«Volume Title: Conference on Research in Business Finance Volume Author/Editor: Universities-National Bureau Volume Publisher: NBER Volume ISBN: ...»
Influence of Financial Standards upon Forms of Financing The study next proposed would isolate for examination the influence of one group of factors — financial standards such as those enumerated in category B of Group II in the classification above — upon the forms of business financing. The principal question to which it would be addressed is this: What weights do the principal financial standards employed by users and suppliers of funds 'have upon the structures of liabiliFACTORS INFLUENCING MANAGEMENTS ties characteristic for firms of different sizes and in different industries?
Questions subsumed under this category are numerous: How did financial standards evolve? How generally are they utilized? How rapidly do they change? How may their validity be tested? In practice, how influential are they in governing choices of forms of financing? Do the various standards in actuality possess the significance commonly attributed to them?
Which of the standards are of primary significance, and which of secondary or peripheral value? In what respect do the standards of different types of suppliers of funds (e.g., investment banks, commercial banks, life insurance companies) differ?
A large research program, utilizing a battery of accounting and statistical techniques of analysis, as well as techniques of attitude measurement, can easily be projected in this area. In all probability the amount of business investment, as well as the form of its financing, is materially affected by prevailing financial standards. This is obviously true in the case of enterprises subject to public regulation. The Securities and Exchange Commission has announced financial standards for public utility holding companies; the Interstate Commerce Commission utilizes such standards in connection with steam railroads and interstate motor carriers; criteria of the Federal Deposit Insurance Corporation exert much influence on the liability structures of commercial banks; those of state public utility commissions influence the capital structures of operating public utility firms, and so on. The standards utilized by banks, life insurance companies, commercial finance companies and other suppliers of funds may have similar effects upon nonfinancial and nonregulated enterprises. If so, it is desirable that these standards be appraised objectively.
General Economic Instability and Forms of Financing Like the previous study, an. investigation into the influence of general economic instability upon forms of business financing would direct attenlion to the role played by one important variable affecting the financial decisions of management. The word "general" is italicized to emphasize the fact that, from the point of view of the individual firm, there are several types of instability in its environment. Herein, we are concerned only with the facts and the expectations of fluctuations in national income, employment, and production — with what is called the "business cycle." We are not concerned with those instabilities of the enterprise that are inherent in a competitive, free-market economic system, in which the competitive position of the firm is constantly shifting as a result of technical innovation, discoveries of new resources, new products, and alterations in consumers' tastes and preferences.
182 RESEARCI-I IN BUSINESS FINANCEEconomic theorists have given much attention to the relation of the amount of business investment to business fluctuations, but singularly little attention has been paid to the forms of business financing through the cycle. Is.there a relative shift to debt financing as aggregate business investment increases, and conversely? If so, what are the factors causing managements and suppliers to change their preferences at different stages of the cycle? Is the major consideration a change in the relative cost of funds obtained in different forms; or are changes in expectations about future and re-evaluations of the risk of insolvency the dominant variable?
Suppose that, in consequence of a long succession of years of high and rising production and stable prices,, business managements generally came to hold expectations of steady growth and general economic stability extending indefinitely into the future. What changes would probably occur in the forms of business financing utilized? Partial answers to such questions may be provided by deductions drawn from the economic theory of business fluctuations, and by empirical studies of aggregative data on forms of financing business investment. Complete answers would require, in addition, measurements of the expectations and attitudes of managements with respect to all of the factors that influence their choices.
well embrace an analysis of the opposite effects — Such a study the influence of forms of business financing upon general economic instability. Conventional doctrines on this subject appear to require re-examination. How is the debt structure of firms related to forced liquidation in the cyclical downswing? Do. some forms of debt or of debtor-creditor contracts provide greater relative flexibility in practice than others? Does the debt-equity ratio of an enterprise materially influence its ability to finance the expansion of its assets in the cyclical upswing, and hence bear upon the timing and aggregate amount of business investment?
Dependable evidence on such questions would be useful in public policy formation.
influence of Tax Policy upon Forms of Financing When taxes have come to appropriate more than 25 percent of the national production for government, it is manifest that tax policy must seriously affect not only the amount of business, investment but also the form in which it is financed. Effects upon the tax liability of the firm of adopting particular financing measures is a variable deserving of independent study.
What types of decisions with respect to asset and liability structure are affected by tax considerations? How important are these decisions in the general policy of the enterprise? Is the influence of tax policy on choices
FACTORS INFLUENCING MANAGEMENTSof financing forms socially advantageous? If not, how should the influential factors be modified?
Many important changes in forms of financing have been stimulated by taxation, especially by the federal tax on corporate income. The "sale and lease-back" arrangement appears to hold attraction for management because it creates rental payments, which are deductible business expenses, in lieu of non-deductible earnings from the ownership of land and buildings. Because interest paid on debt is also deductible, it is possible that the factor of tax liability has produced a lengthening in the term of indebtedness, by reducing the net cost to the enterprise of higher priced longer term credit.
