THE ENHANCEMENT DECISION THROUGH INVESTMENT
OPPORTUNITY SET (IOS): EVIDENCE TO LEVERAGE,
DEBT MATURITY, AND PROTECTIVE COVENANT
UNDERGRADUATE THESIS
SUBMITTED FOR PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR UNDERGARDUATE DEGREE OF ACCOUNTING
DEPARTEMENT OF ACCOUNTANCY ACCOUNTING STUDY PROGRAM
SUBMITTED BY:
YULLIANA EKANINGRUM
NIM: 040913021
FACULTY OF ECONOMIC AND BUSINESS
AIRLANGGA UNIVERSITY
ACKNOWLEDGMENT
By all praise and thanks for Allah SWT, for all the plenty of rahmat and
hidayah, protection, rescue, and blessings to me so that I can finish this
undergraduate thesis on time, and also the accompaniment of salam and sholawat
for the Prophet Muhammad SAW. Alhamdulillah I finally able to finish my
undergraduate thesis entitled “THE ENHANCEMENT DECISION THROUGH
IOS: EVIDENCE TO LEVERAGE, DEBT MATURITY, AND PROTECTIVE
COVENANT” as partial fulfillment of the requirement to obtain bachelor degree
of economics in accounting major at Airlangga University.
In the completion process of this undergraduate thesis, a lot of supports,
assistance, and motivation has been given to me. I would like to gratefully
acknowledge with gratitude to:
1. Mr. Prof. Dr. Muslich Anshori, SE., Msc., Ak., as the Dean of Economics
and Business Faculty, Airlangga University.
2. Mr.. Drs. Agus Widodo Mardijuwono, M.Si., Ak. As the Head of
Accounting Study Program, Economic and Business Faculty, Airlangga
University.
3. Dr. H. Zaenal Fanani, SE., MSA., Ak. as great supervisor, for the invaluable
assistances, supports, directions, advises, and time given in this completion
of undergraduate thesis. I do really deeply thanks for all the aids and
supports.
4. Drs. H. Djoko Dewantoro, MSi., Ak., who has been guiding me in college
5. All lectures in Airlangga University, for valuable teachings that have been
given that helped me to improve my knowledge and thought in many ways.
6. My beloved parents, Mitro Hadi Seputro and Wilarni, who always
understand, give me huge supports, loves and the best wishes for me. And
my lovely brothers, Muhammad Dwikurniawan and Mahendra Triatmaja for
always cheering me up.
7. My beloved Herlambang Setiadi, thank you for the aid in looking for
references, supports, great loves, understandings, and wishes.
8. All of the great and super English Class students, thank you for the
wonderful moments that occurred in the past few years and thanks for
helping me in shaping up my idea and research.
9. To whom has important role to the completion of my undergraduate thesis,
as well as expressing my apology that I could not mention personally.
May Allah SWT gives protection and blessing to all of the party. Hopefully,
this research can give contribution for the development of accounting knowledge.
Surabaya, February 2013
ABSTRACT
The existences of investment opportunity that lead to deal in financing decisions are potential appearing agency conflicts. Some of the former empirical evidences revealed that the consideration of investment opportunity in the choice of leverage, debt maturity and protective covenant can be one of efforts in controlling agency conflict respectively. This study investigates the influence of investment opportunity set (IOS) towards leverage, debt maturity and protective covenant. The sample of the research is non-financial companies that are listed in Indonesia Stock Exchange, issuing and publishing bond instrument, and having positive equity for the year 2009 until 2011. This research uses confirmatory factor analysis (CFA) in the measurement of IOS and protective covenant in accordance providing more accurate and comprehensive measurement in these variables. By using linear regression method, the findings of this research are, IOS has a negative significant effect towards leverage. Meanwhile, IOS has no significant effect towards debt maturity. Moreover, IOS has a positive influence towards protective covenant.
LIST OF CONTENTS
Title Page ... i
Validation Sheet ... ii
Thesis Originality Declaration... iii
Acknowledgment ... iv
Abstract... vi
List of Contents. ... vii
List of Tables ... xii
List of Figures... xiii
List of Appendix ... xiv
CHAPTER 1: INTRODUCTION 1.1. Research Background ... 1
1.2. Problem Formulation ... 7
1.3. Research Objectives ... 7
1.4. Research Contributions ... 7
1.5. Research Systematic ... 8
CHAPTER 2: LITERATURE REVIEW 2.1. Theoretical Review ... 10
2.1.1. Theory of Agency ... 10
2.1.1.1. Agency Theory of Outside Equity ... 12
2.1.1.2. Agency Theory of Debt ... 14
2.1.2. Theory of Investment Opportunity Set ... 15
2.1.3.1. Leverage... 18
2.1.3.2. Debt Maturity... 19
2.1.3.3. Protective Covenants ... 20
2.1.3.3.1. Definition of Protective Covenants... 20
2.1.3.3.2. Classification of Protective Covenants ... 22
2.1.3.4. Investment Opportunity Set (IOS) ... 28
2.1.3.4.1. Proxy Variables for Firm’s Investment Opportunity . 28 2.1.3.4.1.1. The Market-to-Book Assets Ratio ... 29
2.1.3.4.1.2. Market-to-Book Equity Ratio ... 30
2.1.3.5. Fixed Asset Ratio ... 30
2.1.3.6. Profitability ... 31
2.1.3.7. Firm Size ... 32
2.2. Previous Research ... 33
2.3. Conceptual Framework ... 47
2.4. Hypothesis... 49
2.4.1. The Influence of Investment Opportunity Set towards Leverage ... 49
2.4.2. The Influence of Investment Opportunity Set towards Debt Maturity . 51 2.4.3. The Influence of Investment Opportunity Set towards Protective Covenants ... 52
CHAPTER 3:RESEARCH METHODOLOGY 3.1. Research Approach ... 54
3.2. Variable Identification ... 54
3.2.2. Dependent Variables ... 55
3.2.3. Control Variables ... 55
3.3. Operational Definition and Measurement... 55
3.3.1. Investment Opportunity Set ... 55
3.3.2. Leverage... 58
3.3.3. Debt Maturity... 59
3.3.4. Protective Covenant ... 60
3.3.5. Fixed Assets ... 62
3.3.6. Profitability ... 63
3.3.7. Firm Size ... 63
3.4. Type and Source of Data... 64
3.5. Population and Sampling Method... 64
3.6. Data Technique Analysis ... 65
3.6.1. Steps of Data Technique Analysis ... 65
3.6.2. Confirmatory Factor Analysis (CFA) ... 66
3.6.3. Model of Analysis... 68
3.7. Criteria of Hypothesis Testing ... 68
3.8. Classical Assumption Test ... 69
3.8.1. Multicollinearity Test... 69
3.8.2. Autocorrelation Test ... 70
3.8.3. Heteroscedasticity Test ... 70
3.8.4. Normality Test ... 71
4.1. Description of Research’s Object ... 72
4.1.1. Indonesia Stock Exchange ... 72
4.1.2. Non-Financial Company ... 73
4.2. Description of Research’s Result... 75
4.2.1. Descriptive Statistic ... 75
4.2.1.1. Market-to-book Asset Ratio... 75
4.2.1.2. Market-to-book Equity Ratio ... 76
4.2.1.3. Fixed Assets Ratio ... 76
4.2.1.4. Profitability ... 77
4.2.1.5. Firm Size ... 77
4.2.1.6. Leverage... 77
4.2.1.7. Debt Maturity... 78
4.2.1.8. Protective Covenant ... 78
4.2.2. The Result of Investment Opportunity Set Confirmatory Factor Analysis ... 79
