power. Consequently, maintaining
liquidity can contribute to financial flexibility. This view is recognized by the modified
pecking order theory, which emphasizes managerial preference for internal funds.
A interesting liquidity perspective by Kim et al. (1998) can shed more light on the
role of liquid assets for financial flexibility. Kim et al. established an optimal amount of
liquidity model incorporating the cost of external financing, the variance of future cash
flows, the profitability of future investment opportunities (which all increase the demand
for cash) and the rate of return on current investment opportunities (which decrease the
demand for cash). Despite the fact that cash is expensive, lack of sufficient internal funds
may trigger even higher costs in case of unexpected contingencies. Kim et al. (1998, pp.
336) conclude: the existence of capital market imperfections provides a rationale for
significant and predictable amounts of excess liquid asset holdings by firms. In particular,
if external financing is costly, then investment in liquid assets is an optimal response to
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having to seek costly external financing to fund future production needs. In other words,
financial flexibility, created through building liquidity, matters.
2.1.7 Financial flexibility emergence in the theoretical literature
2.1.7.1 Survey findings
The importance of the financial flexibility, somewhat ignored by theoreticians for
the next twenty years after the emerging of the pecking order theory, experienced a rebirth
after the publishing of Grahams and Harvey survey results (2001). The authors conducted
a comprehensive survey among 392 CFOs in the United States about cost of capital, capital
budgeting and capital structure. The results indicated that managements desire for
financial flexibility was the most important item affecting corporate debt decisions and it
was not driven by factors behind the pecking order theory (pp.218). The survey findings
have been confirmed by others, i.e. Bancel and Mittoo (2004), and Brounen et al. (2004).
2.1.7.2 DeAngelo and DeAngelos contribution
The survey findings was triggered by an emergence of theoretical and empirical
papers that included financial flexibility in their considerations. One of the most crucial
was the work of DeAngelo and DeAngelo (2006) who argued that that financial flexibility
is the critical missing link for an empirically viable theory of capital structure. They found
the pecking order theory incapable of producing a comprehensive framework for capital
structure decisions because its numerous restrictive assumptions narrowed its focus
sufficiently to preclude a meaningful analysis of the impact of financial flexibility on
corporate financial policies. Specifically, the pecking order theory falls short because it (i)
focuses on a one-shot financing decision, thus it rules out the inter-temporal trade-offs
that are central to firms debt capacity utilization decisions, (ii) assumes that asymmetric
information allows self-interested managerial behavior at security issuance, but at no
other time, thus it ignores the fact that asymmetric information also engenders agency
costs, i.e., it allows managers to benefit themselves at outside stockholders expense by
over-retaining corporate resources, (iii) assumes away any effect of corporate taxes on
optimal cash balances and debt levels, which is likely to be non-trivial, and (iv) ignores the
inherent interdependence of capital structure and equity payout policies, a factor which we
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show has important implications for how firms build, preserve, and draw down financial
flexibility over time. (2006, pp.2). According to the authors trade-off theories of capital
structure fare no better as they failed to incorporate financial flexibility.
DeAngelo and DeAngelo (2006) developed their own theory of capital structure
that linked the agency costs, tax on corporate cash holding, a dividend policy and the need
for securing future investment distortions and capital shortcomings, i.e. the need for
financial flexibility. Firms preserve low leverage ratios to store the unused debt capacity in
case of future unanticipated events. Cash holdings and retained cash flows come at cost as
they are subject to tax disadvantage, have high opportunity costs and they raise agency
problems. Instead of stockpiling expensive cash companies prefer to build free borrowing
power to satisfy the financial flexibility desire. In addition firms with ample cash flows
prefer paying out equity to shareholders than introducing more debt to capital structure, as
a good track of payouts adds up to investors confidence and increase security valuations.
In that sense the DeAngelos proposition is contrary to what Myers and Majlufs pecking
order theory proposed that companies pile up liquid assets. It also differs from what the
trade-off theory had to offer as managers are not (or are not predominantly) concerned with
interests tax shields and bankruptcy costs but rather they weigh cash holding and agency
costs against the financial flexibility needs. This theory explains the observed phenomena
of low leverage levels among all companies and seems to suit both growing and mature
corporate entities. Companies on a fast growth track avoid debt to reserve borrowing
capacity, keep more cash but too much not to induce agency problems. Mature firms
generating large cash flows do not resort to debt in order to mitigate agency conflicts and
overinvestment problems but rather they limit cash accumulation through dividends
distribution to owners.
2.1.7.1 Gamba and Triantis contribution
An important contribution to the literature and an attempt to value financial
flexibility in a more systematic way were undertaken by Gamba and Triantis (2008). They
focused entirely on the financial flexibility, which they defined as the ability of a firm to
access and restructure its financing at a low cost (2008, pp.2263). Financially flexible
firms are able to avoid financial distress and to fund investment when profitable
opportunities arise. Their most interesting findings are as follows:
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- the value of financial flexibility depends on taxes, growth opportunities,
profitability, and reversibility of capital;
- the effect of financial flexibility is large in the presence of growth opportunities
or/and in the state of low performance;
- high volatility in the firms profitability magnifies the value of financial flexibility;
- investment flexibility and financial flexibility are substitutes to some extent
conclusions supported by MacKay (2003) and Mauer and Triantis (1994);
- cash flow is frequently used to increase a firms liquidity even though investment
opportunities are perfectly correlated with cash flow.
2.1.7.1 Other views on financial flexibility
So far the financial flexibility has been presented as the corporate borrowing
capacity, leverage maturity structure and cash on hand the mix of financial resources that
allowcompanies to quickly adopt to unanticipated occurrences.
It is important to note that in the literature alternative definitions of financial
flexibility have been proposed. Trigeorgis (1993), for instance, examined interactions
between real options and financial flexibility, considering the latter to be a set of options
included in the contract with a capital provider, e.g. option to abandon by lender, options
to revalue later at potentially better terms by each party (Trigeorgis (1993), pp. 203). He
claimed that more advanced and more sophisticated forms of financing added value
(similar to real options) to an investment by creating valuable financial flexibility.
Singh and Hodder (2000) took a more multinational and tax perspective and came
up with an original definition of financial flexibility as a multinational corporations
ability to mitigate tax differentials and influence the costs of leverage by shifting income
and/or tax shields across subsidiaries (pp. 854). Similarly to others, they examined how
differing degrees of such ability impact firm value and capital structure decisions. They
found financial flexibility to have both complimentary and substitutive effects on leverage
and it that could increase value of a multinational if compared to single-country firm.
Jun and Jen (2003) found the financial flexibility to be one of determinants of debt
maturity in their trade-off model of an optimal leverage maturity structure. They
constructed and empirically approved a hypothesis that financially flexible firms
maintained shorter debt maturities. Their definition of financial flexibility involved a
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solid, high-cash inflows asset base that enabled companies to mitigate a risk of financial
distress and, thus, allowed to lower refinancing costs of debt. According to Jun and Jen the
asset mix that make the companies financially flexible has a rather short maturity because
their cash inflows mature earlier and can thus provide funds to repay shorter-term loans if
renewal cannot be obtained (pp. 13).
2.1.8 Summary of the theories
The following matrix summarizes major theoretical contributions in the context of
an impact of financial flexibility or other financial-flexibility-related factors, i.e. leverage,
liquid assets or debt maturity, on corporate real investment ex post
2
(capital expenditures in
the next time period) and growth opportunities, as predicted by the theories.
2
It is important to recognize that investment in time t+1 (ex post) is considered throughout the thesis.
Implications for investment in one period time are not equal to the ones for the current capital expenditures
and they can differ materially.
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Table I Summary of relevant theory implications
Investment
(ex post)
Leverage
(ex ante)
Liquidassets
(ex ante)
Debt maturity
(ex ante)
Financial flexibility
(ex ante)
Growth
opportunities
(ex ante)
Positive
Tobin's Q theory
Negative
Free cash flow theory (low-growth firms)
Pecking order theory (high-growth firms)
Unrelated
DeAngelo and DeAngelo
Positive
Pecking order theory
Kim, Mauer and Sherman
Negative
Contracting costs theory
Positive
Gamba and Triantis
Investment
(ex post)
Negative
Free cash flow theory
Unrelated
DeAngelo and DeAngelo
Positive
Positive
Childs, Mauer and Ott
(overinvestment problem)
Negative
Contracting costs theory
(underinvestment problem)
Positive
Gamba and Triantis
Leverage
(ex ante)
Positive
(asset expansion)
Negative
(asset substitution)
Positive
(asset substitution)
Negative
(asset expansion)
DeAngelo and De Angelo
Liquidassets
(ex ante)
Positive
Gamba and Triantis
Not significant
DeAngelo and De Angelo
Debt
maturity
(ex ante)
Positive
Negative
Jun and Jen proposition
Source: Own work
Iweta Gdala
Aarhus University
2.2 Empirical studies overview
The empirical work focused explicitly on financial flexibility and its impact on
growth and investment is in its infancy. However, there has been an extensive research on
two important aspects of financial flexibility debt (and its maturity structure) and
liquidity. The following review of the empirical literature is limited to the aspects of the
research that are relevant to the topic of the thesis.
2.2.1 Leverage and growth opportunities
All three major capital structure theories (trade-off, free cash flows, pecking order)
have been widely tested but none has established an absolute supremacy. Empirical results
are mixed and ambiguous. To review all existing research in this field is beyond the scope
of this work. Important to this study is, nevertheless, the fact that in Poland tests of capital
structure indicate dominance of the pecking-order-style financing decisions. Skowroski
(2002), Campell and Jerzemowska (2001), Gajdka (2002) and recently Mazur (2008) all
confirmed the preference for internally generated funds among corporations in Poland.
Most empirical studies indicate a negative sign of the correlation between a growth
opportunities set and debt, as predicted by the free cash flow theory for low-growth firms
(overinvestment mitigation) and by the pecking order theory for high-growth companies
(underinvestment problem). Some examples of supportive tests for the negative debt-
growth opportunities relation are the following:
- Smith and Watts (1992) investigated the link between the investment opportunity
set, regulation and firm size on the one hand, and firms financing, dividend and
executive-compensation policies on the other. They observed that high-Q firms
had lower leverage ratios at the significance of 0.001, which was consistent with
the theory that firms with lower assets-in-place base (as proxied by low book
value of assets) carry less debt.
- Kim and Stulz (1995) showed that firms with valuable growth opportunities are
more likely to issue equity when they raise external funds.
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- Minton and Wruck (2001) found that financially conservative firms, as they defined
the bottom 20% of companies with lowest long-term debt to total assets in their
sample, had higher market-to-book ratios than the other firms.
- Johnson (2003), Barclay et al. (2003) and Billett et al. (2007) examined the impact
of growth opportunities upon the initial joint choice of leverage and debt maturity.
They showed that high-growth firms adopted low-leverage and/or short-debt
maturity policies in order to control the agency problems caused by outstanding
risky debt. Further, according to Johnson (2003) these policies could be
considered as strategic substitutes in that the use of (short) debt maturity
attenuated the negative effect of growth opportunities upon leverage.
- Hennesys (2004) empirical results were supportive for underinvestment problem
of debt. He tested the impact of leverage in a dynamic real options framework and
observed that debt overhang distorted not only the level but also composition of
investment, as it became biased against investment in long-lived assets.
- Dang (2007) tested the impact of debt on growth opportunities of the sample of 670
UK firms in the years 1995-2003. He also provided evidence that higher debt
ratios were associated with lower MBA ratios and that firms with valuable growth
opportunities controlled the underinvestment problem by reducing leverage.
In the financial literature there are also some examples of empirical outcome that
indicate positive or no or not significant correlation between leverage and Tobins Q.
McConnell and Servaes (1996), for example, studied the relation between corporate value,
leverage, and equity ownership on a large sample of U.S. firms. They confirmed the above
affirmative results for underinvestment problem but only for firms with high Q-ratios.
Companies with few good NPV projects exhibited a significant positive correlation with
debt. The results were robust using an alternative P/E-related classification into high/low-
growth groups.
The empirical work conducted by Pandey and Chotigeat (2004) is interesting and
relevant to the Polish context of the thesis, as the authors tested corporations operating in
the emerging markets, as contrary to the developed-country settings of the above research.
They analyzed 106 Malaysian companies in the years 1992 1999 and found: 1) no
statistically significant correlation between Tobins Q and all types of debt (short-term,
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long-term, and total); 2) prevalence of low debt ratios and 3) the pecking order style
dominated financing policies.
