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«The Determinants of Corporate debt maturity: a study on listed companies of Bombay Stock Exchange 500 index Raveesh Krishnankutty1 Kiran Sankar ...»

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The Romanian Economic Journal

The Determinants of

Corporate debt maturity: a

study on listed companies of

Bombay Stock Exchange 500


Raveesh Krishnankutty1

Kiran Sankar Chakraborty2

The study was intented to identify the determinants of the debt maturity structure

of listed firms in Bombay Stock Exchange 500 index. For the analysis we have

taken 321 firms during the period 2002- 2011, comprising of a panel model with

fixed effects. We also used GMM (1991) and GMM (1998) estimates of our analysis. The result of robustness tests confirms that past year debt maturity, leverage and growth opportunities are directly determined the debt maturity of Indian firms. Liquidity, effective tax and rate prime lending rate are negatively determining the debt maturity of Indian companies.

Keywords: debt maturity, panel data, GMM, Indian companies, fixed effect JEL Classification: C23, G32 Raveesh Krishnankutty, Research scholar Faculty of Management Studies, ICFAI University Tripura, India, raveeshbabu@gmail.com Kiran Sankar Chakraborty, Regional Director, Indira Gandhi National Open University, Kolkata Regional Centre, Bikash Bhavan, Salt Lake, Kolkata-700091, India ksc_agartala@rediffmail.com Year XVII no. 51 March 2014 The Romanian Economic Journal

1. Introduction Mangers choose a debt maturity structure to maximize the value of the firm (Stephan et al., 2011). The maturity structure of debt capital is one of the vital elements of the capital structure decision.

Debt capital has three major elements: duration (maturity period), fixed rate of interest and repayment of the principal. Cai et al.

(2008) says firm might choose debt maturity policy to address agency problems. Furthermore, firms can signal the quality of their earnings by choosing a specific maturity mix. Moreover, the corporate debt maturity matters if firms happen to consider flexibility in financing, cost of financing, and refunding risk.

Diamond and Rajan (2001) also emphasize its importance with reference to credit availability and financial crises.

The debt maturity structure has not yet received much attention in Indian context. Moreover, most of the existing studies of debt maturity structure predominantly focused on developing countries.

To contribute to the existing literature in Indian context, this paper has been formulated. The objective of the study is to investigate the potential determinants of the debt maturity structure of Bombay Stock exchange (BSE) 500 index listed companies during the period 2002-2011.

The Bombay Stock exchange is

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asymmetries, bankruptcy and taxation. Moreover, India is a mixed economy having number of government owned or controlling companies and private sector companies. Consequently, it is exciting to see the debt maturity theories were designed especially with respect to developed economies to the companies in the emerging economies.

Our empirical result reveals that leverage, growth opportunity and past year debt maturity positively determine the debt maturity, constant with predictions of maturity theories. Specified the estimated positive relation between maturity and growth opportunities, the paper reveals that the overinvestment problem has been paying more attention and is more discernible than the underinvestment problem. The findings, based on panel least squares with fixed effect weekly support the theories concerning growth opportunity, effective tax rate, etc. Nevertheless, after avoiding the indignity problem (the correlation between the error term and regressors) with the help of GMM (1991) and GMM (1998) methods, the expected positive sign for growth opportunity and negative sign of tax rate on debt maturity is found. However, negative sign liquidity is not providing a meaning full inference.

The reaming part of the paper is organized as follows. In Section 2 represent literature review. Section 3 describes research methodology, under methodology explaining variables used, sample, model, etc. In section 4 specified the empirical results and findings from different models. Section 5 compares the results of different models. Section 6 concludes the paper.

2. Literature review Stephan et al. (2011) investigate the determinants of corporate debt maturity choice in emerging markets. Their estimates confirms that the importance of agency cost, liquidity, signalling and tax theories in a Year XVII no. 51 March 2014 The Romanian Economic Journal transition economy for corporate debt maturity structure. They find that creditworthiness of the firm and access to long-term financing at bond market are the key drivers of corporate debt structure.

Deesomask et al. (2009) examine the firm specific and country specific characteristics of the debt maturity structure of Asia pacific region.

Their results indicate that firms in this region have a target optimal debt maturity structure. The maturity structure decision of a firm is driven by both its own characteristics and the economic environment.

Cai et al. (2008) investigate the potential determinants debt maturity structure of Chinese listed firms. Their empirical analysis reveals that firm size, asset maturity and the liquidity factors tend to be significant in explaining debt maturity mix, consistent with predictions of maturity theories.

Kirch and Terra (2012) try to analyze, in a focus-country setting, how firm characteristics, quality of national institutions, and country level of financial development affect the debt maturity of firms from a sample of South American countries. They find that there is a substantial dynamic component in the determination of a firm's debt maturity, and firms face moderate adjustment frictions toward their optimal maturities. More importantly, the level of financial development does not influence debt maturity, whereas the institutional quality of a country has a significant positive effect on the level of long-term debt in a firm's financial structure. Their results also support the hypothesis that the quality of national institutions is an important determinant of corporate financing in general and of debt maturity in particular. Schmukler, and Vesperoni (2006) studies how financial globalization affects the debt structure in emerging economies. They find that by accessing international markets, firms increase their long-term debt and extend their debt maturity. In contrast, with financial liberalization, long-term debt decreases and the maturity structure shift to the short term for the average firm. These effects are stronger in economies with less developed domestic Year XVII no. 51 March 2014 The Romanian Economic Journal financial systems. The evidence is consistent with financial integration having opposite effects on the firms that are able to integrate with world markets and obtain financing globally, relative to the firms that rely on domestic financing only. Aarstol (2000) proposes a new explanation for the inverse relationship between inflation and the maturity structure of business debt. It rests on the empirical finding that the variability of relative price changes increases with inflation.

