Proceedings of 7th Asia-Pacific Business Research Conference

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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Pecking Order Theory of Non-Financial Firms in Indonesia
Included At LQ-45 Index
Aditya Dharma Andriano* and Anggoro Budi Nugroho**
Pecking Order Theory is one of the most important theories in capital structure of
corporate finance. The theories explain about the financing strategy which stated that the
company will prioritize their source of finance according to its costs. The company would
prefer use internal source of funds or retained earnings as the top priority, follow by issue
more debt, and for the last choice issue new shares on equity. This paper tests whether
the stated hierarchy of financing will guide the company to maximize the shareholder’s
wealth as well as reduce their financial risk. The determinant of shareholder’s wealth that
is used on this research is Earnings per Share (EPS). For the determinant of financial risk
that is used on this research is Total Operating Expenses. Three major costs of capital
which are cost of retained earnings, cost of debt, and cost of equity are regressed
through multiple regression analysis using Ordinary Least Square method (OLS). These
three independent variables are tested to those two determinants (dependent variables)
of shareholder’s wealth and financial risk, as the basis of better financing strategies. The
sample used on this research is 8 non-financial firms from different sectors which are
included on LQ-45 index (most liquid firms) from year 2001 to 2012 listed in Indonesia
Stocks Exchange. The result on the first model (maximize EPS) shows that there are four
companies that support the evidence of pecking order theory. The result on the second
model (minimize OPREXP) shows that there are five companies that support the
evidence of pecking order theory. The result explained that those firms are not favorable
to do the external financing. According to the results, it may suggest that the more
profitable firms are better on managing their financial risk by using more internal cash flow
to finance the project rather than do the external financing.
Keywords: Pecking Order Theory, Internal Financing, External Financing, Earnings per
Share, Total Operating Expenses
JEL Codes: G32
1. Introduction
In a corporation there are several parties which have different interests such as
owners/shareholders, managers, debt holders, bondholders, etc. Manager is the one who
represents the shareholder‟s interest. The purpose or aim of every managerial decision
has to maximize the shareholders wealth as well as manage the business risk. Financing
is one of the most important corporate finance activities which focus on to get the money
or to finance the project with the minimum costs. There is cost of capital that the company
has to bear whenever collecting the funds both internally and externally. The capital
structure theories are always associated to the company‟s financing strategy. According to
Myers (1984) in the capital structure puzzle explained that there are two theories which
contrast two ways of thinking about capital structure which are Static Trade-off Theory and
Pecking Order Theory. In Static Trade-off Theory, “firm's optimal debt ratio is usually
__________________________________________________________________
*Aditya Dharma Andriano, School of Business and Management, Bandung Institute of Technology,
Indonesia. Email: [email protected]
**Anggoro Budi Nugroho, S.E., MBA, Bandung Institute of Technology,
Indonesia. Email: [email protected]
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
viewed as determined by a tradeoff of the costs and benefits of borrowing, holding the
firm's assets and investment plans constant. The firm is portrayed as balancing the value
of interest tax shields against various costs of bankruptcy or financial embarrassment”
(Myers 1984, p. 577).
So here, in static trade-off theory there is optimal capital structure which determine by the
optimum debt ratio. The optimal capital structure means that there is minimum cost of
capital resulting from the trade-off between the interest tax shields against bankruptcy
costs. The second theory is Pecking Order Theory. Donaldson stated (as cited in Adrianto
2007, p. 27) that this theory explain that company which going to finance their project
would prefer internal financing rather than external financing. This behaviour occurs
because there is asymmetric information between the managers and the
owners/investors. The asymmetric information problem occurs because the managers are
believed understand more about the company prospects, value, and risk than the
owners/investors. So if the managers issue new shares, investors will believe that
managers think that the firm is overvalued and managers are taking advantage of this
over-valuation. As a result, investors will place a lower value to the new equity issuance.
This asymmetric information will lead to add some extra cost in acquiring the capital
needed from external sources. The most important implication of this problem is there
would be hierarchy of financing exist according to the cost of financing. In other words, the
company will prioritize their source of financing according to its cost. The company would
prefer use internal funds first which is retained earnings as the first priority. If the internal
sources are depleted, then the company would issue debt. Last, when the company is not
able to issue any more debt, then new equity is issued. The debt capital is more
preferable than equity issuance because if the managers issue new equity it gives signal
that the boards lack of confidence about the company and seems that the value of
company is over-value. As the impact, the investors would adjust to reduce the market
value of the firm. This is why the “cost” to issue new equity will be much costly than debt
which is less sensitive with the information problem.
