Edson VENGESAİ, Paul-francois MUZİNDUTSİ

EFFECT OF DISAGGREGATED COUNTRY RISK SHOCKS ON FINANCING DECISIONS OF THE JSE LISTED FIRMS

Firms in South Africa and other developing countries are facing a rapid increase in capital cost accompanied by an increase in leverage as a result of operating in uncertain environments, which complicate firms’ financing decisions and strategies. This paper examined the impact of rising leverage levels on firm’s cost of capital and the effect of country risk shocks on cost of capital and financing decisions among JSE listed firms. A dynamic panel model estimated with two-step system generalised methods of moments (GMM) was used to analyse panel data from 198 listed non-financial firms. The results suggest that the rising debt levels of JSE listed firms are negatively associated with weighted average cost of capital and cost of debt. Cost of equity was found to be an increasing function of firm leverage. High financial risk was found to be associated with an increase in cost of capital, high political risk associated with an increase in cost of equity and weighted average cost of capital (WACC), while an increase in economic risk is associated with high WACC and cost of debt. The study establishes that disaggregated country risk shocks significantly affect firms financing decisions.

Keywords:

Cost of capital, Leverage Country risk components, GMM,

PDF

___

Aivazian, V. A., Ge, Y., & Qiu, J. (2005). The impact of leverage on firm investment: Canadian evidence. Journal of Corporate Finance, 11(1), 277-291.
Akhtar, S. (2005). The determinants of capital structure for Australian multinational and domestic corporations. Australian journal of management, 30(2), 321-341.
Angelopoulos, D., Brückmann, R., Jirouš, F., Konstantinavičiūtė, I., Noothout, P., Psarras, J., Breitschopf, B. (2016). Risks and cost of capital for onshore wind energy investments in EU countries. Energy & Environment, 27(1), 82-104.
Antoniou, A., Guney, Y., & Paudyal, K. (2008). The determinants of capital structure: capital market-oriented versus bank-oriented institutions. Journal of financial and quantitative analysis, 43(01), 59-92.
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The review of economic studies, 58(2), 277-297.
Asiedu, E. (2006). Foreign direct investment in Africa: The role of natural resources, market size, government policy, institutions and political instability. World economy, 29(1), 63-77.
Bas, T., Muradoglu, G., & Phylaktis, K. (2009). Determinants of capital structure in developing countries. Cass Business School, London EC1Y 8TZ, UK.
Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of econometrics, 87(1), 115-143.
Cermeño, R., & Suleman, M. T. (2014). Country Risk and Volatility of Stock Returns: Panel-GARCH Evidence for Latin America. Available at SSRN 2482038.
Dang, V. A. (2011). Leverage, debt maturity and firm investment: An empirical analysis. Journal of business finance & accounting, 38(1‐2), 225-258.
De Souza, S. R. S. (2016). Capital requirements, liquidity and financial stability: the case of Brazil. Journal of Financial Stability, 25, 179-192.
Fosu, S. (2013). Capital structure, product market competition and firm performance: Evidence from South Africa. The Quarterly Review of Economics and Finance, 53(2), 140-151.
Howell, L. D. (2011). International country risk guide methodology. East Syracuse, NY: PRS Group.
Huang, G. (2006). The determinants of capital structure: Evidence from China. China economic review, 17(1), 14-36.
Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. The American economic review, 76(2), 323-329.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
Khadka, H. B. (2006). Leverage and the Cost of Capital: Some Tests Using Nepalese Data. Journal of Nepalese Business Studies, 3(1), 85-91.
Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American economic review, 48(3), 261-297.
Modigliani, F., & Miller, M. H. (1963). Corporate income taxes and the cost of capital: a correction. The American economic review, 433-443.
Moody's. (2017). Private leverage trends in developed and developing economies. Retrieved from https://www.moodys.com/research/Private-leverage-trends-in-developed-and-developing-economies--PBC_157956.
Myers, S. C. (2001). Capital structure. The Journal of Economic Perspectives, 15(2), 81-102.
Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of financial economics, 13(2), 187-221.
Narayanasama, N. (2014). The Relationship between Capital Structure and Overall Cost of Capital in Cooperative Sugar and Spinning Mills. In: India.
Okiro, K., Aduda, J., & Omoro, N. (2015). The effect of corporate governance and capital structure on performance of firms listed at the East African community securities exchange. European Scientific Journal, ESJ, 11(7).
Roodman, D. (2006). How to do xtabond2: An introduction to difference and system GMM in Stata. Center for Global Development working paper (103).
Sagala, G. (2003). The relationship between cost of capital and leverage for companies quoted on the Nairobi Stock Exchange.
Sengupta, K., & Dasgupta, S. (2002). Financial constraints, investment and capital structure: Implications from a multi-period model.
Singh, M., & Nejadmalayeri, A. (2004). Internationalization, capital structure, and cost of capital: evidence from French corporations. Journal of Multinational financial management, 14(2), 153-169.
Suleman, M. T., & Randal, J. (2016). Dynamics of Political Risk Rating and Stock Market Volatility. Available at SSRN 2315645.
Yuan, Y., & Motohashi, K. (2014). Impact of leverage on investment by major shareholders: Evidence from listed firms in China. China Economic Journal, 7(3), 299-319.