5. Suggestions on a Survey Questionnaire
In this section, we enumerate possible behavioral reasons explaining the marginal-debt phenomenon and suggest a survey questionnaire to quantify the impact of those capital structure decisions. We believe that comparing the results of this survey between marginal-debt companies and indebted companies will help understand the marginal-debt phenomenon. The questionnaire covers three topics: the relationship between the manager and shareholders, the manager´s perceived benefit of leverage, and the manager´s perceived loss of flexibility and control due to financial debt. Along with those thee topics, we ask managers to provide four numbers concerning the debt-to-equity ratios of their companies: the current debt-to-equity ratio of the company, the manager´s target debt-to-equity ratio, the maximum debt-to-equity ratio the company could bear, and the maximum debt-to-equity ratio the manager could accept.
The full version of the suggested survey is in the appendix.
5.1. Relationship between the Manager and Shareholders
A key element to understand the marginal-debt phenomenon is to understand the difference between shareholders and managers incentives regarding debt structure. While the trade-off theory provides an optimal capital structure in the shareholders point of view, managers might have a different opinion. Morellec, Nikolov, and Schurhoff (2012) claim that the cost of debt to managers is three times higher than the cost of debt to shareholders, which would explain the low leverage puzzle. While managers have their own target capital structure which is expected to be lower than shareholders´ target, shareholders have tools to change managers´ incentives toward their own objectives. Novaes and Zingales (1995) argue that the risk of being replaced due to a takeover or to shareholders decision give managers the incentive to increase the
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leverage of the company. Debt is well known to be an efficient anti-takeover tool. In case of takeover, it is likely that the current manager of the company might be replaced. Similarly, if shareholders are unhappy with the manager´s decisions, they can decide to fire him and find a new manager. Considering this statement, we calculated the average seniority of CEO. Current CEO of marginal-debt companies have been employed for more than 11 years against 8 years for indebted companies. Morellec, Nikolov, and Schurhoff (2012) argue that a higher manager ownership and higher stock option payments also provide a good incentive for managers to better match shareholders´ target in terms of capital structure. However, it is interesting that we find our marginal-debt sample having a significantly higher insider ownership rate than the indebted sample. On average, marginal-debt companies have 8.3% of insider ownership against 5.2% for indebted companies.
For the reasons mentioned above, we expect the observed debt-to-equity ratio to differ from the manager´s target debt to equity ratio depending on the relation between the manager and shareholders. That is why we decide to include some questions regarding this point in our survey. A better relationship between managers and shareholders, or a dominant position of managers, can help understanding the existence of marginal-debt companies. In case a manager is debt averse, and has the confidence of shareholders, he can better follow his own capital structure strategy without facing the risk of being fired. We actually expect our marginal-debt sample to have good manager-shareholder relationship as marginal-debt managers have a larger ownership on average. Hence, our first category of question aims at understanding the nature and health of the relationship between both agents. Those questions are based on the above literature. Answers from those questions will provide an idea about the power the manager has regarding capital structure decisions. Those questions try to quantify the manager´s feeling
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about how CEO friendly shareholders are, how secured his position is, how much pressure he receives from shareholders regarding capital structure decisions, and how his objectives and shareholders´ objectives differ in terms of capital structure strategy. We expect marginal-debt companies to have more CEO friendly shareholders. Managers from marginal-debt companies might receive less pressure from shareholders regarding capital structure decisions, and they might feel more confident about their position. Finally, we asks if the company is family owned Also, as mentioned in the literature, we expect the marginal-debt sample to have a higher proportion of family owned businesses.
5.2. Benefits of Leverage
Even if theory is clear about the added value of financial leverage on firm value, the manager´s perception might differ from theory. Hence, we ask their opinion about the following statements to valid or not this assumption:
Increasing debt could help diminishing the threat of takeover
I believe a superior debt-to-equity ratio can significantly increase company value
Debt allows companies to enjoy tax shield
Overall, I consider financial debt as a useful tool for companies
In case managers of marginal-debt companies consider that financial debt is not a good tool for the company, if they have a low perceived value of the tax shield, and of the increase of company value from higher debt-to-equity ratio, or if they do not see debt as a means to decrease the threat of takeover, some efforts could be spent in convincing them that they might be wrong. It would help reaching a more optimal capital structure.
