Intuitively, firms are more likely to use debt when the cost of borrowing is low. Conversely, when interest rates are high, companies would be inclined to use equity financing since higher interest rates increases the probability of financial distress. This implies a positive relationship between firm’s change in leverage and interest rates. However, the regression between debt-equity ratio and the explanatory variables produce mixed results. The coefficients of the regression are summarised and presented in Table 5.13.
The data show that there is no impact of interest rate on the firm leverage in the NTS period. This was the period the New Tax System (NTS) was introduced.
Considering the real estate property enterprises in the sample, it is possible that the adjustment to the changes brought about by the introduction of the NTS, especially the introduction of the Goods and Services Tax (GST), is more important than the low interest rate.
Table 5.13: Regression Coefficient of IRATE
Types/Ratio Period NTS POST-NTS1 POST-NTS2
Investment 0 -33.4352 -28.9188 (0) (-2.0144)** (-1.0536)* Development 0 11.6654 -0.8992 (0) (0.7036) (-0.0482) Hybrid 0 10.4903 -19.3070 (0) (0.4295) (-0.7064)
Debt-Equity (all types) 0 -9.8665 -6.3889
(0) (-0.9695) (-0.4578)
Short-Term Debt ( all types) 0 -15.3491 1.2801
(0) (-1.6366)** (0.1115)
Long-Term Debt (all types) 0 17.2482 -8.4144
(0) (2.1657)** (-1.0308)*
Note: 1- * indicates significant at 5% and ** indicates significant at 1%. 2 - The figures in brackets are the values of t-statistic.
3 - Period NTS (1998-2000), Post-NTS1 (2001-2003), Post-NTS2 (2004-2006). 4 - Adjusted R2 and F-statistic are extracted from Appendix 5.1 - 5.3.
The coefficient of interest rate in the Post-NTS1 for all types of enterprises is positives and marginally significant. Although this finding supports the results obtained in Gau and Wang (1990), Ooi (2000) and Howton et al. (2003) who study the impact of interest rates as a determinant of capital structure of real estate property enterprises and find a positive relationship between leverage and the cost of issuing and employing debt it does not however, support the Hypothesis 9 which postulates a negative relationship. An explanation is that increases in interest rate risk are generally associated with an immediate reduction in the equity market value, given
the tradeoff between the tax shield associated with increasing leverage and the costs of financial distress associated with increasing leverage. This reduction in the equity market value is hypothesised to be related to the inability of equityholders to fully hedge interest rate risk, and to the lower likelihood that they will be able to fully capture the franchise value of the higher risk firm (Babbel, 1995).
On the other hand, the relationships between the debt-equity ratio of the real estate enterprises and of the Investment enterprises and the interest rate in the Post- NTS1 and the Post-NTS2 periods are negative and marginally significant. This relationship supports the Hypothesis 9. There are two factors can be used to explain this negative relationship. Firstly, an increase in interest rates may result in higher costs of financing and hence effects demand, because investing in real estate is reliant on borrowed funds. Secondly, Finance Theory suggests investors determine their required rate of return from a risk-free return plus a risk premium. An increase in interest rates may lead to a higher required rate of return translating into lower valuations (Allen et al., 2000).
In addition, the significant negative coefficient for Debt-equity Ratio and for the Long-term Debt of all types of real estate enterprises in the Post-NTS2 indicates that real estate enterprises are more likely to retire some of their existing debts in the rising interest rates period. The descriptive statistics (See Table 4.3, Chapter 4) show that the short-term debt decreased from 22.66 percent in Post-NTS1 period to 17.56 percent in the Post-NTS2 period while the long-term debt increased to 35.78 percent from 30.39 percent in the same period. The result indicates that the real estate enterprises in the sample retire short term debt using the long term one. Consistent with the Market Timing Theory, the real estate property enterprises have increased
reliance on debt capital in both Post-NTS1 and Post-NTS2 periods. This also corresponded with a low interest rate regime (Ooi et al., 2007).
However, the negative relationship between interest rates and the firm leverage is debatable “because of the underlying forces that cause interest rate movements” (Allen et al., 2000 p. 143). Declining interest rates are a result of weaker economic conditions and low inflationary expectations. Weakening economic conditions may cause downward pressure on real estate prices and an increase in the number of vacancies. This results in lower income streams for real estate enterprises, especially the Investment enterprises, and vice versa.
5.5.11 Market Performance (MKTIND)
Firms tend to substitute debt capital with equity when the market indicators is performing well (Ooi, 1999a; Frank and Goyal, 2004). For this a negative relationship between debt-equity ratio and market performance is hypothesised.