4.2.3. The Result of Protective Covenant Confirmatory Factor Analysis ... 80
4.3. Classical Assumption Test ... 84
4.3.1. Multicollinearity Test... 84
4.3.2. Autocorrelation Test ... 85
4.3.3. Heteroscedasticity Test ... 86
4.3.4. Normality Test ... 87
4.4. Analysis of Hypothesis Testing ... 87
4.5.1. The Influence of Investment Opportunity Set towards Leverage ... 90
4.5.2. The Influence of Investment Opportunity Set towards Debt Maturity . 92 4.5.3. The Influence of Investment Opportunity Set towards Protective Covenants ... 94
CHAPTER 5:CONCLUSIONS, SUGGESTIONS AND IMPLICATIONS 5.1. Conclusions... 95
5.2. Limitations ... 96
5.3. Suggestions ... 96
5.4. Implications... 96
LIST OF REFERENCES ... 98
LIST OF TABLES
Table 2.1. Classification of Covenants ... 24
Table 2.2.The Established Classification of Covenants in this Research ... 27
Table 2.3. Previous Research Results ... 40
Table 3.1. Types of Protective Covenants ... 61
Table 3.2. The Determination of Sampling ... 65
Table 4.1. The List of Subsectors of Non-Financial Companies in IDX... 73
Table 4.2. Statistic Descriptive of Research Variables... 75
Table 4.3. Confirmatory Factor Analysis of IOS... 79
Table 4.4. Confirmatory Factor Analysis for 5-Classifications of Covenant Indicators ... 82
Table 4.5. Confirmatory Analysis Factor of Protective Covenants ... 83
Table 4.6. Multicollinearity Test ... 85
Table 4.7. The Result of Durbin-Watson Test ... 85
Table 4.8. White’s Test ... 86
Table 4.9. Kolmogorov-Smirnov Z Test... 87
LIST OF FIGURES
Figure 1.1. Domestic and Foreign Direct Investment Realization in Indonesia ... 1
Figure 2.1. Research Framework ... 48
Figure 4.1. The Result of Confirmatory Factor Analysis of Event-Driven
LIST OF APPENDIX
APPENDIX A: List of Companies Sample ... xv
APPENDIX B: Market-to-Book Assets Ratio ... xvi
APPENDIX C: Market-to-Book Equity Ratio... xix
APPENDIX D: Leverage Ratio ... xxii
APPENDIX E: Resuming of Weighted Average of Debt Maturity ... xxv
APPENDIX F: Index of Protective Covenant ... xxvi
APPENDIX G: Fixed-Assets Ratio ... xxviii
APPENDIX H: Profitability Ratio... xxxii
APPENDIX I: Firm Size... xxxix
APPENDIX J: Descriptive Statistic... xlii
APPENDIX K: Confirmatory Factor Analysis of Investment Opportunity Set . xliii
APPENDIX L: Confirmatory Factor Analysis of Restriction of Payouts to
Equityholders and Others... xliv
APPENDIX M: Confirmatory Factor Analysis of Restriction of Payouts
Financing Activities ... xlv
APPENDIX N: Confirmatory Factor Analysis of Restriction of Changing
Business Form and Structural... xlvii
APPENDIX O: Confirmatory Factor Analysis of Event-Driven Covenants .... xlviii
APPENDIX P: Confirmatory Factor Analysis of Restriction of Investment Policy
and Asset Sales ... xlviii
APPENDIX R: Regression of Investment Opportunity Set towards Leverage .... lvi
APPENDIX S: Regression of Investment Opportunity Set towards Debt Maturity
... lx
APPENDIX T: Regression of Investment Opportunity Set towards Protective
Covenants ... lx
CHAPTER 1
INTRODUCTION
1.1. Research Background
The main company goal is increasing the value of the company. The
investment decision and financing decision have the important role in the
enhancement of company value. Recent years, Indonesia is increasingly balancing
investment growth with domestic consumption which has been the primary
growth driver in recent years. A good incremental in investment depicts good
incremental in investment opportunity, the industrial sectors are expected to reap
the benefits in this condition.
Figure 1.1
Domestic and Foreign Direct Investment Realization in Indonesia
Source: (Economist Intelligence Unit (2012) in Sitorus and Avianti (2012))
Generally, company needs funds to finance the investment decision. The
numerous financing decisions are vital for the financial welfare of the company.
An incorrect decision about the capital structure may lead to significant financial
Concerning the financing activities of a company, it can obtain the fund
whether from internal and external source. First, it comes from the internal
sources, such as the issuance of stock and retained earnings. Second, it is derived
from external sources of the company in the form of a debt from a third party.
Regardless the size of the company, usually the companies choose to use the fund
from outside the company in the form of debt because it is cheaper than equity.
Debt is being a cheaper source of fund as compared to equity. Generally,
by dealing on debt through issuance of bonds is cheaper than raising equity
through a share issue. A major advantage is that the return on debt (interest) is
tax-deductible, whereas the return on equity (dividends) is paid out of a
company’s profits, which are taxed before dividend payments can be made to
stockholders. Financing by raising debt is a useful way of monitoring a
corporation’s overall health, as the ability to repay the debt reflects the overall
financial stability of the company (QFinance, 2012).
Regarding investment decision, if the company has improper decision in
dealing investment opportunity, then it can cause overinvestment problem or
underinvestment problem. Generally, overinvestment problem occurs in the
company that has low investment opportunity have low growth level, but have
large free cash flow and assets in place. The main problem is in the different
perspectives between manager and stockholder in allocating the capital excess
(Myers, 1977). The agency conflict of outside equity between manager and
stockholder has appeared. Manager tends to invest the capital excess to risky
dividends (Jensen 1986). The improper decision in exercising the investment
opportunities and financing the investment could bring harmful for the company.
These faults could stimulate the agency conflict within company that can decrease
the firm value and leads to financial distress.
Otherwise, underinvestment problem generally occur in the company that
has high investment opportunities, high growth rates, active conducting
investment, low cash flow and smaller assets in place. Myers (1977) explains that
the underinvestment problem occurs when firm with high investment
opportunities is facing opportunities to invest in positive NPV projects that
require the higher usage of funds, whereas the company only has low cash flow
and assets in place. In addition, if company takes the new project by dealing on
debt as financing, that is also susceptible in appearing agency conflict of debt
between stockholders and bondholders. Stockholders insist that profits should be
distributed as dividend, while bondholders want that profits should be used to pay
off debt. As consequences, the mix of assets in place and investment opportunities
influences a firm’s capital structure, especially for debt policy.
