In today’s tight credit environment, more and more businesses are having to turn to alternative financing and non-bank financing options to access the capital they need to keep the gears of their business running smoothly.
There are a number of different tools available to owners of cash-strapped businesses in search of financing, but two of the main ones are factoring and accounts receivable (A/R) financing. Sometimes, business owners lump these two options together in their minds, but in reality, there are a few slight differences that result in these being different financing products.
Factoring is the outright purchase of a business’ outstanding accounts receivable by a commercial finance company, or “factor.” Typically, the factor will advance the business between 70 and 90 percent of the value of the receivable at the time of purchase; the balance, less the factoring fee, is released when the invoice is collected. The factoring fee—which is based on the total face value of the invoice, not the percentage advanced—typically ranges from 1.5-5.5 percent, depending on such factors as the collection risk and how many days the funds are in use.
Under a factoring contract, the business can usually pick and choose which invoices to sell to the factor—it’s not usually an all-or-nothing scenario. Once it purchases an invoice, the factor manages the receivable until it is paid. The factor will essentially become the business’ defacto credit manager and A/R department, performing credit checks, analyzing credit reports, and mailing and documenting invoices and payments.
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A/R financing, meanwhile, is more like a traditional bank loan, but with some key differences. While bank loans may be secured by different kinds of collateral including plant and equipment, real estate and/or the personal assets of the business owner, A/R financing is backed strictly by a pledge of the business’ assets associated with the accounts receivable to the finance company.
Under an A/R financing arrangement, a borrowing base of 70 to 90 percent of the qualified receivables is established at each draw against which the business can borrow money. A collateral management fee (typically 1-2 percent) is charged against the outstanding amount and when money is advanced, interest is assessed only on the amount of money actually borrowed. Typically, in order to count toward the borrowing base, an invoice must be less than 90 days old and the underlying business must be deemed creditworthy by the finance company. Other conditions may also apply.
As you can see, comparing factoring and A/R financing is kind of tricky. One is actually a loan, while the other is the sale of an asset (invoices or receivables) to a third party. However, they act very similarly. Here are the main features of each to consider before you decide which one is the best fit for your company:
Factoring:
Offers more flexibility than A/R financing because businesses can pick and choose which invoices to sell to the factor.
Is fairly easy to qualify for. Ideal for newer and financially challenged companies.
Simple fee structure helps the company track total costs on an invoice-by-invoice basis.
A/R financing:
Is usually less expensive than factoring.
Tends to be easier to transition from A/R financing to a traditional bank line of credit when the company becomes bankable again.
Offers less flexibility than factoring because the business must submit all of its accounts receivable to the finance company as collateral.
Businesses will typically need a minimum of ,000 a month in sales to qualify for A/R financing, so it may not be available for very small companies.
Both factoring and A/R financing are usually considered to be transitional sources of financing that can carry a business through a time when it does not qualify for traditional bank financing.
After a period typically ranging from 12-24 months, companies are often able to repair their financial statements and become bankable once again. In some industries, however, companies continue to factor their invoices indefinitely—trucking is an example of an industry that relies heavily on factoring to keep its cash flowing.
The good news is that, despite the tight credit environment, there are many alternative financing and non-bank financing options available to companies that need a cash infusion, whether it’s to beef up working capital or help facilitate growth.
However, the bad news is that business owners often shy away from non-bank financing because they don’t understand it. Most owners simply rely on their banker for financial information and many bankers (not surprisingly) have only limited experience with options beyond those offered by the bank.
To help ease some of the fear that owners often have of alternative financing, here is a description of the most common types of non-bank financing. There are many struggling businesses out there today that could benefit from one of these alternative financing options:
If a business has financial challenges, full-service factoring is a good solution. The business sells its outstanding accounts receivable on an ongoing basis to a commercial finance company (also referred to as a factoring company) at a discount—typically between 2-4 percent—and then the factoring company manages the receivable until it is paid. It is a great alternative when a traditional line of credit is simply not available. There are a number of variables to a program, including full recourse, non-recourse, notification and non-notification.
Here, a business can sell just one of its invoices to a factoring company without any commitment to minimum volumes or terms. It sounds like a good solution but it should be used sparingly. Spot factoring is typically more expensive than full-service factoring (in the 5-8 percent discount range) and usually requires extensive controls. In most cases, it does not solve the underlying lack of working capital issue.