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5.3. Value of Flexibility and Control
One reason mentioned by Morellec, Nikolov, and Schurhoff (2012) to explain the higher cost of debt for managers is that debt limits managerial flexibility. Managerial flexibility is defined as the management team´s ability to take its investment decisions depending on the business environment and opportunities offered to the management at any time. By having no debt, companies can easily access to debt at any time to capture new profitable opportunities.
Indebted companies might not be able to do so when facing capital intensive projects in case they already have too much debt. As mentioned in the article “Debt-free Zara looks beyond pain in Spain”, marginal-debt companies can also better absorb economical shocks than their indebted peers, as its cash flow is not penalized by any debt reimbursement. Also, banks often ask for collateral, or restrictions on future investments and financial ratios before lending money to a company. Hence, this third category aims at assessing the perceived impact of debt on flexibility and control of the company. This section gathers the following five statements and questions:
I consider debt to have a negative impact on the company´s flexibility.
Debt holders might prevent me from making the optimal decisions for the company.
In order to increase my debt level, I would accept to provide collateral.
In order to increase my debt level, I would accept restrictions on my future investments.
In order to increase my debt level, I would accept restrictions on some financial ratios.
I believe my company has a high threat of takeover.
We expect marginal-debt company managers to claim that debt has a high negative impact on the company´s flexibility, and that debt holders might prevent them from making the optimal
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decisions for the company. They would not accept to provide collateral, to restrict their future investments, and to have restrictions on their financials in order to access to debt financing.
Finally, they might not see any takeover threat.
5.4. Risk-Averse Inclination
In their paper, Agrawal and Nagarajan (1990) found that marginal-debt companies are more likely to be family owned. They argue that family owned companies do not have the same incentives regarding their capital structure. Unlike companies with financial institutions as the main shareholders, they might not have a well diversified portfolio of investments. Moreover, the company might serve as a source of income for the family. It increases the family´s risk exposure, leading to more conservative capital structure decisions. Becker (1981) and Bertrand and Schoar (2006) argue that family members in the management team have a different utility than typical shareholders. They are more altruistic toward the family and focus on “the family legacy and safeguarding the well being of other family members”. This long-term goal of sustaining the family business for the future generations increases the perceived risk of debt.
Novaes and Zingales (1995) claim that managers tend to avoid debt as it increases the bankruptcy cost. Bankruptcy is extremely costly for managers as it costs them their jobs, and highly affect their reputation. When a manager is at a key position of a company which goes bankrupt, he might be considered as responsible for this failure. Hence, his managerial skills might be questioned, which negatively impacts its value on the job market. Those differences in incentives between managers and shareholders are defined as agency costs. Morellec, Nikolov, and Schurhoff (2012), using data on financing choices and the model’s predictions for different moments of leverage, show that agency costs of 1.5% of equity value on average are sufficient
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to resolve the conservative debt policy puzzle and to explain the time series of observed leverage ratios. This agency cost varies among companies.
We expect managers of marginal-debt companies to believe that having financial debt significantly increase the company´s probability of default. In case of bankruptcy of their company, managers of marginal-debt companies might have greater financial difficulties, have more difficulties to find a new position, and they might have less valuable past experience to compensate the impact of a company bankruptcy on their CV. Finally, they would rather sacrifice growth opportunities than using financial debt.
Three additional questions concern family owned business in order to assess the degree of diversification of the family´s assets, the involvement of the family in the business, and the long term strategy of the business (e.g. profits maximization versus long term survival). We expect marginal-debt family business to have a lower degree of diversification, a higher involvement of the family, and a preference for the long term survival of the company over profit maximization.