Qiuyan et al. (2012) employs the financial engineering approach to test the influencing factors of debt maturity structure with the data of 2012 listed companies distributed in 11 industries of China, by the simulation of single equation models and simultaneous equation model, using stepwise multiple regression analysis. The result of the paper conveys the endogenous relationship between capital structure and debt maturity structure matters a lot. Therefore, when the companies consider this relationship, the short-term debt maturity will not be an effective way to solve the problem of insufficient investment. In contrast, growth opportunity and leverage rate are significant negative correlation. With the role of leverage, growth opportunity will indirectly affect the debt maturity structure.

Lopsz-Gracia and Mestre-Barbera (2011) analyses the influence of the tax effect on small and medium-sized (SME) enterprise debt maturity structure. This study builds a dynamic adjustment model which endogenous optimum structure and assumes the existence of adjustment costs. Using Spanish data, the model is estimated using a system- GMM regression to a complete panel 11,028 firms covering 1997–2004. The main results indicate that the model fits the data well and that SMEs seem to adopt an optimum debt maturity structure, which they converge to slowly due to the high adjustment costs they face. Average adjustment speed is estimated at around 37%, the equivalent of taking some 20 months to cover half the existing gap.

Year XVII no. 51 March 2014 The Romanian Economic Journal The effective tax rate is highly significant and both the interest rate gap and interest rate volatility also have a significant impact on debt maturity.

Hajiha and Akhlaghi (2012) test the main theories of firm debt maturity structure in an emerging economy, including agency conflict, signaling and tax theories. The paper investigates the firm specific determinants of debt maturity structure for a sample of 140 Iranian manufacturing firms listed on the Tehran Stock Exchange during the period 2001-2009. They have used random effect panel data analysis and multivariate regression for the analysis. The study provides the empirical evidence that profitability, firm size, tangibility, growth opportunity and financial leverage have significant effects on debt maturity choice. However, tax effects and business risk are not significantly related to the debt maturity structure.

3. Research Methodology The debt maturity theories and their proxies for the study: The study considers the available debt maturity theories in order to constrain the dependent and independent variables in the analysis.

3.2 variables used for the study Dependent variables: in our study, the dependent variable are debt maturity, LTDTD. The ratio of long-term debt to total debt to measure debt maturity (Stephan et al. 2011, Cai et al. 2008, Antonious et al. 2006, Barclay and Smith. 1995).

Independent variables: Antoniou et al. (2006) and Stohs and Mauer (1996), have divided the main debt maturity theories into four categories: agency costs, signaling and liquidity risks, matching and tax effect theories. Under each theory, we discuss the corresponding proxies and define their measurement to test the theories.

Proxies for agency theory:

Year XVII no. 51 March 2014 The Romanian Economic Journal Growth opportunity: we measure the growth opportunity by using the variable GROWTH which is the sales growth to total asset growth.

We assume that growth opportunity will be directly related to debt maturity.

Firm size: We measure a firm's size (LNSA) by the natural logarithm of its total sales. We assume that debt maturity is directly related to firm size..

Proxies for signaling and liquidity risk theories:

Firm’s quality: Due to the lack data relating to the credit rating of the companies We measure firms’ quality as earnings before interest and tax to net sales (PROFIT). The study expects debt maturity to be inversely related to firms’ quality.

Liquidity: We measure liquidity (CR) by current assets to current liabilities ratio (Myers and Rajan 1998, Morris 1992). The study predicts debt maturity will be directly related to liquidity.

Leverage ratio: We measure leverage (TDTA) by the ratio of the book value of total debt divided by the book value of total assets. Morris (1992) Stohs and Mauer (1996) Leland and Toft (1996) Dennis et al.

(2000). Debt maturity may be positively or inversely related to leverage as there is difference in findings of among literatures.

Proxies for matching principles:

Asset maturity: Stohs and Mauer's (1996) was measured the asset maturity (NFADEP) by the sum of the weighted maturity of current assets and the weighted maturity of fixed assets. We calculate the unweighted maturity of fixed assets by the ratio of net fixed assets to the depreciation (NFADEP), which shows the speed of consuming fixed assets. We expect that asset maturity will be positively related to debt maturity.

Proxies tax theories:

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Effective tax rate (EFTAX). We measure the effective tax rate (EFTAX) with the ratio of tax expense to pre-tax profit. Kane et al.

(1985) indicate that the tax shield advantage is inversely related to debt maturity. In other words, if the effective tax rate is low, then firms prefer to issue long-term debt.Thus, we expect to find a negative relationship between debt maturity and the effective tax rate.

We have used two macroeconomic variable to test its dependence on debt maturity. The proxies for macroeconomic variables are Prime lending rate (PLR): in India banks are the major contributor of debt capital. So we consider PLR will be an important factor that determine the debt maturity. We predict a negative relation between debt maturity and prime lending rate.

Wholesale price index (WPI): wholesale price is having a major role in deciding the sales growths. It directly influences the company growth. So we predict a negative relation between WPI and debt maturity.

3.2 Data source The study is dealing with the Bombay Stock Exchange 500 index companies. The banking and finance companies are proposed to be kept out of the scope of the study. A period of ten years ranging from 2002 to 20011 is considered for the study. A total of 321 companies has been selected for the final analysis. Capital line data base is used for collecting the financial data for the prescribed period.

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The table. 1 shows the result of correlation analysis. The correlation among the independent variables is narrow. Same as the case for depended variable too.

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