This research investigate the influence of investment opportunity towards
debt policy that is classified into three components: leverage, the debt maturity
and covenant structure of its debt contracts. Leverage is commonly described as
the use of borrowed money to make an investment (Bhatti et al., 2010). Debt
maturity is the period of time for which a bond remains outstanding
(Investorwords, 2012).Covenants are contracts aimed at borrowers by creditors to
2001). In Indonesia, covenants must be involved in trusteeship agreement,
trusteeship agreement is agreement between the issuers (companies that issue the
bonds) and trustee regarding the issuance of bond in the form of notary deed
(Kep-412/BL/2010). The trustees act as a party representing the interests of
bondholders as well as providing protection to them (UU No. 8 Year. 1995 about
Capital Market, article 1).
Some researchers have investigated the enhancement decision in financing
and controlling the agency conflicts. Billett et al. (2007) and Fatmasari (2010)
investigates the influence of growth opportunity towards the choice of leverage,
debt maturity and covenants. They also observe whether covenant could attenuate
the relation between investment opportunity and leverage as well as debt maturity.
Billett et al. (2007), Fatmasari (2011), Goyal et al. (2002), Sari (2011), as
well as Singhania and Seth (2010) find that direct effect of growth opportunities
on leverage is negative. In addition, Awan et al. (2010) and Bulan (2008)
investigate that there is a positive correlation between the growth opportunities
and debt levels for the segments of firms with low and medium growth
opportunity, and negative relation between debt level in high growth opportunity.
Barclay and Smith (1995), Barclay et al. (2001), Billett et al. (2003) and
Fatmasari (2011) find that investment opportunity has strong negative influence
towards debt maturity, this concludes that firms with high investment opportunity
use larger proportions of short-term debt in their capital structures. Otherwise,
Dang (2010), Abdullah (2005), Childs, et al (2005) find that investment
al. (2007), Fatmasari (2011) and Sari (2011) find a positive relation between
growth opportunities interacted with covenant protection.
This research is encouraged by the reasons of there are inconsistencies in
the research finding, hence the researcher want to reexamine the influence of
investment opportunity set (IOS) towards leverage, debt maturity, and protective
covenants by using more accurate and comprehensive indicators through
confirmatory factor analysis (CFA). The sample of this research is non-financial
companies listed in Indonesia Stock Exchange (IDX) for 2009 until 2011.
This research uses confirmatory factor analysis in measuring investment
opportunity set and protective covenant in accordance confirming the measured
variables for a latent variable. It is a statistical approach involving finding a way
of condensing the information contained in a number of original variables into
smaller set of dimensions (factors) (Jairo, 2008). Thus, in measuring investment
opportunity set and protective covenants, these research models use more than one
indicator in construction of a variable in accordance obtaining results that are
more accurate. Ecker et al. (2006) asserts that any various single measurements
can be the less accurate measurement in research settings. By using various
indicators through confirmatory factor analysis, hence the measurement be more
accurate and comprehensive.
Investment opportunity set is typically unobservable by outsiders, hence
investment opportunity rely on various proxy variables (Adam and Goyal, 2007).
The proxy of investment opportunity set is different among researches. Billett et
and Fatmasari (2010) used capital-expenditures-to-total-assets (CAXBVA) ratio.
Moreover, Adam and Goyal (2007) used four investment opportunity
measurements, which are market-to-book asset (MBA) ratio, market-to-book
equity (MBE) ratio, earnings-price ratio, and
capital-expenditure-to-plant-property-and-equipment (CAXNPPE) ratio. From those proxies, this research is
strongly motivated to use market-to-book asset ratio and market-to-book equity
ratio, because these are the most of two significant proxies related to growth
opportunity (Adam and Goyal, 2007). Then, MBA and MBE ratio are composited
to construct investment opportunity set as independent variable.
Moreover, most of companies also involve many covenants in their
trusteeship agreement. Billett et al. (2007) list 15-covenants, moreover Fatmasari
(2010) lists 24-covenants. This research use 15-covenants that are adapted from
the combination of Billett et al. (2007) and the covenant listed in trusteeship
agreement. These 15-covenants are composited become five classifications: 1)
Restrictions on Payouts to Equityholders and Others, 2) Restrictions on Financing
Activities, 3) Restriction on Changing Business Form and Structural, 4)
Event-Driven Covenant, 5) Restriction on Investment and Asset Sales. If all
classifications fill the requirement of confirmatory factor analysis, hence the five
classifications are composited to construct protective covenant as dependent
variable (Y3.)
The difference economic conditions in different countries motivate the
also wants to examine the consistency of the prior research result with take the
research object from non-financial companies. Hence, this research is expected
can obtain results that applicable in Indonesia.
1.2. Problem Formulation
Based on the problems background described above, the formulation of the
problem are:
1. Does the investment opportunity set have an influence towards leverage?
2. Does the investment opportunity set have an influence towards debt
maturity?
3. Does the investment opportunity set have an influence towards covenants?
1.3. Research Objectives
In accordance with the identification of problems that have been described, the
author intends to obtain data and information relating to research the issue to
achieve the purpose of the study as follows:
1. To investigate the influence of investment opportunity set towards
leverage.
2. To investigate the influence of investment opportunity set towards debt
maturity.
3. To investigate the influence of investment opportunity set towards
covenants.
1.4. Research Contributions
By doing this research, there are several beneficial contributions expected
1. Contribution for Theory.
This research enhances the theory about the effect of investment
opportunity set (IOS) towards leverage, debt maturity, and covenants. In
this case, the author improves by using more accurate and comprehensive
indicators through confirmatory factor analysis (CFA).
2. Contribution for Empirical
These research results are going to be expected can provide information to
corporation, in accordance the measurement of investment opportunity set
within company shall be considered in enhancing the capital structure,
specifically for debt. This research is also expected can be reference for
the next research within a field.
3. Contribution for Policy
The results of this research aim to provide information to the companies
that the certain conditions of investment opportunity set within company
can be considered as one of the necessary factor in arrangement of
leverage policy, debt maturity and covenant, in accordance enhancing
decision in financing.
1.5. Research Systematic
This research is systematically compiled in the following order:
CHAPTER 1: INTRODUCTION
This part contains of elucidation the research background, problem
formulations, which construct what is going to be the specific
the logical reason and urgency of the choice to investigate this
topic.
CHAPTER 2: THEORETICAL REVIEW
This section contains of theories and previous research results used
to support the topic discussion and examine the developed
hypotheses. Moreover, the conceptual framework is built in this
chapter to elucidate the brief flows of logical thinking of the
research
CHAPTER 3: RESEARCH METHODOLOGY
This chapter explains the method approached, operational
definition of variables and measurement, determination of
population and sample, as well as the data analysis technique
which are used to examine the hypotheses which provide assurance
for the validity of research results.
