Impact of Troika's intervention on Capital Structure of Irish, Greek and Portuguese Companies

I Joana Sofia Sousa Teixeira [email protected]m Dissertation MSc in Finance Supervisor: Prof. Paulo Jorge Marques de Oliveira Ribeiro Pereira 2014/2015 Impact of Troika’s intervention on Capital Structure of Irish, Greek and Portuguese Companies i Biographical note Joana Sofia Sousa Teixeira was born on June 5, 1989 in Matosinhos, Porto. In 2007, Joana joined the School of Economics and Management, of the University of Porto (FEP), later completing a Degree in Business Administration in 2010 and re-enrolling in Master in Finance degree in mid-2012. Joana has been working in Rangel Group since 2010, a multinational freight forwarding company, starting from an internship program, Joana changed to a role within accounts receivable collections team and moved later on to the international affairs department, as financial and administrative support. ii Acknowledgements This dissertation is the culmination of an important stage of my life and there are many people that I am grateful for being by my side. First of all, I have to thank God and my closest family. My mother – the most loyal friend I would ever had, for being always by my side and all patience she had; my sister for being the best person I ever met; and my father – in posthumous tribute, that even absence his presence was constant through the love and example he left us. They are my pillars of strength and without their support nothing of this would be possible. I would like to express my deepest appreciation to my supervisor Prof. Dr. Paulo Jorge Pereira for all guidance and tutorship which contributed significantly to this dissertation, as well as Prof. Dra. Natércia Fortuna and all professors of MSc Finance for their dedication and availability to their students. For all my friends, with a special thanks to Artur Dias and Tiago Loureiro for their friendship, concern and support; Dra. Irene Moreira Barros and her magnificent team for being always by my side during this last ten years. Without all of you this would have been harder. My co-workers, for everything that they taught me; and to Dr. Helder Correia and Dr. Vitor Cardoso for all advices, guidance and example they both gave me during this last five years. Finally, I would like to express my gratitude to Prof. Dr. Manuel Oliveira Marques that since my very first lesson of Estudo de Empresas in 2007 captivated me and all his students and passed his passion for corporate finance. iii Abstract The subprime crises in USA led to a general debt crisis in the European countries. This enabled some countries to refinance their government debt and so an intervention from European Financial Stabilization Mechanism (EFSM), European Central Bank (ECB) and International Monetary Fund (IMF) was needed. In this dissertation we are focused in analyze how the European Debt crisis and Troika’s intervention affected the capital structure of those assisted countries – Ireland, Greece and Portugal. This study is based on accounting information of 31.775 companies existing in Amadeus database of Bureau Van Dijk for the period between 2005 and 2013. The results showed that European Debt Crisis and Troika’s intervention had impact on companies, however it was not uniformed in those three countries. Key words: European Debt Crisis; Troika; Capital Structure; Trade Credit; Trade-off Theory; Pecking Order Theory JEL-Codes: B26; C10; C12; G30; G32 iv “How do firms choose their capital structures? We don’t know.” Myers (1984) v Contents Biographical note ..................................................................................................................... i Acknowledgements ................................................................................................................ ii Abstract ................................................................................................................................. iii Contents .................................................................................................................................. v 1. Introduction ..................................................................................................................... 1 2. Literature Review ............................................................................................................ 2 2.1. European Debt Crisis ............................................................................................... 2 2.2. Capital Structure Theories ........................................................................................ 3 2.3. Impact on companies capital structure during crisis ................................................ 6 3. Data and Methodology .................................................................................................... 8 3.1. Data collection ......................................................................................................... 8 3.2. Hypothesis .............................................................................................................. 