The ratio of equity to debt funds in the liability structure of business has probably been reduced by federal taxation in two ways; first, income tax payments have reduced the amount of earnings retained, and thus inhibited the growth of ownership funds; secondly, the deductibility of interest has made credit cheaper, and transferred at least some decisions from equity financing to borrowing. How important these effects have been, when weighed against all of the other factors influencing managerial decisions, remains to be discovered by research.38 A number of investigations have already been launched into the impact of taxation on business behavior, but it would appear desirable that one study deal intensively with the effect of taxation on forms of financing.39 Influential Factors in the Financing of Expanding vs. Stable Businesses In decisions regarding financing, the managements of stable or mature enterprises may respond to different factors, carrying different sets of The dangers of generalization on this subject are revealed by the results of a mail questionnaire addressed by the writers in December 1949 to a sample of 75 firms, all of which had recently made public offerings of securities. In answer to the direct question "To what extent did the present federal tax policies influence the source of financing you selected?" almost 50 percent of the respondents stated that federal tax policies had no influence. Responses to other questions suggested that financial standards were more influential determinants of managerial choices.
The Tax Research Program at the Graduate School of Business Administration of Harvard University, the direction of Professor Dan Throop Smith, includes seven different studies dealing with the direct effects of federal taxation. The first of these, by J. Keith Butters and Powell Niland, is on Effects of Taxation on Inventory Accounting and Policies (Cambridge: Haryard University Press, 1949).
Other studies in process deal with the effects of taxation on: 1) individual savings and investment policies; 2) management incentives; 3) corporate compensation and retirement plans; 4) mergers; 5) depreciation policy; and 6) corporate financial policy (op. cit., pp. vi-vii). The last-mentioned study would appear to include the subject of tax effects on forms of financing.
184 RESEARCH IN BUSINESS FINANCEweights from those governing managements of rapidly growing businesses.
Research is now proposed to test this hypothesis. Does the firm in the early stages of its growth cycle typically give less weight to such factors as risk of insolvency, cost of funds, and effects upon managerial decision-making powers, and more weight to speed of availability, flexibility in amount of funds utilized and likelihood of renewal? What are the dominant factors in the minds of managements of young, expanding concerns in choosing sources of funds? How do they compare with the dominant considerations that motivate policy-making officers of stable or declining enterprises? Is the range of choice of alternative financing forms open to one narrower than that open to the other?
A set of related questions deserves investigation because of their overriding importance. To what extent is unavailability of the needed or desired kind of financing equivalent, in practical effect, to an absolute lack of funds? Is expansion of business assets inhibited by unavailability of funds of the desired form? If so, is the retarding effect of such unavailability greater on some types of firms and industries than on others? To what extent is the vigor of innovation and adaptation of enterprise stifled by poverty of financial means?
Two different methodological approaches might be made to this study.
One would be to make a longitudinal analysis of the relevant factors in an unchanging sample of enterprises, observing changes in the weights of different factors as these firms progressed from "youth" to "maturity." A second method would be to compare the factors influencing financing decisions over a short time period, (a) for a group of firms in rapid expansion, and (b) for a group of firms in "maturity." The findings of research on this subject should be useful in the formulation of public policies intended to remove obstacles to the growth of new and small enterprises.
They should also aid financing institutions in devising new arrangements that more accurately satisfy the respective demands of growing and of mature enterprises.
VI CoNcLusIoNThe authors venture to set forth succinctly the of this exploratory essay.
1) Important issues of business and public policy may not be formulated with confidence until knowledge of the factors influencing business decisions on forms of financing has been increased. The consequences of changes in monetary or tax policy, or of alterations in financial practices, cannot be predicted without a firmer grasp of the financial decision-making process in business.
FACTORS INFLUENCING MANAGEMENTS
2) Existing treatments of business financing policy embrace only a limited number of variables, and have not been tested to ascertain whether the factors they do include really are the strategic ones.
3) A comprehensive classification of relevant factors is suggested, containing a wider range of variables which exploratory work indicates to be influential. These influences appear to be numerous and variable both among firms and through time.
4) The nature of the factors included in the suggested classification framework indicates that intensive study of the dynamics of decisionmaking in the enterprise probably is the most fruitful research approach in the initial stages of.inquiry. Whether this approach will reveal that the decision-making process is sufficiently systematic to permit of the selection of a relatively small number of important variables for use in econometric and statistical studies cannot be determined at the present time.
5) A number of possible areas of research are suggested. These.studies would be oriented to the measurement of the influence of different factors and factor-categories upon (a) the most important types of financing decisions, and (b) the financing patterns of given types of enterprises. They would also analyze the effects upon business financing forms of tax policy, general economic instability, and other forces exogenous to the enterprise that appear• to be especially significant.
DISCUSSION AND COMMENT
W. YOST FULTON, Fulton, Reid & Company
The questions which Messrs. Jacoby and Weston raise in their paper are:
What factors do influence management in the choice of forms of financing?
And, second, what factors should influence management? The authors group the factors which they mention as "direct" and as "indirect," the direct being factors which appeal to the company, indirect being those which affect the market in which the company seeks its financing.
I suggest that there is a further possible grouping. This would be external and internal factors. All of the factors mentioned in the JacobyWeston paper fall under the first heading — that is, Our own observation suggests that the internal factors may be even more significant in corporate decisions than those outlined in the paper, whatever ought to be the case.