A/R financing is an ideal solution for companies that are not yet bankable but have good financial statements and need more money than a traditional lender will provide. The business must submit all of its invoices through to the A/R finance company and pay a collateral management fee of about 1-2 percent to have them professionally managed. A borrowing base is calculated daily and when funds are requested an interest rate of Prime plus 1 to 5 points is applied. If and when the company becomes bankable, it is a fairly easytransition to a traditional bank line of credit.
This is a facility secured by all the assets of a company, including A/R, equipment, real estate and inventory. It’s a good alternative for companies with the right mix of assets and a need for at least million. The business continues to manage and collect its own receivables but submits an aging report each month to the ABL company, which will review and periodically audit the reports. Fees and interest make this product more expensive than traditional bank financing, but in many cases it provides access to more capital. In the right situation, this can be a very fair trade-off.
Ideal for a business that has a purchase order(s) but lacks the supplier credit needed to fill it. The business must be able to demonstrate a history of completing orders, and the account debtor placing the order must be financially strong. In most cases, a PO finance company requires the involvement of a factor or asset-based lender in the transaction. PO financing is a high-risk kind of financing, so the costs are usually very high and the due diligence required is quite intense.
The message I am trying to convey is simply that financially challenged business owners should not be afraid to consider alternative or non-bank financing options. It’s a fairly simple matter to learn what they are, how much they cost and how they work. Alternative financing is a much better option than facing the challenges of growth or turnaround alone. It is a known fact that the vast majority of business failures are due to a lack of working capital—but it doesn’t have to be that way.
With a better understanding of these different types of non-bank financing, you’ll be in a better position to decide if they might be the answer to your financing challenges.
This time Max Keiser and co-host, Stacy Herbert, look at the scandals of Tony “No Blood for Oil” Blair lying about selling the UK gold supply on “technical advice of the Bank of England;” a millionaire tramp in Sweden and a casino that refuses to pay in America; and, finally, the Irish ‘Bad Bank’ and the ‘Celtic Chernobyl.’ Max also talks to William ‘BJ’ Lawson, who is running for Congress in North Carolina’s 4th District, about Ron Paul Republicans, the Federal Reserve setting fiscal policy and defining President Obama. Video Rating: 4 / 5
Finding proper business financing is not easy at the best of times for most small and medium sized business owners and managers.
There are a number of reasons that collectively explain why the business financing market can be so difficult to understand and navigate.
But probably the single biggest reason is the lack of useful information about how the business financing market actually works.
Business financing information and education sources predominantly come in two forms: 1) institutional education material; 2) major bank advertising.
If you’ve ever read through a educational finance text book or taken a business finance course, you already know how difficult it can be to apply the theories, principles, and strategies to a small or medium sized business scale.
From a formal educational point of view, there is very little useful information provided as to how the market place works, how to plan for financing requirements, how to manage periods of growth, decline, transition, start up, etc.
Sure academic books and courses can go through all these areas in great detail, but is the information practical, real world, something you can relate to and apply yourself as a manager or owner of a small or medium sized business?
In most cases, the answer is a resounding NO.
Most finance text books speak to big business financing dynamics that are not easily transferable to small and medium sized business scenarios.
Outside of the formal education system, the next great source of business financing information is the information provided by the major banks, which they tend to make available to you by the boat load through there broad based marketing campaigns.
Unfortunately, the information by itself seldom helps you determine if a particular institution would be able to provide you with financing, or what would be required to qualify for a loan.
The massive brand advertising campaigns run by the major banks have told us for years that these institutions will take care of all our banking needs, and that basically all we have to do is show up on their door step and they’ll take care of the rest.
Depending on whose numbers you look at, in reality major banks provide less than 30% of the financing required by small and medium sized businesses and this number is on the decline.
So, when equipped with little or no useful information, the average business owner or manager for a small or medium sized business will first approach their existing bank for financing.
After all, you just need to show up at the door step of a major bank and they will take care of your needs, especially if you are a long time customer, right?
Despite the branded messages to the contrary, major banks tend to be very selective when providing business financing to small and medium sized businesses.
So, if your bank can’t provide you with the business financing you require, what is your alternative?
The good news is that business financing sources continue to grow in numbers as more and more lenders carve out a particular piece of the market to service.
In order to take advantage of these alternatives, you need to have a solid approach in place when seeking business financing.
Here’s a short list of things to consider
>>> Develop a thorough understanding of both your personal and business assets, income, and cash flow.
Regardless of financing model, these elements will always come into play to some degree.
