International Journal of Basic Sciences & Applied Research. Vol., 3 (10), 721-725, 2014 Available online at http://www.isicenter.org ISSN 2147-3749 2014 Surveying Different Stages of Company Life Cycle on Capital Structure (Case Study: Production companies listed in Tehran stock exchange) Masoud Mocarrary, Mansour Garkaz * Department of Management, Aliabad Katoul Branch, Islamic Azad University, Aliabad Katoul, Iran * Corresponding Author Email: m_garkaz@yahoo.com Abstract Decisions related to the capital structure of an economic unit have two aspects of capital requirements, and combination of funding. The process leading to final decision making is called supply of capital structure. Based on the fact that surveying the factors affecting the capital structure in accounting literature has caught the eye of researchers, it seems that surveying the correlation between the life cycle and the capital structure has been less at the center of attention of researchers; thus the current research aim is to study the life cycle and the capital structure in companies listed in Tehran stock exchange. The current research is a descriptive-correlative research and from the point of aim it is an applied research. From all the current production companies in stock exchange, 71 companies were chosen as the research samples by applying special conditions. Results showed that different stages of life cycle including growth, maturity and decline affect the book leverage of long-term debts. The growth stage has a positive and significant effect on the book leverage of long-term debts, and maturity and decline stages have a negative effect and significant effect on the book leverage of long-term debts. Also the results showed that different stages of life cycle which include growth, maturity and decline affect the market leverage of long-term debts; and all three stages of growth, maturity and decline had a positive and significant effect on the market leverage of long-term debts. At the end a few suggestions for further studies are provided. Keywords: Company life cycle, Capital structure, Stock exchange. Introduction For financing, managers proceed through operational funds of the organization, then they turn toward foreign markets, and in the same way they prefer the debt to equity. Based on this logic, most financial managers firstly, evaluate their borrowing power and after applying special considerations to the level of achieved power they create debt. The major risk of increased debt is lack of ability to pay principal and interest in due date. Thus these fixed payments should be settled without considering the profitability of the economic unit. Any failure to pay, results in bankruptcy or legal actions against the economic unit (Asadi et al., 2011). In addition to that, maintaining the financial integration and competitive position of the economic unit is also important. The economic unit acts in a way to provide adequate funds for strategic investments, share dividends, research and development cost. Lack of ability to provide these funds threaten the financial health of the economic unit. Decisions related to the capital structure of an economic unit have two aspects of capital requirements, and combination of funding. The process leading to final decision making is called supply of capital structure. Subjects related to the supply of capital structure evolve around methods by which the economic unit determines the amount of risk and return for each of different structures of capital. The goal of determining the capital structure is specifying the combination of financial resources in order to maximize the shareholders wealth (Setayesh et al., 2011). Although the provided framework for financial management sections is a good source for this issue, undoubtedly practically it makes us encounter many problems, because the shareholders wealth is affected by many different factors and capital structure is one of them. Capital structure of an economic unit has a close correlation with the cost of capital. Capital structure is a combination of long-term sources of cash used by an economic unit, and a change in it results in change in cost of capital of an economic unit. Main aim of capital structure decisions is creating an appropriate combination of long-term sources of cash in order to minimize the cost of capital of an economic unit and to maximize the market value of that economic unit through it. Capital structure is considered as the most important parameter affecting the valuation of companies, and their orientation in capital markets. Current changing environment has made the companies grading to be depended on the capital structure in terms of credit. This matter has made their 721
strategic planning closer to choosing the sources affecting the goal of maximizing the shareholders wealth. Thus the indeterminate factors and variables affecting the capital structure can affect the corporate profitability and performance (Sinaei & Rezaeian, 2005). Chen and Strange (2005) surveyed the factors affecting the capital structure of companies located in Central Asia, and they concluded that capital structure is under the influence of an environment in which the companies do their activities. In a research on 1200 Chinese companies, Huang and Song (2006) studied the correlation of some of the components of capital structure with debt ratio. Their research results showed that debt ratio decreases by increase of profitability and managerial ownership share in the company, and it also decreases by increase of size of the company. In a