CHAPTER 4: RESULTS AND ANALYSIS
The description of the result will be explained in this chapter,
together with research data, model analysis, interpretation,
hypotheses testing and discussion.
CHAPTER 5: CONCLUSION AND SUGGESTION
This last chapter contains the summary of research conclusion
including the research limitation and suggestion for the next
CHAPTER 2
LITERATURE REVIEW
2.1. Theoretical Review
Agency theory is the grand theory that elucidates the conflicts potentially
to be happened among manager, stockholder, and bondholder, which can
influence the financial structure of the company. Moreover, the investment
opportunity set (IOS) comes up as supporting theory that explains the investment
opportunities within certain conditions in company regarding its influence
towards debt structure and agency conflict of the company.
2.1.1. Agency Theory
This research examines the influence of investment opportunity towards
leverage, debt maturity and protective covenants. This theory explores the
divergence of opportunistic behavior among manager, stockholder, and
bondholder, which potentially raise the agency conflict and potentially influence
the debt structure of the company.
According to Jensen and Meckling (1976),
Jensen and Meckling (1976) argue that the divergences of interest between
principal and agent can be reduced, when principal is establishing appropriate
incentives for the agent and by incurring monitoring costs, which are designed to
reduce deviation activities of the agent that may be able harm the principal.
In agency relationship, the principal and the agent will incur positive
monitoring and bonding costs. Jensen and Meckling (1976) define agency costs in
general as the sum of:
1. The Monitoring Expenditures by the Principal,
Monitoring cost is such as cost for writing provisions, costs to restrict
deviation activities of the agent.
2. The Bonding Expenditures by the Agent,
Bonding cost is the cost incurred to pay the agent to expend resources to
guarantee that the principal will be compensated if the agent does take
such actions. The example is bondholder paying manager to agree
incurring the cost of providing financial reports and to have their accuracy
testified by an independent outside auditor.
3. The Residual Loss.
The dollar equivalent of the reduction in welfare experienced by the
principal because of this divergence and the covenants that restrict
management’s ability to take optimal actions on certain issues is also a
cost of the agency relationship.
The agency conflict might be happened among stockholder, manager and
appearance of agency conflict. Those agency relationships will be explored in
detail.
2.1.1.1. Agency Theory of Outside Equity
Separation of ownership and control are closely associated with the
general problem of agency between stockholder and manager. This subchapter
explores of why and how the agency costs of outside equity are generated by the
corporate.
Jensen and Meckling (1976) observe that when an owner-manager owns
100 percent of residual claims, there will be no separation between corporate
ownership and control. This means that the owner-manager bears all the cost and
generates all the pecuniary returns and non-pecuniary returns of his actions such
as, the attractiveness of the office staff, the level of employee discipline, the kind
and amount of charitable contributions, personal relations with employees.
If the owner-manager sells the part of his equity claims on the corporation
to stockholders, then agency costs will be appeared by the divergence between his
interest and those stockholders. This due to the owner-manager also has worked to
bear the entire wealth effects in accordance increasing firm value while the
owner-manager’s fraction of the equity falls and induces his fractional claim on
the outcomes falls too. Thus, this will encourage him to appropriate larger
amounts of the corporate resources in the form of perquisites consumption.
Singhania and Seth (2010) elucidate that owner-manager is expected to act
as taking decisions on behalf of prospective stockholders. In actuality, managers
from the overall organizational goal of maximization of company value, such as
higher bonuses, job position safety and security, etc. Managers because of formal
powers may try to lever decisions to meet their own goals, which may potentially
meet with disapproval from stockholders. In this way, owner or stockholders may
succeed in discouraging the relatively selfish motives of managers. Moreover,
shareholder and manager try to achieve a balance for these divergent goals to not
hinder the daily operational of the company. However, this entire process involves
considerable monitoring and control and thereby results in this so called agency
costs.
Explicitly, agency cost against malfeasance on the part of the manager,
and contractual limitations on the manager’s decision-making power, which
impose costs on the firm because stockholder limit manager’s ability to take full
advantage of some profitable opportunities as well as limiting manager’s ability to
harm the stockholders while making himself better off. In practice, it is usually by
expending resources to alter the opportunity the owner-manager has for capturing
benefits. These methods include auditing, formal control systems, budget
restrictions, the establishment of incentive compensation systems, which serve to
identify the manager’s interests more closely with those of the outside equity
holders, and so forth. In order to carry out their functions properly, management
should be given incentives and adequate supervision. Control can be done through
ways such as binding agents, examination of financial statements, and restrictions
Generally, when the agency costs are engendered by the existence of
outside owners are positive, the company will pay the outside owners to sell back
their equity claims to an owner-manager who can avoid these costs. Other ways,
debt and less external equities can reduce the agency cost of outside equity.
Jensen and Meckling (1976) stated that the usage of debt aims to
overcome the agency cost of outside equity. Regarding this argument, the interests
of managers and stockholders are likely to diverge in industries that generate
abundant free cash flow. Managers supposedly have a stronger preference for
retaining free cash flow within the firm, while stockholders have a stronger
preference for using free cash flow for financing higher payouts in the form of
dividends and share repurchases. Debt is one means of resolving this tension. It
can be understood from two perspectives. First, using debt means a firm can sell
less external equity and still finance its operations. If agency cost of outside equity
rise more than proportionally, then minimizing outside equity sales will reduce the
deadweight agency cost. Second, the benefit of using debt is that it reduces
managerial perquisite consumption. The need to make regular debt-service
payments effectively disciplines managers.
2.1.1.2.Agency Theory of Debt
This theory recognizes when a firm has debt that potentially increase the
conflict interest between stockholders and bondholders. The conflict arises
because of the different mechanism of revenue receipt between stockholders and
bondholders. Bondholders earn a fixed income of interest and repayment of
used to meet obligations to bondholders. This causes the incentives of corporate
managers to act in the interests of stockholders. However, those conditions show
that debt arise the conflict between shareholder and bondholder. According to
Megginson et al. (2007: 491) and Ross et al. (2008: 464), these actions include but
are not limited to:
1. Unauthorized asset disposition – Stockholder may attempt to transfer
corporate assets to themselves by liquidating the firm’s assets and
distributing the proceeds as a dividend or repurchasing shares at a
premium.
2. Claim dilution – Stockholder may attempt to dilute the claim of
existing bondholder by issuing debt of higher priority than existing
debt.
3. Asset substitution – Acceptance of substituting a riskier asset
promising a higher return than that had been anticipated by
bondholders when bondholders were purchasing their bonds.