There is so many researches have been done about testing the pecking order theory
through empirical studies. Shyam-Sunder and Myers (1999, p. 242) conduct comparative
analysis between pecking order theory and static trade-off theory. The results suggest
greater confidence in the pecking order than in the target adjustment model (static tradeoff). While Jibran, Wajid, Waheed, and Muhammad (2012, p. 93) finds weak form of
pecking order theory (limited amounts of equity issues are acceptable) exist on Pakistan‟s
Non-financial Sector. Atiyet (2012, p. 9) also finds that the capital structure in french firms
are better explain on pecking order theory rather than trade-off theory. He figure out from
the existence of asymmetric information involving adverse selection problems.
Arowoshegbe and Emeni (2014, p. 112) study about the various debt-equity mix to the
shareholder‟s wealth in Nigeria‟s non-financial firms. They found that there is a significant
negative relationship between shareholder‟s wealth and debt-equity mix of quoted
companies in Nigeria. These findings supporting the pecking order theory because it
stated that firms, which are profitable and therefore generate high earnings, are expected
to use less debt capital than those that do not generate high earnings. So it means that
the use of debt financing contributes negatively to the shareholder‟s wealth.
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
The research question in this paper is whether the hierarchy or the order of the pecking
order theory truly maximize the shareholders wealth and minimize the risk of the firm.
Using sample in Indonesia‟s non-financial firms, the key determinant of shareholders
wealth that used in this paper is Earnings per Share. This variable is adopted from
Arowoshegbe & Emeni (2014, p. 108). For the determinant of minimize the risk, Total
Operating Expenses is used as the second dependent variable. Various costs of capital
which are cost of retained earnings, cost of debt, and cost of equity are tested to those
two dependent variables and analyze the effect and the significance. The objective of this
research is to know whether there is supporting evidence on pecking order theory using
maximizing shareholder‟s wealth and minimizing the risk as the basis of better financing
strategy.
2. Literature Review
Capital Structure has been one of the most influential theories in modern finance. Capital
Structure is a combination of various long term capitals that will be used as source of fund
for long-term financing. Source of fund could be obtain both from internal or external. For
the internal financing, the company will used some profit to finance new project or simply
ask the owners. In finance terminology, it called retained earnings. For the external
financing, the company will choose either to borrow some fund or issue new shares to
extend the ownership in order to get more money. In other words, there three major
sources of capital which are internal funds (retained earnings), debt, and new equity.
Pecking order theory is one of the modern finance theories about capital structure which
modified and popularized by Myers and Majluf on 1984. Donaldson (as cited in Adrianto
2007, p. 27) was the first man who suggests this initial theory. He found that the
management of company will prefer internal financing rather than external financing. The
pecking order theory stated that the managers will prefer use internal funds as the top
priority source of financing. If the internal fund is depleted, then the company will issue
debt to raise funds from external. If the companies are not sensible to issue more debt,
then new shares of equity will be issued as the last option. This hierarchy of financing
appear based on these following reasons :
A. Asymmetric information in the capital market
B. Assumption that the managers always act behalf existing shareholder‟s interest
from new investors point of view
C. Debt has lower information problem than issue new equity
As the implication of these problems, the hierarchy of financing exists. The company will
prioritize their source of finance according to its costs which influenced by those three
factors. The company would prefer to use internal source of funds or retained earnings as
the top priority, follow by issue more debt, and for the last choice issue new shares on
equity.
This research is intended to know whether the hierarchy or the order of the pecking order
theory really maximize the shareholders wealth and minimize the risk of the firm using
costs of capital as the factors. The key determinant of shareholders wealth that used in
this paper as the first dependent variable is Earnings per Share. For the determinant of
minimize the risk, Total Operating Expenses is used as the second dependent variable.
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Various costs of capital which are cost of retained earnings, cost of debt, and cost of
equity are tested to those two dependent variables and analyze the effect and the
significance. The objective of this research is to know whether there is supporting
evidence on pecking order theory using maximizing shareholder‟s wealth and minimizing
the risk as the basis of better financing strategy.
Below is in-depth explanation about the variables and the calculation method used on this
research :
A. Earnings per share is used as the determinant of shareholder‟s wealth. This
variable is adopted from Arowoshegbe & Emeni (2014, p. 108). In their research,
they used EPS as the determinant of shareholder‟s wealth. Earnings per share is
net income divided by the number of shares outstanding. So in other words, it
measures the profitability of their investment on per share basis. EPS is used to
test whether there is positive effect from those three costs of capital on EPS and
determine which capitals give better impact to the EPS.
