The purpose of this paper is to provide empirical insight into the impact of a financial crisis on capital structure of private firms. Specifically, the authors use the…
The purpose of this paper is to provide empirical insight into the impact of a financial crisis on capital structure of private firms. Specifically, the authors use the example of the systemic Icelandic financial crisis from 2008 to 2010 and analyze the influence of internally generated funds on leverage during the financial crisis compared to the non-crisis period.
The authors use a fixed-effects dynamic model to examine the impact of internally generated funds – measured as cash flow – with a data set that includes non-listed Icelandic firms. In addition, generalized method of moments is used to address potential endogeneity issues.
The authors find that internally generated funds have a different effect on capital structure during the financial crisis compared to the non-crisis period. While cash flow has an overall negative association with leverage, a positive relationship appears to exist during the crisis. However, when analyzing changes in cash flow from one year to the other, the sample firms appear to rely more on internally generated funds to adjust leverage during the financial crisis than in the non-crisis period.
Analyzing the extreme case of the Icelandic financial crisis allows us to shed light on capital structure effects in situations when both debt financing and internal financing opportunities are heavily curtailed.
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…
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.
This paper surveys corporate finance practices of 80 out of the 250 largest bank-centred private firms after the financial crisis.
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.
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.
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.
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.