Does financial flexibility enhance firm value? A comparative study between developed and emerging countries
Abstract
This paper investigates the effect of financial flexibility on firm value, on a comparative basis between developed and emerging countries in Europe. Our dataset covers 4,334 companies from 15 developed and 1,436 companies from 6 emerging countries in Europe for the period between 2000 and 2016. First, depending on companies’ maintenance of leverage that is below-predicted levels for a successive number of years, I identify the financially flexible companies in the sample. Second, I examine whether financial flexibility affects firm value. Our results demonstrate that firms’ financial flexibility positively contributes to firm value in all estimations. Furthermore, this study presents unprecedented evidence that the effect of financial flexibility on firm value is more significant for emerging countries when compared to developed countries in Europe. Moreover, I demonstrate for the first time that firm characteristics, including firm size and age, which proxy for asymmetric information within a company, negatively moderate the relationship between flexibility and firm value. Managers, both in developed and in emerging countries, who aim to surge their firm value up, should give importance to the maintenance of financial flexibility in their capital structure decisions. Last, managers of relatively smaller and younger companies should put more emphasis on becoming financially flexible if they want to improve their firms’ value.
Keyword : financial flexibility, firm value, leverage, emerging and developed countries, GMM
How to Cite
Bilyay-Erdogan, S. (2020). Does financial flexibility enhance firm value? A comparative study between developed and emerging countries. Business: Theory and Practice, 21(2), 723-736. https://doi.org/10.3846/btp.2020.12680
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Bancel, F., & Mittoo, U. R. (2004). Cross-country determinants of capital structure choice: a survey of European firms. Financial Management, 103–132. https://doi.org/10.2139/ssrn.683111
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Bekaert, G., & Harvey, C. R. (2003). Emerging markets finance. Journal of Empirical Finance, 10(1–2), 3–55. https://doi.org/10.1016/S0927-5398(02)00054-3
Berger, A. N., & Udell, G. F. (2005). Small business and debt finance. Handbook of Entrepreneurship Research, 1, 299–328. Springer-Verlag. https://doi.org/10.1007/0-387-24519-7_13
Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87(1), 115–143. https://doi.org/10.1016/S0304-4076(98)00009-8
Bond, S. R., Klemm, A., Newton-Smith, R., Syed, M., & Vlieghe, G. W. (2004). The roles of expected profitability, Tobin’s Q and cash flow in econometric models of company investment. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.641241
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Byoun, S. (2011). Financial flexibility and capital structure decision. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1108850
Chung, K. H., & Pruitt, S. W. (1994). A simple approximation of Tobin’s q. Financial Management, 23(3), 70. https://doi.org/10.2307/3665623
De Jong, A., Verbeek, M., & Verwijmeren, P. (2012). Des financial flexibility reduce investment distortions? Journal of Financial Research, 35(2), 243–259. https://doi.org/10.1111/j.1475-6803.2012.01316.x
De Miguel, A., Pindado, J., & De La Torre, C. (2004). Ownership structure and firm value: New evidence from Spain. Strategic Management Journal, 25(12), 1199–1207. https://doi.org/10.1002/smj.430
DeAngelo, H., & DeAngelo, L. (2007). Capital structure, payout policy, and financial flexibility. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.916093
DeAngelo, H., DeAngelo, L., & Whited, T. M. (2011). Capital structure dynamics and transitory debt. Journal of Financial Economics, 99(2), 235–261. https://doi.org/10.1016/j.jfineco.2010.09.005
Demir, F. (2009). Volatility of short-term capital flows and private investment in emerging markets. The Journal of Development Studies, 45(5), 672–692. https://doi.org/10.1080/00220380802582379
Denis, D. J. (2011). Financial flexibility and corporate liquidity. Journal of Corporate Finance, 17(3), 667–674. https://doi.org/10.1016/j.jcorpfin.2011.03.006