research, Robicheaux et al (2008) indicated that in big companies, increase of remuneration of the board, and percentage of non-bound members of the board results in increase of possibility of using the capital lease. In a research, Yang et al (2010) studied the hypothesis of free cash flow and the life cycle theory in Thailand. In this research Tanatayi used the cash flow achieved from the operational activities after deducting the funds required for investment in order to test the hypothesis of free cash flow. Tanatayi also used the ratio of retained earnings to book value of equity in order to test the life cycle theory. This research results showed that there is a positive and significant correlation between the free cash flow, stages of life cycle, and dividend share policy. Karami and Omrani (2010) studied the effect of companies life cycle on the relevance of risk and performance measures. In their research they considered the stock returns as the dependent variable and risk and performance measures as the explanatory variable in order to survey the amount of relevance of measures by considering the moderating variable of company life cycle. Results achieved from studying 518 companies during 2001-2007 showed that the amount of relevance of risk and performance measures and also the incremental explanatory power of the risk measures in different stages of life cycle (growth, maturity and decline) have significant difference. Results achieved from Wong s statistical test show that the incremental explanatory power of the risk measures in growth stage has the highest amount and in maturity stage has the lowest amount. Rahmani et al (2011) did a research about surveying the correlation between profitability and return based on the life cycle and size of the company. Variables of earnings per share and change in earnings per share were considered as the independent variables and rate of stock return was considered as the dependent variable and also two variables of life cycle and size of the company were considered as the control variable. In this research the required information during 2004-2008 were studied. In order to study the research hypotheses, method of combination of time series and cross-sectional data was used. Achieved results indicate that variables of life cycle and size of the company are effective factors on the correlation between profitability and return and they result in increase of adjusted coefficient of determination. Managers always try to make best decisions for financing, because as it was stated, this decision affects their company value. By making a decision about the financing through the capital structure, several factors under the influence of this decision can affect the company value under their management. Thus managers should consider the type of correlation of effective factors on the financing through the capital structure. Although surveying the factors affecting the capital structure has been at the center of attention of researchers in accounting literature, it seems that surveying the correlation between the life cycle and capital culture has gained much less attention, thus the current research surveys the correlation between life cycle and capital structure of companies listed in Tehran stock exchange. According to the theoretical definition of life cycle, companies have financially and economically specific behaviors during different stages of life cycle, and this could result in different combination in capital structure. This research is important because in today s competitive world, managers of all of the companies try to maximize the company value and maximize their shareholders interests, and capital structure is considered as one of the financing methods. Thus because the capital structure is one of the parameters affecting the company valuation then this research has tried to survey the correlation between company life cycle and capital structure. Methodology The current research is a descriptive (non-experimental) research. Descriptive (non-experimental) research includes methods with aim of describing the under-study conditions or phenomena. It must be noted that in descriptive (non-experimental) researches field, the current research is also a correlative research. Based on the current research goal which is developing the applied knowledge of information included in financial reports and improving the use of this information in making economic decisions, the current research is considered as an applied research. In order to have quality and to have easy access to the information of companies listed in Tehran stock exchange, the current research population includes all of the companies in pharmaceutical industry and non-metallic minerals listed in Tehran stock exchange from 2006 which have the following features: Listed in Tehran stock exchange before 2006. In order to have equal statistical samples during the under-study years. In order to be able to compare the information, the companies fiscal year must end on 20 th of March. The companies shares must be traded during the fiscal year. Companies must not be investment companies or intermediary companies. Companies information required for the research must be available. By the use of Cochran formula the statistical sample including 71 companies was chosen. Information required for calculating the research variables was extracted from statistics letters, information provided for stock exchange, central bank archive, Tadbirpardaz database and other related sources of information. Also for achieving some of the research data in this research, website of research management, development, and Islamic studies of stock exchange (http://rdis.ir) was used. After collecting the required research data, choosing the appropriate tools for calculating, and analyzing the data related to the variables was 722