11 4. Results analysis ............................................................................................................. 13 4.1. Statistical analysis .................................................................................................. 13 4.1.1. Total assets analysis ........................................................................................ 13 4.1.2. Capital Structure analysis ............................................................................... 15 4.1.3. Long term debt ................................................................................................ 17 4.1.4. Short term debt ................................................................................................ 19 4.1.5. Trade credit ..................................................................................................... 21 vi 4.2. Econometric analysis ............................................................................................. 23 4.2.1. Model .............................................................................................................. 23 4.2.2. Results ............................................................................................................. 24 5. Conclusions, limitations and suggestions for future researches .................................... 30 6. References ..................................................................................................................... 32 vii Table of Figures Figure 1 Real GDP growth rate .............................................................................................. 2 Figure 2 Final consumption expenditure of general government ........................................... 3 Figure 3 Sum of Total Assets (thousand euro) ..................................................................... 13 Table 1 Descriptive statistics of the sample .......................................................................... 10 Table 2 Average asset evolution by country and companies’ dimension ............................. 14 Table 3 Evolution of debt on companies’ capital structure by country ................................ 15 Table 4 Weight of Debt in capital structure by period, country and companies’ dimension 16 Table 5 Evolution of Long term debt/total assets by country ............................................... 17 Table 6 Long Term Debt by Total Assets by period, country and companies’ dimension .. 18 Table 7 Evolution of Short term debt/total assets by country ............................................... 19 Table 8 Short Term Debt by Total Assets by period, country and companies’ dimension .. 20 Table 9 Evolution of Trade Credit/total assets by country ................................................... 21 Table 10 Trade Credit by Total Assets by period, country and companies’ dimension ....... 22 Table 11 Effect of financial crisis on leverage ratios – Ireland ............................................ 25 Table 12 Effect of financial crisis on leverage ratios – Greece ............................................ 26 Table 13 Effect of financial crisis on leverage ratios – Portugal .......................................... 28 1 1. Introduction The recent years have witnessed one of the worst financial crisis since Great Depression of 1930 (IMF, 2008) one that started in the USA and rapidly spread to Europe. During this period, companies faced several restrictions on access to credit (Campello et al., 2010) which affected companies and financial markets. Some European countries that were unable to refinance their sovereign debt required the assistance of the European Financial Stabilization Mechanism (EFSM), the European Central Bank (ECB) and International Monetary Fund (IMF) 1 . The aim of this study is to understand how this financial crisis and Troika’s assistance affected companies in Ireland, Greece and Portugal, specifically how their’ financing decisions were impacted and how they adjusted their capital structure. In addition, it is attempted to assess the reaction of these companies in light of their country and size. This financial crisis had a worldwide impact, and several researches were undertaken in order to understand its causes and its consequences, however researchers that studied its impact on companies’ financing decisions are limited (Akbar et al., 2013). This serves as the main motivation to develop this dissertation. The results show that the financial crisis and Troika’s intervention had a significant impact on the companies’ capital structure, noting that such impact was not homogenous, depending on the country and companies’ size. This dissertation is divided in four main parts. Firstly, it is presented a literature review about financial crisis and capital structure main theories, accompanied by a reference of similar studies. The second part focuses the data and methodology used in the study. It is followed by the applied statistical and econometric analysis, to be latter concluded with the main results and limitations of the study. 1 Hereafter the set of these three entities will be designated as the commonly attributed name of Troika. 