In principle, bondholders involve of various covenants in the indenture
provisions, to limit the managerial behavior. The covenants impose voluntary
constraints on management’s activities that prevent corporate managers from
taking certain actions and require them to take others. At the same time, these
covenants provide bondholders assurance that the firm’s management will not
expropriate their wealth. Consequently, bondholders would be willing to pay more
for a debt contract that includes protective covenants. All costs associated with
to agree in incurrence the cost of providing financial reports and to have their
accuracy testified to by an independent outside auditor. This is an example of
bonding costs.
2.1.2. Investment Opportunity Set (IOS) Theory
Investment opportunity set plays an important role in financing corporate.
The mix of assets in place and investment opportunities influence a firm’s capital
structure, the maturity and covenant structure of its debt contracts (Billett et al.,
2007). IOS theory enhances the decision in which the investments in place have
been financed, whether with debt or with equity, and if debt, whether with short or
long-term debts, which influences the profits stockholders make from exercising
growth options.
Myers (1977) states that the essence of growth for a company is generating
profit from investment opportunities, in accordance increasing the firm’s value.
The greater the profitable investment opportunity, the investment will increase.
Regarding IOS theory, the company is a combination of assets in place that it is
tangible and investment opportunities that intangible. The combination of both
assets in place and investment opportunities will affect the capital structure and
firm value.
Regarding to Jensen (1986) companies with high investment opportunities
have high growth rates, active conducting investment, have low cash flow and
smaller assets in place. In these circumstances, firms potentially suffer
underinvestment problem. In addition, Myers (1977) explains that the
facing opportunities to invest in positive NPV projects that also require the higher
usage of funds. In the low free cash flow condition, the company will take on debt
to take investment opportunities that exist. However, it is susceptible in appearing
conflict between stockholders and bondholders. Stockholders insist that profits
should be distributed as dividend. While bondholders assume that profits should
be used to pay off debt. In such circumstances, the company will choose to leave
the project with a positive NPV and lost investment opportunities. If the company
wants to continue the positive NPV projects, companies with high investment
opportunities have some alternatives such as using internal funds, using a small
amount of debt with shorter debt maturity, or involving protective covenants.
Moreover, according to Myers (1977), companies with lower investment
opportunity have a low growth level, and have large free cash flow and asset in
place. In these circumstances, the company is potential to overinvestment
problem. Overinvestment problem is caused by the excess capital, which will lead
to conflict due to the divergence perspectives between the managers and
stockholders. Managers argue that the excess in capital shall be used to invest in
project and currently they tend to invest the capital excess on the risky projects.
Managers consider that this action would raise the investment opportunity above
the optimal level. Otherwise, stockholders insist to distribute the capital excess as
dividends.
By using debt this problem can be solved, the managers can carry out a
new project, while managers able to provide assurance to stockholders that
put the company on the part of external oversight, thereby reducing tendency of
managers to invest in projects that are not profitable. Hereby, company will be
more effective to deal with debt when the company has low investment
opportunity (Jensen, 1986).
2.1.3. Variables in this Research
2.1.3.1. Leverage
Applying leverage means using borrowed money to earn a return greater
than the cost of borrowing (Megginson et al., 2008: 655). Leverage is commonly
described as the use of borrowed money to make an investment and return on that
investment (Bhatti et al., 2010). Thus, leverage can be defined as the proportion
usage of debt, which will be used as financing sources for which predicted as
profitable projects, then it is expected to increase the value of the company by
reflecting incremental in its actual earnings.
This research use debt to total assets as measurement of leverage. Bhatti et
al. (2010) argue that this ratio emphasizing the importance role of financing by
measuring the amount of debt used to fund assets that used by the company in its
operational activities.
Jensen (1986) argues that the usage of debt (leverage) is the most severe
for firms with low growth opportunities, this due to this company needs debt as
investment financing sources for new projects. Debt also becomes the guarantee
that high free cash flow will be used to pay off the dividends. By using debt, firms
likelihood that managers will squander free cash flow on value-reducing
investments.
2.1.3.2. Debt Maturity
Debt Maturity is the period of time for which a debt instrument remains
outstanding. Maturity refers to a finite time-period at the end of which the
financial instrument will cease to exist and the principal is repaid with interest
(Investorwords, 2012).
Regarding debt maturity, the company has tradeoff between the
transactions costs of issuing debt and the gains from adjusting debt level
dynamically, this means the firm should issue short-maturity debt and therefore
affords itself the opportunity to issue new debt optimally, depending on the firm
value when the old debt matures. On the other hand, if new debts are issued too
often, transactions costs will become too large. When the firm behaves optimally,
in addition to an optimal capital structure, an optimal maturity structure emerges.
Myers (1977) argues if debt matures after the expiration of the firm's
investment option, it reduces the incentives of the shareholder-management
coalition in control of the firm to invest in positive net-present-value investment
projects since the benefits accrue, at least partially, to the bondholders rather than
accruing fully to the stockholders. Hence, compared to firms with shorter debt
maturities, firms with long-term debt are less likely to exploit valuable growth
opportunities. The extant literature focuses on ways in which firms can resolve the
underinvestment problem, including the shortening of the maturity of debt to
opportunity sets contain more growth options should employ a higher proportion
of short-term debt (Barnea et al., 1980). Since when short-term debt matures
before growth options are exercised, there is an opportunity for firms to
re-contract and for debt to be re-priced, so that gains from new investment do not
accrue to bondholders.
2.1.3.3. Protective Covenants
2.1.3.3.1. Definition of Protective Covenants
When the stockholders must pay higher interest rates as insurance against
their own selfish strategies, then they frequently make agreements with
bondholders in hopes of lower interest rates. These agreements, called protective
covenants, are incorporated as part of the loan document (or indenture) between
stockholders and bondholders (Ross et al., 2008:463). In addition, covenants are
contracts aimed at borrowers by creditors to limit activities that may damage the
value of loans and recovery loans (Cochran, 2001). In Indonesia, covenants must
be involved in trusteeship agreement, trusteeship agreement is agreement between
the issuers (companies that issue the bonds) and trustee regarding the issuance of
bond in the form of notary deed (Kep-412/BL/2010). The trustees act as a party
representing the interests of bondholders as well as providing protection to them
(UU No. 8 Year. 1995 about Capital Market, art. 1).
It is true that lenders may demand such covenants before lending money at
a given interest rate, but the choice of covenants is fundamentally in the
shareholders decision (Myers, 1977). Hence, the covenant is agreement between
for protecting the loan value and help the stockholders to meet with the lower
interest rates payment for the bond.
Company with high investment opportunity often face underinvestment
problem that can stimulate the agency conflict between stockholders and
bondholders. To reduce stockholder-bondholder conflict, loans are more likely to
include protective covenants when the borrower is small and has high growth
opportunities (Bradley and Roberts, 2004). Based on the analysis of Myers
(1977), high growth firms are more likely to include covenants that restrict what
they do with the funds they obtain. By involving more covenants in high
investment opportunity, it can increase the value of the firm at the time bonds are
issued by reducing the opportunity loss caused by the results when stockholders
follow a policy, which does not maximize the value of the firm, such as the claim
dilution problem (which involves only a wealth transfer), asset substitution, etc
(Bradley and Roberts, 2004). Although firms with high growth opportunities are
more likely to face stockholder–bondholder conflicts and thereby benefit the most
from restrictive covenants, it is easy to argue that these same firms would seek to
preserve future financing and investment flexibility by having few if any
restrictive covenants.