significantly important. For calculating and preparing data for the required research information and also analyzing them, Excel and Eviews software were used. In addition to descriptive statistics, the inferential method of stepwise multiple regression method was used. Companies were divided into three groups; we allocated score 3 to growing companies, score 2 to mature companies and score 1 to companies in decline. Then we added the scores of three criteria for the companies, and achieved a combined score for each company. Then we arranged the companies based on this combined score, and then divided them into three groups of growing, mature companies and companies in decline. Table 1. Classification of companies in terms of life cycle. Life cycle Sales growth Capital expenditure variations Age Growth High High Young Maturity Medium Medium Mature Decline Low Low Old Operational definition of the above mentioned variables is as followed: SGt = [ (SALESt SALESt-1) / ( SALESt-1 ) ]*100 CEVt = (CEt / VALUEt )*100 AGEt = CYEARt FYEARt SG: Sales Growth CEV: Capital expenditure variation AGE: Company age SALES: Sales in year t CE: Capital expenditures in year t which is achieved from fixed assets variation between t and t-1 years VALUE: Market value of equity plus the book value of long-term debts in year t CYEAR: Current year in calculations FYEAR: Company foundation year (Rahimian et al., 2010) Results Table 2 which can be observed below displays the descriptive statistics of research variables. As it is observable, book leverage which is achieved from dividing total long-term debts to total assets at the end of the year equals 9% and it shows that averagely 9% of the total assets of the companies are debts and market leverage which is achieved from dividing total long-term debts to total long-term debts and market value of equity equals 16%. Ratio of market value to book value is equal to 2.19. Ratio of profitability achieved from dividing the net profit to total assets is equal to 13%, and it shows that the under-study companies had a positive performance during the time period. Ratio of fixed assets shows the amount of 29% which indicates that 29% of total company assets is fixed assets. Growing companies score is equal to 1.11%; mature companies score is equal to 29%, and score of companies in decline is equal to 49%. Table 2. Descriptive statistics of research variables. Variable Mean Median SD Book leverage 0.09 0.05 0.12 Market leverage 0.16 0.09 0.18 Company size 5.76 5.69 0.52 Ratio of market value to book value 2.19 1.69 4.31 Ratio of profitability 0.13 0.11 0.12 Ratio of fixed assets 0.29 0.21 0.47 Standard deviation of operating cash 0.07 0.05 0.04 Growth stage 1.11 1 0.46 Mature stage 0.29 0 0.45 Decline stage 0.49 0 0.51 In model 1 we surveyed the effect of different stages of life cycle on book leverage of long-term debts. Test results are provided in table (3). Statistical hypotheses in this model are as followed: H0: Different stages of company cycle do not affect the book leverage of long-term debts. H1: Different stages of company cycle affect the book leverage of long-term debts. The above mentioned statistical hypothesis is about the 1 st hypothesis. The above mentioned hypothesis was tested at 5% error level (95% level of significance). Results show that different stages of life cycle including growth, maturity and decline have an effect on the book leverage of long-term debts. Growth stage has a positive and significant effect on the book leverage of long-term debts, and maturity 723
and decline stages have a negative and significant effect on the book leverage of long-term debts. As a conclusion, H0 statistical hypothesis is rejected and H1 hypothesis is confirmed. Also the company size has a positive and significant correlation with book leverage of long-term debts, and ratio of market value to book value has a negative and significant correlation with book leverage of long-term debts. Ratio of profitability which is profit divided by total assets also has a negative and significant correlation with book leverage of long-term debts. Ratio of fixed assets to book leverage of long-term debts is a positive and significant correlation. Moreover, financial constraints and lack of financial constraints that are measured through dividend profits (if a company has dividend profit it does not have financial constraints, but if a company does not have dividend profits it has financial constraints) do not have a significant correlation with book leverage of long-term debts. Table 3. 