8 3. Data and Methodology This study intends to analyze the impact of financial crisis and Troika’s intervention in the capital structure of Irish, Greek and Portuguese companies. Firstly, an analysis of some financial ratios dividing by country and companies’ dimension will be performed, in order to identify different patterns. After that, we will present the model developed by Akbar et al. (2013) in order to explain the verified changes in capital structure in the three countries. 3.1. Data collection Data was extracted from Amadeus of Bureau Van Dijk, where we select active private (not state-owned) companies from Ireland, Greece and Portugal from 2005 to 2013. The study exclude assurance companies, guarantees, limited liability partnerships, public investment trusts and unlimited companies, companies that operate in financial sectors, public sector and regulated industries 4 . According the NACE Rev.2 codes, this implies that the sample should exclude companies classified as 64 - Financial service activities, except insurance and pension funding, 65 - Insurance, reinsurance and pension funding, except compulsory social security, 66 - Activities auxiliary to financial services and insurance activities and 84 - Public administration and defense; compulsory social security. It was only considered companies with available data for the key variables of the study – short term debt, long term debt, account receivables, account payables, total assets and earnings before interest and tax (EBIT) and for all years considered in the study. Companies with negative equity were also not considered. The final sample includes a total of 31.775companies, divided in 2.186 Irish, 8.334 Greek and 21.255 Portuguese companies. The sample was divided in four groups according to the companies’ dimension. 4 As Akbar et al. (2013). 9 For that it was estimated the average total assets of each company during these 9 years and classified as 5 : Lange companies – companies which average annual balance sheet is higher than 43 million euro; Medium companies – companies which average annual balance sheet does not exceed 43 million euro; Small companies – companies which average annual balance sheet does not exceed 10 million euro; Micro companies – companies which average annual balance sheet does not exceed 2 million euro. Below in Table 1 it is presented the descriptive statistics of the sample. From the sample, 67% are Portuguese companies, 26% are Greek and 7% are Irish companies. The average asset is 12.492,73 thousand euro (35.937 thousand euro, 19.851,77 thousand euro and 7.196,12 thousand euro for Ireland, Greece and Portugal, respectively). Concerning the dimension of all companies in the sample 3% are large companies and have an average asset of 306.492,87 thousand euro; 8% are medium-sized companies with an average asset of 19.453,61 thousand euro; 25% are small companies with an average asset of 4.446,13 thousand euro; and finally 64% are micro companies and have an average asset of 608,93 thousand euro. 5 According the European Commission the definition of Micro, Small and Medium-sized companies follows three criteria – staff headcount, annual turnover and annual balance sheet. So, a large companies are defined as companies which employ more than 250 persons and whose annual turnover is higher than 50 million euro or annual balance sheet total higher than 43 million euro; medium companies are defined as companies which employ fewer than 250 persons and whose annual turnover does not exceed 50 million euro or annual balance sheet total does not exceed 43 million euro; small companies are defined as companies which employ fewer than 50 persons and whose annual turnover or annual balance sheet total does not exceed 10 million euro; micro companies are defined as companies which employ fewer than10 persons and whose annual turnover or annual balance sheet total does not exceed 2 million euro. (http://ec.europa.eu/enterprise/policies/sme/files/sme_definition/sme_report_2009_en.pdf). In order to simplify it was only considered in this study the value of annual balance sheet. 10 Table 1 Descriptive statistics of the sample Ireland and Portugal follow the same pattern concerning the dimension segmentation of companies (8% of Irish companies are classified as large, 10% as medium-sized, 13% as small and 69% as micro companies; in Portugal 2% are large companies, 6% mediumsized, 19% small and 73% micro companies). In the case of Greece, small and micro companies has almost the same presence in the country (4,5% are large companies, 13,5% medium-sized, 42% small and 40% micro companies). 11 3.2. Hypothesis The main aim of this study is to identify and interpret changes in companies’ capital structure during Troika’s intervention. In order to identify those changes we subdivided our period of analysis in three parts: 1) Pre-crisis: 2005-2007 This is the period of time where there are not evidences for financial markets disruptions, there are market liquidity and credit facility. 