Corporate Debt Financing in the Philippines: Examining the Role of Firm-Level Factors through Binary Choice Model

Article excerpt

ABSTRACT

The Pecking Order Theory, first introduced by Donaldson in 1961, states that companies prefer to raise funds, in the order of priority, through internal sources, debt and then equity.

While clearly debt is the next best option to internally raised funds, it 's not clear whether debt should be in the form of either bank loan or bond issuance and if there is an order of preference between the two.

This study will investigate if certain firm-level factors contribute in determining that choice. Logit estimation will be used to process the cross-sectional data gathered from listed Philippine companies in identifying which firm-level factors significantly affects the choice of debt financing..

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INTRODUCTION

Most corporations in ASEAN countries are heavily reliant on bank credit for their funding despite of the restrictive covenants associated with it. On top of this, the reliability of bank lines of credit diminishes in times of financial crises because the banking sector becomes the most susceptible to significant loss of equity capital which purposely determines the bank's ability to provide funds to borrowers (Chava & Purnanandam, 2009).

As such, the urgency for financial reform towards a deeper and more efficient system has surfaced. Plummer and Click (2003) argues that a financial system that is dominated by banks limits the alternatives available to investors and borrowers and may allow markets to become more susceptible to efficiency losses. This has challenged institutions to adopt financing means that are less reliant on banks and are more diversified towards alternative markets such as equities and fixed-income instruments.

In the Philippines, while corporate bond issuance is available to firms as an alternative financing vehicle to bank loans, firms' willingness to issue bonds is hampered by legal and cost impediments, as well as transparency concerns associated with the weak infrastructure of the market. This contributes to the country's inability to hasten the growth and development of the corporate bond market thereby causing it to lag behind fellow ASEAN members such as Singapore and Malaysia in terms of expansion in bond volume.

Relative to the Philippine government bond market, the local corporate bond market is small and underdeveloped. In 2000, local currency (LCY) corporate bond obligations as a proportion of nominal GDP was at 0.2 percent, much lower when compared to the 31.1 percent of government bonds. In 2010, while this ratio grew to 4.6 percent for the corporate classification, this number remains dwarfed when compared to the share of government bonds. Despite having low volumes in the bond market, corporate bonds have shown continuous growth via increases in volumes over a 10-year span.

Factors that are inherent to individual firm may have been playing a role in the preference between bank financing and bond issuance. Specifically, Mizen and Tsoukas (2010) claimed that profitability, leverage, liquidity and growth are firm-specific variables that primarily influence a firm's decision to issue bonds over acquiring bank loans. The variables that were mentioned are generally those that measure a firm's performance, which consequently determine the firm's ability to establish investor confidence that the firm can service its obligations when the bonds mature. A firm's age may also contribute to investor confidence since longer existing firms become more reputable plus the fact that it indirectly implies proven track record, assuming that the weaker firms are likely to fold up earlier in the game. In addition, given the fact that debt offers tax benefits, tax levels may also influence a firm in its decision to source its debt. This study aims to understand the impact that each of the mentioned variables has on the decision of firms to source debt financing either through bank loans or through bond issuance. …