B. Total operating expenses is used as the determinant of minimizing cost to minimize
the financial risk. Total Operating Expenses is Cost of Goods Sold plus Selling
Expenses plus General and Administrative Expenses plus Depreciation plus
Amortization. Revenue minus total operating expenses equal to Earnings Before
Interest and Taxes (EBIT). EBIT is a basic measure of the firm‟s ability to generate
cash flow from operations, and it can be used as a measure of cash flow available
to meet financial obligations. So, the lower the total operating expenses, the higher
the company‟s EBIT. Higher EBIT indicates the company reduces the financial risk
which is unable to pay the obligation (tax and interest payment). In this situation the
management will try to minimize the total operating expenses. Total Operating
Expenses is used to test whether there is negative effect from those three costs of
capital on Total Operating Expenses and determine which capital give better impact
to the Total Operating Expenses. Higher negative effect to Total Operating
Expenses indicates that the firms are reduces their financial risk, which is more
preferable to be selected as priority.
C. Cost of retained earnings is the return that is expected by the existing
shareholders. The earnings would likely to be distributed as dividends or would be
retained by the firms in order to finance project. This paper used the Dividend
Growth Model for calculating the cost of retained earnings (Damodaran 1996, p.
61) because the samples that used in this research are companies which relatively
pay dividend each year.
= Cost of Retained Earnings
= Dividends per Share next year
= Price of the stock today
= growth rate in earnings /dividend
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
To get the cost of retained earnings each year, it needs growth rates each year.
The growth rates formula :
= growth rate in earnings /dividend
= Return on Equity
= 1 – Dividends Payout Rate
D. Cost of debt measures the current cost to the firm of borrowing funds to finance
projects (Damodaran 1996, p. 62). There are three determinants associated with
cost of debt which are the current level of interest rates, the default risk of the
company, and the tax advantage associated with debt. Galuh (2013, p. 20) in her
paper “Modigliani and Miller Revisited : Theories of Capital Structure in Indonesia‟s
Cigarette Industry Year 2003-2012” estimate the cost of debt using the synthetic
rating based on review of Damodaran.
To calculate the cost of debt, the first step is to determine the interest coverage
ratio in year t. The interest coverage ratio explain how well a company has its
interest obligations covered (Ross, Westerfield, and Jordan 2010 p. 59). It also
usually called time interest earned ratio.
For large manufacturing firms
If interest coverage ratio is
>
? to
Rating is
-100000.00
0.20
D
0.20
0.65
C
0.65
0.80
CC
0.80
1.25
CCC
1.25
1.50
B1.50
1.75
B
1.75
2.00
B+
2.00
2.50
BB
2.50
3.00
BBB
3.00
4.25
A4.25
5.50
A
5.50
6.50
A+
6.50
8.50
AA
8.50
100000.00
AAA
For smaller and riskier firms
If interest coverage ratio is
>
? to
Rating is
-100000.00
0.50
D
0.50
0.80
C
0.80
1.25
CC
1.25
1.50
CCC
1.50
2.00
B2.00
2.50
B
2.50
3.00
B+
3.00
3.50
BB
3.50
4.50
BBB
4.50
6.00
A6.00
7.50
A
7.50
9.50
A+
9.50
12.50
AA
12.50
100000.00
AAA
Table 1. Interest Coverage Ratio and Bond Ratings table (pages.stern.nyu.edu n.d.)
Before decide the current level of bond rating, the second step is to decide whether the
sample is categorized as large manufacturing firms or smaller and riskier firms. In order to
know the size of the firms, the indicator used for determine whether the company large or
small is based on the market capitalization. If the market capitalization is above $5 billion,
then the firm is categorizes as large firm. If the market capitalization is below $5 billion,
then the firm is categorizes as smaller firm.
After decided which table rating used to refer, the next step is to relate the results of the
interest coverage ratio to the current level of bond rating according to the table 1. The
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
current level of bond rating will be matched to the Indonesian market interest rate refer to
Nurhadi (as cited in Nurhikmah 2013, p. 139) on the following table 2.