2) European Debt Crisis: 2008-2013 This is a period of time characterized by high government debt levels, high interest rate spreads for government bonds, liquidity problems and limited credit access. 3) Troika’s Intervention: i. Ireland: 2010-2013 ii. Greece: 2010-2013 iii. Portugal: 2011-2013 This is the period in which this countries were assisted by EFSF, ECB and IMF. This period was characterized by the implementation of several contingency measures. Four hypothesis were formulated: H1: In periods of crisis (debt crisis and Troika’s intervention) the financial leverage of companies decrease During periods of crisis it is expected some credit restriction, which could led to a decrease of companies debt. With this hypothesis we intend to show if there were significant changes in the financing policies of companies. For that we are going to use the ratio Total Debt to Total Assets. (1) it itit Assets Total Debt Term Long + Debt TermShort Assets Total Debt to Total  12 H2: In periods of crisis the long term debt decrease It is expected that in periods of crises, and due to some potential credit restrictions, companies refinance its debt with short term debt instead of long term. With this hypothesis we are going to analyze if companies had restrictions to refinance their long term debt. It will be used the ratio Long Term Debt to Total Assets. H3: In periods of crisis the current debt increase With this hypothesis we intend to confirm if debt was refinanced by short term debt. It will be used the ratio Short Term Debt to Total Assets. H4: In periods of crisis the trade credit increase It is expected that during crisis periods companies extend payment terms to their suppliers, as well as implement more efficient collection policies in order to reduce the average time of receivables. We are going to analyze if companies substitute short term debt for trade credit. It will be used the ratio Trade Credit to Total Assets. (2) it it Assets Total Debt Term Long Assets Total Debt to Term Long  it it Assets Total Debt TermShort Assets Total Debt to TermShort  it it Assets Total Credit Trade Assets Total Credit to Trade  (3) (4) 13 Results analysis In this Chapter start presenting the analysis of capital structure. This analysis is divided in two main parts – statistical and econometric analysis. In the first part (section 4.1) an analysis to the dimension of companies will be done based on its total assets. Then it will be presented changes on capital structure, long term debt, short term debt and trade credit based on those ratios presented in the end of this Chapter. In the second part (section 4.2) it will be presented the econometric analysis. 3.3. Statistical analysis 3.3.1. Total assets analysis The total assets of our sample had some changes during this 9 years of study, as presented in Figure 3. Figure 3 Sum of Total Assets (thousand euro) 14 In 2005 the 31.775 companies in study had a total asset of 314.186 million euro, reaching almost 434 billion euro in 2010 and in the end of the study they had a total of 430.079 million euro in assets. In Table 2 it is presented the average assets by country and dimension of companies. Table 2 Average asset evolution by country and companies’ dimension Ireland had a continuous growth, highlighting the period pre-crisis (2005-2007) and where there were a growth of 25% and in 2010 with 9,6%. When analyzing in detail, medium-size companies had a decrease in its average assets during the first two years of European Debt Crisis and almost all years of Troika’s assistance. Small and micro companies have a similar behavior, however started recovering in 2012, earlier than medium-size companies. 15 Greek companies had a clear slowdown or even decrease since 2008. Large, medium and small companies maintained this decrease until 2013, however micro companies showed a slight growth in the two last year. Concerning Portugal, only in the last three years of the study is showed a clear decrease or slowdown of average companies’ assets. In general, Ireland started its slowdown in 2008 while Greece and Portugal showed crisis impact only in the next year. During Troika’s assistance, Ireland maintain a weak growth, excepting in the year of 2010 that has a growth rate of almost 10% due to the impact of large companies, however Greece and Portugal saw the average assets of their companies decrease. 3.3.2. Capital Structure analysis Concerning capital structure it is important to note that, based in this sample, Greek and Portuguese companies are financed mainly by debt. Table 3 Evolution of debt on companies’ capital structure by country According Table 3 and 4 Ireland showed that its companies were financed around 33% by debt, until 2010. In that year, that correspond at the beginning of Troika’s intervention, the percentage of debt decrease to 27,6% and in next years it maintains its level of debt. It could be found that all categories had decrease its debt in capital structure during European Debt Crisis, which could be justified by some credit restrictions in financial markets due to some political measures. It was the small and micro companies that had been mostly affected. According our sample, the amount of debt of small Irish companies 16 was reduced in 16,2%, in average and 20,9% to micro companies. After 2010, with Troika’s intervention, the reduction of debt continues. Table 4 Weight of Debt in capital structure by period, country and companies’ dimension Greek and Portuguese companies had also changed their financing policies. During the period of this analysis, Greek companies had reduced 10,1% of debt in their capital structure. Portuguese companies had also diminish the amount of debt in companies capital structure in 12,2%. Still, Portugal is the country that have more debt in capital structure of its companies. 