Covenants are expecting to reduce the agency cost and increase the value
of the firm. Ross et al. (2008: 464) considered three choices by stockholders to
reduce agency cost:
1. Issuing no debt. Due to the tax advantages to debt, this is very costly
2. Issuing debt with no restrictive and protective covenants. In this case,
bondholders will demand high interest rate to compensate for the
unprotected status of their debt.
3. Writing protective and restrictive covenants into the loan contracts. If
the covenants are clearly written, the creditors may receive protection
without large costs being imposed on the stockholders. The creditors
will gladly accept a lower interest rate.
Thus, involving the covenants in a contract can be the lowest cost solution
to the stockholders-bondholders conflict. Based on the analysis of Myers (1977),
firms with significant growth opportunities will include covenants in their
indenture agreements.
2.1.3.3.2. Classification of Protective Covenants
According to Ross et al. (2008:463) protective covenants can be classified
into two types: negative covenants and positive covenants. A negative covenant
prohibits activities that the company may take. The type of negative covenants
such as: (1) The firm may not pledge any of its assets to other lenders, (2) The
firm may not sell or lease its major assets without approval by the lender. A
positive covenant specifies an action that the company agrees to take or a
condition that the company must abide by. The type of positive covenants such as:
The company agrees to maintain its working capital at a minimum level and the
The list and the type of covenants in bond agreement are varied. Fatmasari
(2010) used 24 of covenants in her research. Billet et al. (2007) found 15 of
covenants.
Table 2.1
Classification of Covenants
No. Covenant Type Description
Restrictions on Payouts to Equityholders and Others
1. Dividend Restriction Covenant limiting the dividend payments of the issuer or a
subsidiary of the issuer.
2. Share Repurchase Restriction Covenant that limits the issuer to make the return payment (other than dividend) to the stockholders.
Restrictions on Financing Activities
3. Funded Debt Issue
Restriction
To prevent the issuer and/or subsidiary to issue new debt with maturity of 1-year or longer
4. Subordinate Debt Restriction To prevent the issuer and/or subsidiary to issue subordinate debt
5. Senior Debt Restriction To prevent the issuer and/or subsidiary to issue senior debt 6. Secured Debt Restriction To prevent the issuer and/or subsidiary to issue secured debt
7. Total Leverage Test Involving a variety of accounting-based restrictions on
leverage, ranging from a requirement that the issuer maintain a specified minimum net worth to a requirement that the issuer maintain a specified minimum ratio of earnings to fixed charges
8. Sale-and-lease back Limiting issuer and its subsidiaries to sell, then lease back the assets which has been pledged as collateral on debtholder without the approval of the trustees
9. Stock Issue Restriction To limit the issuer and/or subsidiary from issuing additional common or preferred stock
Event-Driven Covenants
10. Poison Put Provision A provision, which makes the instrument puttable to the
issuer following a change of control or a restructuring which reduces the credit quality of the issue
11. Rating or Net Worth Trigger Certain provision, which are triggered when either the credit rating or net worth of the issuer falls below specified level 12. Cross-default Provision If default (or acceleration of payments) is triggered in the
issue when default (or acceleration of payments) occurs for any other debt issue
Restrictions on Investment Policy
13. Merger Restriction Limiting the issuer and/or subsidiary in conducting merger,
consolidation, or acquisition.
14. Investment Policy Restriction Proscribe certain risky investments for the issuer and/or subsidiary.
15. Asset Sale Clause Limit the ability of the issuer to sell assets or limit the
Restrictions on payouts prohibit managers from paying out proceeds from
liquidating firm assets to stockholders. Black (1976) in Reisel (2010) states that
there is no easier way for a company to escape the burden of debt than to pay out
all of its assets in the form of a dividend, and leave the creditors holding a
worthless obligation. Myers (1977) argues that restrictive covenants on dividends
provide a partial solution to the warped incentives created by risky debt. If
dividends are restricted, then the firm cannot raise money and pay it all out to
stockholders. He warns however, that restrictions on dividends may, also force the
firm to invest in negative present value projects, as stockholders may prefer risky
assets to safe ones, hence, risk-shifting may be escalated. Within this framework,
payouts to stockholders represent a wealth transfer from bondholders.
Restrictions on financing activities directly mitigate the claim dilution
problem. The claim dilution is harmful in, at least, two ways: additional debt may
increase the likelihood of bankruptcy and reduce the recovery amount. Covenants
restricting financing activities may also mitigate agency problems arising from
sub-optimal investment decisions. This highlights the importance of restrictions
on financing activities to bondholders (Reisel, 2010).
Restriction on changing form and structural of business mitigate the firm’s
management to change the form of business, to prevent the changing the group’s legal
form, articles of association, members of its boards of directors and commissioners and
stockholders.
Event-driven covenant is provision, which triggered as the consequences when
The merger covenant states that a consolidation, acquisition, or merger of
the issuer with another entity is restricted. In some cases, the covenants place
certain requirements on the profitability and leverage of the new entity. The
restrictions on asset sales limit the ability of the issuer to sell assets or limit the
issuer’s use of the proceeds from the sale of assets. Such restrictions may require
the issuer to apply some or the entire sale proceeds to the repurchase of debt
through a tender offer or call. Restrictions on mergers and asset sales are often
cited in the literature as a means of mitigating the risk-shifting problem
(sometimes referred to as the asset substitution problem or over-investment).
Those protective covenants are analyzed and adapted based on the list
covenants in trustee agreement listed in financial statement. Hence, this research
uses 15- types of covenants, as follows,
Table 2.2
The Established Classification of Covenants in this Research
No. Covenant Type Description
Restrictions on Payouts to Equityholders and Others
1. Dividend Restriction Covenant limiting the dividend payments of the issuer or a subsidiary of
the issuer.
2. Share Repurchase Restriction Covenant that limits the issuer to make the return payment (other than dividend) to the stockholders and others and redeem subordinate debt
Restrictions on Financing Activities
3. Debt Issue Restriction To prevent the issuer and/or subsidiary to issue new debt to another
party.
4. Total Leverage Test Involving a variety of accounting-based restrictions on leverage,
ranging from a requirement that the issuer maintain a specified minimum net worth to a requirement that the issuer maintain a specified minimum ratio of earnings to fixed charges
5. Sale-and-lease back Limiting issuer and its subsidiaries to sell, then lease back the assets
which has been pledged as collateral on debtholder without the approval of the trustees
6. Stock Issue Restriction To limit the issuer and/or subsidiary from issuing additional common or preferred stock
7. Loan Provider Restriction To prevent the issuer and/or subsidiary to provide new loans to anyone including the stockholders, except in the context of business transactions of the company (Fatmasari, 2010).