Rating
AAA
AA
A+
A
ABBB
BB+
BB
B+
B
BCCC
CC
C
D
Indonesian Market Interest Rate (%)
12.2
12.72
13.24
13.76
14.28
14.8
15.32
15.84
16.36
16.88
17.4
17.92
18.44
18.96
19.48
Table 2. Indonesian Market Interest Rate (Nurhikmah 2013, p. 139)
The Indonesian market interest rate is the pretax cost of debt. To calculate the after
tax cost of debt, according to Damodaran (1996, p. 63) :
The tax rate that will be used to calculate after-tax cost of debt vary from year 20002012. The tax rate will be refer basen on Indonesia‟s corporate tax regulation on
the following table 3 :
Year
Corporate Tax Rate
2000 - 2008
30%
2009
28%
2010
25%
2011
25%
2012
25%
2013
25%
Table 3. Indonesia‟s Corporate Tax Rate (www.kpmg.com, 2014)
E. Cost of equity is the rate of return that investors require to make an equity
investment in a firm (Damodaran 1996, p. 47). If the company wants to issue new
shares of stocks, the cost that the company has to pay is the investor‟s expected
return. In this research, the approaches that will be used to measure cost of new
equity is using risk and return models or the capital asset pricing model (CAPM).
“The CAPM measures risk in terms of non-diversifiable variance and relates
expected return to this risk measure. The non-diversifiable risk for any asset is
measured by its beta, which can be used ti yield an expected return ” (Damodaran
1996, p. 47). Below is the CAPM equation for determine the cost of equity :
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
= Cost of Equity
= Risk-free Rate (using SBI rate, see Appendix 1)
= Beta
= Expected Return on the market index (using IHSG, see Appendix 2)
Notes that the flotation cost that adjusted when issue new stock is assume to be zero. So
there is no flotation cost in calculation component.
By testing the various costs of capital to the EPS and Total Operating Expenses, it will
results to make rank or order from the most preferable source of capital until the least
preferable. Then the hierarchy will be used to compare with the pecking order theory
which stated that internal financing is more preferable than external financing.
3. The Methodology and Model
The population in this research is all Indonesia‟s non-financial companies listed in
Indonesia Stocks Exchange (IDX) which included in LQ-45 index. The sample was
selected using purposive sampling or judgmental sampling method. The sample used will
be based on the most relevance to the test the pecking order theory. In this research the
indicators used to select the sample are :
a. The companies that listed before year 2000 in Indonesian Stocks Exchange. These
company will get access to the capital market so they will be able to execute
external equity financing.
b. The companies that is included in LQ-45 index at least three times consecutively
during the most recent period 2001-2014
c. The companies that classified as financial sector is excluded in this research based
on the reason that he financial firms are strictly regulated by the government and
have different format of its financial statement. These factors will affects the capital
structure of the firms and the results will be bias.
d. The companies which pay dividend during 2001-2013
e. The companies that have annual audited financial statement from year 2000 to
2013. The audited financial statement ensures there is assurance regarding the
information inside.
f. If the number of company or companies which represent each sectors is/are not in
the same amount after processed using the above indicators (for example in
Agriculture sector there is only 1 company that match with the above criteria,
however in Mining sector there are 2 companies that match with the criteria). In this
case, it will take the least amount for uniformity (which is 1 company). To select
which one company should be selected, it will used simple random sampling
method. The companies will be given numbers and randomly selected using the
random number generator in www.StatTrek.com.
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Based on those indicators there are 8 companies used as the sample of this research.
There is one company for each sector because in the Miscellaneous Industry,
Infrastructure, Utility, and Transportation Industry, and Trade, Service, and Investment
Industry there is only one company which qualify those above criteria. These are the
names and the sectors of the companies that are selected as the sample of study on this
research :
Table 4. List of Companies used as sample
The model used on this research was adopted from Arowoshegbe & Emeni and adjusted
according to the pecking order theory. Arowoshegbe & Emeni (2014, p. 107) test the
effect of debt-equity mix to the shareholder‟s wealth (EPS as the dependent variables).
Their findings support the pecking order theory. In this research, the approach will be the
same regarding the use of “shareholder‟s wealth” as the determinant of whether the
financing strategy is good or bad. Besides, there also another dependent variables that
will be tested which is total operating expenses. This variable will be the determinant of
whether the company is better on reducing the financial risk by choosing the best
financing strategy. Based on the pecking order theory, there are three major source of
financing which are internal funds or retained earnings, debt, and external equity. To test
whether there is support on pecking order theory, which stated that “there is hierarchy of
financing exists as the consequence of prioritize the lowest cost of capital so then the
company would prefer to use internal funds or retained earnings first, then issue debt, and
issue new shares as the last option”, these three source of capital will be tested against
the EPS and Total Operating Expenses. In this research, it will examine the relationship
and the effect of those variables. In order to answer the research question, three are two
models that will be tested :
Model 1 :
EPS
: Earnings Per Share (dependent variable/Y)
CRET
: Cost of Retained Earnings (independent variable/
CDEBT : Cost of Debt (independent variable/ )
CEQUITY : Cost of Equity (independent variable/ )
: Regression model coefficients
)
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
: Residual error or difference between the observed and estimated dependent
variable
In this model, it will examine the relationship between those three costs of capital to the
determinants of shareholder‟s wealth which is earnings per share (EPS). According to the
pecking order theory the desirable output of this model are :
1. There is significant relationship between the EPS and those three costs of
capital. Since the sample is relatively small, the level of significance used in this
research is at 10%.