2.2.2 Leverage and investment ex post
The influence of leverage at the beginning of the period on capital expenditures ex
post is expected to be negative in the light of under- and overinvestment problems. The
empirical tests were conducted by:
- Lang et al. (1996) investigated interdependencies between different measure of
leverage in time 0 (ex ante) and investment in time 1 (ex post) for both core and
non-core business segments of 142 firms over the period of 20 years. They found
that the relation between investment ex post and debt was negative and
statistically significant for low-growth firms (with Tobins Q less than one) but
not significant for high-growth firms (Tobins Q>1). This was true for both core
and non-core business segments. Lang et al. (1996, pp.18) concluded that
leverage should have a negative effect on investment growth for firms doing
poorly because of a lack of recognized investment opportunities, poor managerial
performance, or other reasons. The cost of capital of these firms increases with
their leverage because, in contrast to firms with valuable investment opportunities,
it is not clear that funds raised externally will be used profitably.
- Aivazian et al. (2005a) used a similar methodology to that of Lang et al. (1996) but
extended to panel data settings and on an independent sample of 863 Canadian
publicly traded companies for the period between the years 1982 1999.
Similarly, they showed that leverage was negatively related to investment and that
this negative effect was significantly stronger for firms with low growth
opportunities than those with high growth opportunities. They concluded that the
results provided support to agency theories of corporate leverage, and especially
the theory that leverage has a disciplining role for firms with low growth
opportunities.
- Dang (2007) was consistent with the above research in that his results revealed a
significantly negative coefficient on leverage in the investment equation but only
for low-growth firms. He suggested that leverage exerted a negative and
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disciplining effect upon investment ex post if management showed propensity to
overinvestment.
- Marchica and Mura (2006) investigated a sample of UK companies to check for the
link between investment and financing decisions. They found that low-leveraged
firms, classified according to their lower than the debt ratio predicted by their
model, were able to investment more in the following periods. An average firm
could increase its investment by more than 50%. The authors also observed that
firms tended to respond to financial constraints by decreasing their leverage, thus,
building their financial flexibility.
2.2.3 Debt maturity and growth opportunities
Myers (1977) predicted a negative sign of the relationship between growth
opportunities and debt maturity as a result of firms effort to mitigate the underinvestment
initiative that is associated with debt overhang. This contracting costs theory seems to have
a balanced number of proponents and opponents. The following empirical research
supported the theory:
- Barclay and Smith (1996) regressed the percentage of debt that matures in more
than three years is on U.S. firms market-to-book ratio, a dummy variable for
firms in regulated industries, the natural log of firm value, future abnormal
earnings, and the risk-free term structure. Their results provided strong support for
Myerss propositions.
- Guedes and Opler (1995) exercised an incremental approach in their attempt to
examine the determinants of debt maturity structure for 7,368 public debt issues
made by U.S. corporations between 1982 and 1993. They found, among others,
that firms which had above average growth prospects were most likely to issue at
the short end of the maturity spectrum, which also supports Myers view again.
- Barcley et al. (2003) examined data for over 5000 industrial firms over two decades
and found market-to-book ratio and debt maturity and level follow the Myers
pattern of dependencies. Thus, more growth options in the investment opportunity
set cause the firm to reduce leverage and reduce its fraction of long-term debt.
Similar results reported Johnson (2003) and Billet (2007).
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Aarhus University
The contracting costs theory has been challenged by the following researchers:
- Sherr and Hulburt (2001) focused on debt maturity structures of small companies
and provided contrasting results. They didnt detect any significant and consistent
relation between growth options measures (but not proxied by the MBA ratio as
the majority of sample firms were not publicly traded) and debt maturity, despite
the supposedly higher potential for growth options among smaller firms.
- Stohs and Mauer (1996) tested 328 companies on their debt maturity structures but
didnt provide results consistent with Myers. The coefficient estimates on the
market-to-book ratio were either insignificant or had a positive sign, suggesting
that long-term debts share in corporate capital structure increases with growth
opportunities availability. The authors argued that the Barclay and Smith debt-
maturity regressions were misspecified because they did not control for
differences in leverage.
- Anotoniou et al. (2006) performed a test on differences in debt maturity structure of
European companies from France, Germany and the UK. Their results revealed
that the MBA ratio, as a proxy for growth opportunities, had no significant effect
on debt maturity of firms operating in any of the sample countries (except some
evidence of support in Germany prior to 1992) and they refuted the contracting
costs hypothesis.
- Dang (2007) found that growth did not exert any significant effects upon debt
maturity.
2.2.4 Debt maturity and investment ex post
Debt maturity should have the same implications for investment ex post as it has
for growth opportunities if the contraction costs theory holds. Childs et al (2005) predicted
mixed relations, dependent on a type of growth options owned by a company. Empirical
outcome is rather inconclusive.
The presumption by Myers was partially confirmed by Aivazian, Ge and Qiu
(2005a). They showed that debt maturity structure influenced firms investment decisions
but only for companies that had high growth opportunities. In their analysis it is not the
nature of growth options that determines the investment-debt maturity relations (as it was
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the case in Childs et al.) but rather growth opportunities availability made the impact of
leverage structure significant. A higher percentage of long-term debt in total debt
significantly reduced investment for firms with high growth opportunities.
Dang (2007) denied the significance of the relation between debt maturity and
investment for his entire sample of 670 firms.
2.2.5 Liquidity versus growth opportunities and investment ex post
Availability of internal funds is expected to positively impact growth, as it allows to
effectively capture an option if an attractive investment opportunity arises. A similar logic
is expected to imply a positive investment-cash relationship.
Kim et al. (1998) built on their model of optimal liquidity under costly external
financing and conducted an empirical analysis that proved their models predicting power
for the U.S. industrial companies. They found that firms with larger market-to-book ratios
had significantly larger positions in liquid assets.
Opler et al. (1999) examined the determinants of corporate holdings of cash and
marketable securities among publicly traded US firm from 1971-1994. They found that
firms with strong growth opportunities held more cash than other companies and
concluded that it was consistent with the view that firms held liquid assets to ensure that
they would be able to keep investing when cash flow is too low, relative to investment, and
when outside funds were expensive. However, they failed to support the view that positive
excess cash lead firms to spend substantially more on investment or acquisitions
(1999, pp. 44).
Pinkowitz and Williamson (2001) compared determinants of cash holdings in
United States, Germany and Japan. They found that the cash level of firms was increasing
with growth opportunities, cash flow/net assets, and R&D/sales for the full sample of all
countries. When they ran three separate regressions, the positive MBA ratio-cash remained
unchanged but Japan firms exhibited a significant and negative relation between capital
expenditures and cash holdings.
Ozkan and Ozkan (2002) investigated the empirical determinants of corporate cash
holdings for a sample of UK firms over the period 1984-1999. The results revealed that
growth options exerted a positive influence on cash holdings and the higher the cash level
the lower the leverage in firms capital structure.
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Aarhus University
Mikkelson and Partch (2003) studied a sample of 89 U.S. firms that maintained
large cash holdings and compared their sample to the other companies. They observed that
the sample firms held much larger MBA ratios, lower leverage and higher capital
expenditures (in particular on R&D projects) than their cash-poor benchmarks. Similar
results in regards to higher MBA ratios and higher investments were reported by Dittmar et
al. (2003) who examined a large international sample of 11 000 firms.
The results of Arslan et al. (2006) are of particular importance for the thesis for
several reasons. Firstly, the authors focused on an emerging market and Turkish companies
publicly traded the Istambul Stock Exchange over 1998-2002, which may make the results
more comparable to the outcome from the Polish market. Secondly, they classified the
companies into financially flexible or financially unconstrained on the basis of their firms
cash balance status, predicted by a model of optimal cash holdings. Although their
definition of financial flexibility did not include debt capacity and it differs from the
definition adopted in this thesis, the results of their work give some insight into the relation
between cash, short-term debt, investment and growth options. The authors found that
growth opportunities and cash holdings were positively and significantly correlated, which
is consistent with the argument that cash rich firms usually have greater financial
flexibility to exploit investment opportunities when they arise. Cash reserves and external
short term debt proved to work as substitute sources for financing corporate investment.
Finally, the results did not point to a significant relation between growth opportunities and
investment for the sample of firms.
Ramezani and Soenen (2007) ran regressions on cash holdings and found that
increases in cash holdings are associated with increased Tobins Q, capital expenditures,
R&D investments and decreased debt ratios.
2.2.5.1 Sensitivities of investment to cash flows
The positive relation between investment to cash flows is well documented in the
financial literature. To a different degree but persistently the pattern of capital expenditures
has proven to follow a flow of generated funds for most companies, regardless of their
individual or group characteristics. Although the relation seems unquestionable, the its
determinants are subject to different interpretations. A dispute has been evoken by
academnics whether financial constraints lessen or magnify the correlation between cash
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flows and investment or whether high investment outlays sensitivity to cash flows
describes financially constraint or unconstraint corporations.
Below a few important contributions to the large body of tests are presented:
- Fazzari et al. (1988) empirically supported the view that investment was positively
influenced by cash flows and balance sheet measures of liquidity. The impact of
these financial factors on investment was magnified at times when capital market
information problems were likely to be most severe for high-retention firms.
Consequently, financially contraint firms had investments that are more cash-
flow-sensitives.
- Gilchrist and Himmelberg (1995), like the previous researchers, confirmed the high
correlation of cash flows and other measures of internal funds with investment
after controlling for the fact that rising profits might signal investment
opportunities.
- Kaplan and Zingales (1997) questioned the results of Fazzari et al. (1988) that
investment-cash flows sensitivities provide useful measures of financial
constraints
3
and found, contrary to previous evidence, that investment decisions of
the least financially constrained firms were the most sensitive to the availability of
cash flow. Similar conclusions were drawn from an empirical analysis conducted
by Cleary (1999).
- Kadapakkam et al. (1998) found a positive correlation between investment and cash
flows in firms in six OECD countries (Canada, France, Germany, Great Britain,
Japan and the United States). They also found that smallest companies had
investments less cash-flow-sensitive than large corporations.
- Pawlina and Renneboog (2005) investigated the investment-cash flow sensitivity of
a large sample of the UK listed firms and confirmed that investment was strongly
cash flow-sensitive and found that the sensitivity resulted mainly from the agency
costs of free cash flows.
3
Kaplan and Zingales (1997) did not question, however, the overall positive impact of cash flows on
investment.
Iweta Gdala
Aarhus University
2.2.6 Financial flexibility
Although a vast empirical literature on the financial flexibility-related factors, like
leverage, cash or debt maturity, has emerged, there is no systematic approach as to how to
measure financial flexibility while performing a test on its implications. Different authors
apply various definitions and measures, which negatively affect comparability of results.
Among the few researchers that focused on financial flexibility in their empirical work
on non-financial companies are Minton (2001), Byoun (2008), Dang (2008), Marchica and
Mura (2009), Jun and Jen (2003), Garcia-Teruel and Martinez-Solano (2007).
Minton (2001) studied financially conservative companies, i.e. under-leveraged
firms [that] carry substantially less debt than predicted by dominant theories of capital
structure (pp. 1). He found that financially conservative corporations seemed to
stockpile financial flexibility, that is tap into unutilized debt capacity when internal
funds fall off and/or to undertake discretionary expenditures. The evidence supported the
modified pecking order theory. Financially conservative firms proved to have higher
market-to-book values, suggesting a positive relation between growth opportunities and
financial flexibility.
Byoun (2007 and 2008) followed DeAngelo and DeAngelo (2006) in their
proposition that firms could develop potential sources of future financial flexibility through
cash accumulation, the preservation of debt capacity, and equity payouts. He focused on
the interplay between size, leverage, retained earnings and cash. Byoun confirmed that
firms with negative retained earnings were more likely to issue equity to build up cash
holdings in order to preserve financial flexibility and hence have low leverage. The
corollary to this hypothesis is that cash holdings will be negatively associated with
leverage (2007, pp.4).
In the latter paper of 2008 Byoun developed and empirically tested a more
generalized hypothesis: Small developing firms with negative or low earned capital,
negative or low operating cash flows, higher cash holdings, no dividend payouts and no
credit ratings are in the most need of financial flexibility and hence issue more equity and
maintain lower leverage ratios. Growing firms with mediocre earned capital, mediocre
cash flow to value ratios, low cash holdings, low dividend payouts and low credit ratings
issue debt and hence maintain high leverage ratios. Large mature firms with large earned
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capital, large cash flow to value ratios, moderate cash holdings, large dividend payouts
and high credit ratings mainly rely on internal equity and safe debt, and maintain
moderate leverage ratios (pp. 16). Byoun, thus, suggested an inverted U-shaped
relationship between leverage ratio and financial flexibility.
Dang (2008) took into account financial flexibility while examining leverage, debt
maturity and investment interactions and found that liquidity risk and financial flexibility
considerations played a more important role than underinvestment incentives in
determining the firms joint choice of leverage and maturity ex ante.