8. Business Changing Restriction To prevent the issuer and/or subsidiary to change its business (Fatmasari, 2010).
9. Managerial Changing
Restriction
To prevent the changing the group’s legal form, articles of association, members of its boards of directors and commissioners and stockholders (Fatmasari, 2010).
Event-Driven Covenants
10. Poison Put Provision A bond indenture that gives the bondholder the right to demand
redemption before maturity at its high par value in case certain event happen (Investorwords, 2012).
11. Rating or Net Worth Trigger Certain provision, which are triggered when either the credit rating or net worth of the issuer falls below specified level
12. Cross-default Provision A provision that allows a trustee or lender to require full payment
on all loans in a group, if any single loan in the group is in default (Investorwords, 2012).
Restrictions on Investment and Asset Sales
13. Merger Restriction Limiting the issuer and/or subsidiary in conducting merger,
consolidation, or acquisition.
14. Investment Policy Restriction Proscribe certain risky investments for the issuer and/or subsidiary.
15. Asset Sales Limit the ability of the issuer to sell assets or limit the issuer’s use
of the proceeds from the sale of assets
2.1.3.4. Investment Opportunity Set (IOS)
Investment Opportunity Set (IOS) is all of the investments that a company
is able to make at a given point in time. The determinants of a company
investment opportunity set is largely depend on its financing ability to deal with
new project, whether through equity financing, debt financing or even personal
savings (Farlex Financial Dictionary, 2012).
Investment opportunities play an important role in corporate finance. The
mix of assets in place and investment opportunities affect a firm’s capital
structure, the maturity and covenant structure of its debt contracts (Billett et al.,
2007). Despite the important role that investment opportunities play in the
corporate finance literature, there is no consensus on how to measure the value of
2.1.3.4.1. Proxy Variables for Firm’s Investment Opportunity
As investment opportunities are typically unobservable by outsiders, a
common practice is to rely on proxy variables. Adam and Goyal (2007) classified
the proxy variables for investment opportunity become four; market-to-book asset
ratio, market-to-book equity ratio, earning-price ratio, and capital expenditures
ratio. From the four ratios, market-to-book asset ratio and market-to-book equity
ratio are the proxy that used to measure investment opportunity in this research.
Both ratios are most commonly used as investment opportunity proxy.
Moreover, Adam and Goyal (2007) point out that EP ratio has been
interpreted as an earnings growth indicator, as a risk measure, or as an earnings
capitalization rate. An EP ratio does not always indicate its firm investment
opportunities because current earnings sometimes deviate temporarily from their
long-run expected values. The motivation for the
Capital-Expenditures-to-Net-Plant-Property-and-Equipment ratio is that capital expenditures are largely
discretionary and lead to the acquisition of new investment opportunities. Firms
that invest more acquire more investment opportunities relative to their existing
assets than do firms that invest less, but capital expenditures may or may not lead
to the acquisition of investment opportunities, and it is not clear whether the
relationship between expenditures and the value of the acquired investment
options is even linear.
2.1.3.4.1.1. The Market-to-Book Assets Ratio
According to Adam and Goyal (2007) the market-to-book assets (MBA)
this is the most commonly used proxy for investment opportunities. The book
value of assets is a proxy for assets in place, whereas the market value of assets is
a proxy for both assets in place and investment opportunities. Hence, a high MBA
ratio indicates that a firm has many investment opportunities relative to its assets
in place. Otherwise, MBA ratio (or Tobin’s q) is also used as a proxy for many
other variables such as corporate performance, intangibles, the quality of
management, agency problems, and firm value. Billett et al. (2007) use this proxy
to measure growth opportunity in association towards leverage, debt maturity, and
covenants.
2.1.3.4.1.2. Market-to-Book Equity Ratio
Market to book equity (MBE) ratio is the market value of equity divided
by the book value of equity, this ratio is the second commonly used proxy for
investment opportunities.
Adam and Goyal (2007) elucidated that the market value of equity
measures the present value of all future cash flows to equity holders, from both
assets in place and future investment opportunities, whereas the book value of
equity represents the accumulated value generated from existing assets only.
Therefore, the MBE ratio measures the mix of cash flows from assets in place and
future investment opportunities.
However, like the MBA ratio, the MBE ratio proxies for other variables
too, such as corporate performance. Another concern is that the MBE ratio is
influenced by leverage. If low-growth firms choose more debt in their capital
growth opportunities alone. Finally, a concern with the MBE ratio is that firms
with negative equity values must be omitted from the analysis since negative
MBE ratios are not meaningful in measuring investment opportunities.
2.1.3.5. Fixed Asset Ratio
Fixed Asset Ratio (FAR) or also known as asset tangibility is the ratio of
fixed assets to total assets (its assets). Assets show the capacity of operating
activities in a company. The greater the asset is expected to yield the greater
operational products, which are produced by the company. The incremental of
assets, which are followed by an incremental in operational products, will raise
the convenience of outside party to the company. Company that has a large
amount of assets can gain larger debt because the company has the larger assets,
which can be used as collateral (Korner, 2007).
Firms with a higher share of collateralizable assets can pledge these assets
in favor of the long-term debt (Korner, 2007). Moreover fixed asset ratio is
expected to be consistent with investment opportunity set theory. This theory
elucidates that the company with high investment opportunity, will have small
free cash flow and small assets in place. Consequently, this certain conditions are
potentially to suffer underinvestment problem and to control this problem, the
company usually involves more protective covenant as constraint for
management. Hence there is an inverse relation between FAR and protective
2.1.3.6. Profitability
Profitability is the ability of the firm to generate earnings (Gibson, 2009).
Increased profits can cause a rise in market price, leading to capital gains. Profits
are also important to creditors because profits are sources of funds for debt
coverage. Management uses profit as a performance measurement.
Empirically, the opposite relation often has been found. Elliot et al. (2008)
document a negative relation between leverage and profitability, higher profits
will increase retained earnings, which mechanically reduces leverage. Thus,
without making a strong prediction on the sign of the relation, this research
includes profitability, which be measured as EBITDA divided by book assets, as a
control variable. Debt maturity is also increasing with firm profitability, as firms
that are more profitable are better able to commit to long-term payments (Agca et
al., 2007). Profitability is expected to be positively related to debt maturity,
because profitable firms have higher taxable income, and thus receive greater tax
benefits from long-term debt (Deesomsak et al., 2012). Since bondholders face a
lower default risk when a firm is very profitable, they do not have any incentive to
set more covenants (Inamura, 2009).
2.1.3.7. Firm Size
Firm size is a measure of the size of the companies as measured by the
natural logarithm of total assets (Ln total assets). Firm size (which is measured as
the natural log of assets) to be an important determinant of both the leverage and
debt maturity. Large firms tend to have more collateralizable assets and more
of default, which suggests that large firms would be expected to carry more debt.
Diamond (1992) also argues that large established firms have better reputations in
the debt markets, which also allows them to carry more debt.