2. There is positive effect from those three costs of capital to the EPS
3. Cost of Retained Earnings is expected to have the highest positive effect to the
EPS, following by Cost of Debt, and last Cost of Equity.
4. Alternatively, Cost of Retained Earnings is expected to have positive significant
effect to the EPS, whereas Cost of Debt and Cost of Equity are expected to
have negative significant effect to the EPS.
These four postulates will determine whether there is support on pecking order theory
about the “preferable order” of financing. Higher positive effects indicate the capital will be
the better option to be selected as the source of financing because it resulted to
maximizing shareholder‟s wealth issue.
Model 2 :
OPREXP
CRET
CDEBT
CEQUITY
: Total Operating Expenses (dependent variable/Y)
: Cost of Retained Earnings (independent variable/ )
: Cost of Debt (independent variable/ )
: Cost of Equity (independent variable/ )
: Regression model coefficients
: Residual error or difference between the observed and estimated
dependent variable
In this model, it will examine the relationship between those three costs of capital to the
determinants of ability to reduce the financial risk which is total operating expenses.
According to the pecking order theory the desirable output of this model are :
1. There is significant relationship between the total operating expenses and those
three costs of capital. Since the sample is relatively small, the level of
significance used in this research is at 10%.
2. There is negative effect from those three costs of capital to the total operating
expenses
3. Cost of Retained Earnings is expected to have the highest negative effect to the
total operating expenses, following by Cost of Debt, and last Cost of Equity.
4. Alternatively, Cost of Retained Earnings is expected to have negative significant
effect to the EPS, whereas Cost of Debt and Cost of Equity are expected to
have positive significant effect to the EPS.
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
These four postulates will determine whether there is support on pecking order theory
about the “preferable order” of financing. Higher negative effects indicate the capital will
be the better option to be selected as the source of financing because it resulted to
minimizing financial risk issue.
4. The findings
Results of Model 1 :
Company
AALI
ASII
BUMI
INTP
LPKR
TLKM
UNTR
UNVR
Constant
4,883.472***
(1,237.142)
-1,245.746
(797.43)
692.313**
(248.6)
2,493.868*
(1,181.478)
41.217*
(20.871)
60.075
(154.31)
4,446.339*
(2,189.762)
154.964***
(29.018)
Coefficients
CRET
CDEBT
-2,673.991
(1,670.223)
-1,722.389**
(570.224)
-209.716
(114.305)
1,990.956
(1,916.097)
-0.982
(20.319)
-322.766***
(72.722)
-4,528.261*
(2,190.766)
308.359**
(117.877)
-36,583.269**
(12,460.344)
19,772.793*
(9,786.533)
-4,700.661*
(2,306.403)
-24,833.112*
(11,794.016)
37.734
(147.244)
1,042.548
(1,747.455)
-29,869.123
(25,519.435)
3,079.824***
(501.157)
CEQUITY
-329.760
(299.458)
-41.719
(61.938)
29.114
(38.739)
103.754
(310.63)
-204.966*
(89.721)
-3.482
(23.283)
-84.997
(228.213)
67.82
(164.837)
Adjusted
R²
0.458
0.438
0.432
0.176
0.609
0.603
0.409
0.865
Table 5. Multiple Regression Results of Model 1
Note : Significant at significance level (α) =
*) 10%
**) 5%
***) 1%
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Proceedings of 7th Asia-Pacific Business Research Conference
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Result of Model 2 :
Company
AALI
ASII
BUMI
INTP
LPKR
TLKM
UNTR
UNVR
Coefficients
Adjusted
R²
Constant
16,300,286,618,658.5**
(5,826,685,206,494.32)
-330,293,793,600,278
(274,293,872,180,145)