A good practice to follow is to maintain a personal net worth statement and update it at least quarterly so that when you do need to access this information you don’t have to dig through stock certificates, pension statements, life insurance policies, etc., to come up with a current value for the assets you own and the debts you owe.
Your knowledge of your own business financials is also an indication of your ability to manage your business.
>>> Monitor and manage your personal and business credit. Small and medium sized business financing is focused on both personal and business credit histories. Regular reviews of both personal and business credit reports from the credit reporting agencies are important to avoid errors and credit practices that can severly damage your borrowing power. >>> Develop your marketing position. Yes, seeking business financing is a marketing exercise. When applying for business financing, you are marketing your business to lending sources. In order for them to seriously consider your application, they need to know what’s in it for them. What will they make as a return? What is the risk of you not paying the money back? What are the business risks and how do you intend to manage them? When will they get their money back? How will you secure the loan, and so on. >>> Research Lending Sources Your goal when seeking business financing is to locate the amount of capital you require to accomplish a specific purpose from a financing source that meets your business needs. Again, there are lots of business financing sources. But there is also lots of variation in the types of business applications each one can consider. Broad based lenders reply on credit history and net worth. As you get more specific in terms of financing application and industry, lender applications become more narrow and can be harder to locate. Financing consulants and business loan brokers can be an excellent source of information.
>>> Qualify The Lender Before you make a formal application, find out if the lender has the programs and lending track record to meet your specific needs. Too often, only the lender does any amount of qualification. Both sides should get comfortable with what each can offer the other before proceeding with a formal application process. >>> Compare your options Depending on the scenario, there can be several financing strategies that could work for your business. Make sure you take the time to compare before making a decision. The extra time spent could save you considerable time and money in the long run. >>> Start Today Regardless of what your business financing needs are right now, you should regularly invest time in staying on top of your business’s financials and researching financing sources that fit your industry and potential future applications. When the time comes to acquire additional capital, your proactive efforts can make all the difference in getting the capital you require, when you need it, for terms that are acceptable to your business.
Golf course loans and funeral home financing provide a particularly challenging set of circumstances for both refinancing and purchases. For most small business loan programs involving specialized properties like funeral homes and golf courses, the prevailing chaotic bank lending climate has made a bad situation even worse. These specialized businesses are among the most difficult small business finance situations for commercial borrowers.
Buying or refinancing a golf course or funeral home is usually difficult to finalize. Funeral home financing and golf course financing involve problems not found in most commercial loan situations. Refinancing for both of these business categories is likely to be more complicated than the original business financing for purchase.
Fewer Business Lenders – Golf Course and Funeral Home Financing
As a further complication for a difficult business loan for a golf course or funeral home, fewer business lenders are currently willing to offer competitive small business finance terms. There has recently been a noticeable shrinkage in regional and local banks which offer commercial mortgage programs for golf course loans and funeral home loans.
Buy a Business – Business Opportunity Financing
Business financing to buy a business opportunity is a special commercial loan variation in which commercial property is not purchased. In such a situation, the buildings and land are typically subject to a long-term lease. Similar to a conventional mortgage to buy a golf course or funeral home, competitive business opportunity financing is not easy to find.
Avoiding Problematic Commercial Mortgage Terms
Some regional and local banks will probably offer short-term business financing instead of a long-term business loan for golf course financing and funeral home financing. Another key term that can vary significantly is the percentage of value for the commercial financing. It is of critical importance to avoid undesirable commercial loan terms, especially commercial mortgage loan conditions involving length of loan and percentage of value when buying or refinancing a funeral home or golf course business.
Stated Income Business Financing Difficulties
Stated income small business loans (involving minimal or no income verification for the borrower) are not widely available for commercial real estate financing in the current restrictive lending conditions. The use of stated income business financing is not recommended for a funeral home loan or golf course loan, even though a stated income commercial loan has a certain number of benefits when available. A major limitation of a stated income commercial mortgage is the maximum amount which can be financed. A further limitation is the low percentage of value for stated income commercial financing involving either golf course financing or funeral home financing. In other words, a stated income approach to financing funeral homes and golf courses is not recommended even if it were an option.
When Commercial Real Estate Loan Value is Less Than Business Value
For golf course loans and funeral home loans, the commercial real estate loan value is often less than the business value. This is particularly true with a funeral home appraisal. The problem with this disparity is that many business lenders will provide a business loan that includes only the commercial mortgage loan value, and this will produce significantly reduced business financing.