Korner (2007) document that debt maturity increases with firm size. These
larger firms are believed to have easier access to capital markets, they can more
easily overcome the transaction costs and greater negotiation power due to they
have a stronger position in debt negotiation than smaller firms. This is so because
larger firms have the ability to reduce the unsystematic risk via diversification
(Taleb and Shubiri, 2011). The literature in this area suggests that larger,
well-established firms have reputations in the market and hence are subject to more
analysis than smaller firms. Their investment opportunity set is considered to be
available public information. The market has shown trust in the firm by allowing
it to grow, thus that packages of covenants with higher levels of protection are
more likely the smaller the size of the issuing firm (Carter et al., 2004). Large
firms may have sufficient assets that can be sold to meet obligations. Therefore,
bondholders face lower default risks with large firms (Inamura, 2009).
2.2. Previous Research
Previous researches are summarized, as follow:
1. Billett et al. (2007)
Billett et al. (2007) investigates the relation of growth opportunity and
the choice of leverage, debt maturity and covenants. This research uses a sample
of over 15,000 debt issues during the period from 1960 to 2003 that obtain from
protection is increasing in leverage and the market-to-book ratio, and decreasing
in the proportion of a firm’s debt that is short-term. These results are consistent
with the predictions that firms use covenants to control stockholder–bondholder
conflicts over the exercise of growth options, and that short-term debt and
restrictive covenants are substitutes in controlling these conflicts. Although the
direct effect of growth opportunities on leverage is negative, they find a positive
relation between leverage and growth opportunities interacted with covenant
protection. Importantly, this supports the prediction that covenants attenuate the
negative effect of growth opportunities on leverage. Billet et al. (2007) also find
that short-term debt can similarly attenuate the negative effect of growth
opportunities on leverage for riskier borrowers.
2. Fatmasari (2011)
Fatmasari (2011) observes the relation among growth opportunity with
debt maturity and leverage policy moderated by covenants. The sample is from
manufacturing company that listed in Indonesia Stock Exchange.
By using panel data regression model and data observation for over
six-years, this research finds that, firms with high growth opportunity tend to use low
leverage policies with short maturity to control the agency conflict between
stockholders and bondholders. On the other hand, firms with low growth
opportunity tend to use higher leverage policies with a longer period of debt
maturity. Moreover, covenant as a moderating variable, could lower the negative
relation between growth opportunity and leverage, but it could not diminish the
and covenant also could not be use as substitution variable in solving the
investment problem.
3. Sari (2011)
This research investigates the influence of growth opportunity towards
leverage and moderated by debt covenants. The sample which is used in this
research is non-financial company which issued bond in 2006 until 2010 and
drafting its bond covenant. The sample is analyzed using regression.
This research finds that growth opportunity influences negative
significantly towards leverage. Covenant as the moderating variable has
significant to weaken the negative effect of growth opportunity towards leverage.
4. Taleb et al. (2011)
This study examines the capital structure decisions and debt maturity
structure of 60 industrial companies listed in Amman Stock exchange. This is the
first time such study has been attempted for a multi-country emerging market
sample. To achieve this objective the study was set to test a number of hypotheses
regarding the determinants of capital structure decisions and debt maturity
structure.
These hypotheses were related to the effects of profitability, growth
opportunities, asset maturity, size, liquidity and age. Total debt ratio was found to
be positively and significantly related to the percentage growth in total assets and
negatively and significantly related to liquidity and asset structure. A growth
-term debt and was negatively and significantly related to long -term debt. The
relationship between asset maturity and long term debt was found to be negative
and significant. Therefore, there is no support of the hypothesis that debt maturity
decreases as the proportion of growth potentials increase. Size was found to be
positively and significantly related to long term debt and negatively and
significantly related to short term debt implying that larger firms borrow on long
term and small ones borrow on short term. Profitability, age and liquidity
appeared to have no statistical significance on the different types of debt.
5. Goyal et al. (2002)
The U.S. defense industry provides a natural experiment for examining
how changes in growth opportunities affect the level and structure of corporate
debt. Compared with other firms, the growth opportunities of defense firms
increased substantially during the Reagan defense buildup of the early 1980s, but
then declined significantly with the end of the cold war and associated defense
budget cuts in the late 1980s and early 1990s.
The author examine how the level and structure of corporate debt changed
for a sample of 61 defense firms and a benchmark sample of 61 manufacturing
firms during 1980-1995, a period spanning the changes in growth opportunities.
The debt levels of weapons manufacturers, which were most affected by the
changes in growth opportunities, increased significantly as their growth
opportunities declined. In addition, these firms lengthened the maturity structure
of their debt, decreased the ratio of private to public debt, and decreased the use of
studies that have found cross-sectional relations between proxies for growth
opportunities and leverage variables and validate the prominent role played by
growth opportunities in the theory of corporate finance.
6. Barclay et al. (2003)
This research titled The Joint Determination of Leverage and Maturity,
which examine theories of leverage and debt maturity, focusing on the impact of
firms’ investment opportunity sets and regulatory environments in determining
these policies. Using results on strategic complementarities, Barclay et al. (2003)
identify sufficient conditions for the theory to have testable implications for
reduced-form and structural-equation regression coefficients. Obtaining testable
implications form structural equations requires less from the theory but more from
the data than the reduced-form specification because it requires an
instrumental-variables approach. This research examines this trade-off between theory and
statistical methods and provides tests using two decades of data for over 5000
industrial firms. The analysis provides reasonably compelling evidence that they
are not complements. Incentive contracting theory suggests that they are
substitutes.
7. Awan et al. (2010)
The purpose of this study is to find out how growth opportunities in Pakistan are
related to leverage decisions for the listed manufacturing corporate concerns. This
research uses financial data from a sample of 110 manufacturing companies listed
along with estimation of fixed-effects regression analysis to assess the subject
relationship.
There is a positive relationship between the growth opportunities and debt
levels of the corporate firms. This positive relationship is highly significant for the
segments of firms with ‘low’ and ‘medium’ growth opportunities. The reason for
this finding may be that the owners of these firms view the available growth
opportunities as unsustainable and more risky and intend to pass on that higher
risk to the creditors. Another important finding of this study is that industry type
is also a relevant variable which influences the relationship between growth
opportunities and leverage.
8. Singhania and Seth (2010)
The primary objective of this paper is to isolate the company
characteristics that determine capital structure, in the context of Indian companies.
The sample consists of 963 companies that are listed on the Bombay Stock
Exchange (BSE) for the period 2004-2008. The data has been collected through
the information available on the Prowess database of Center for Monitoring
Indian Economy (CMIE). The company characteristics are analyzed as
determinants of capital structure according to different explanatory theories.
The hypothesis that has been tested is that the debt ratio at timet depends
on the size of the company at time t, the liquidity of the company at time t, the
growth of the company at time t and the interest coverage ratio at time t. The
companies that have a high ratio of debt are examined using a dummy variable.