-12,223,215,051,283.7
(23,981,787,356,714.8)
21,116,639,393,592.2**
(6,694,705,186,999.99)
9,802,423,424,062.28***
(2,257,656,684,092.26)
-16,330,274,384,201.7
(93,871,779,824,847.8)
84,515,235,045,454.6
(62,646,398,362,927.2)
CRET
-15,854,144,236,003.7*
(7,866,409,670,129.97)
-495,236,098,362,727**
(196,141,074,158,944)
-2,694,399,792,391.17
(11,026,674,538,880.1)
13,577,249,010,805.1
(10,857,341,045,536.2)
-5,433,218,989,173.06**
(2,197,991,657,333.5)
-143,908,050,048,191**
(44,239,004,451,166.4)
-150,607,410,663,687**
(62,675,140,149,123.2)
CDEBT
-99,226,325,044,655.9
(58,685,666,767,225.2)
5,540,620,414,672,270
(3,366,295,111,123,930)
270,704,850,420,621
(222,492,856,176,794)
-181,666,848,616,067**
(66,829,403,632,074.1)
-38,606,656,350,391.3**
(15,927,695,208,105.2)
827,200,279,237,724
(1,063,036,492,735,830)
-338,105,995,744,619
(730,079,795,399,684)
CEQUITY
78,392,533,242.527
0.258
(1,410,384,172,041.72)
-17,406,808,047,952
0.334
(21,304,823,943,317.5)
-2,087,144,988,009.16
-0.155
(3,737,028,340,590.9)
-42,916,796,399.767
0.356
(1,760,147,063,701.03)
-43,172,326,568,510***
0.736
(9,705,309,057,508.85)
-6,435,739,100,978.21
0.417
(14,163,641,359,216.1)
-5,028,071,786,627.98
0.374
(6,528,903,380,610.75)
6,343,258,828,235.37***
(972,461,451,771.731)
9,481,328,250,051.67**
(3,950,278,982,509.5)
93,367,118,665,374.3***
(16,794,671,975,123)
3,333,254,210,229.94
(5,523,993,193,049.58)
0.837
Table 6. Multiple Regression Results of Model 2
Note : Significant at significance level (α) =
*) 10%
**) 5%
***) 1%
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
The following tables are summarized the findings and interpretation of the results :
Model 1 : EPS = β0 + β1 CRET + β2 CDEBT + β3 CEQUITY + ε
No
1
The
Actual Sign Preferrable
that match
Order
Company
to Expected according to
Sign
Beta
Coefficients
AALI
Findings
Support to
Pecking Order
Theory
Reject
External
Equity, R/E,
Debt
Debt
negative
significant
Support
Debt positive
significant
and R/E
negative
significant
No Support
2
ASII
Debt
Debt,
External
Equity, R/E
3
BUMI
Reject
External
Equity, R/E,
Debt
Debt
negative
significant
Support
4
INTP
Reject
R/E, External
Equity, Debt
Debt
negative
significant
Support
External
Equity
negative
significant
Support
5
LPKR
Reject
Debt, R/E,
External
Equity
6
TLKM
Reject
Debt,
External
Equity, R/E
R/E negative
significant
No Support
7
UNTR
Reject
External
Equity, R/E,
Debt
R/E negative
significant
No Support
Debt, R/E
Debt, R/E,
External
Equity
R/E and Debt
positive
significant,
debt higher
No Support
8
UNVR
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Table 7. Summary of the findings on Model 1
Model 1 : OPREXP = β0 + β1 CRET + β2 CDEBT + β3 CEQUITY + ε
The
Actual Sign Preferrable
that match
Order
No Company
to Expected according to
Sign
Beta
Coefficients
Findings
Support to
Pecking Order
Theory
1
AALI
R/E
Debt, R/E,
External
Equity
R/E negative
significant
Support
2
ASII
R/E
R/E, External
Equity, Debt
R/E negative
significant
Support
3
BUMI
Reject
External
Equity, R/E,
Debt
No conclusion
-
4
INTP
Debt
Debt,
External
Equity, R/E
Debt negative
significant
No Support
R/E negative
significant,
Debt negative
External
significant,
Equity, Debt, External Equity
R/E
negative
significant,
External Equity
> Debt > R/E
No Support
5
LPKR
Accept
6
TLKM
R/E
R/E, External
Equity, Debt
R/E negative
significant
Support
7
UNTR
R/E
Debt, R/E,
External
Equity
R/E negative
significant
Support
Reject
External
Equity, R/E,
Debt
R/E positive
significant and
Debt positive
significant,
debt higher
Support
8
UNVR
Table X
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Table 8. Summary of the findings on Model 2
A.