Marchica and Mura (2009) tested the hypothesis that a conservative leverage
policy directed at maintaining financial flexibility could enhance investment ability.
Financially flexible firms were defined as having debt that was below the level predicted
by a leverage equation. The leverage model followed Flannery and Rangans specification
that used a number of generally accepted factors to capture the targeting behavior of firms.
A conservative (financial flexibility orientated) policy was delineated by negative
deviations from estimated target leverage of 10% or more for a given period of time.
If valuable growth options are anticipated by a company, it pursue the policy of
low leverage to build a borrowing capacity for a number of consecutive years . The
conservative debt policy allows for higher capital expenditures in the years to come.
Marchica and Mura provided evidence that an average company that maintained a low
leverage policy for 3 years could increase its capital expenditures by around 34%. Further,
their tests showed that the longer the period of conservative debt policy, the lower the
economic impact of financial flexibility on the firms investment ability. Moreover, they
found financial flexibility of firms to be value-enhancing.
Jun and Jen (2003) tested an impact of financial flexibility (i.e. an attribute of a
solid, high cash-inflow assets mix on corporate debt maturity structures of over 5134
companies. They used two proxies for financial flexibility average maturity of assets,
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expected to measure the level of cash inflows derivable from total assets
4
, and leverage
ratio
5
, expected to proxy for the collateral value of assets to back up each dollar borrowed.
The smaller both proxies the higher financial flexibility. Jun and Jen found the coefficient
of average maturity of assets and of leverage ratio both significant and positive and
concluded that firms with higher financial flexibility would use more shorter-terms loans.
Garcia-Teruel and Martinez-Solano (2007) confirmed the results of Jun and Jen
(2003) on positive dependencies between short-term debt and financial flexibility using the
same approach for financial flexibility variable and a sample of small Spanish companies.
2.2.7 Summary of empirical studies
The following matrix presents a review of major correlations among flexibility, its
related components, real and potential investment, as reported by major empirical findings.
The correlation table is not intended to provide all of empirical tests in this field but should
rather be considered as an indicator of major trends in the literature with a few important
examples of empirical work.
4
Average maturity of assets was formulated as:
1
Re
_ _ _
Re
_
& , Pr
4 3 2 1
+
|
|
.
|
+ + + = w
netSales
ceivables
sold goods of Cost
Inventory
w
netSales
ceivables
w
on Depreciati Annual
Equipment Plant operty net
w AMAS
, where
w1 is the share of net Property Plant and Equipment in Total Assets
w2 is the share of Receivables in Total Assets
w3 is the share of Inventories in Total Assets
w4 is the share of (Current Assets minus Cash) in Total Assets
5
Leverage ratio = book value of current liabilities plus long-term debt / book value of total assets
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Table II Summary of relevant empirical results
Investment
(ex post)
Leverage
(ex ante)
Liquidassets
(ex ante)
Debt maturity
(ex ante)
Financial flexibility
(ex ante)
Growth
opportunities
(ex ante)
Positive
Malkiel et al.(1979),
Schaller(1990), Hayashi/
Inoue(1991), Lang et al.
(1996), Blose/ Shieh(1997),
Kalyvitis(2006),
Dang(2007)
Unrelated
Arslan et al.(2008)
Positive
for low-growth firms: McConnell/ Servaes(1995),
Michaelas et al.(1999)
Negative
for high-growth firms: McConnell/ Servaes(1995),
Johnson(2003), Billett et al.(2007); for all: Minton/
Wruck(2001), Barcley (2003), Hennessy(2004),
Eldomiaty(2007), Dang(2007), Byoun(2008)
Unrelated
for Malesian firms: Pandey/Chorigeat(2004)
Positive
Kimet al.(1998), Opler et al.(1999),
Minton/Schrand(1999),
Pinkowitz/Williamson(2001),
Mikkelson/Partch(2002),
Dittmar et al. (2002), Ozkan/Ozkan(2004),
Arslan et al.(2006), Ramezani/Soenen(2007)
Negative
Barclay/ Smith(1995), Guedes/
Opler(1996), Barclay et al.(2003),
Johnson(2003), Jun/Jen(2003)
Billet et al.(2007)
Positive
Stohs et al.(1996)
Unrelated
Scherr/ Hulburt(2001), Dang(2007),
Antoniou et al.(2006)
Positive
Minton (2001)
Dang (2007)
Investment
(ex post)
Negative
for low-growth firms: Lang et al.(1996),
Dang(2007)
for high and low-growth firms:
Aivazian et al.(2005a), Marchica/Mura (2009)
with R&D expenditures: Byoun (2007)
Unrelated
for high-growth firms: Lang et al.(1996)
Positive
Fazzari et al.(1988), Mikkelson/
Partch(2002), Dittmar et al. (2003), Arslan et
al.(2006), Ramezani/ Soenen(2007),
U.S.&Germany:Pinkowitz/Williamson(2001)
Negative
Japan: Pinkowitz/Williamson(2001)
Unrelated
Opler et al.(1999)
Negative
for high-growth firms:
Aivazian et al.(2005b)
Unrelated
for low-growth firms:
Aivazian et al.(2005b)
for all: Dang(2007)
Positive
Byoun (2007)
Marchica/ Mura(2009)
Leverage
(ex ante)
Negative
Fazzari et al.(1996),Kimet al.(1998), Opler et
al.(2001), Minton/ Wruck(2001), Ozkan/
Ozkan (2004), Marchica/ Mura(2009),
Byoun(2007), Ramezani/ Soenen(2007)
Positive
for small firms: Faulkender (2002)
Positive
Elyasiani (2002),
Barclay et al.(2003),
Johnson(2003), Marchica/
Mura(2009), Dang (2007)
Negative
Mitchell (1993)
U-shaped
Byoun(2008)
Liquidassets
(ex ante)
Negative
Antoniou et al.(2006)
Positive
small firms: Byoun(2008)
Marchica/Mura(2006)
Debt
maturity
(ex ante)
Negative
Jun/Jen (2003)
Garcia-Teruel/ Martinez-
Solano(2007)
Source: Own work
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CHAPTER3 EMPIRICAL ANALYSIS
3.1 Research context and hypotheses development
The existing theoretical and empirical literature suggests (sometimes without
naming it directly) that financial flexibility maintained in the form of borrowing capacity
reserves or increased liquidity can enhance firms potential or real investment. Corporate
actions that can be observable in the advent of profitable ventures include building and
owing increased cash balances or/and storing debt capacity in anticipation of future capital
requirements. Among characteristics of growing entities expected are lower debt ratios
and/or higher cash balances.
As most research has been conducted either on U.S., U.K. or other Western sample
companies, there is little evidence
6
that the above relations hold in other marketplaces,
such as emerging economies
7
. Poland is an emerging Central-Eastern European country
that has experienced a rapid growth in recent years and as such it has been subject to
increased investment activity. On average Polands GDP and investment outlays had been
growing at 5,14% and 10,5% respectively
8
between 2003 and 2007. Another important
characteristics of the Polish business environment in this period was an ease of debt market
access. Historically, since the start of the Polish free market economy, Polish corporations
experienced constrained credit market conditions. Polands EU accession and global warm
embracement towards debt at that time allowed participants on Warsaw Stock Exchange to
use leverage more freely than before.
The aim of this research is to investigate the interplay between financing and
investment decisions in the context of the Polish market between the years 2003-2008. In
particular, the following hypotheses are to be tested and form the core of the thesis:
6
It is possible that some empirical studies in other markets are distributed locally and are not documented in
the English literature.
7
The exceptions are e.g. papers of Arslan et al.(2006), Pandey and Chotigeat (2004), Mazur (2008).
8
Statistical Yearbook of the Republic of Poland 2008, Central Statistical Office.
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Hypothesis 1:
Leverage ex ante is negatively related to real and potential investment ex post.
The companies that exhibit high debt ratios at the beginning of a year have lower
net capital expenditures in the following period. Debt overhang also suppresses future
growth possibilities as it limits companys ability to exercise its growth options.
Hypothesis 2:
Liquidity ex ante is positively related to real and potential investment ex post.
Accumulated cash holdings give companies ability to efficiently capture growth
opportunities and translate into higher growth component of their value. Higher liquidity at
the beginning of a year encourages increases in net capital expenditures ex post.
Hypothesis 3:
Firms build financial flexibility to meet major real investment. Financial flexibility
changes are positively related to growth opportunities.
Financial flexibility measure is a derivative of debt capacity and liquidity.
Companies, which anticipate higher net capital expenditures and are perceived by a market
as having a better growth opportunities set, are expected to build financial flexibility
through adjustment of the its two components over time.
Hypothesis 4:
Debt maturity is negatively related to real and potential investment.
Managers of growing companies shorten debt to attenuate underinvestment and the
agency costs between shareholders and bondholders. As a result, lower share of long-term
debt is associated with higher net capital expenditures and better growth prospects.
3.2 Data
The sample consists of 102 public non-financial companies, traded on Warsaw
Stock Exchange before 1 of January 2003 and with a traceable history of quotations
between 1 of January of 2003 and 31 of December 2008 and available financial data.
Financial information for the sample firms include six reporting periods (2003-2008),
which with the lagged variables gives five years observations. Excluded from the sample
are financial companies as they are subject to specific, incomparable regulations that
highly influence their financial and investment decisions. A brief description of sample
companies is included in the Appendix I.
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The sample size is guided by the availability of data. The size and time selections
are a trade-off choice between a number of companies against a length of the observation
period. The Warsaw Stock Exchange is a relatively young Eastern European stock
exchange started in 1991, currently hosting about 375 firms but having gone through a
rapid growth first after Polands European Union accession in May 2004. In the years
following the accession the number of traded companies has almost doubled. The choice of
six-yearlong observations and 102 companies seems reasonable as it considers both a
sizeable group of companies and a meaningful number of years.
The sample is smaller than data used in many similar U.S. and U.K. research
9
, as it
is restricted by the size of the market and shorter history of the open market economy in
Poland. Of comparable size is the data pool constructed by Andres-Alonso et al. (2005)
who tested the real options value determinants on 101 Spanish public companies between
the years 1991and 1997 or Pandey and Chotigeat (2004).
To avoid the effect of outliers, the observations are winsorized following Cleary
(1999), Aivazian et al. (2005a) and Dang (2007). This approach allows limiting the impact
of extreme observations on results without the need to reduce the sample size. The final
sample includes the panel of 510 balanced firm-year observations. Financial data are
derived from Reuters.
3.3 Variables
This section provides justifications for each variable included in the analysis in the
context of the major theories of capital structures and financial flexibility.
3.3.1 Dependent variables
The empirical analysis is to provide evidence of the impact of financial flexibility
and its components (leverage and liquid assets), on two categories real and potential
investment. Potential investment refers to growth options available to a company and real
9
For example Aivazian et al. (2005b) used an unbalanced panel of 6231 observations of 863 firms between
1982 to 1999, Lang et al. (1996) constructed a sample of 142 companies between 1970 and 1989, Minton and
Wruck had a final pool that contained 5,613 unique firms and 46,675 firm years of data.
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investment is a term used to describe actual ex post capital expenditures undertaken by a
firm in the following period.
3.3.1.1 Measuring real investment
In the analysis real investment is represented by net investment. The net
investment represents the excess investment activity ex post (+1 year) that captures
capital outlays over the expenditures directed at maintaining the current asset base
(approximated by depreciation). An advantage of this approach is its incremental feature
that eliminates regular, non-growth investments associated with activities preventing assets
already in place from their economic impairment. A drawback of this measure is imperfect
approximation of economic depreciation by accounting figures, which may deviate from an
economic reality if for instance companies engage in an aggressive accounting practice
to take advantage of tax savings provided by accounting depreciation. To partially
attenuate this effect and possible non-comparability of financials resulting from changes in
accounting rules the financial data from most updated and restated reports are incorporated
into the analysis.
Following Lang et al. (1996), Aivazian (2005a,2005b) and Dang (2007) the net
investment variable is specified as capital expenditures minus depreciation in year +1,
scaled by net fixed assets in year 0.
t
t t
t
Assets Fixed Net
on Depreciati Capex
Investment Net
_ _
_
1 1
1
+ +
+

=
3.3.1.2 Measuring potential investment
Potential investment refers to all the good NPV projects available to a company
that can be translated into a future growth if exercised. A growth factor is included in
almost every leverage or investment equation. As investment opportunities are typically
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unobservable, various measures are present in the literature
10
. The most popular proxy for
growth opportunities is Tobins Q, approximated by the ratio of market value of assets to
book value of assets (MBA ratio). In the original Tobins Q there is a replacement value of
assets instead of its book value in the denominator. However, most researchers
11
and the
author of this thesis utilize the book value approach, as accounting figures are easily
observable in contrast to replacement values. Moreover, Perfect and Wiles (1994) showed
that Tobins q and the MBA ratio were highly correlated (the correlation coefficient was
about 0.96). Additionally, Adam and Goyal (2008) found the MBA ratio to be the best
performing proxy that had the highest information content with respect to investment
opportunities, better than the following: market-to-book equity ratio, the earningsprice
ratio, the ratio of capital expenditures over the net book value of plant, property, and
equipment.