1 st model test results. Description Coefficient t-statistic Prob. C 0.55 3.15 *0.000 Size 0.08 2.78 *0.005 Ratio of market value to book value -0.03-3.51 *0.000 Ratio of profitability -0.07-2.71 *0.006 Ratio of fixed assets 0.03 3.44 *0.000 SD of operating cash -0.03-0.41 0.67 Financial constraints 0.08 0.14 0.88 Lack of financial constraints 0.009 0.21 0.83 Growth stage 0.02 4.19 *0.000 Maturity stage -0.03-2.21 *0.012 Decline stage -0.04-3.22 *0.000 Adjusted R-squared 0.83 F-statistic 22.48 Prob(F-statistic) 0.000 D.W 2.21 Significant at error level of 5%. In second model we surveyed the effect of different stages of life cycle on the book leverage of long-term debts. Test results are provided in table (4). Statistical hypotheses in this model are as followed: H0: Different stages of company cycle do not affect the market leverage of long-term debts. H1: Different stages of company cycle affect the markt leverage of long-term debts. The above mentioned statistical hypothesis is about the 2 nd hypothesis. The above mentioned hypothesis was tested at 5% error level (95% level of significance). Results are provided below. Results show that different stages of life cycle including growth, maturity and decline have an effect on the market leverage of long-term debts and all three stages of growth, maturity and decline have a positive and significant effect on the market leverage of long-term debts. As a conclusion, H0 statistical hypothesis is rejected and H1 is confirmed. Also the company size has a positive and significant correlation with market leverage of long-term debts, and there is a negative significant correlation between the ratio of market value to book value and market leverage of long-term debts. The ratio of profitability which is profit divided by total assets also has a negative and significant correlation with market leverage of long-term debts. Ratio of fixed assets to market leverage of long-term debts is a negative and significant correlation. Furthermore, the financial constraints and lack of financial constraints that are measured through dividend profits (if a company has dividend profit it does not have financial constraints, but if a company does not have dividend profits it has financial constraints) do not have a significant correlation with market leverage of long-term debts. Table 4. 2 nd model test results. Description Coefficient t-statistic Prob. C -0.14-0.47 0.63 Size 0.06 3.18 *0.000 Ratio of market value to book value -0.03-3.19 *0.000 Ratio of profitability -0.14-1.98 *0.04 Ratio of fixed assets -0.01-4.85 *0.000 SD of operating cash -0.10-0.76 0.44 Financial constraints 0.01 0.02 0.98 Lack of financial constraints -0.008-0.11 0.91 Growth stage 0.01 3.65 *0.000 Maturity stage 0.02 2.51 *0.008 Decline stage 0.02 5.74 *0.000 Adjusted R-squared 0.80 724
F-statistic 18.78 Prob(F-statistic) 0.000 D.W 1.58 Significant at error level of 5%. Discussion and Conclusion The current research aim is to survey different stages of company life cycle on the capital structure among companies listed in Tehran stock exchange. Results show that different stages of life cycle including growth, maturity and decline affect the book leverage of long-term debts. Growth stage has a positive and significant effect on the book leverage of long-term debts. Maturity stage and decline stage have a negative and significant effect on the book leverage of long-term debts. Also the company size has a positive and significant correlation with book leverage of long-term debts, and ratio of market value to book value has a negative and significant correlation with book leverage of long-term debts. The ratio of profitability which is profit divided by total assets also has a negative and significant correlation with book leverage of long-term debts. Ratio of fixed assets to book leverage of long-term debts is a positive and significant correlation. Furthermore, the financial constraints and lack of financial constraints that are measured through dividend profits (if a company has dividend profit it does not have financial constraints, but if a company does not have dividend profits it has financial constraints) do not have a significant correlation with book leverage of long-term debts. Adjusted R 2 of the above mentioned model is 83% which indicates that independent variables and control variables managed to predict 83% of changes of book leverage of long-term debts. Achieved results are consistent with the results of Akhtar (2012), Dollinger (1995), Daskalakis and Psillaki (2005), and Huang and Song (2006). Also another part of the results show that different stages of life cycle including growth, maturity and decline affect the market leverage of long-term debts, and all three stages of growth, maturity and decline have a positive and significant effect on the market leverage of long-term debts. Also the company size has a positive and significant correlation with market leverage of long-term debts, and there is a negative significant correlation between the ratio of market value to book value and market leverage of longterm debts. The ratio of profitability which is profit divided by total assets also has a negative and significant correlation with market leverage of long-term debts. Ratio of fixed assets to market leverage of long-term debts is a negative and significant correlation. Furthermore, the financial constraints and lack of financial constraints that are measured through dividend profits (if a company has dividend profit it does not have financial constraints, but if a company does not have dividend profits it has financial constraints) do not have a significant correlation with market leverage of long-term debts. Adjusted R 2 of the above mentioned model is 80% which indicates that independent variables and control variables managed to predict 80% of changes of book leverage of long-term debts. Achieved results are consistent with the results of Akhtar (2012), Dollinger (1995), Daskalakis and Psillaki (2005), and Huang and Song (2006) Due to the fact that increase of long-term debts results in increase of companies risks in providing appropriate efficiency, thus the investors should consider that above mentioned variables could be important factors in making optimal decision. 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