Result Discussion of Model 1
In this model, better financing strategy will be based on the objective of maximizing
shareholder‟s wealth. Based on the table 7 there are four companies that shows the result
that support the evidence of pecking order theory which are AALI (Agriculture Company),
BUMI (Mining Company), INTP (Basic and Chemical) and LPKR (Property and Real
Estate). The results show that these companies are not favorable to do the external
financing. In the pecking order theory stated the internal financing is more preferable than
external financing due to asymmetric information problem that will be lead to add some
extra cost to the company. On the other hand, there also four companies that shows the
result that not support the evidence of pecking order theory which are ASII (Miscellaneous
Company), TLKM (Infrastructure, Utility, and Transportation), UNTR (Trade, Service, and
Investments), and UNVR (Consumer Goods Company). The results show that these
companies are not favorable to do the internal financing. In the pecking order theory
stated the internal financing is more preferable than external financing due to asymmetric
information problem that will be lead to add some extra cost to the company. This result
supports the trade-off theory which stated that the more profitable the firms, the more debt
they have to issue in order to reduce the corporate taxes.
B.
Result Discussion of Model 2
In this model, better financing strategy will be based on the objective of minimizing the
financial risk. Based on the table X, there are five companies that shows the result that
support the evidence of pecking order theory which are AALI (Agriculture Company), ASII
(Miscellaneous Company), TLKM (Infrastructure, Utility, and Transportation), UNTR
(Trade, Service, and Investments), and UNVR (Consumer Goods Company). The results
show that these companies are not favorable to do the external financing. In the pecking
order theory stated the internal financing is more preferable than external financing due to
asymmetric information problem that will be lead to add some extra cost to the company.
It also can be conclude that the more profitable companies are better managing the
financial risk by using internal cash flow. On the other hand, there also two companies that
show the result that not support the evidence of pecking order theory which are INTP
(Basic and Chemical) and LPKR (Property and Real Estate). The results show that these
two companies are not favorable to do the internal financing. In the pecking order theory
stated the internal financing is more preferable than external financing due to asymmetric
information problem that will be lead to add some extra cost to the company. For the last
company which is BUMI (Mining Company), there is no conclusion could be obtained from
the results because none of the independent variables have any significant effect to the
total operating expenses. This also indicated by the previous data which shows negative
value of adjusted coefficient of determination (R²)
Because not all of the independent variables have significant effect to the dependent
variables, there is no conclusion can be taken for the third postulate.
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Below is the table which summarize the advantages and disadvantages of using earnings
per share as the determinant of maximizing shareholder‟s wealth and total operating
expenses as the determinant of minimizing financial risk :
Advantages
1. It is a good measures for
profitability of
shareholder's investment
on per share basis
2. The earnings per share is
net income divided by the
total shares. It means that it
reflects the final "earnings"
Earnings Per of the company each year
which had been deducted
Share
from all company's cost
Disadvantages
1. It is not the only one
factors that reflects the
shareholder's wealth
2. It is assume that all the
companies will prioritize
to maximize the growth of
EPS in terms of maximizing
sharholder's wealth each
year
3. Maximizing EPS will
3. Earnings figures not
maximize the P/E ratios and adequately reflect risk
hence its shares value
-
Total
Operating
Expenses
4. The EPS ignores the
importance of dividend
policy which affect the
company's value
1. It is basic measures to
1. It is not the only one
determine company's EBIT. determinant of financial
EBIT explained the ability of risk
the firm's to pay the
obligation which turns to
the degree of financial risk
2. It is still ambiguous to
include depreciation as
total operating expenses
Table 9 Advantages and Disadvantage of the dependent variables
5. Summary and Conclusions
The research objective of this paper is to answer whether the stated hierarchy of financing
on pecking order theory is truly maximizing the shareholder‟s wealth as well as reduce the
risk of the firm. The sample used in this research is eight Indonesia‟s non-financial firms
which listed in Indonesia Stocks Exchange and included in LQ-45 index with the study
period range from 2001 to 2012. The key determinant of shareholders wealth which used in
this paper is Earnings Per Share and using total operating expenses for the determinant of
minimize the risk (financial risk). These two variables used as the dependent variables.
Various cost of capital which are cost of retained earnings (internal funds), cost of debt
and cost of equity have been tested to those two dependent variables and analyze the effect
and the significance. In the pecking order theory stated the internal financing is more
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Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
preferable than external financing due to asymmetric information problem that will be lead
to add some extra cost to the company. The empirical test is conducted to prove whether
there is supporting evidence to this theory using the cost of capital as the point of view.
The result on the first model (maximize EPS) shows that there are four companies that
support the evidence of pecking order theory. The result on the second model (minimize
OPREXP) shows that there are five companies that support the evidence of pecking order
theory. The result explained that those firms are not favourable to do the external
financing. According to the results, it may suggest that the more profitable firms are better
on managing their financial risk by using more internal cash flow to finance the project
rather than do the external financing.