In the following analysis the potential investment variable is specified after
Aivazian et al. (2005b) as a ratio of market value of a firm to book value of assets. The
market value of the firm is calculated as the sum of total liabilities and the value of
common stock as of the end of every year 0 in the testable period. As preferred stocks were
almost nonexistent on the Polish market between 2002 and 2008, they didnt add up to
market values of the sample firms.
t
t t
t
Assets Total of value Book
s Liabilitie Total tion capitaliza Market
ratio MBA
_ _ _ _
_ _
_

=
MBA ratio in time 0 is expected to be positively related to net investment in time
1, as it represents a set of growth options, some of which are be exercised and become real
investment.
10
Examples of definitions include, among others, percentage change of total assets, percentage change of net
revenues from sales, long term investment/total assets (Mazur, 2008), net investment in year + 1 divided by
the book value of fixed assets in year 0, growth rate of real capital expenditures (Lang et al.,1996).
11
For example: Smith and Watts (1992), Barcley and Smith (1995), Stohs and Mauer (1996), Guedes and
Opler (1996), Jung, Kim and Stulz (1996), Minton and Wruck (2001), Pinkowitz and Williamson (2001),
Johnson (2003), Aivazian et al. (2005a, 2005b), Antoniou et al. (2006), Byoun (2007), Ramezani and Soenen
(2007), Dang (2007), Arslan et al. (2008) and others.
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3.3.2 Explanatory variables
The aim of the empirical analysis is to find the relation between financial
flexibility and real and potential investment. As financial flexibility can be difficult to
compute, leverage and liquidity measures are also used as the proxies to assess the impact
of reserve borrowing power and stockpiled cash on investment activities. Additionally,
control variable are employed to account for other determinants of growth opportunities
and capital expenditures, elsewhere mentioned as significant.
3.3.2.1 Measuring leverage
There are two alternative approaches as to how to measure leverage: one uses
market values and the other applies book values. Both are commonly used in the financial
literature.
Lang et al. (1996) employed book values of debt to total assets and argued that in
comparisons of leverage across firms, a market value measure of leverage would give too
much importance to recent changes in equity values. If we regress growth measures on a
market-based leverage measure, we could be regressing growth on market expectation of
growth as reflected in the firms stock price, producing a negative relation between
leverage and growth. In contract, the book value measure of leverage does not reflect
recent changes in the markets valuation of the firm (1996, pp.6).
On the other hand, Bowman (1980) provided a direct empirical evidence on the
comparability of the book-value and market-value measures of leverage in association tests
on systematic risk. The cross-sectional correlation between both calculations of debt was
very large and he found both measures to be indistinguishable in the context of beta
calculations.
Titman and Wessel (1988) argued there is no reason to suspect that the cross-
sectional differences between market values and book values of debt should be correlated
with any of the determinants of capital structure suggested by theory, so no obvious bias
would result because of this misspecification (pp. 7). The authors noticed, however, that
spurious correlations might arise between debt ratios and variables such as growth
opportunities or collateralizable assets if managers set debt levels in terms of either book
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values or market values. Fortunately, this spurious association might be level out, as the
book and market value debt ratios induce correlation in opposite directions.
In this empirical analysis the recent Welchs proposition not to measure debt ratios
as financial-debt-to-asset ratio but rather to calculate it as either debt-to-capital ratio or
liabilities-to-asset ratio is followed. Welch (2008, pp. 2) argued that financial debt divided
by total assets, was simply not correct. The financial-debt-to-asset ratio is flawed as a
measure of leverage, because the converse of financial debt is not equity. This is because
most of the opposite of the financial-debt-to-asset ratio is the non-financial liabilities- to-
asset ratio. Following to Welchs remedy suggestion to the above inconsistency and
Langs preference for book values the two debt measures employed in the thesis are:
t t
t
t
Debt Financial Total Equity
Debt Financial Total
Leverage
_ _
_ _
1 _
+
=
where:
Total Financial Debt = book value of total debt at the end of year 0;
Equity = book value of shareholders equity at the end of year 0;
t
t
t
Assets Total
s Liabilitie Total
Leverage
_
_
2 _ =
where:
Total Liabilities = book value of total liabilities at the end of year 0;
Total Assets = book value of total assets at the end of year 0.
Both proxies of leverage are used interchangably to check for robustness of the
results. The leverage data are winsorized following Aivazian (2005a) and Dang (2007)
according to the rule of assigning value 0 or 1 to outliers exceeding the cutoff rates.
As predicted by the underinvestment theory, the expected relationship between
leverage and growth opportunities is negative, in particular for high-growth companies.
The corporations that anticipate future growth tend to limit debt overhang so that they can
capture flexibily the potential opportunities. For high-growth firms the negative relation
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becomes unclear. According to the overinvestment theory if agency costs are present and
low-growth high-cash companies will follow the inverse strategy of incorporating debt into
their capital structure, as leverage is perceived as a discipling tool for management. The
increased debt will cause increased firms value due to lower agency costs, as perceived by
shareholders (higher MBA ratio), but it will also mean there are few growth opportunities
for the company in the market (lower MBA ratio). The relationship between investment
and leverage is expected to have a negative sign for both low- and high growth companies,
with a stronger negative impact on the latter.
3.3.2.2 Measuring liquidity
Liquidity is measured as cash and cash equivalents deflated by book value of total
assets at the end of year 0:
t
t
t
Assets Total
s Equivalent Cash and Cash
Liquidity
_
_ _ _
=
It is a popular proxy for cash ratio among many researchers like, for example, Kim
et al. (1998), Mikkelson and Partch (2003) or Arslan et al. (2006)
12
.
A positive sign of relation between growth opportunities and cash reserves is
expected for at least two reasons. The first one is implied by the theory that predicts a
speculative function of cash holdings in anticipation of future growth and by the results of
large empirical work of other researchers who supported the view. The second one is the
evidence of pecking-order-style financing decisions of the Polish companies and
supportive tests for the preference for internally generated funds
13
, conducted in Poland.
The implied positive impact of liquidity on real investment seems logical, as more internal
funds may increase capital expenditures.
12
A similar version of the cash ratio was used by Opler et al. (1999) or Dittmar et al. (2003) who calculated
total assets netted of cash and equivalents in the denominator. Another alternative measure is cash to sales
ratio.
13
Evidence of the positive pecking order test were provided by Skowroski (2002), Campell and
Jerzemowska (2001), Gajdka (2002) and recently Mazur (2008).
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3.3.2.1 Measuring debt maturity
The common way to construct a debt maturity variable is to express it as a
percentage of long-term debt in total debt. However, there are no strict rules on how to
classify debt into short-term and long-term. Some studies consider debt long-term if it is
payable after a year
14
, which is in accordance with accounting convention and has the
advantage of data availability. Others define the long-term debt if it is due after three
years
15
or use an alternative measures such as weighted-average debt or liabilities
maturity
16
.
Stohs and Mauer (1996, pp. 290) emphasized the importance of current liabilities
while considering debt maturity structure. They argued that inclusion of current liabilities
was important since these were the obligations that the firm must meet and were analogous
to short-term debt. This is particularly clear for the matching hypothesis. Under the
matching principle managers plan to match the amount and the maturity of current
liabilities to asset maturity. In a similar vein, the contracting costs theory by Myers (1977)
predicts managerial behavior managers will match debt and assets maturity to reduce the
agency costs associated with the shareholders-bondholders conflict.
In order to incorporate the above matching dependencies of liabilities and to deal
best with the limited data the following Maturity 1 variable is constructed:
t
t
t
s Liabilitie Total
Debt Financial Longterm
Maturity
_
_ _
1 _ =
where:
Long-term Financial Debt = book value of long-term debt payable after one year
Total Liabilities = book value of total liabilities at the end of year 0
17
14
For instance: Dang (2007), Antiniou (2006), Scherr and Hulburt (2001).
15
For example: Barclay and Smith (1995), Aivazian (2005a), Billet et al. (2007).
16
For example: Stohs and Mauer (1996), Scherr and Hulburt (2001).
17
As the long-term financial debt make the most of the total long-term liabilities, current liabilities ratio can
be approximated as the converse of the Maturity 1 ratio.
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To check the robustness of the Maturity 1 measure and for the purpose of
comparability with other studies the second debt maturity proxy is as follows:
t
t
t
Debt Financial Total
Debt Financial Longterm
Maturity
_ _
_ _
2 _ =
3.3.2.2 Financial flexibility
Financial flexibility per se has the shortest history of applications in the empirical
tests and has no universal measure that would be widely accepted. The definition adopted
in the thesis involves two components: cash and debt capacity and for the purpose of
empirical purpose is formulated in the incremental terms as:
t t t t tt
Leverage Liquidity y Flexibilit Financial
, 1 , 1 , 1
1 _ 1 _ _

A A = A
t t t t tt
Leverage Liquidity y Flexibilit Financial
, 1 , 1 , 1
2 _ 2 _ _

A A = A
The advantage of the incremental approach is that it does not involve estimation of
an absolute measure of financial flexibility, which would have to involve subjective
judgments. Another attribute of the above measure is that by relying on the previously
defined liquidity and leverage ratios it allows to control for changes in cash balances
associated with changes in business size and for approximate changes in absolute debt
capacity related to a growing collateral. A supremacy of the financial flexibility measure
over separate liquidity and leverage measures is that is allows to simultaneously control for
debt capacity and cash effects and to compare the joint effect with real and potential
investment. If considered in separation, a company that accumulates cash holdings and
reduces debt concomitantly but to a lesser extent before major capital expenditures might
not report any significant differences in leverage or cash. However, the firm does take
actions in anticipation of growth, which is diluted between both leverage and liquidity
effects. The financial flexibility measure could amplify the separate effects and would
increase their significance. A drawback of the measure is that if company follows for
example a cash accumulation strategy for a longer time period rather than reserving debt
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capacity, its financial flexibility will not be reflect in the measure. The financial flexibility
measure discriminates the companies that have preserved financial flexibility earlier than
within a year before the investment. Moreover, cash and debt capacity might not be
additive in the simple way it is proposed here and possible weighting of the components of
financial flexibility can be a matter of future research.
A raise in financial flexibility during the year 0 can be contributed by an increase
in liquid assets and/or a decrease in leverage (interpreted as an increase in debt capacity).
This increased financial flexibility is expected to positively influence growth opportunities,
as managers have more resources to exercise good growth options. Managements effort to
increase financial flexibility can be interpreted as a signal to the market that good NPV
projects are along the way and will result in higher MBA ratio. This view is contrary to the
overinvestment theory, as financial flexibility gives more discretion to the firms agents. If
agency costs are high and firms opportunities set perceived as modest, increase in
financial flexibility will have ambiguous impact on the MBA ratio.
An improvement of firms financial flexibility status is expected to precede capital
expenditures and consequently there should be a positive relation between net investment
and financial flexibility.
3.3.2.3 Control variables
Previous studies indicated that besides the above mentioned factors there are other
determinants of investment and growth opportunities that need to be controlled for, such as
cash flows and sales.
Cash Flows
As already mentioned in the theoretical section there has been an extensive
discussion over the investment-cash flows sensitivity and its impact on financial status of a
corporation in the financial literature. The empirical results support the matching
hypothesis that managers attempt to time capital expenditures with operating cash flows.
Therefore, the positive relation between cash flows and investment and growth
opportunities is expected.
Cash flows and cash balances are internal funds generated by firms. In spite of
similarities between cash holdings and cash flows the latter are not considered to be a part
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of financial flexibility in this study as they are calculated ex post, i.e. in the year of capital
expenditures and, thus, cannot be anticipated with certainty ex ante by managers (although
managers may try to time both). The differences between cash holdings and cash flows
relate not only to the timing but also to their distributions. Cash balances can be viewed as
cash flows retained in the past by a company while cash flows in time 1 are yet subject to
allocation among shareholders.
Cash Flow variable is measured in a way similar to Aivazian (2005a, 2005b) and
Kaplan and Zigales (1997) as the sum of earnings and depreciation in year 1, deflated by
book value of total assets at the beginning of the year:
t
t t
t
Assets Total
on Depreciati Income Net
Flow Cash
_
_
_
1 1
1
+ +
+
+
=
Volatility of cash flows may affect financial flexibility. The more volatile the
future inflows are expected to be, the higher the need to hedge the fluctuations through
building financial flexibility. If predictability of cash flows increases together with their
level, the hedging needs are reduced.