Exorbitant Commercial Loan Fees for Funeral Home and Golf Course Financing
Business owners should be prepared for reasonable business financing fees during the beginning of the business loan process for golf course financing and funeral home financing. Several lenders are taking advantage of the shortage of commercial loan choices for building, purchasing and refinancing a golf course or funeral home. A common tactic is to charge excessive fees of ,000 and more even if the commercial financing is not finished.
Fewer Commercial Lender Options for Funeral Home Loans and Golf Course Loans
As already noted, the availability of suitable lenders for this specialized type of business loan is shrinking. A viable commercial mortgage for funeral home financing or golf course financing will depend upon a prudent choice involving the lender. It is critical to select a lender with the ability to successfully complete the complex business loan process and at the same time avoid the commercial mortgage obstacles described earlier. It is important for a borrower seeking to buy a golf course or funeral home to be prepared in advance for the limited number of acceptable business financing lenders.
One Solution – Business Consulting and Small Business Finance Experts
In complex commercial loan and SBA business loan financing, the use of a small business finance consulting expert should be conducive to a better understanding of difficulties to anticipate. Since funeral home loans and golf course loans are among the more difficult commercial financing situations that a commercial borrower is likely to encounter, the use of preliminary business consulting should be helpful in obtaining better terms and avoiding serious problems.
The Effects of Financing Deficit on Leverage Choice of Quoted Firms In A Developing Economy: The Nigerian Experience
                  ONWUMERE J.U.J Ph.D
                  OKOYEUZU CHINWE
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ABSTRACT:   This paper examines time-series patterns of external financing decisions consistent with the pecking order theory. Emerging markets provide an excellent  laboratory to test the explanatory power of financing deficit given the under developed markets for corporate control.The adverse selection problem of external financing automatically leads to the standard pecking order in which debt dominates equity.we run a regression with a firm’s change in debt as the dependent variable and its financing  deficit as explanatory variable. we control for other determinants of debt issuance. Controlling for other determinants of debt issuance helps us to see whether the adverse selection model falsely omits critical determinants of leverage. This allows a nesting of the conventional determinants of leverage from the trade-off theory within an adverse selection model. Our empirical results indicate that the financing deficit alone accounts for 40% of the variation in leverage and that no single variable is as potent as the financing deficit in explaining the variations in leverage over the period.   We predict that publicly traded Nigerian firms fund a much larger proportion of their financing deficit with net external debt
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   INTRODUCTION
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The basic pecking order theory predicts that leverage is a decreasing function of profitability. Adverse selection problem is the basis for the theory and since liquid assets/ retained earnings ï€ do not have any adverse selection problem, they constitute the best source of funds from insiders’ perspective.
Accordingly, the firm will fund all projects using retained earnings if possible. If there is an inadequate amount of retained earnings, then debt financing will be used. This argument leads to the standard pecking order in which debt dominates equity. Frank and Goyal (2003) assume that the adverse selection   problem of external financing automatically leads to the standard pecking order in which debt dominates equity .
          ∆Dit  = a + bpo  DEFit +    Eit                     Â
We run a pool panel regression where ∆Dit represents net debt issues and  DEFit     represents financing deficit.
Following the argument of Halov and Heider (2005), that the standard Pecking order is a special case only when there is no asymmetric information about risk, we control for other determinants of debt issuance. The basic trade-off theory states that the level of leverage is determined by trading off the tax benefit of debt against the costs of financial distress. Controlling for other determinants of debt issuance helps us to see whether the adverse selection model falsely omits critical determinants of leverage. This allows a nesting of the conventional determinants of leverage from the trade-off theory within an adverse selection model.The specification in a nested model  enables us to determine how the financing deficit performs when combined with conventional factors. The pecking order theory implies that the financing deficit ought to wipe out the effects of other variables. If the financing deficit is simply one factor among many that firms trade-off, then what is left is a generalized version of the trade-off theory. The pecking order theory financial behaviour is driven by adverse selection costs and the theory should perform best among firms that face particularly several adverse selection problems. Small high growth firms are often thought of as firms with large information asymmetric .if internal financing is not adequate, then debt financing will be used. Thus, for a firm in normal operations, equity will not be used and the financing deficit will match up net debt issues.
The remainder of the paper is organized as follows. section 11 provides an overview of capital structure theories. Section 111 describes the methodology. The empirical analyses of deficit are presented in section 1V.section V concludes our work.