Denis, D. J., & McKeon, S. B. (2012). Debt financing and financial flexibility evidence from proactive leverage increases. Review of Financial Studies, 25(6), 1897–1929. https://doi.org/10.1093/rfs/hhs005
Erdogan, S. B. (2019). Financial flexibility and corporate investment: does financial flexibility affect sustainability of firms? The Circular Economy and Its Implications on Sustainability and the Green Supply Chain (pp. 230–245). IGI Global. https://doi.org/10.4018/978-1-5225-8109-3.ch013
Fama, E. F., & French, K. R. (2005). Financing decisions: who issues stock? Journal of Financial Economics, 76(3), 549–582. https://doi.org/10.1016/j.jfineco.2004.10.003
Faulkender, M., Flannery, M. J., Hankins, K. W., & Smith, J. M. (2012). Cash flows and leverage adjustments. Journal of Financial Economics, 103(3), 632–646. https://doi.org/10.1016/j.jfineco.2011.10.013
Ferrando, A., Marchica, M.-T., & Mura, R. (2017). Financial flexibility and investment ability across the Euro Area and the UK: financial flexibility and investment ability. European Financial Management, 23(1), 87–126. https://doi.org/10.1111/eufm.12091
Flannery, M. J., & Rangan, K. P. (2006). Partial adjustment toward target capital structures. Journal of Financial Economics, 79(3), 469–506. https://doi.org/10.1016/j.jfineco.2005.03.004
Gamba, A., & Triantis, A. (2008). The value of financial flexibility. The Journal of Finance, 63(5), 2263–2296. https://doi.org/10.1111/j.1540-6261.2008.01397.x
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60(2–3), 187–243. https://doi.org/10.1016/S0304-405X(01)00044-7
Jensen, M. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323–329.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. https://doi.org/10.1016/0304-405X(76)90026-X
Lemmon, M. L., & Lins, K. V. (2003). Ownership structure, corporate governance, and firm value: evidence from the East Asian Financial Crisis. The Journal of Finance, 58(4), 1445–1468. https://doi.org/10.1111/1540-6261.00573
Lemmon, M. L., Roberts, M. R., & Zender, J. F. (2008). Back to the beginning: persistence and the cross-section of corporate capital structure. The Journal of Finance, 63(4), 1575–1608. https://doi.org/10.1111/j.1540-6261.2008.01369.x
Lonkani, R. (2018). Firm value. Firm Value: Theory and Empirical Evidence, 1. https://doi.org/10.5772/intechopen.77342
Marchica, M.-T., & Mura, R. (2010). Financial flexibility, investment ability, and firm value: evidence from firms with spare debt capacity. Financial Management, 39(4), 1339–1365. https://doi.org/10.1111/j.1755-053X.2010.01115.x
Meehan, J., Simonetto, M., Montan, L., & Goodin, C. (2011). Pricing and profitability management: a practical guide for business leaders. John Wiley & Sons. https://doi.org/10.1002/9781119199564
Modigliani, F., & Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261–297.
Modigliani, F., & Miller, M. (1961). Dividend policy, growth, and the valuation of shares. The Journal of Business, 34(4), 411–433. https://doi.org/10.1086/294442
Modigliani, F., & Miller, M. (1963). Corporate income taxes and the cost of capital: a correction. The American Economic Review, 53(3), 433–443.
Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147–175. https://doi.org/10.1016/0304-405X(77)90015-0
Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574–592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x
Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221. https://doi.org/10.1016/0304-405X(84)90023-0
Pindado, J., De Queiroz, V., & De La Torre, C. (2010). How do firm characteristics influence the relationship between R&D and firm value? Financial Management, 39(2), 757–782. https://doi.org/10.1111/j.1755-053X.2010.01091.x
Rapp, M. S., Schmid, T., & Urban, D. (2014). The value of financial flexibility and corporate financial policy. Journal of Corporate Finance, 29, 288–302. https://doi.org/10.1016/j.jcorpfin.2014.08.004
Rauh, J. D. (2006). Investment and financing constraints: evidence from the funding of corporate pension plans. The Journal of Finance, 61(1), 33–71. https://doi.org/10.1111/j.1540-6261.2006.00829.x
Wintoki, M. B., Linck, J. S., & Netter, J. M. (2012). Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics, 105(3), 581–606. https://doi.org/10.1016/j.jfineco.2012.03.005