Sales
Sales variable or its transformation is usually used in studies of investment to
control for multiplier-effect. Sales variable is deflated by net fixed assets following
Aivazian (2005a, 2005b) and then log-transformed to capture the multiplicative nature of
its relation with investment:
|
|
.
|
\
|
=
t
t
t
Assets Fixed
Sales
Sales
_
ln
3.3.2.4 Descriptive statistics of the variables
The summary description of the investment and financial statistics is presented in
the following table. The mean market-to-book ratio of the Polish sample firms is about
1.65, which is close to 1.67 and 1.75 of Aivazian et al. (2005a, 2005b) sample or 1.79 of
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Dangs (2007) but higher than the mean Tobins Q of 0.965 calculated by Lang et al.
(1996). It indicates the expectation of high growth for the Polish companies over the
sample period, which can be justified by Polands EU accession in 2004 and the global
economic upward swing after the 2001-2003 recession. Another reason for the high MBA
ratios is the expansion phase the business cycle at the time of measurement. The collapse
of the global market in the second half of 2008 only marginally impinges on the data.
The mean and median of net investment in the sample are relatively low in
comparison with the results of Aivazian et al. (2005a, 2005b) or Lang et al. (1996). Given
the relatively high macroeconomics investment growth during the sample period, the low
investment ratios can be attributed to higher-than-average depreciation among the Polish
firms as compared to their international peers. The statistics for investment reveals a high
variation among the companies, as the standard deviation is 2.5 times the mean of 0,077.
Leverage 1 based on financial debt and book values is has a mean of 0.236 close to
results of Lang et al. (0.243) and little more volatile. The second leverage measure
indicates higher debt levels among the Polish sample than in a comparable set of Canadian
companies (Aivazian, 2006b), with a dominance of short-term financing.
Table III Summary statistics for the variables
Descriptive statistics
510 0 ,077 ,034 ,184 -,363 1,820
510 0 1,661 1,423 ,912 ,585 9,298
510 0 ,236 ,191 ,215 ,000 1,000
510 0 ,528 ,520 ,208 ,075 1,000
510 0 ,076 ,049 ,078 ,000 ,529
510 0 ,129 ,047 ,163 ,000 ,684
510 0 ,382 ,329 ,347 ,000 1,000
408 102 ,007 ,006 ,210 -,955 ,999
408 102 ,031 ,009 ,161 -,802 ,756
510 0 ,113 ,100 ,205 -1,342 2,600
510 0 1,030 1,058 ,962 -1,885 4,347
Investment
Growth
Leverage_1
Leverage_2
Liquidity
Maturity_1
Maturity_2
Financial_Flexibility_1
Financial_Flexibility_2
Cash_Flow
Sales
Valid Missing
N
Mean Median Std. Dev. Min. Max.
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3.4 Methodology
This section presents statistical methods that are used to test the main hypotheses
stated in the thesis. The statistical software used in the analysis is the SPSS 17.0 software.
3.4.1 Correlation analyses
To investigate interactions between financial flexibility and investment variables
and to compare the dependencies between leverage, liquidity and maturity and growth
opportunities/capital expenditures with the theoretical propositions and empirical studies,
correlation analyses are introduced. The correlation analyses will help to define a broad-
spectrum map of relationships between the variables.
To begin with, a bivariate correlation analysis is conducted at the general level,
examining relations based on the entire set of data. Two types of correlation analysis:
parametric and non-parametric are examined. The parametric correlation Pearson's
correlation reflects the degree of linear relationship between two variables. It is based on
the assumption of normal distributions of both variables. To check whether nonlinear
relation would fit the correlation better, a non-parametric matrix of Spearmans table is
investigated. Spearmans correlation coefficients measure the rank-order association
between two variables, which works regardless of distribution of variables (i.e. it is
distribution free).
As the impact of industry membership might play an important role in explaining
the financing-investment relations, a correlation matrix with industry-adjusted values (also
referred as an industry level correlation) is constructed. This approach was set out by Lang
et al. (1996) who corrected all variables by deducting an industry median. They claimed
the maneuver would allow to check e.g. whether firms that grew more in an industry had
higher or lower leverage than other firms in the industry (pp. 10). The companies in the
sample are classified to various industries according to the Warsaw Stock Exchange
convention. As a result, there are 21 industries, of which six sectors have only one
representative in the sample. The six units are further excluded from the industry-level
correlation analysis. The excluded data constitute less than 5% of the observations and the
omission is not expected to materially influence results.
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Grouping into industries brings more insight into the analysis but still it can be
biased by a limited sector representation or because of the fact it leaves out the impact of
individual firm circumstances. Therefore, to attenuate the individual effects of companies
in the correlation analysis, variables are adjusted at the firms level by deducting a firms
median value of variables across the sample period. The resulting parametric and non-
parametric correlation matrices of dual relations among the variables are then compared
and analyzed.
Although the bivariate correlation analysis is useful in understanding combined
movements of two variables, it leaves some questions unanswered. One of them that is of
interest in the context of this thesis is: what is the coefficient of correlation between
financial flexibility and investment/growth when effects of other elsewhere proven
investment determinants are considered? Do the yet unconsidered factors create the
appearance of a relationship between variables where none actually exists? The questions
are addressed in a partial correlation analysis that comes next. The partial correlation
analysis checks the dependencies of variables while controlling for other effects.
3.4.2 Panel data analysis
As the data are longitudinal, that is cross-sectional (firms) and time-series (the
years 2003-2008), the panel data methodology is a recommended statistical approach that
can bear most meaningful inferences. The advantages of the panel data analyses over a
simple cross-sectional or pooled regression approach are overwhelming and include:
- reduced multicollinearity problem as the number of data points, degrees of
freedom are increased, which translates into a better efficiency of
econometric estimates;
- control for individual heterogeneity caused by hidden factors, which, if
neglected in time-series or cross-section estimations, leads to biased results;
- reduced key econometric problems, such as omitted variables.
In general, there are two ways for handling the correlations of within-subjects
(here: measurements across time) in the longitudinal data analysis that can be distinguished
in the statistical and financial literature: subject-specific and population-averaged
(marginal) models. They are not identical and the choice between them can imply different
inferences about the data. A subject-specific model describes a group (here: firms)
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response to changing independent variables and can be implemented via a mixed model
analysis, which accounts for dependencies within groups by incorporating unobservable
random effects into the model. When models contain variables that do not vary within
groups, however, interpretation of resulting regression parameters can be complicated.
Population-averaged coefficients measure average changes in response across various
subpopulations (here: across firms), regardless of whether the variables vary within groups.
Others point out that differences in the two approaches disappear as the intragroup
correlation coefficient approaches zero and that more empirical work is needed to compare
pros and cons of the two approaches in practice (Young et al., 2007, pp.167).
The methodology applied in the panel data settings of the thesis adopts population-
averaged approach, as it gives an average response for observations and allows to answer
the question: how much the average response would change for every one-unit increase in
a independent variable across the population. To find an answer the Generalized
Estimating Equations (GEE) model, developed by Liang and Zeger, is implemented. It is
important to recognize, however, that the correlation analyses conducted at the industry
and, in particular, at the firm level are based on a quasi-subject-specific approach.
Fitting a GEE model requires the user to specify (a) the link function to be used,
(b) the distribution of the dependent variable, and (c) the correlation structure of the
dependent variable (Ballinger, 2004, pp.131).
Because the variables nature is continuous and it is reasonable to assume their
asymptotical normal distribution, the identity link is assumed. The assumption of normal
distribution seems safe, as indicated by Ballinger (pp.132): although the specification of
the distribution is important, users do not need to be precise in the specification of the
variance functions for the parameter estimates to have a sampling distribution that is
approximately normal. The third step, i.e. specification of the form of correlation of
responses, is to help in efficient estimation of coefficients. As the data are expected to
correlate over time, an autoregressive correlation structure is specified for the within-
subject correlations.
The testable model formulation is similar to that of Aivazian et al. (2005b):
Sales Flow Cash Leverage ratio MBA Investment Net + + + = _ _ _
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Aivazian et al. (2005b) studied the relationship between leverage and investment,
in a similar manner to Lang et al. (1996) or McConnell and Servaer (1995) but with the use
of the subject-specific panel data methodology.
Additionally, to examine whether the impact of leverage on investment changes as
growth prospects improve an additional variable is employed which will is equal to 1 for
growing firms and 0 for low-growth companies. The classification (I classification) into
high/low-growth groups is based on firm-year observations of MBA ratios. The low-
growth group includes the observations in the low one-third of the entire sample MBA
ratios. The second group includes firm-year observations above the 66,6 percentile of
MBA ratios. The middle observations are excluded to increase the distance between the
two groups. To check the robustness of the results in the next step the sample is
reclassified (II classification) according to the midpoint, into 50% of highest and lowest
MBA ratio observations, without reducing the number of observations as in the earlier
example.
Similar to Aivazian et al. (2005b), the following specification for testing the role
of leverage for high versus low-growth companies is proposed:
Leverage D Sales Flow Cash Leverage ratio MBA Investment Net + + + + = _ _ _
where D is the dummy variable.
If the dummy coefficient proves significant, the difference in the impact of
leverage on investment for the two groups of companies cannot be rejected.
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3.5 Empirical results
3.5.1 Correlation analyses
Tables IV through IX show parametric and non-parametric correlation matrices for
the financing and investment variables at three levels of generalization. A few interesting
relationships are identified in the correlation analysis.
As expected, growth opportunities and real investment measures are strongly and
significantly positively correlated around the 0.267 0.348 level, regardless of industry or
individual effects. The degree of the correlation is for example twice as strong as
presented by Lang et al. in their correlation table (1996, pp.8). The plus sign of the
correlation coefficient is in accordance with the theory and with other empirical studies.
Mixed and ambiguous results are produced in the analysis of leverage-investment
relationship. The significance of the correlation coefficients does depend on the measure
applied, which spurs doubts about the robustness of the results. The hypothesis that
Leverage 1 is not related to real investment cannot be rejected at an acceptable 0.1 level. In
contrast, the second leverage measure, which includes not only financial debt but also
other liabilities, fits better the theoretical predictions of the negative impact of debt on
capital expenditures, but only after controlling for industry or individual effects. The
correlation coefficient between Leverage 2 and investment ranges between -0.128 to
-0.160. To define the underlying relation between leverage and real investment a further
investigation is required and is continued in the multivariate correlation and panel data
analyses.
On the other hand, little doubt seems to be left on the negative impact of leverage
on growth opportunities. The negative relationship between the variables stays moderate
but significant after accounting for industry or individual firm effects for both parametric
and non-parametric tests and for both leverage measure. Whether growth opportunities
availability influences the way in which leverage and real investment are related is
investigated in the panel data analysis.
In line with expectations, higher cash balances at the beginning of a year are
related to increased capital expenditures in the following months. The significance of the
positive correlation coefficients in the relationship between growth opportunities and cash
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cannot be rejected at 1% level in all correlation matrices. The relationships are even
amplified at the individual-firm level.
Interestingly, the relations between maturity measures and real and potential
investment is either statistically insignificant or positive. This finding contrasts a range of
other supportive tests for contracting costs theory, suggesting that shortening debt in effort
to mitigate agency costs and underinvestment is not a practice of the managers in Poland.
Conversely, more long-term financing seems to be employed as major capital expenditures
are to come. If the matching principle holds, it would imply a more long-term nature of
investments.
Financial flexibility adjustments and their association with real and potential
investment remain unexplained by the bivariate correlation analysis. Although the positive
sign of the relation meets the expectations, its significance is below acceptable levels in
particular for Financial Flexibility 1 measure. Only when controlled for individual firm
effects, the increased financial flexibility building activity (both measures) before capital
expenditures cannot be rejected at the 5% significance level in the non-parametric test.
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Table IV Matrix of Pearsons correlations for the unadjusted sample
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Table V Matrix of Spearmans correlations for the unadjusted sample
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Table VI Matrix of Pearsons correlations for the industry-adjusted sample
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Table VII Matrix of Spearmans correlations for the industry-adjusted sample
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Table VIII Matrix of Pearsons correlations for the individual-effect-adjusted sample
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Table IX Matrix of Spearmans correlations for the individual-effect-adjusted sample
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In the financial literature cash flows-investment relations have been strongly
emphasized and the above results of bivariate correlations should be considered after
controlling for cash flows impact on growth and capital expenditure. Lang et al. (1996)
and Aivazian et al. (2005b) also pointed out the need to include sales multiplier effect in
the analysis of investment. There is a possibility that the underlying relationship between
the control and dependent variables may fade away the dependencies identified in the
bivariate correlation analysis. It is important to note, however, that the partial correlation
results assume linear relations and normal distribution of variables so it cannot be simply
compared to the Spearmans correlation coefficients.
