Diseño metodológico

As opposed to the traditional view of capital structure which concentrates on the effects of taxes and taxation associated costs in explaining the capital structure decisions, the theory of capital structure with asymmetric information provides support for a larger role of debt beyond taxes. The behavioural model of capital structure with asymmetric information was developed through the works of Myers (1984) and Myers and Majluf (1984). In the asymmetric information theory, managers or insiders are assumed to possess private information about the firm’s characteristics, prospects and the value of its risky securities. Myers and Majluf (1984) argue that capital structure is designed to mitigate inefficiencies caused by

information asymmetry. They show that managers use their superior information to issue risky securities when they are over-priced. Investors, however, recognise this asymmetric information problem and they discount the firm’s risky securities. This under-investment problem can be avoided by using a security that is not so severely under-valued by the market such as retained earnings or riskless debt that involve no asymmetric information problem (or adverse selection problem). As a result, firms finance new investments, first internally with retained earnings, then with safe debt, then with risky debt, and finally with equity to minimise those costs. This order of corporate financing is known as the pecking order.

The major implication of the pecking order theory is that there is no optimal or target debt ratio, and firms do not aim at any target debt ratio, instead, the debt ratio is just the cumulative result of financing following the pecking order. Myers (1984) points out that dividends are less attractive for firms with less profit, large investment opportunities and high leverage because of high costs of equity financing. Thus, in a simple model, leverage is lower for more profitable firms, and higher for firms with more investments. He suggests that, however, firms with larger expected investments have less current leverage to balance current and future costs.

In contrast, Ross (1977) suggests another aspect of the symmetric information theory, based on the incentive signaling approach. In his model, managers know the true distribution of firm returns, but investors do not. Since managers are penalised if the firm goes bankrupt, managers of low quality firms do not imitate higher quality firms by issuing more debt. Thus, contrary to Myers and Majluf (1984), investors take larger debt levels as a signal of higher quality.

Bond and Scott (2006) test a sample of 18 U.K listed real estate companies over a seven year period up to 2004. Using dynamic specifications of the model’s

inferences about firm financing behaviour, they find the financing patterns of the selected sample follow closely the pecking order pattern. Their finding supports the Shyam-Sunder and Myers (1999) result. However, other studies (Chirinko and Singha, 2000; Barclay, Morellec and Smith, 2001; and Frank and Goyal, 2004)) fail to verify these results and assign the contrary result to the techniques employed in the testing.

Whilst Welch (2004) observes that it is virtually impossible to distinguish between firms that truly follow the pecking order theory and those who have no policy at all, Leary and Roberts (2005) conclude that neither theory (e.g., trade-off and pecking order theory) dominate the financing decision. Leary and Roberts suggest that firms may simply choose the cheapest source of financing at any point in light of both the tax advantages of debt and asymmetric information costs of external financing.

In summary, the Asymmetric Information Model (pecking order theory) cannot be entirely corrected; otherwise firms would never issue equity when they could have issued investment-grade debt. Nevertheless, it does offer an explanation for some of the observations not explained by the static trade-off model. At the least, it helps in explaining the strong negative association between profitability and leverage found in various studies (e.g., Ghosh, Nag and Sirmans, 1999; Fama and French, 2002; Frank and Goyal, 2003; and Gaud et al., 2005).

2.3.6 Market Timing Theory

The Market Timing Theory was developed by Baker and Wurgler (2003). The theory is more behavioural in nature and scope and postulates that managers make financing decisions according to capital market conditions. The Market Timing

Theory departs from traditional capital structure theories not only because it examines capital structure changes from the capital market perspective, but it also relaxes the assumption of market efficiency. Equity market timing means that decisions to issue equity depend on stock prices and the debt market timing means that decisions to issue debt depend on the interest rate levels. The concept of an optimal leverage ratio is relegated to a secondary role in the market timing theory. In other words, the security choice of a firm depends on market conditions rather than some pecking order (Ooi, Ong and Li, 2008).

Empirical studies on the underlying reason for equity and debt market timing remain inconclusive. Equity market timing gains support from two different hypotheses: information-based market timing (Korajczyk, Lucas and McDonald, 1992; Li et. al., 2007; Ooi, Ong and Li, 2008) and market-efficiency based market timing (Loughran and Ritter, 1995; Howton, Howton and Friday, 2000). The information-based market timing hypothesis focuses on the variations in adverse selection costs of equity offerings arising from asymmetric information. Since managers issue equity only when stock prices are high or overvalued, equity offerings should precipitate a fall in stock prices. Li et al. (2007) examine the security choice of REITs to evaluate the market timing theory. The empirical results from 1993 through 2004 support the information-based market timing theory for equity offerings and backward looking market timing in debt issuances. On the other hands, in their

study, Korajczyk, Lucas and McDonald (1992) conclude that market asymmetric

information is not fixed over time, and firms tend to issue equity when the market is most informed about the quality of the firm, for example, after earnings releases.

The market-efficiency based equity market timing hypothesis is predicated on post offering long-run stock performance. The problem of the equity price

underperformance after IPO (Howton, Howton and McWilliams, 2003) and long-run underperformance after equity issues (Loughran and Ritter, 1995), suggest that managers capitalise on the inefficiency in capital markets by timing the market. The evidence on market inefficiency-related market timing is mixed and there are methodological concerns in the test for long-run anomaly (Ooi, Ong and Li, 2008).

In their study, Baker and Wurgler (2002) and Ooi, Ong and Li (2008) show empirically that market timing has persistent effects on capital structure, and that the capital structure is the cumulative outcome of past attempts to time the equity market. In particular, they find that leverage has a strong negative correlation with market-to-book ratio, which is the usual measure for market timing opportunities. On the other hands, Feng, Ghosh and Sirman (2007) show that REITs with historically high market-to-book ratio tend to have persistently high leverage ratio. In other words, firms with high growth opportunity and high market valuation raise funds through debt issues.

In fact, both information-based market timing and market-efficiency based equity market timing hypotheses could explain the negative long-run correlation between leverage and market-to-book ratio. Under the information-based market timing, the market-to-book ratio is inversely related to adverse selection, and temporary fluctuations in the market-to-book ratio measure variations in adverse selection. The market inefficiency timing theory assumes that managers time the equity market when they perceive that investors overvalue the firm. They would use the market-to-book ratio as a proxy of market misevaluations. Since market-to-book ratio could represent both adverse selection and market misevaluations, it is difficult to differentiate which market timing hypothesis dominates.

Empirical work on the market timing theory is provided by Graham and Harvey (2001) and Ooi, Ong and Li (2007, 2008) where they show that managers would issue equity when their stocks are overvalued and issue debt when interest rates are low. Both debt and equity would be issued when investors are more risk- averse. According to Li et al. (2007), the long-run relative underperformance of stocks after initial public offerings or secondary equity offerings is consistent with the market timing theory.

On the other hands, Baker, Greenwood and Wurgler (2003) find that the maturity of debt issues is negatively related to the term spread. Ooi, Ong and Li (2007, 2008) also support market timing in debt issuances in that firms tend to issue long-term debt when interest is low and term spread is narrow, and issue short-term debt when interest is high and term spread is wide. Further, Barry et al. (2005) investigate the debt issuing decision of firms in relation to historical interest rates, and conclude that the amount and number of debt issues are higher when current interest rate is lower compared to historical interest rates.