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SECTION 11
REVIEW OF RELEVANT LITERATURE
In finance capital structure refers to the way a corporation finances its assets through some combination of equity and debt or hybrid securities. The key division in capital structure is between debt and equity. The proportion of debt funding is measured by leverage. There are different factors that affect a firm’s capital structure, and a firm should attempt to determine what its optimal or best mix of financing.
The pecking order predicts changes in mature firm’s debt ratios. These companies’ debt ratios increase when the firms have financial deficits and declines when they have surpluses. By implication, a firm may never have a preference for external finances as long as it is able to meet its investment needs via internal equity funds. But in the presence of financial deficit as mostly the practical case, the need for external finance becomes pressing.
The pecking order theory is formally proposed in Myers (1984) and Myers and Majluf (1984).in the theoretical framework of Myers and majluf, investors are willing to buy risky securities only at a discount because of the information asymmetry between managers and outside investors. Expecting this problem, managers prefer internally generated funds .when external funds have to be raised, firms prefer straight debt, and then a convertible debt, with external equity issued as last resort.
Despite extensive investigations into how firms determine their capital structures, the capital structure puzzle prevails. One of the difficulties researchers face in these studies is that a firm may deviate from its target leverage ratio. these deviations arise because operating and financial decisions push leverage above or below the firm’s target and transaction costs and market conditions may prevent immediate corrections. This financing deficit is attributed to factors that cause a firm to deviate from its target capital structure.
Shyam-sunder and Myers (1999), provide an influential empirical test of the pecking theory against the tradeoff theory. Using a sample of 157 firms, that had traded continuously from 1971 to 1987, they find that the basic pecking order model which predicts external debt financing driven by the financing deficit, has much greater explanatory power than the static trade off model. They argue that firm’s need for external financing and their internally generated funds may have time-series properties that lead to mean reversion of the debt ratio when firms follow a pecking order financing.
In recent years,Frank and Goyal (2003)find that the financing deficit is positively related to changes in leverage which indicates pecking order financing behaviour. In other words, managers prefer issuing debts to issuing equity when firms tend to make a financial decision by taking external funds. If asymmetric information makes major equity issues or retirements rare, this behaviour is nearly inevitable. The pecking order suggests that managers try to time issues when shares are fairly priced or overpriced. Investors understand this, and interpret a decision to issue stock as bad news. That explains why stock price usually fall when a stock issues is announced. The pecking order theory stresses the value of financial slack. Without sufficient slack, the firm may be caught at the bottom of the pecking order and be forced to choose between issuing undervalued shares, borrowing and risking financial distress, or passing up valuable investment opportunities. Financial slack is most valuable to firms with plenty of positive –NPV growth opportunities. This is another reason why growth companies usually aspire to be conservative in capital structures. Heaton documents some benefits and costs of free cash flow (Heaton, 2002:40-41).
Ho, et al (2006) shows that a firm’s ability to reap growth opportunities from research and development (R&D) investments depends on its size, leverage, and the industry concentration. The authors shed further important insights on the size- leverage interaction. They reveal that large firm’s advantages over small firms disappear as their leverage increases. In general, the pecking order should work well for small young nonpayer of dividend since they face more asymmetric information
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SECTION 111
METHODOLOGYÂ Â Â Â Â Â Â Â Â Â A cross section of 60 firms was investigated. Data was obtained from annual financial reports and securities and exchange commission over a ten year period (1996-2005) A cross section of 60 firms was investigated. Data was obtained from annual financial reports and securities and exchange commission over a ten year period (1996-2005)
(The financing deficit variable)
The basic pecking order theory predicts that leverage is a decreasing function of profitability. Adverse selection problem is the basis for the theory and since liquid assets/ retained earnings ï€ do not have any adverse selection problem, they constitute the best source of funds from insiders’ perspective.
Accordingly, the firm will fund all projects using retained earnings if possible. If there is an inadequate amount of retained earnings, then debt financing will be used. This argument leads to the standard pecking order in which debt dominates equity. Frank and Goyal (2003) run the following pooled panel regression
    ∆Dit  = a + bpo  DEFit +    Eit                                        … (3.1)
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Where ∆Dit represents net debt issues and DEFit represents financing deficit. They argue that there is a support for the standard pecking order if a = 0 and b = 1.
∆Dit  =net debt issued in year t(∆Di =long-term debt issuance-long-term debt reduction)
DEFit =Divt/+ It + ∆wt- ct……..(11)
Divt= cash dividends in year t.