Tables X through XII provide detailed partial correlation tables for the three levels
of generalization (i.e. general, industry and individual). The relationship between variables
is controlled for cash flows and sales impacts.
Table X Partial correlations for the unadjusted sample
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Table XI Partial correlations for the industry-adjusted sample
Table XIIPartial correlations for the individual effect-adjusted sample
For the unadjusted sample a no-correlation hypothesis on the relationship between
leverage and net investment cannot be rejected. A similar story emerges for the negative
relation between debt and growth opportunities that cannot be statistically supported
except for the very general level of the sample considerations.
A positive association between liquidity and growth opportunities cannot be
rejected in any of the above correlation matrices and is significant at the 10% level.
However, inclusion of cash flows and sales impacts cancels out the previous conclusions
on the significant relationship between cash holdings and net investment.
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Financial flexibility 2 impact, in line with the bivariate correlation analysis, is
considerable after controlling for cash flows and sales. The hypothesis that the correlation
coefficients of the Financial flexibility 1is equal to zero cannot be rejected.
3.5.2 Generalized Estimating Equations
The unclear relationship between leverage and investment is further investigated
with the use of Generalized Estimating Equations. The results of the panel data analysis are
presented in the Table XII through XV.
3.5.2.1 Leverage and real investment
When the correlation of measurements is considered, leverage is not a significant
determinant of investment, regardless how it is estimated. With a Wald chi-square tests
significance of 0.148 and 0.326 for Leverage 1 and 2 respectively, the null hypothesis that
the leverage coefficient is equal to 0 cannot be rejected. Consequently, there is not enough
evidence to conclude that pre-investment leverage level has an effect on net capital
expenditures.
The Growth coefficient, as expected and in accordance with the previous
correlation analyses, is positive and statistically significant at the level <1%. However, in
the GEE model, the strength of the relationship is weakened.
The control variables relationships with the dependent variable are positive and
significant. In particular cash flows coefficient has an effect on the outcome, as one-unit
increase in cash-flow variable results with, ceteris paribus, an average 0.16 increase in net
capital expenditures.
The working correlation matrices indicate a fair amount of correlation between
measurements, ranging from 0.34 between the first and the second year and approx. 0.12
between the first and the third year.
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Table XIII GEE models with Leverage 1 and Leverage 2
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3.5.2.2 Leverage and growth opportunities
The above models do not distinguish between firms with a poor and promising
opportunities set. The distinction, nevertheless, may yield different relationship
implications for leverage and investment, as already discussed in the Literature Review
chapter. The underinvestment problem suggests a negative impact of leverage for growing
companies that try to avoid debt overhang not to be forced to pass up anticipated good
investment projects. On the other hand, Aivazian et al. (2005b) and others
18
supported the
view that debt had a disciplining role in preventing overinvestment, which implies a
stronger negative impact on investment for firms with low growth opportunities.
To investigate what impact has leverage on the Polish low vs. high growth firms,
the GEE model is applied after with dummy that takes the values 0 and 1 for each group
respectively. Table XIV presents the coefficient estimates for the augmented model.
Table XIV GEE Leverage 1 and 2 model for two growth groups (I classification)
18
A more detailed review of other studies is presented in the section: Empirical Studies Overview.
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The results reveal no support for any of the theories. On average there is no
significant investment response of firms to different leverage level regardless how they are
measured and how their growth opportunities set is classified. The null hypothesis that the
leverage coefficients are equal zero cannot be rejected.
The separation into two groups involves subjective judgment so the above results
are checked for the robustness in another low-high growth setting. Table V presents the
outcome of the repeated analysis for differently assigned groups. The view that there is no
significant relation between leverage and investment, no matter how good or bad growth
prospect the company has cannot be rejected.
Table XVGEE Leverage 1 and 2 model for two growth groups (II classification)
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CHAPTER4 CONCLUSIONS
4.1 Interpretation of the results
The results of the statistical analysis help to assess hypotheses stated in the thesis.
Proof to the Hypothesis 1
Leverage ex ante is not significantly related to real and potential investment.
The leverage coefficients in the correlation and panel data analysis of the
association with net investment fail to prove to be significantly different from zero or/and
fail the robustness tests. Similarly, the correlation between growth opportunities measure
and leverage remains unclear, as doubts are spurred by volatile significance level in
different correlation tests. In addition, no supportive evidence is provided in the GEE
model, regarding the difference in leverage impact on high and low-growth companies.
Consequently, the negative relationship between leverage and real and potential investment
cannot be supported.
The above outcome is contradictory to the theoretical predictions of the pecking
order theory that assumes managers aversion toward leverage when faced with capital
expenditures. It does not support the free cash flows theory, which expects a proactive
actions of low-growth companies introducing more debt into their capital structure to avoid
agency conflicts. Further, both overinvestment and underinvestment problems do not
emerge from the analysis.
The findings support the minority of the empirical work that failed to find a
relationship between debt and investment. Interestingly, similar results provided Pandey
and Chotigeat (2004) who investigated a similar in size sample of Malaysian companies.
The apparent contradiction with the major body of studies can have a few plausible
explanations. One lies in the sample period. As the financial data are collected from the
period of an expansion of the Polish credit market and the debt impact on real and potential
investment may have been of a second- order consideration. Conversely, ease of access to
credit combined with an expansionary strategy of banks, amplified by a global mild
sentiment towards debt, could, in fact, reverse managerial aversion to this form of external
financing. It is important to note that other empirical studies spanned over longer time
period so this phenomena was not incurred by other authors.
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Another possible explanation is of a technical nature. As pointed out in the
analysis, different debt measures may yield different results. The measures applied in this
thesis follow some recommendations that have appeared in the financial literature just
recently, after the major papers had been published
19
. There is a possibility that unification
of the approach to calculations could bring more consistency to the results.
Proof to the Hypothesis 2:
Liquidity ex ante is positively related to potential investment but a liquidity level
and real investment ex post are not significantly related.
The positive mutual interactions liquidity and growth opportunities are supported
by the statistical analysis of correlations. This finding is in line with pecking order theory
and supports Kim, Mauer and Sherman and others findings on the role of growth
opportunities in liquidity determination. Interestingly, Arslan et al. (2006) found consistent
results in their Turkish sample over the period 1998 2002. Moreover, the outcome
complies with the previous capital structure studies on the Polish market that revealed
managerial preference for internally generated funds. Managers seem to accumulate cash
balances to meet growth expectations. The relationship remains significant regardless of
the financial status of companies, as measure by their investment-cash flows sensitivities.
Although the results on the growth-liquidity interplay are straightforward, the
evidence on the association between real investment and cash is not. The initially
confirmative outcome on the significant and positive relationship between net investment
and cash becomes unconvincing, once the impact of cash flows and sale multiplier is taken
into consideration. Consequently, managers align cash holdings with potential investment
but the one-year ahead net cash expenditures are rather matched with cash flows. The high
investment-cash flows sensitivity is confirmed in the panel data analysis.
19
For ex ample: Welch (2008).
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There is mixed evidence on firms financial flexibility building activity related to
potential and real investment.
Minton (2001) provided evidence that financially conservative companies seemed
to stockpile financial flexibility. His definitions of financial flexibility, however,
included debt capacity but not liquidity. When the two components are considered
simultaneously, the hypothesis on the positive association between financial flexibility
changes and real and potential investment is only partially confirmed, only by the financial
flexibility measure that incorporates total liability adjustments. Companys investment-
cash flows sensitivity does not change the conclusions. It is important to recognize that the
high sensitivity of investment to cash flows combined with high predictability of inflows in
the expansionary phase of the business cycle may attenuate the need for building financial
flexibility.
As financial flexibility is derived from leverage and liquidity measures, the
contradictory results leverage-investment tests as well as confirmative conclusions on the
positive liquidity-investment relationship influence the outcome on the Hypothesis 3. The
additional information content of this evidence is the focus on a simultaneous and
complimentary process of capital structure adjustments and cash accumulating policy. The
results add to the previous suggestions stated in the Proof 1 that no financial debt aversion
is found in the light of investment.
Debt maturity is not negatively related to real and potential investment.
The hypothesis is rejected because of either insignificance of correlation
coefficients (in particular in the relationship with growth opportunities) or a positive sign
of the relationships detected in the analysis (in particular in the association with net
investment) or both. Consequently, the contradicting costs theory, suggesting that
managers of growing companies shorten debt to ease agency conflicts and underinvestment
problems, is not supported. The results contribute to the opponents of Myers proposition
and are similar to Stohs and Mauer (1996), Sherr and Hulburt (2001) or Antoniou et al.
(2006).
A possible explanation is found in the paper of Dang (2007) who similarly found
no evidence on the preferred short-term debt choice in the context of investment: Liquidity
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risk associated with short debt may impose a constraint on the firms financing decisions
in that it deters the firm from adopting a short debt strategy required to control the
underinvestment problem (pp.7). The liquidity risk hypothesis is even reinforced for the
Polish companies sample by some evidence of positive relationship between maturity and
net investment. It also fits Childs et al. (2005) proposition that a positive relation between
maturity and leverage is due to the potential of short-term financing to reduce agency costs
associated with overinvestment.
4.2 Limitation of the thesis
The thesis attempts to tie research on capital structure, cash holdings, investment
and the recent literature on financial flexibility. Although the perspective on financial
flexibility seems broad, the work is subject to limitations, mostly of a technical nature.
An example of such limitation is related to the sample construction. The sample
period and size are a trade-off choice, guided by limited data availability. The sample
period covers a relatively short time of five to six years that does not include a full
business cycle, i.e. a recession is not a part of the analysis. The length and the business
cycle phase positioning can have a material impact on the conclusions, as they influence
both data and statistical analysis credibility. Alike, sample size is relatively small in
comparison to other Anglo-Saxon studies.
Another restriction is imposed by the way the variables are measured. Although
the variables construction has been guided by a review of available suggestions in the
literature, there are no perfect measures and all estimations rely on available financial data.
These can be another source of possible errors, as accounting practices are not perfectly
synchronized, even within one country of interest.
Financial flexibility measure is a special case of estimate, as it is authors original
attempt to handle the topic. As the measure has no history of verification in the financial
literature and is exposed to possible criticism. Some drawbacks of the measure have
already been presented in the previous sections.
In addition, the statistical analysis and the population averaged panel data
approach have their limitations and are based on certain assumptions within which the
drawn conclusions can be considered as correct.
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4.3 Suggestions for further research
Financial flexibility clearly requires more researchers attention and more
statistical evidence. The theoretical and empirical studies on financial flexibility are in
infancy and much more needs to be done to bring together the three perspectives in the
economic literature: investment, capital structure and cash management.
Most studies are focused on the developed markets, leaving the emerging
economies an open question. This thesis is an example how some theories developed in the
Western economies does not seem to describe the emerging markets specifications well.
The possible differences create even more opportunities for future research.
In case of Poland, the relatively short history of open market economy may
discourage some researchers as it may impose non-stationary implications and restrict
extrapolation of results. It is important to keep in mind, however, that even restricted in
scope the current theoretical and empirical attempt may form a basis for comparisons in
future research.
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APPENDICES
Appendix 1 - Description of the sample companies
Appendix 2 - Key financials of the sample companies over the period 2003-2008
APPENDIX 1 Description of the sample companies Page 79 of 87
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COMPANY NAME DESCRIPTIONOF ACTIVITIES
1 Telekomunikacja Polska SA The company, together with its subsidiaries and associated companies, operates in the telecommunications and inf ormation technology sectors.
2 Polski Koncern Naf towy Orlen SA
The company specializes in the manufacture, distribution, wholesale and retail sale of ref ined petrochemical products. It is principally engaged in the
processing of crude oil.
3 KGHMPolska Miedz SA
The producer of non-f errous metals, mainly copper and silver. It produces copper primarily in the f ormof electrolytic copper and processed wire rod. Its
silver is produced in the f ormof granules and bars.
4 Asseco Poland SA
Formerly Sof tbank SA, it is a Polish integrator of inf ormation technology (IT) solutions. The company provides solutions f or the banking, f inance,
insurance, public administration, telecommunication and industry sectors. It of f ers IT solutions complemented with business consultancy.
5 Agora SA
It is a media company principally engaged in the publishing of daily newspapers, magazines and periodic print media, as well as advertising, radio
broadcasting and online services.
6 Mondi Swiecie SA
The company is engaged in the paper industry. It specializes in the manuf acture of the craf t paper f or containerboard and paper bags. The f irmhas one
subsidiary, Swiecie Recykling sp. z o.o.