References
Adrianto 2007, „Testing the Pecking Order Theory on Nonfinancial Firms Included in 20012005 LQ45 Index Computation‟ Unpublished Bachelor Thesis, University of
Indonesia.
Alifani, GA 2013, „Modigliani and Miller Revisited : Theories of Capital Structure in
Indonesia‟s Cigarette Industry Year 2003-2012‟ Bachelor thesis, Bandung Institute of
Technology.
Arowoshegbe, AO & Emeni, FK 2014, „Shareholders‟ Wealth and Debt- Equity Mix of
Quoted Companies in Nigeria‟ International Journal of Financial Research. Vol. 5,
no. 1, pp. 107-113.
Bank Indonesia n.d. Sertifikat Bank Indonesia Rate from 1999 to 2013, viewed 5 May
2014, (www.bi.go.id/seki/tabel/TABEL1_25.xls).
Ben Amor Atiyet 2012, „The Pecking Order Theory and the Static Trade Off Theory :
Comparison of the Alternative Explanatory Power in French Firms‟ Journal of
Business Studies Quarterly, vol. 4, no. 1, pp. 1-14.
Damodaran, A 1996, Investment Valuation, John Wiley & Sons, Canada
Jibran, S, Wajid, SA, Waheed, I & Muhammad, TM 2012, „Pecking at Pecking Order
Theory : Evidence from Pakistan‟s Non-Financial Sector‟ Journal of Competitiveness,
vol. 4, no. 4, pp. 86-95.
DuniaInvestasi 2014 IHSG, viewed 5 May 2014,
www.duniainvestasi.com/bei/prices/stock.
Levine, DM, Krehbiel, TC & Berenson, ML 2010, Business Statistics, 5th edn, Pearson,
New Jersey.
Myers, SC 1984, „The capital structure puzzle’, The Journal of Finance, vol. 39, no.3, pp.
575-592.
Nurhikmah, D 2013, „Optimal Capital Structure Analysis : A Study of Indonesia
Telecommunications Companies Listed In Indonesia Stock Exchange Period 20092011‟ Bachelor Thesis, Bandung Institute of Technology.
n.d
,Ratio
and
Bond
Ratings
table,
viewed
2
May
2014,
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/syntrating.ht
m.
KPMG 2014, Indonesia‟s Corporate Tax Rate, viewed 2 May 2014,
http://www.kpmg.com/global/en/services/tax/tax-tools-andresources/pages/corporate-tax-rates-table.aspx.
Ross, SA, Westerfield RW, and Jordan BD 2010, Fundamentals of Corporate Finance,
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16
Proceedings of 7th Asia-Pacific Business Research Conference
25 - 26 August 2014, Bayview Hotel, Singapore ISBN: 978-1-922069-58-0
Stat Trek 2014, Random number generator.
www.StatTrek.com
Appendix
Appendix
1.
Sertifikat
Bank
Indonesia
(www.bi.go.id/seki/tabel/TABEL1_25.xls n.d.)
SBI Rate
Tenor
Period
1 Month 3 Month 6 Month
Dec-99 11.93% 12.64%
Dec-00 14.53% 14.31%
Dec-01 17.62% 17.63%
Dec-02 12.93% 13.12%
Dec-03
8.31%
8.34%
7.43%
Dec-04
Dec-05 12.75%
Dec-06
9.75%
Dec-07
8.00%
Dec-08 10.83% 11.08% 11.82%
Dec-09
6.46%
6.59%
Dec-10
6.26%
Dec-11
Dec-12
Dec-13
Appendix
2.
Expected
return
on
(www.duniainvestasi.com/bei/prices/stock, 2014)
Period
30-12-1999
22-12-2000
28-12-2001
27-12-2002
30-12-2003
30-12-2004
29-12-2005
28-12-2006
28-12-2007
30-12-2008
30-12-2009
30-12-2010
30-12-2011
28-12-2012
30-12-2013
Rate
from
1999
Arithmetic
Mean
9 Month
12.29%
14.42%
17.63%
13.03%
8.33%
7.43%
12.75%
9.75%
8.00%
11.24%
6.53%
6.60%
6.43%
5.04%
5.04%
4.80%
4.80%
7.22%
7.22%
market
index
to
2013
/
IHSG
Close
Market Return
676.92
416.32
-48.61%
392.04
-6.01%
424.95
8.06%
691.9
48.75%
1000.23
36.85%
1162.64
15.05%
1805.52
44.02%
2745.83
41.92%
1355.408
-70.60%
2534.356
62.58%
3703.512
37.93%
3821.992
3.15%
4316.687
12.17%
4274.177
-0.99%
17
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