It= net investment in year t(simply put, changes in fixed assets and long term investments).
∆wt = change in working capital in year t
Ct =cash flow after interest and taxes.
According to theory, the specification in equation (1) is defined in levels. When actually estimating equation (1),it is conventional to scale the variables by assets or by sales.Ayla Kayhan et al,(2007).The pecking order theory does not require such scaling. Of course, in an algebraic equality, if the right-hand side and the left-hand side are divided by the same value, the equality remains intact.however, in a regression, the estimated coefficient can be seriously affected if the scaling is by a variable that is correlated with the variables in the equation. Scaling is most often justified as a method of controlling for differences in firm size. When this variable is positive the firm invests more than it internally generates. When it is negative, the firm generates more cash than it invests; in other words, the firm has positive free cash flow. The interpretation of the pecking order hypothesis, described in Shyam-sunder and Myers(1999) and Frank and Goyal(2003),is that since debt is likely to be marginal source of financing; firms with high financial deficits are likely to increase their debt ratios
Following the argument of Halov and Heider (2005), that the standard Pecking order is a special case only when there is no asymmetric information about risk, we control for other determinants of debt issuance. The basic trade-off theory states that the level of leverage is determined by trading off the tax benefit of debt against the costs of financial distress. Controlling for other determinants of debt issuance helps us to see whether the adverse selection model [that is,(3.1)] falsely omits critical determinants of leverage. This allows a nesting of the conventional determinants of leverage from the trade-off theory within an adverse selection model. Following Frank and Goyal  (2003) and Halov and Heider (2005), the set of regressions becomes:
∆Dit   = ao ï€ ï€ ï€«ï€ ï€ bpoï€ ï€ ï€ DEFit  + bc   ∆Cit + bv ∆Vit + bÏ€ ∆πit + bs ∆LOGS +  Eit                                                  Â
                                                                      …(3.2).
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         The logic of (3.2) is simple. The pecking order theory is a competitor to other mainstream empirical models of corporate  leverage. The specification in a nested model as in (3.2) above enables us to determine how the financing deficit performs when combined with conventional factors. The pecking order theory implies that the financing deficit ought to wipe out the effects of other variables. If the financing deficit is simply one factor among many that firms trade-off, then what is left is a generalized version of the trade-off theory.
 Thus, for a firm in normal operations, equity will not be used and the financing deficit will match up net debt issues.
The pecking order in terms of the relative explanatory power of the financing deficit in observed capital structures can be stated thus:
ßpo = ßs =   ßr  =  ßc =   ßp           Â
ßpo >  ßs v, c, p       = (Financing deficit dominates).
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Our version of the regression analysis follows five stages thus
Ä® t    =       α + ßpo DEFt       Â
Į t    =       α + ßpo DEFt  =  ßs St + ßvVt
Į t    =       α + ßpo DEFt  =  ßs St + ßvVt  +  ßcCt
Į t    =       α + ßs St  =  ßv Vt + ßcCt  +  ßp     pt
Į t    =       α + ßpo DEFt  =  ßs St + ßvVt  +  ßcCt  + ßp pt
Where      Į t      =       Market leverage at time t
                DEFt =        Financing deficit at time t
      St      =       Proxy for size at time t
      Vt      =       Growth opportunities at time t
      Ct      =       Tangibility of assets at time t
      pt      =       Profitability at time tÂ
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Our model of target leverage was computed thus:
Į*t      =    Į t     +   DEFt
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SECTIONÂ Â IV
Presentation And Analysis
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TABLE 4.1a: EMPIRICAL RESULTS ON THE STANDARD PECKING ORDER
Constant
Deficit
R2
Adjusted R2
Std. Error of Estimate
F
DW
0.20
0.98
0.40
0.03
5.32
1.11
(4.29)+
(2.31)++
0.32
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FÂ Â Â Â Â Â Â represents FÂ Ratio, while DW Dursin-Watson.
t        values are in brackets    n = 10
+Â Â Â Â Â Â Â signifies one percent (0.01) significance
++Â Â Â Â Â signifies five percent (0.05) significance.
The pecking order hypothesis can be stated statistically as
H1: a = 0Â Â Â Â Â (pecking order holds)
         Hi: a ≠0     (pecking order does not hold)
And
Ho: b = 1Â Â Â Â Â (pecking order holds)
         H1: b ≠0     (pecking order does not hold)
Table 4.1a indicates that the constant a is statistically different from zero. However, the slope coefficient b is close to one in support of the pecking order. The coefficient of determination indicates that the deficit explains forty percent (40%) of the variation in market leverage, our proxy for net borrowing.