Yung, K., Li, D. D., & Jian, Y. (2015). The value of corporate financial flexibility in emerging countries. Journal of Multinational Financial Management, 32–33, 25–41. https://doi.org/10.1016/j.mulfin.2015.07.001
Al Ani, M., & Al Amri, M. (2015). The determinants of capital structure: an empirical study of Omani listed industrial companies. Business: Theory and Practice, 16(2), 159–167. https://doi.org/10.3846/btp.2015.471
Ammann, M., Oesch, D., & Schmid, M. M. (2011). Corporate governance and firm value: International evidence. Journal of Empirical Finance, 18(1), 36–55. https://doi.org/10.1016/j.jempfin.2010.10.003
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: monte carlo evidence and an application to employment equations. The Review of Economic Studies, 58(2), 277. https://doi.org/10.2307/2297968
Arellano, M., & Bover, O. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29–51. https://doi.org/10.1016/0304-4076(94)01642-D
Arslan-Ayaydin, O., Florackis, C., & Ozkan, A. (2014). Financial flexibility, corporate investment and performance: evidence from financial crises. Review of Quantitative Finance and Accounting, 42(2), 211–250. https://doi.org/10.1007/s11156-012-0340-x
Bancel, F., & Mittoo, U. R. (2004). Cross-country determinants of capital structure choice: a survey of European firms. Financial Management, 103–132. https://doi.org/10.2139/ssrn.683111
Bates, T. W., Kahle, K. M., & Stulz, R. M. (2009). Why do US firms hold so much more cash than they used to? The Journal of Finance, 64(5), 1985–2021. https://doi.org/10.1111/j.1540-6261.2009.01492.x
Bekaert, G., & Harvey, C. R. (2003). Emerging markets finance. Journal of Empirical Finance, 10(1–2), 3–55. https://doi.org/10.1016/S0927-5398(02)00054-3
Berger, A. N., & Udell, G. F. (2005). Small business and debt finance. Handbook of Entrepreneurship Research, 1, 299–328. Springer-Verlag. https://doi.org/10.1007/0-387-24519-7_13
Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87(1), 115–143. https://doi.org/10.1016/S0304-4076(98)00009-8
Bond, S. R., Klemm, A., Newton-Smith, R., Syed, M., & Vlieghe, G. W. (2004). The roles of expected profitability, Tobin’s Q and cash flow in econometric models of company investment. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.641241
Bowsher, C. G. (2002). On testing overidentifying restrictions in dynamic panel data models. Economics Letters, 77(2), 211–220. https://doi.org/10.1016/S0165-1765(02)00130-1
Brounen, D., de Jong, A., & Koedijk, K. (2006). Capital structure policies in Europe: Survey evidence. Journal of Banking & Finance, 30(5), 1409–1442. https://doi.org/10.1016/j.jbankfin.2005.02.010
Bruno, V. G., & Claessens, S. (2007). Corporate governance and regulation: can there be too much of a good thing? The World Bank. https://doi.org/10.1596/1813-9450-4140
Byoun, S. (2011). Financial flexibility and capital structure decision. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1108850
Chung, K. H., & Pruitt, S. W. (1994). A simple approximation of Tobin’s q. Financial Management, 23(3), 70. https://doi.org/10.2307/3665623
De Jong, A., Verbeek, M., & Verwijmeren, P. (2012). Des financial flexibility reduce investment distortions? Journal of Financial Research, 35(2), 243–259. https://doi.org/10.1111/j.1475-6803.2012.01316.x
De Miguel, A., Pindado, J., & De La Torre, C. (2004). Ownership structure and firm value: New evidence from Spain. Strategic Management Journal, 25(12), 1199–1207. https://doi.org/10.1002/smj.430
DeAngelo, H., & DeAngelo, L. (2007). Capital structure, payout policy, and financial flexibility. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.916093
DeAngelo, H., DeAngelo, L., & Whited, T. M. (2011). Capital structure dynamics and transitory debt. Journal of Financial Economics, 99(2), 235–261. https://doi.org/10.1016/j.jfineco.2010.09.005
Demir, F. (2009). Volatility of short-term capital flows and private investment in emerging markets. The Journal of Development Studies, 45(5), 672–692. https://doi.org/10.1080/00220380802582379
Denis, D. J. (2011). Financial flexibility and corporate liquidity. Journal of Corporate Finance, 17(3), 667–674. https://doi.org/10.1016/j.jcorpfin.2011.03.006
Denis, D. J., & McKeon, S. B. (2012). Debt financing and financial flexibility evidence from proactive leverage increases. Review of Financial Studies, 25(6), 1897–1929. https://doi.org/10.1093/rfs/hhs005