17 In Greece, only medium, small and micro companies decrease the percentage of debt in its capital structure in Debt Crisis, however with Troika’s assistance and the imposition of limits in bank’s leverage, that affect the access to credit for companies, all categories were affected by it. Large companies were the last categories of companies affected by these crisis, and according to our sample the effect of these crisis in companies were greater with decreasing firms’ dimension. This results corroborate the study of Voutsinas and Werner (2011), where they observed that large firms have higher debt ratios. In relation to Portugal, it showed an identical behavior of Greece in the European Debt Crisis and Troika’s intervention, however the slope between categories were less. 3.3.3. Long term debt Analyzing the long term debts by total assets we pretend to study changes in financing policies of companies regarding the maturity of its debt. According Table 5 and 6, Ireland decreased the use of long term debt in its companies financing in all period in analysis, however it was more critical in European Debt Crisis period. Table 5 Evolution of Long term debt/total assets by country Analyzing by category, it was the small and micro companies that had the most significant change. Small companies decrease 30% of their long term debt during the Debt Crisis, comparing with the Pre-Crisis period; and micro companies had a reduction of 50,3% (during Pre-Crisis the amount of long term debt was almost 6,5% of the total assets and during the Debt Crisis it reduced to 3,2%). During Troika’s intervention those companies maintained this tendency, however slower. 24 The control variables chosen are the return on assets (ROA) and the natural logarithm of total assets as proxy of dimension and growth. One of the main objectives of this research is to identify the impact of these crisis in companies taking into account its dimensions. These control variables were chosen in order to identify in the model what is the impact of dimension in those debt indicators that are in study. 3.4.2. Results Results are presented in Table 11, 12 and 13 for Ireland, Greece and Portugal, respectively. The most important variables of this study are “crises” and “troika” and, according model (1) they are in accordance with Hypothesis 1. It suggests that in periods of credit restrictions it was a negative impact in the leverage ratio of companies, which corroborate with the statistical analyses done. Analyzing results for Ireland (Table 1), whose dependent variable is the total debt ratio, it is shown that the variable of ROA before the European Debt Crisis period (ROA) is the coefficient with more impact in companies’ capital structure and with a significance of 1% or better. These variables have a negative impact on companies’ long term debt, which suggest that profitable companies use less debt. According pecking order theory, companies should prefer internal financing to external financing and so this theory could be applied to Irish companies. The independent variable of growth during Troika’s assistance (Ln_Assets*CR*TR) is positive as expected. This suggest that growing firms are more external financing dependents because they might not have internal funds available to finance their growth, which is in line with Akbar et al. (2013). With this results, it is suggested that during Troika’s intervention the total debt increase 0,03€ for each 1% positive variation of total assets. In the case of model (2) the coefficient of the dummy “crisis” is negative and statistical significant, confirming the hypothesis 2 that during crisis period the long term debt tends to decrease. 25 Table 11 Effect of financial crisis on leverage ratios – Ireland In model (3) the dummy variables are negative (CR and CR*TR), indicating the negative impact that European Debt Crisis and Troika’s intervention had in the short term debt of companies. These results do not corroborate the third hypothesis presented, which could suggest that Irish companies do not substituted their long term debt to short term debt. Finally model (4) had no statistical significance in its main variables. 