It is important to stress that the variables used above were scaled by assets in line with empirical method. Scaling is most often justified as a method of controlling for differences in firm size.
The pecking order test implicitly makes different exogeneity assumptions and uses slightly different information set than is conventional in empirical research on leverage and leverage-adjusting behaviour. The conventional set of explanatory factors for leverage is the conventional set for a reason. The variables have survived many tests. As explained in our literature review, these variables also have conventional interpretations. Excluding such variables from consideration may (potentially) be a significant omission. More so, the result above indicates an unexplained variation in leverage of about sixty percent. Including such variable further poses a tough test for the pecking order theory.
Our version of the regression analysis follows five stages thus:
lt = a +bpo DEFt              ……………………………..                 (as in 4.1)
lt = a +b po DEFt +bsSt + BvVt   ……………………..                  (4.2)
lt = a +bpo DEFτ +bsSt + BvVt  + bcCt…………………               (4.3)
lt = a +bsSt + bvVt +bcCt + bππt …………………..            (4.4)
lt = a +bpoDEFt + bsSt +bvVt + bcCt + bππt ……..…..                  (4.5)
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Where        lt       =       market leverage at time t.
DEFt =       financing deficit at time t.
St      =       Proxy for size at time t.
 Vt     =       Growth opportunities at time t.
Ct      =       tangibility of assets at time t.
πt      =       profitability at time t.
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Our empirical results are tabulated in 4.5b below.
Table 4.1b:Â RESULTS ON CONVENTIONAL LEVERAGE REGRESSION WITH FINANCING DEFICIT IN NESTED MODELS.
Regression Equation
Constant
DEF
Size
(S)
Growth
(V)
Collateral
(C)
Profit
(Ï€)
R2
F
DW
4.4
0.20
(4.29)+
0.98
(2.31)++
Â
Â
Â
Â
0.40
5.32
1.11
4.5
0.36
(5.90)+
0.73
(2.44)++
-0.13
(-1.26)
-0.23
(-2.47)++
Â
Â
0.70
8.08
1.45
4.6
0.40
(9.04)+
0.53
(2.43)+++
-0.19
(-2.55)++
-0.30
(-4.35)+
-0.06
(-2.78)++
Â
0.86
14.81
1.93
4.7
0.45
(7.47)+
Â
-0.18
(-1.66)
-0.34
(-3.26)++
-0.08
(-2.58)++
-0.01
(-0.42)
0.70
6.36
2.27
4.8
0.39
(7.44)+
0.52
(2.12)+++
-0.19
(-2.23)++
-0.31
(-3.78)++
-0.06
(-2.50)++
-0.01
(-0.15)
0.83
9.53
1.88
n =  10
+Â Â Â Â Â Â Â Significant at one percent (0.01)
++Â Â Â Â Â Significant of five percent (0.05)
+++Â Â Â Significant at ten percent (0.10)Â
Confirming predictions shared by the trade-off model and the standard pecking order model, firms with more growth opportunities have less market leverage. Confirming the pecking order model but contradicting the trade-off model, more profitable firms are less levered. However, the profitability coefficient is statistically insignificant.
         On the explanatory power of deficit on observed debt ratios, table 4.1b indicates its dominance over the remaining conventional variables both by the partial derivatives and the coefficient of determination (R2 ).
Again, the financing deficit alone accounts for 40 percent of the variation in leverage while size and growth (put together) make up the balance of 30 percent. Collateral, our proxy for tangibility of assets explains 16 percent of the variations in leverage while the explanatory power of the regression once profitability is added. Table 4.1b indicates that no single variable is as potent as the financing deficit in explaining the variations in leverage over the period. A one percent increase in financing deficit leads to a .73% increase in market leverage. A one percent increase in size leads to a .19% decline in market leverage. A one percent increase in growth opportunities leads to a .3% decline in market leverage. A one percent rise in tangible assets leads to a decrease of .06% in leverage while a one percent rise in profitability leads to a decline of .01% in leverage. Though the profitability coefficient is consistent with the pecking order theory, it is not significant at all. This casts doubt on the plausibility of the pecking order. However, the statistically significant deficit coefficient that dominates other coefficients at all levels indicates that the pecking order is a strong theory in the Nigerian corporate environment. Empirical research along this line includes Graham and Harvey (2001), Fama and French (2002). Halov and Heider (2005).
