Modelo de los tres componentes del Compromiso Organizacional

According to Modigliani and Miller (1963), a company‟s value can be maximized through the use of debt; this argument is based on the absence of costs. However, in the real world, there are agency and bankruptcy costs that restrain the use of debt financing and compel companies that look to maximize their value to trade-off the benefits and costs of debt. The following section describes the costs related to debt financing, such as agency costs and costs of financial distress.

5.3.1 The agency costs of debt

According to Jensen and Meckling (1976), the use of debt financing may lead to the so- called overinvestment problem, in which managers and shareholders may use debt funds to invest in risky projects. The justification behind the use of debt for investment in risky projects is the concept of limited liability, in which shareholders profit from the probability of gaining more at the cost of losing more. Jensen and Meckling (1976) argue that the overinvestment behaviour of shareholders reduces the value of the company and, therefore, they gain the wealth of creditors. As a result, creditors foresee

the shareholders‟ behaviour and ask for a higher risk premium, increasing the cost of debt. This is known as the “agency cost of assets substitution” problem.

In contrast, the underinvestment problem may arise, which is the result of a reduced return to the shareholders of the company, which in turn leads them to reject projects even if they have positive net present value. The reasoning behind this behaviour is that shareholders are paid after the debt of the company is paid, which means that undertaking a project with positive net present value will yield higher profits to the debt-holders (Lasfer, 1995).

Regarding the problem of assets substitution, it has been argued that highly leveraged companies have a higher probability of bankruptcy, which means that they will face a greater underinvestment problem. According to Myers (1977) and Titman and Wessels (1988), a high-growth company should raise capital through equity rather than debt, in order to be able to undertake all projects with positive net present value. In addition, Myers (1977) argues that the agency costs related to the substitution of assets may be lowered with the use of short-term debt instead of long-term debt because long-term debt requires higher incentives for asset substitution.

On the other hand, the issuing of secured debt may lessen the asset substitution problem within a company: if the company collateralizes its debt, it will be restrained from using the raised funds, which reduces the agency costs related to the asset substitution and consequently the costs of debt. At this point, it can be argued that the rates charged for debt financing are more attractive for companies that have more fixed assets because fixed assets can be used as collateral in case of bankruptcy or financial distress (Rajan and Zingales, 1995). According to Titman and Wessels (1988), companies with high growth face higher agency costs because they can be more flexible when choosing future investments and when drawing capital from banks or bondholders. Consequently, if the company cannot collateralize the debt it raises, the debt will be more expensive because a higher risk premium will be requested. Therefore, there is an inverse relationship between growth and leverage.

To sum up, the above analysis indicates that the trade-offs between the benefits and the costs of debt result in a company having an optimal capital structure, where if leverage increases above the target level, the costs of using debt financing will be greater than the

benefits, and vice versa. The benefits and costs of debt financing are important when the level of leverage is more than that targeted despite the fact that the optimal capital structure is the important one according to the trade-off theory. This suggests that both optimal capital structure as well as costs and benefits of debt financing confirm the trade-off theory (Brounen et al., 2005). This may be why many companies use less debt than that suggested by theory, which indicates that a company‟s reported leverage ratio may not be the optimal one, thus necessitating adjustment of the observed leverage towards the optimal leverage.

However, according to Myers (1977), adjustment of observed leverage towards the optimal level may be costly because of transaction costs. This implies that adjustment may be prevented by transaction costs. For this reason, adjustment may take place only if the benefits of moving towards the targeted level of leverage are greater than or equal to the costs of the adjustment.

5.3.2 Costs of financial distress

The costs of financial distress are costs that arise because of the probability of bankruptcy: in the presence of the probability of bankruptcy, the market value of a company‟s assets reduces. Financial distress costs occur when a company cannot meet its financial obligations because it uses a large amount of debt as a means of financing. There are two types of bankruptcy costs: direct costs and indirect costs (Barclay and Smith, 1995). Direct costs include administrative and legal costs and costs associated with dissipated assets; shareholders are unwilling to be part of a company that will dissipate its assets as well as its overall value if it becomes bankrupt. Additionally, in the likelihood of bankruptcy, shareholders seek to expropriate bondholders‟ wealth by undertaking risky projects (Cornelli and Felli, 1995).

It should be mentioned that bankruptcy is not a cause of the decrease in a company‟s value; bankruptcy is a result of this decrease. This view is supported by Van der Wijst and Thurik (1993, p. 57): “bankruptcy costs refer to the added costs (such as legal fees, reduced sales, increased production costs, etc.) that arise because the firm cannot meet its obligations to creditors without changing its operating or external financing activities”. Therefore, it can be argued that, if the marginal bankruptcy costs of a company reduce, then the use of debt capital as a means of financing will increase. In

other words, companies with high marginal bankruptcy costs will use less debt as a means of financing (DeAngelo and Masulis, 1980). However, it is also argued that the more the value of a company decreases, the higher the bankruptcy costs (Warner, 1977). For this reason, bankruptcy costs are lower for large companies than for small companies, and small companies are therefore more likely to face higher bankruptcy risk, and more likely to borrow at higher rates, than large companies.

Regarding indirect costs, these are costs that arise because of the reluctance of investors to invest in a company that faces a high possibility of financial distress (Brealey and Myers, 2002). Indirect costs include costs of retaining or losing employees and customers, and costs that are related to suppliers (such as changes in agreement terms and removal of discounts).

Moreover, debt financing is associated with the so-called “debt overhang” cost (Myers, 1977), which arises when the outstanding debt of a company is at high risk. The higher the probability of bankruptcy, the higher the so-called debt overhang problem; companies may need to neglect investments that would otherwise maximize the value of the company (Calomiris et al., 1994). Therefore, it can be argued that financial distress costs are higher for companies that have more volatile earnings because in these companies there is a higher possibility that the level of their earnings will drop below the level of their financial obligations; therefore, companies with more volatile earnings employ less leverage.

In the context of the Greek market, “bankruptcy does not constitute a principle for the satisfaction of several claims but a collective enforcement procedure aiming at the proportional satisfaction of all creditors by reference to the amount of their claims” (European Commission Report, n.d., p. 1). That is, Greek bankruptcy law places emphasis on the creditors‟ benefits and satisfaction and not on the distribution of profits or the liquidation of assets. Additionally, indirect costs such as retaining or losing customers are high for Greek companies, which means that it becomes difficult for companies facing bankruptcy to retain their customers, because the latter seek stable suppliers. On the other hand, indirect costs of employee loss are low in Greece because of its high unemployment rate. In addition, the market will not be willing to provide capital to all those companies that face a high risk of bankruptcy. As a result of the conservative policies followed by Greek banks, the banks are reluctant to offer debt to

high-risk companies. Therefore, lower-risk Greek companies raise debt at a more attractive rate than high-risk companies.