26 Analyzing Greek companies (Table 12) results for model (1) we can realize that our main variables are statistically significant. Our dummy variables “Crisis” and “Troika” are negative and suggest that have a negative impact on companies total debt, corroborating with our first hypothesis. Table 12 Effect of financial crisis on leverage ratios – Greece 27 The Ln_Assets variable and its interactions with crisis and Troika period LN_ASSETS*CR and LN_ASSETS*CR*TR) are positive and might indicate that grow companies use less debt.According this results, the variable ROA and its interaction with European Debt Crisis and Troika’s assistance suggest that profitability companies use less debt, especially during the second period. In model (2) the variable ROA remains negative and statistical significant, which could indicate that profitable companies used less long term debt. This is consistent with the pecking order theory. The dummy “crisis” is also negative, which is in line with our fourth hypothesis, however it indicates that Troika’s assistance do not have impact on companies’ long term debt structure. In model (3) the ROA variable during crisis periods (ROA*CR and ROA*CR*TR) is negative and statistically significant, which suggest that during that period the short term debt tended to decrease, which is corroborated by the statistical analysis. Finally model (4), as it was expected, financial crisis had a positive impact in trade credit (CR and CR*TR), which suggest that part of debt was substituted by trade credit. According model (1) for Portugal, all variables are statistical significant and our main variables (CR and CR*TR) are negative, confirming that in periods of crisis Portuguese companies tend to reduce the amount of debt in its capital structures. The variables ROA in interaction with Troika are negative, as expected after our statistical analysis. The coefficient of the interaction of Ln_Assets with crisis periods (LN_ASSETS, LN_ASSETS*CR and LN_ASSETS*CR*TR) have a positive sign which could mean that growing companies use less debt, especially during crisis periods. 28 Table 13 Effect of financial crisis on leverage ratios – Portugal In model (2) during crisis periods the ROA variables (ROA*CR and ROA*CR*TR) have a negative sign, which corroborate with what was mentioned before, that profitability companies prefer internal financing to increase its debt. The short term debt, according this econometric analysis, suggest that profitable Portuguese companies tend to decrease it. In opposite to our third hypothesis, our variables dummy are 29 negative, which could indicate that companies have difficulty to refinance in short term due to credit restrictions. Finally model (4), as it was expected, financial crisis had a positive impact in trade credit, which suggest that part of debt was substituted by trade credit. 30 4. Conclusions, limitations and suggestions for future researches This study aims to understand the impact that European Debt Crisis and Troika’s assistance have in companies from Ireland, Greece and Portugal. To develop this research, a comparison was drawn out of the evolution of four different ratios – total debt to total assets, long term debt to total assets, short term debt to total assets and trade credit to total assets. This analysis considered periods that precede the crisis, the European Debt crisis itself and Troika’s intervention to each country. Furthermore, the companies were divided by size – namely into large, medium, small and micro groups, – considering its average annual balance sheet. This intends to analyze if crisis effect was specific to companies’ dimension. From the statistical analyses, it was generally observed that the companies decreased the weight of debt in their capital structure during European Debt Crisis and Troika’s assistance, which is in accordance with the first hypothesis formulated. It was found significant differences regarding the debt maturity ratio on the companies’ behavior, according its country and size. According our sample, Irish companies decrease the weight of long and short term debt in both crisis periods. The trade credit increased for micro companies, however large firms had a significant decrease during Troika’s assistance. In general, Greek and Portuguese companies increased their long term debt during the European Debt Crisis, however some long term debt decreased during Troika’s assistance. Our third hypothesis, was rejected. The short term debt ratio tended to decrease during both crisis periods. Both, Greek and Portuguese companies increased their trade credit ratios, with the exception of large and medium size Greek companies during Troika’s assistance. According to the performed econometric analyses, the total debt (model 1) showed the dummy variables crisis and troika were significant and indicate that the European Debt Crisis and Troika’s assistance events had impact on the companies’ debt. 31 The results of our models are considered significant, however some limitations to the study should be highlighted. First of all, our analyses were based in information from 2005 to 2013, however better conclusions should be taken if this period was extended, since Troika’s assistance didn’t conclude in 2013 and a post crisis analysis could be made. Another limitation is regarding the available data for this study, since it was detected a lack of financial information for Irish and Greek companies. 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