To test for the degree of multicollinearity amongst the explanatory variables, the table below hereby presents our intercorrelation matrix. Â
TABLE 4.1c: INTERCORRELATION MATRIX OF MARKET LEVERAGE (L) WITH Â Â DEFICIT, SIZE, GROWTH, COLLATERAL AND PROFITABILITY.
Â
L S V C Î
DEF
PPMCC. Â Â Â Â Â Â L.
1.00
Â
Â
Â
Â
Â
                 S
0.63
1.00
Â
Â
Â
Â
                 V
-0.76
-0.92
1.00
Â
Â
Â
                  C
                  πÂ
-0.28
0.49
0.02
0.75
-0.14
-0.77
1.00
0.12
Â
1.00
Â
                DEF
0.63
0.32
-0.31
-0.28
0.13
1.00
Sig (I-tailed) L
.
Â
Â
Â
Â
Â
                                      S            Â
Â
0.03
Â
.
Â
Â
Â
Â
                    V
0.01
0.00
Â
Â
Â
Â
                   C
0.21
0.48
0.35
Â
Â
Â
                     π   Â
0.08
0.01
-0.01
0.37
.
Â
                  DEF
0.03
0.18
-0.20
0.22
0.36
1.00
Â
Â
Â
SECTION V
SUMMARY/CONCLUSION.
Â
DEBT AND THE FINANCING DEFICIT
         We now look at the analysis of the capital structure decision from a different point of view, the pecking order theory of Myers and Majluf (1984) and Myers (1984). As can be recalled, Myers and Majluf analyzed a firm with assets – in – place and a growth opportunity requiring additional financing. They assumed perfect financial markets, except that investors do not know the true worth of either the existing assets or the new opportunity. Therefore, investors cannot precisely value the securities issued to finance the new investment; If the firm announces an issue of common stock. This is good news for investors if it reveals a growth opportunity with positive net present value. It is bad news if managers believe the assets –in-place are overvalued by investors and decide to try to issue overvalued shares. (Issuing shares at too low a price transfers value from existing shareholders to new investors if the new shares are overvalued, the transfer goes the other way). The interested reader is referred to Myers (2001), Fama and French (2002) and the references cited in these papers for excellent exposition.
         The pecking order theory predicts that the firm will fund all projects using internal equity if possible (Information asymmetries are assumed relevant only for external financing). If internal finance is not adequate, then debt financing will be used. Thus, for a firm in normal operations, equity will not be used and the financing deficit will match the net debt issues.
         The empirical specification for the test of the standard pecking order is given as
         lit = a + bpo D
Â
Â
CONCLUSION.A statistically significant deficit coefficient that dominates other coefficients in a nested regression model indicates that no single variable is as potent as the financing deficit in explaining the variation in leverage over the period of the financing deficit provides a strong support for the standard pecking order. The result is well in line with the empirical findings of Titman and Wessels(1988)our result was a strong confirmation of the pecking order in the financing behaviours of Nigeria quoted firms.
Â
Â
Â
REFERENCES
Â
Â
Fama, E.F. and K.R. French (2002a) “Testing trade-off and pecking order predictions About Dividends and Debt,” Review of financial studies, Â 15, (1):1-33.
Frank, M.Z and V.K Goyal (2003) “Testing the Pecking Order Theory of Capital Structure,” Journal of Financial Economics, 67: 217-248.
Graham, J.R and C.R Harvey (2001)”The Theory and Practice of Corporate Finance: Evidence from the Field, ” Journal of financial Economics, 60, ( 2-3)May: 187-243.
Â
Halov, N. and F. Heider (2005) “Capital Structure, risk and Asymmetric Information, “Working Paper NYU Stern School of Business. (December 1st, 2005).
Ho, Y.K, M. Tjahjapranata and C.M Yap (2006) “Size, Leverage, Concentration, and R&D Investment in Generating Growth Opportunities”, Journal of Business 79, ( 2):851-876.
Â
Myers, S.C. (1984) “The Capital structure puzzle”, Journal of Finance, 39, July, 575 – 592.
Myers, S.C. and N.S. Majluf (1984) “Corporate Financing and
Investment Decisions When Firms Have Information Investors Do Not Have”, Journal of Financial Economics, 13, June, 187 – 222.
Â
Â
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Titman, S. and R. Wessels (1988) “The Determinants of Capital Structure Choice, ” Journal of Finance, 43, (1): 1-19
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