Consistent with the expectation, Table 5.14 shows that the estimated coefficients of market performance and total debt-equity ratio of all sample and of Investment and Hybrid enterprises are negative and insignificant in most periods. This result supports Hypothesis 10 and previous study of Baker and Wurgler (2000) who observe that the proportion of new equity issues is higher when market performance is more highly valued.
Employing the discrete choice models to study the debt-equity choices of real estate enterprises, Ooi (2000) and Brown and Riddiough (2003) observe that REITs with higher pre-offer levels of secured debt tend to issue equity, while those with higher pre-offer levels of unsecured debt tend to issue public debt. Their study finds that equity offerings are more likely to be used for investment and debt offerings are
normally used for adjusting leverage. In contrast with Ooi (2000) and Brown and Riddiough (2003), this study shows that the real estate property enterprises did not substitute debt finance with equity despite the Market Performance improved substantially, from 576.33 points in the NTS to 1412.67 points in the Post-NTS2
Table 5.14: Regression Coefficients of MKTIND
Note: 1- * indicates significant at 5% and ** indicates significant at 1%. 2 - The figures in brackets are the values of t-statistic
3 - Period NTS (1998-2000), Post-NTS1 (2001-2003), Post-NTS2 (2004-2006). 4 - Adjusted R2 and F-statistic are extracted from Appendix 5.1 - 5.3.
period. In terms of debt finance, the real estate property enterprises issues more long- term debt to finance the new investment and to retire the short-term debt. The long- term debt increased from 35.07 percent in the NTS period to 36.39 percent in the Post-NTS1 and slightly decreased to 35.78 percent in the Post-NTS2 period. This was matched by the decrease of the Short-term Debt employed during the same
Type/Ratio Period NTS POST-NTS1 POST-NTS2
Investment -0.0006 -0.0004 0.0004 (-0.2119) (-0.7532) (1.0761)* Development 0.0010 0.0008 0.0006 (0.4098) (1.3338)** (-0.2128) Hybrid -0.0062 -0.0007 0.0005 (-1.1170)* (-0.7356) (0.9764)
Debt-Equity (all types) -0.0012 -0.0003 0.0002
(-0.7214) (0.1020) (0.8047)
Short-Term Debt (all types) 0.0002 -0.0001 -0.0004
(0.1376) (-0.0425) (0.2732)
Long-Term Debt (all types) 0.0003 0.0003 0.0002
period. The average short-term debt decreased from 19.11 percent in the NTS period to 17.56 percent in the Post-NTS2 period (See Table 4.3, Chapter 4).
While the relationship between debt-equity ratios of the sample are negative, the positive and significant coefficients of Development enterprises and of the Long- term Debt in all periods indicate that real estate property enterprises in the sample did not substitute debt with equity as hypothesised, despite the Market Performance showing a big increase, from an average of 576.33 points in NTS period to 1,412.67 points in Post-NTS2. Instead, they issued more long-term debt to retire the short- term debt and to finance new investments.
5.6 Chapter Summary
This Chapter discusses the various tests required for the evaluation of the model developed for regression estimation of the impact of explanatory variables on the variation in the dependent variable. Test for Significance results in rejecting of the null hypothesis and accepting the alternative hypothesis recognise that the relationship between dependent variable and the explanatory variables exist. The Test for Robustness concludes that the difference in the estimated regression between the various testing periods and the control period is insignificant. The Test for Heteroskedasticity of the sampled data indicates that the variance of the data in the estimation is constant. The insignificant coefficients between pair-wise dependent and explanatory variables and among explanatory variables indicates that multicollinearity does not cause alarming problem in the regression.
Low value of Adjusted R2 of the regression between debt-equity ratio suggests that there are other factors, in addition to the ones proxied by the explanatory variables, that cause the movement of the debt-equity ratio. When
replace the debt-equity ratio with either the short-term debt ratio or the long-term debt ratio and re-estimating the model, the explaning power of the model improved significantly.
The estimated regression coefficients and signs of the variables obtained from regression are different when regressed using different data set. The estimated signs of the explanatory variables were used to test the ten hypotheses developed in this study. Despite the mixed results obtained in separate regression of each type of real estate property enterprises in the sample, the findings support most of the hypotheses and also back up the Trade-off, Pecking Order and Agency Costs theories of capital structure. The relationship between leverage and interest rate and market performance also support the Market Timing Theory of capital structure.
CHAPTER 6