Erdogan, S. B. (2019). Financial flexibility and corporate investment: does financial flexibility affect sustainability of firms? The Circular Economy and Its Implications on Sustainability and the Green Supply Chain (pp. 230–245). IGI Global. https://doi.org/10.4018/978-1-5225-8109-3.ch013
Fama, E. F., & French, K. R. (2005). Financing decisions: who issues stock? Journal of Financial Economics, 76(3), 549–582. https://doi.org/10.1016/j.jfineco.2004.10.003
Faulkender, M., Flannery, M. J., Hankins, K. W., & Smith, J. M. (2012). Cash flows and leverage adjustments. Journal of Financial Economics, 103(3), 632–646. https://doi.org/10.1016/j.jfineco.2011.10.013
Ferrando, A., Marchica, M.-T., & Mura, R. (2017). Financial flexibility and investment ability across the Euro Area and the UK: financial flexibility and investment ability. European Financial Management, 23(1), 87–126. https://doi.org/10.1111/eufm.12091
Flannery, M. J., & Rangan, K. P. (2006). Partial adjustment toward target capital structures. Journal of Financial Economics, 79(3), 469–506. https://doi.org/10.1016/j.jfineco.2005.03.004
Gamba, A., & Triantis, A. (2008). The value of financial flexibility. The Journal of Finance, 63(5), 2263–2296. https://doi.org/10.1111/j.1540-6261.2008.01397.x
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: evidence from the field. Journal of Financial Economics, 60(2–3), 187–243. https://doi.org/10.1016/S0304-405X(01)00044-7
Jensen, M. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review, 76(2), 323–329.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. https://doi.org/10.1016/0304-405X(76)90026-X
Lemmon, M. L., & Lins, K. V. (2003). Ownership structure, corporate governance, and firm value: evidence from the East Asian Financial Crisis. The Journal of Finance, 58(4), 1445–1468. https://doi.org/10.1111/1540-6261.00573
Lemmon, M. L., Roberts, M. R., & Zender, J. F. (2008). Back to the beginning: persistence and the cross-section of corporate capital structure. The Journal of Finance, 63(4), 1575–1608. https://doi.org/10.1111/j.1540-6261.2008.01369.x
Lonkani, R. (2018). Firm value. Firm Value: Theory and Empirical Evidence, 1. https://doi.org/10.5772/intechopen.77342
Marchica, M.-T., & Mura, R. (2010). Financial flexibility, investment ability, and firm value: evidence from firms with spare debt capacity. Financial Management, 39(4), 1339–1365. https://doi.org/10.1111/j.1755-053X.2010.01115.x
Meehan, J., Simonetto, M., Montan, L., & Goodin, C. (2011). Pricing and profitability management: a practical guide for business leaders. John Wiley & Sons. https://doi.org/10.1002/9781119199564
Modigliani, F., & Miller, M. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261–297.
Modigliani, F., & Miller, M. (1961). Dividend policy, growth, and the valuation of shares. The Journal of Business, 34(4), 411–433. https://doi.org/10.1086/294442
Modigliani, F., & Miller, M. (1963). Corporate income taxes and the cost of capital: a correction. The American Economic Review, 53(3), 433–443.
Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147–175. https://doi.org/10.1016/0304-405X(77)90015-0
Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574–592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x
Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221. https://doi.org/10.1016/0304-405X(84)90023-0
Pindado, J., De Queiroz, V., & De La Torre, C. (2010). How do firm characteristics influence the relationship between R&D and firm value? Financial Management, 39(2), 757–782. https://doi.org/10.1111/j.1755-053X.2010.01091.x
Rapp, M. S., Schmid, T., & Urban, D. (2014). The value of financial flexibility and corporate financial policy. Journal of Corporate Finance, 29, 288–302. https://doi.org/10.1016/j.jcorpfin.2014.08.004
Rauh, J. D. (2006). Investment and financing constraints: evidence from the funding of corporate pension plans. The Journal of Finance, 61(1), 33–71. https://doi.org/10.1111/j.1540-6261.2006.00829.x
Wintoki, M. B., Linck, J. S., & Netter, J. M. (2012). Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics, 105(3), 581–606. https://doi.org/10.1016/j.jfineco.2012.03.005
Yung, K., Li, D. D., & Jian, Y. (2015). The value of corporate financial flexibility in emerging countries. Journal of Multinational Financial Management, 32–33, 25–41. https://doi.org/10.1016/j.mulfin.2015.07.001