7 Cersanit SA It is an investment holding company that, through its subsidiaries, is principally engaged in the manuf acture and sale of bathroomf urnishings.
8 LPPSA
The company designs and distributes clothing. Designs are draf ted in the Gdansk (Poland) head of f ice. The head off ice is also responsible f or all
decisions concerning garment accessories and materials, as well as packaging and transport.
9 Orbis SA The company is principally engaged in the hotel and tourismsector.
10 Budimex SA It is a construction company. It operates as a general contractor, subcontractor and developer.
11 Polimex Mostostal SA The company is engaged in the engineering and construction sector.
12 Stalprodukt SA
It is a parent company of Capital Group that comprises nine enterprises: Stalprodukt-Centrostal Krakow sp. z o.o., Stalprodukt-Wamech sp. z o.o.,
Stalprodukt-Serwis sp. z o.o., Stalprodukt-Zamosc sp. z o.o., Stalprodukt-MB sp. z o.o., STPElbud sp.
13 Netia SA
Formerly Netia Holdings SA, it is an independent f ixed-line telephony operator in Poland. It operates on the basis of its own fiber-optic backbone
network, which covers major Polish cities, as well as on the basis of local access networks.
14 Mostostal-Warszawa SA The company f ocuses mainly on the construction sector.
15 ZEW Kogeneracja SA It is a power industry company operating in the production of heat and electric power, as well as the transf er and distribution of heat.
16 Kopex SA (Katowice) The company is engaged in the mining and construction services.
17 Mennica Polska SA
It is a Poland-based mint. The company is principally engaged in the production of circulation and collector coins, medals, signs, decorations, seals and
related products.
Iweta Gdala
Aarhus University
18 Elektrobudowa SA The company is engaged in production and sale of electrical equipment and services, mainly f or the power engineering industry.
19 Grupa Kety SA The company is mainly engaged in the aluminumindustry. It produces and trades the aluminumprof iles and systems.
20 Farmacol SA
The company is engaged in storage and distribution of pharmaceuticals, cosmetics and herbs, as well as in the marketing services and operations of
hotels and restaurants.
21 Polnord SA
The company is primarily engaged in the real estate sector. Its construction activities include building site development, industrial, commercial and of f ice
space buildings, housing projects f or the mass market and interior design.
22 Debica SA
It is a producer of passenger and light truck tires. The company mainly targets the markets of whole-steel heavy truck tires, as well as tires f or all-
terrain vehicles, agricultural machinery and equipment tires.
23 Mostostal Zabrze Holding SA
It is a construction company and the parent company of a capital group that comprises 12 companies, which are active in building construction, power
engineering, environmental and civil engineering works, as well as the production of construction elements.
24 ComArch SA
It is a sof tware vendor and systemintegrator that specializes in the provision of inf ormation technology (IT) solutions to the banking and f inance,
telecommunication, industry, services and e-commerce sectors.
25 Impexmetal SA The company is active in the non-f errous metal sector.
26 Pf leiderer Grajewo SA
The company is a supplier f or the f urniture industry. It manuf actures the chipboard and veneers (the f urniture f oils and the melamine f ilms) dedicated to
f urniture and interior design.
27 Stalexport Autostrady SA The company f ocuses its activity on the construction and exploitation of motorways.
28 Polska Grupa Farmaceutyczna SA The company is active in the sector of pharmaceuticals.
29 Sygnity SA The company is engaged in the inf ormation technology solutions f or business and management support.
30 Apator SA
The company is active in the switchgear and metering segments of the electrical engineering sector. Its f our main product lines include switchgear and
surge protective devices; electricity, gas and heat meters; billing and reading systems, and mining equipment.
31 Fabryka Kotlow Raf ako SA The company is engaged in the design, development and manuf acture of industrial and power-generation boilers.
32 MNI SA MNI SA, f ormerly Szeptel SA, is an independent telecommunication service operator in Poland.
33 VISTULA GROUPSA Formerly Vistula & Wolczanka SA and Vistula S.A., the company specializes in the design, manuf acture and distribution of clothing.
34 Energomontaz Polnoc SA
It is a holding company f or a group, whose main scope of activities includes investment, assembly works, and renewing and repairs in power plants
and heat and power generating plants on the domestic market.
Iweta Gdala
Aarhus University
35 Wasko SA Formerly HOGA.PL SA, it is a Poland-based data communication company. It provides Internet technology (IT) and data communication solutions.
36 Ulma Construction Polska Formerly Bauma S.A., the company is primarily involved in the development, production and sale of construction products.
37 TIMSA The company is engaged in the distribution of electrotechnical products.
38 Boryszew SA
The company is mainly engaged in the chemical industry. It is a manuf acturer of chemicals, plastics, aluminum, rolled copper, zinc and titaniumproducts,
among others. The f irmis a dominant entity in the Boryszew Group.
39 Stomil Sanok SA
The company f ocuses on the development, production and marketing of products made f romrubber and rubber combined with metal and other
materials.
40 Energomontaz Poludnie SA
The company is engaged in the provision of principal contracting, assembly, modernization and overhaul services f or power plants or industrial
installation components and equipment.
41 Centrostal Gdansk SA
The company operates in the metallurgical industry. It f ocuses on steel processing and trading. The main products are various kinds of sheet metal,
ribbed bars, round rolled bars, square bars, f lat bars, steel sheet and plates, as well as sheet zinc and tin plates.
42 Naf tobudowa
Th company is active in the oil, petrochemical and chemical industries in Poland. It of f ers a range of services in various areas of construction and
erection works.
43 Mostostal Plock SA The company is principally engaged in the construction and building sectors.
44 Lentex SA Lentex SA is a Poland-based textiles manuf acturer.
45 Forte SA The company is principally engaged in the production and trade of f urniture. It specializes in home, of f ice and kitchen f urniture.
46 Stalprof il SA The company is primarily engaged in the steel industry. It distributes metallurgical products and semi-f inished steel.
47 Mostostal-Export SA The company is engaged in the construction sector. It acts as a general contractor, subcontractor and developer.
48 Projprzem
Formerly Bydgoskie Biuro Projektowo-Badawcze Budownictwa Przemyslowego, the company is active in the construction of industrial f acilities, public
buildings, shopping centers, of f ices and other f acilities based on steel structures.
49 Ponar Wadowice SA The company is principally involved in the production of applied power hydraulic equipment.
50 Lubawa SA
Lubawa SA, f ormerly Zaklady Konf ekcji Technicznej Lubawa SA, is a Polish-based company involved in the production of tourist, saf ety and logistic
equipment f or the needs of Ministry of Def ense, the Ministry of Internal Af f airs and national emergency services, such as the Fire Brigade.
51 ProchemSA
The company is engaged in the engineering and construction sectors. Its main activities are the provision of services f or projects f rompre-investment
activities to design and contracting and property management.
Iweta Gdala
Aarhus University
52 Internet Group SA It is a holding company engaged in the sectors of media, inf ormation and communication technology (ICT), and telecommunications.
53 Yawal SA
It is a holding company primarily active in the aluminumsector. Through its subsidiaries, the company is engaged in the manuf acture of aluminum
architectural systems f or the production of panel walls, windows, door, verandas, skylights and non-standard constructions.
54 Sanwil Holding SA Formerly Sanwil SA, the company specializes in the production of ecological leather and coated f abrics.
55 Zaklady Odziezowe BytomSA The company operates in the clothes industry. It produces clothes f or men, such as suits, jackets and trousers, in classical cuts.
56 Amica Wronki SA Amica Wronki SA is a manuf acturer of household appliances. The company provides f reestanding, built-in and small kitchen appliances.
57 Prochnik SA
The company is active in the design, manuf acture and distribution of men's and ladies' clothes f or the domestic and export markets. Finished products
are retailed through a network of the company's own stores, including outlet stores, warehouses and licensed dealers.
58 PMUERemak SA It is a Poland-based company engaged in the provision of construction services.
59 Hutmen SA
The company is a\ manuf acturer of non-f errous metals. Its main activities include copper tubes production, scrap processing and cuprif erous waste
material processing. The company specializes in the production of tubes, rods, wires, sheets, strips, disks, prof iles and casting alloys.
60 PPWK SA It is a Poland-based company dealing with cartographic publications.
61 Relpol SA
The company specializes in electromagnetic relays. Their products belong to the industrial automation branch, including power relays, interf ace relays,
Polychlorinated Biphenyl (PCB) signal relays and relay sockets.
62 NKT Cables S.A. NKT Cables SA is a Poland-based cable manuf acturer.
63 ZMRopczyce SA
The company is principally engaged in the production of ref ractory materials f or the non-f errous, cement, lime, glass making, f ounding, as well as iron
and steel industries.
64 PPHKOMPAPSA
It is a producer of paper products. The company's range of activities includes the production and trade of printed f orms, envelopes, paper f or computer
printers, paper rolls, cash registered rolls, thermal, f ax and self -adhesive rolls.
65 Elzab SA (Zabrze)
The company is engaged in the designing, production and distribution of electronic devices, systems f or point-of -sale terminals and other peripherals.
Their main products include cash registers, cash drawers, f iscal printers, electronic scales and auto IDsystems.
66 Optimus SA
The company specializes in the manufacture and wholesale of computers, sof tware and peripherals and in the of f ice equipment, computer maintenance
and repair services. It operates mainly on the Polish market.
67 Krosnienskie Huty Szkla KROSNOSA The company is principally engaged in the design, production and sale of glass and glass products.
68 Grupa Kapitalowa FASINGSA The company specializes in the production of link chains.
Iweta Gdala
Aarhus University
69 Macrologic SA
The company is engaged in the inf ormation technology (IT). It provides management support and knowledge management solutions to medium-sized
companies and administrative departments of courts and prosecutor's of f ices.
70 Swarzedzkie Fabryki Mebli Swarzedz SA
The company is principally engaged in the production and sale of f urniture. The main product groups of f ered by the company are bedroomsuites,
dinning roomsuites, study suites, upholstered f urniture and hotel f urniture.
71 Energoaparatura SA
The company is principally engaged in specialty engineering, building and architectonic services. It undertakes projects in such f ields as instrumentation
and control, electrical and telecommunications works, as well as intelligent building installations.
72 Ampli The company specializes in the wholesale and retail of manuf actured electrical goods, especially f or power engineering, construction and retail trade.
73 Budopol Wroclaw SA Budopol Wroclaw SA is a construction company. It operates in the construction and assembly industries.
74 Muza SA
Muza SA is a publishing company. It also runs a readers' club and an Internet bookstore. The f irmtakes part in national and international book f airs and
cooperates with f oreign book issuers, translators and editors.
75 Trion SA
The company is principally engaged in the manuf acture of polyvinyl chloride (PVC), wooden and aluminumconstruction carpentry, window f rames, as
well as wooden pallets and containers. Additionally, the company of f ers road transportation services.
76 Huta Szkla Gospodarczego Irena SA It is a producer of glass that specializes in the production of glass f or domestic purposes, as well as in the production of crystal.
77 Echo Investment SA Echo Investment SA is a Poland-based company active in the real estate sector.
78 Gant Development SA
Formerly GANT SA, the f irmis mainly engaged in the real estate operations. The company specializes in the building and development of f lats,
apartments and of f ices.
79 PHS Hydrotor SA PHS Hydrotor SA is a Poland-based company mainly engaged in the industrial machinery sector.
80 Prosper SA
The company deals with the retail and wholesale supply of pharmaceuticals (medication, medical materials, dressings, remedy cosmetics) and herbs. It
has 13 distribution centers in Poland.
81 Fabryka Kosmetykow Pollena-Ewa SA
It is a Poland-based cosmetics company that is principally engaged in the production, sale and distribution of beauty products. The company of f ers f ace
and body care cosmetics, shampoos, as well as a range of perf umes f or both women and men.
82 Talex SA
The company supplies inf ormation technology (IT) products and services f or medium-sized and large companies. It operates in three business areas:
integration of IT systems, outsourcing services and sof tware production.
83 Alma Market
It is an investment holding company, which main activity is the retail of f ast-moving consumer goods (FMCG) branch articles through the Alma
delicatessen chain.
84 Emperia Holding SA Formerly Eldorado SA, it is a trading company engaged in the retail sale and wholesale of f ood products and household chemicals and cosmetics.
85 Korporacja Gospodarcza Ef ekt SA
The company is engaged in three business sectors: retail, wholesale, warehousing and logistics; hotel and tourist services, and environmental
services.
Iweta Gdala
Aarhus University
86 Wandalex SA The company specializes in the provision of logistic services.
87 LZPS Protektor SA It is a producer of leather f ootwear. Its products range includes military, f iremen, as well as saf ety and work f ootwear.
