Corporate finance approaches of Icelandic private firms after the financial crisis

Abstract

Purpose

The purpose of this paper is to provide insights about corporate finance decision-making of Icelandic private firms that have experienced a dramatic financial crisis in 2008–2010. It observes the capital budgeting methods and cost of capital techniques for private firms after a systemic financial crisis. Moreover, the paper identifies the main determinants of capital structure and capita rationing during this period.

Design/methodology/approach

This paper surveys corporate finance practices of 80 out of the 250 largest bank-centred private firms after the financial crisis.

Findings

Highly leveraged private firms that have experienced a dramatic financial crisis in 2008–2010 use payback and net present value techniques almost at a similar rate when assessing new investments. The sample firms largely rely on the cost of debt to determine the cost of invested capital. However, capital asset pricing model is the most popular method among the few sample firms that estimate the cost of equity. The need to maintain financial flexibility and cost associated with financial distress are the most influential factors regarding capital structures, whereas investment practices avoid capital rationing associated with the financial crisis.

Research limitations/implications

The limitations of the study are that it is country specific and absence of data over the period before the financial crisis that may have been applied to present more insight into this topic.

Practical implications

Sample firms fail to incorporate appropriate cost of capital methods and as the result they are likely to apply incorrect “hurdle rate” which could undervalue or overvalue new investments. This paper indicates that capital budgeting decisions by managers of the bank-centred Icelandic private firms who tend to be major shareholders do not reflect the tendency to expropriate outside and minority investors. Private firms that have emerged from the meltdown of the financial system highlighting the importance of “special” lending relationship in assisting bank-centred firms to avoid the severity of financial constraints.

Originality/value

This study employs a failure of the banking system to provide new knowledge about corporate finance practices of private firms after the financial crisis that have curtailed the access to both internal and external sources of capital.

Citation

Khalfan, T. and Sturluson, J.Þ. (2018), "Corporate finance approaches of Icelandic private firms after the financial crisis", Managerial Finance, Vol. 44 No. 11, pp. 1274-1291. https://doi.org/10.1108/MF-05-2017-0167