88 Permedia SA It is a manuf acturer of inorganic pigments, pastes f or pigment base, paints, varnishes, as well as the cadmium, nickel and cobalt compounds.
89 Instal Lublin SA
The company specializes in the provision of construction and instalment services. It is principally engaged in the design, implementing and assembly of
central heating installations, air conditioning, and the external water and gas installations.
90 Inter Groclin Auto SA
It is a Polish car accessory manuf acturer. The company specializes in the production of natural leather upholstery. Its car seat upholstery is an integral
part of such automobiles as Volvo, Mitsubishi, Renault, Volkswagen, Mercedes, Smart and Audi.
91 Simple SA Simple SA is a Poland-based company that produces sof tware supporting company management, aiming at small and medium-sized f irms.
92 Odlewnie Polskie SA Odlewnie Polskie S.A. is a Poland-based producer of f oundry materials.
93 Beef -San Zaklady Miesne SA Beef -San S.A. is a Polish meat processing company. It is specializing in the animal slaughter and the production of meat products.
94 Duda SA
The company is active in the meat processing industry. It f ocuses on the red meat production. Its main line of business is purchasing and slaughtering of
pigs and cattle, as well as butchery services
95 Grupa Zywiec SA Grupa Zywiec SA is a Polish brewing company. The company's principal activities are the production and distribution of beer products.
96 Wilbo SA
The company operates in the f ish industry. The range of products includes canned fish, seaf ood, f rozen f ish, smoked f ish, canned meat and pate. The
company of f ers its products under such brand names as Dal-Pecsa, Neptun, Taaka Ryba, Przysmak, Wilbo and Wilbo Catering.
97 Wawel SA
It is a conf ectionery manuf acturer. The company's main products are cocoa, chocolate, candies, waf ers and chocolate goods. Its major brands include
Michalki zamkowe, Malaga, Tiki Taki, Lekka, Mieszanka Krakowska, Raczki, Fistaszki, Maciek, Olmeca, Kasztanki, Raczki and Kukulka.
98 Pepees SA The company is a manuf acturer of potato starch, maltodextrin, potato protein, starch syrups and crystalline glucose.
99 ZPCMieszko SA The f irmis a conf ectionery manuf acturer.
100 Kruszwica SA The company (part of the Bunge Group) is primarily involved in the manuf acture and sale of vegetable oils and f ats.
101 Jutrzenka Holding SA
The company specializes in the conf ectionery sector. It is principally engaged in the production, wholesale and retail sale of sweets, as well as
rendering f ood production services.
102 OZDIndykpol SA
The company is engaged in the meat processing. It is a producer of turkey meat and processed goods and specializes in turkey rearing, poultry
processing, the wholesale and retail sale of whole poultry birds and poultry elements.
APPENDIX I1 Key financials of the sample companies over the period 2003-2008 [average values in m PLN] Page 85 of 87
Iweta Gdala
Aarhus University
No. Company name Market capitalization Sales Net income Total assets Total debt Cash
1 Telekomunikacja Polska SA 28 752,59 18 365,50 2 051,67 33 884,33 9 872,33 1 581,17
2 Polski Koncern Naftowy Orlen SA 17 880,38 48 746,17 1 702,33 34 986,83 7 802,67 1 268,50
3 KGHM Polska Miedz SA 11 430,67 10 161,82 2 389,04 11 784,58 1 038,80 1 676,46
4 Asseco Poland SA 1 726,69 987,80 119,95 1 848,36 327,93 150,33
5 Agora SA 2 637,50 1 123,40 58,74 1 511,61 142,60 233,75
6 Mondi Swiecie SA 3 315,00 1 371,74 205,03 1 381,96 99,42 33,01
7 Cersanit SA 2 623,53 914,56 103,40 1 685,22 788,05 316,33
8 LPP SA 1 806,82 886,90 76,34 607,78 164,56 39,56
9 Orbis SA 1 924,87 1 029,07 79,06 2 195,08 330,85 75,27
10 Budimex SA 1 423,30 2 744,93 29,63 2 083,41 190,41 456,42
11 Polimex Mostostal SA 1 496,14 2 442,11 74,26 1 732,74 329,23 124,42
12 Stalprodukt SA 1 959,10 1 191,72 189,29 765,39 27,32 81,04
13 Netia SA 1 593,32 875,38 -154,33 2 318,11 16,79 186,87
14 Mostostal-Warszawa SA 518,82 1 259,66 10,91 742,85 46,76 153,56
15 ZEW Kogeneracja SA 643,80 726,69 41,41 1 400,56 433,58 100,97
16 Kopex SA (Katowice) 817,92 889,63 121,66 1 257,44 168,71 79,38
17 Mennica Polska SA 561,75 558,19 40,62 381,01 7,18 70,51
18 Elektrobudowa SA 392,35 470,70 22,03 260,84 13,75 25,69
19 Grupa Kety SA 1 234,47 942,24 83,04 998,54 215,64 29,16
20 Farmacol SA 757,74 3 298,26 65,84 1 161,01 31,01 46,82
21 Polnord SA 692,91 237,16 -4,81 721,56 214,60 28,07
22 Debica SA 1 177,83 1 440,44 77,08 1 068,03 55,82 72,84
23 Mostostal Zabrze Holding SA 371,57 509,66 15,49 346,03 44,11 32,95
24 ComArch SA 775,25 467,26 57,10 470,17 61,25 78,55
25 Impexmetal SA 803,90 3 006,81 65,69 1 794,92 548,52 44,11
26 Pfleiderer Grajewo SA 1 629,57 1 052,46 89,85 1 192,83 300,78 36,81
27 Stalexport Autostrady SA 394,48 522,38 16,89 749,37 100,37 57,04
28 Polska Grupa Farmaceutyczna SA 744,04 4 088,96 54,54 1 636,96 414,98 58,69
29 Sygnity SA 592,48 886,86 -11,55 695,87 58,54 64,55
30 Apator SA 432,40 254,98 31,07 184,35 21,83 11,24
31 Fabryka Kotlow Rafako SA 390,86 705,07 12,35 588,45 18,95 31,01
32 MNI SA 216,92 113,59 14,36 219,36 59,85 8,86
33 VISTULA GROUP SA 375,84 245,24 15,83 328,53 74,98 34,43
34 Energomontaz Polnoc SA 239,05 258,71 -6,69 216,82 6,55 26,95
AVERAGE KEY FINANCIALS OF THE SAMPLE FIRMS OVER THE PERIOD 2003-2008 [mPLN]
Iweta Gdala
Aarhus University
35 Wasko SA 212,98 215,38 11,60 157,49 5,51 14,22
36 Ulma Construction Polska 526,89 143,65 20,52 250,63 87,32 7,01
37 TIM SA 271,33 318,68 17,17 176,72 15,20 1,01
38 Boryszew SA 1 168,02 2 825,11 50,13 2 057,26 784,94 54,34
39 Stomil Sanok SA 391,51 368,12 28,89 290,27 40,77 6,30
40 Energomontaz Poludnie SA 88,04 166,74 3,21 156,04 23,81 11,93
41 Centrostal Gdansk SA 69,91 301,73 1,89 208,13 33,34 21,04
42 Naftobudowa 120,45 156,69 5,63 89,87 9,79 10,61
43 Mostostal Plock SA 78,85 116,44 5,50 76,86 0,81 13,59
44 Lentex SA 224,88 193,49 4,87 232,00 11,85 16,45
45 Forte SA 229,78 425,75 14,17 390,07 83,62 14,07
46 Stalprofil SA 218,43 623,87 26,30 250,23 52,41 5,81
47 Mostostal-Export SA 95,28 234,10 9,53 280,21 22,65 18,30
48 Projprzem 107,78 131,55 6,06 84,39 1,20 14,73
49 Ponar Wadowice SA 99,40 61,06 -19,32 117,45 25,35 15,38
50 Lubawa SA 83,19 31,72 5,88 52,41 0,37 11,53
51 Prochem SA 126,49 292,17 13,27 211,08 24,40 31,50
52 Internet Group SA 65,85 128,94 2,75 142,89 34,06 3,74
53 Yawal SA 108,08 166,15 13,93 174,57 33,52 18,00
54 Sanwil Holding SA 58,81 42,55 -0,67 65,54 2,09 9,07
55 Zaklady Odziezowe Bytom SA 48,78 63,07 3,00 58,81 12,68 3,01
56 Amica Wronki SA 185,65 1 180,86 6,42 868,37 80,33 23,19
57 Prochnik SA 58,33 17,85 -4,32 18,78 0,57 2,13
58 PMUE Remak SA 45,38 145,95 0,88 73,71 5,85 6,24
59 Hutmen SA 203,16 955,58 -6,63 613,24 208,78 8,68
60 PPWK SA 54,93 44,48 2,52 67,73 7,24 5,70
61 Relpol SA 69,10 93,74 0,63 100,15 24,12 7,12
62 NKT Cables S.A. 99,28 430,45 8,24 235,92 84,50 12,57
63 ZM Ropczyce SA 120,74 378,92 -0,65 272,84 57,56 5,90
64 PPH KOMPAP SA 17,38 18,37 -1,58 25,03 2,14 1,12
65 Elzab SA (Zabrze) 43,85 73,35 2,15 58,34 3,93 3,35
66 Optimus SA 59,25 157,62 1,43 53,21 5,06 2,84
67 Krosnienskie Huty Szkla KROSNO SA 169,36 355,93 -20,64 385,01 158,25 3,50
68 Grupa Kapitalowa FASING SA 32,34 82,94 4,10 105,00 23,81 4,86
Iweta Gdala
Aarhus University
69 Macrologic SA 51,92 37,48 4,27 23,73 1,17 3,21
70 Swarzedzkie Fabryki Mebli Swarzedz SA 44,96 27,00 -9,99 47,49 14,14 7,51
71 Energoaparatura SA 17,07 31,28 -0,74 17,76 0,62 1,35
72 Ampli 14,51 94,57 1,16 44,18 5,93 0,25
73 Budopol Wroclaw SA 48,93 47,81 -0,47 25,48 0,81 6,57
74 Muza SA 17,20 28,58 0,44 45,11 1,73 2,19
75 Trion SA 33,90 92,35 -4,06 88,88 17,65 2,73
76 Huta Szkla Gospodarczego Irena SA 62,76 90,65 -10,24 106,24 22,41 1,82
77 Echo Investment SA 1 861,30 341,27 162,31 2 638,78 1 113,87 229,68
78 Gant Development SA 269,33 962,23 36,58 429,24 177,20 22,03
79 PHS Hydrotor SA 69,27 69,24 6,35 64,13 4,02 6,76
80 Prosper SA 87,57 1 750,92 -0,32 507,71 68,56 11,58
81 Fabryka Kosmetykow Pollena-Ewa SA 37,48 29,92 -2,79 20,39 1,74 0,87
82 Talex SA 45,67 101,47 2,61 65,39 0,59 15,64
83 Alma Market 217,93 486,89 17,08 262,17 61,23 17,51
84 Emperia Holding SA 836,56 2 398,69 36,58 784,65 139,38 28,98
85 Korporacja Gospodarcza Efekt SA 29,19 47,29 1,45 91,91 42,15 1,82
86 Wandalex SA 45,04 86,70 2,92 49,09 9,47 2,22
87 LZPS Protektor SA 64,21 66,01 5,35 56,11 7,43 3,88
88 Permedia SA 61,40 44,82 5,32 35,42 2,50 6,69
89 Instal Lublin SA 18,60 31,95 -1,75 30,72 0,39 0,45
90 Inter Groclin Auto SA 312,57 457,35 12,67 406,49 102,89 25,68
91 Simple SA 12,92 13,47 -0,02 11,92 3,77 0,49
92 Odlewnie Polskie SA 57,70 105,90 -14,01 58,58 5,04 8,07
93 Beef-San Zaklady Miesne SA 62,67 106,34 -5,34 90,96 15,47 7,48
94 Duda SA 572,73 926,81 23,25 606,62 141,68 23,48
95 Grupa Zywiec SA 5 381,19 3 220,70 331,50 2 343,69 515,53 80,81
96 Wilbo SA 42,39 179,49 0,45 119,21 11,79 4,13
97 Wawel SA 256,09 220,40 23,06 168,45 10,07 2,59
98 Pepees SA 73,39 159,65 14,66 185,19 41,64 9,47
99 ZPC Mieszko SA 103,34 191,94 -0,08 209,46 68,05 2,18
100 Kruszwica SA 797,03 1 124,12 50,31 918,36 451,54 5,69
101 Jutrzenka Holding SA 216,95 349,26 18,15 371,51 54,55 4,27
102 OZD Indykpol SA 203,52 656,70 9,31 316,28 88,14 10,75

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MSc in Finance and International Business

Aarhus School of Business

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