Corporate Finance in Africa: The Interactive Impact of Firm Nationality and Characteristics

• Date: 01 August 2017
• Author: Abel Ebeh Ezeoha
• DOI: http://doi.org/10.1111/rode.12277
• Published date: 01 August 2017

Corporate Finance in Africa: The Interactive Impact

of Firm Nationality and Characteristics

Abel Ebeh Ezeoha*

Abstract

Using a balance panel data of 351 publicly quoted firms in eleven major African stock exchanges, I

investigated the impact of the differences in the internal structures of domestic and foreign firms on

corporate financial decisions in Africa. I also analyzed the sensitivity of the impact of the internal firm

characteristic on changes in the level of exogenous factors such as marginal tax structure and financial

system development. The arising results showed that among the selected key internal characteristics of

firms, only the impact of profitability and tangibility on financial structure was significantly sensitive to

the proportion of domestic/foreign shareholding and that, consistent with capital structure theories,

corporate financing decisions in Africa were significantly sensitive to marginal tax policies and the degree

of financial system development prevailing in a country. The results suggest that by investing in assets

that are acceptable to lenders and investors as collaterals and maintaining reasonable stability in their

cash flow positions, domestic firms can in practice enhance their access to strategic investment capital.

1. Introduction

Among the widely held views on corporate financial structure is that firm-specific

characteristics such as size, profitability, age, tangibility, risk exposure and

nationality have some definite impact on financing decisions. Existing empirical

evidence also provides proof for such a view. Another aspect of the debate is that

the impact of the above-mentioned internal characteristics is also influenced by the

level of economic development in the host country. On the contrary, Booth et al.

(2001), in a study of the capital structures of firms in 10 developing countries, have

established that the variables that are relevant for explaining capital structures in

developed countries are also useful in the case of developing countries.

However, a less researched and probably yet to be resolved issue in the financial

structure debate focuses on the comparative difference between the financial

structures of domestic and foreign firms operating in developing economies; as well

as the differential impacts of internal firm characteristics on the financial structures

of the two groups. For the latter, the arising emphasis is on whether foreign firms’

access to local financial markets undermines domestic firms’ access. In a developing

region like Africa, this evolving area of corporate financing debate is more

pronounced and is heightened by some global events. Increasing financial pressure

owing to persistent economic and financial crises in both the home and the host

countries of foreign firms operating in Africa, has, for instance, intensified foreign

firms’ reliance on the domestic markets for debt finance. More than ever before,

foreign firms appear to have more incentives to borrow locally. According to the

*Ezeoha (Corresponding author): Department of Economics & Department of Accountancy & Banking

& Finance, Ebonyi State University, 053, Abakaliki, Nigeria. Tel: +234 7033665383; E-mail:

aezeoha@gmail.com.

Review of Development Economics, 21(3), 849–873, 2017

DOI:10.1111/rode.12277

©2016 John Wiley & Sons Ltd

Economist (2014), “since the financial crisis, big Western banks, short of capital and

weighted down by regulations, have become much less enthusiastic about lending to

companies in emerging economies.” This emerging development accounts for the

renewed interest in the corporate nationality and finance debate in developing

countries. In the context of this paper, the concept of corporate nationality implies

whether, by the level of shareholding, the ownership of a firm is dominated by

foreign or local investors; and corporate finance is restricted to access to short- and

long-term debt finances. This restriction is based on the widely available evidence

that Africa’s equity markets are generally small, illiquid and are characterized by

loanable and investible capital (Masetti and Mihr, 2013; Hearn, 2012; Honohan and

Beck, 2007).

In the event of any scramble for local financial resources in the case of Africa,

foreign firms might have more access than their local counterparts. The underlying

assumption is that they are more attractive to lenders and investors because of their

high financial flexibility, compliant with global standards for financial accounting,

disclosure and corporate governance, superior performance and quality collateral

value. Foreign firms might therefore utilize their vantage position to dominate the

markets for corporate finance. Consequently, the limit of access of foreign firms to

the domestic financial markets can then only be moderated by exogenous factors

such as the overall debt maturity structure in the system, the prevailing corporate

tax policy imposed by the government and the level of financial system

development in the host economies. The financing decisions of foreign firms, for

instance, would tilt more towards using the domestic financial markets if the host-

country’s tax rate is high (Aggarwal and Kyaw, 2008) and more so when the tax

differential between the home and the host countries is higher (Chowdhry and

Coval, 1998).

The internal capital markets, which essentially provide some sort of relief in the

presence of constrained access to external finance, are held to be more favorable to

foreign firms by virtue of their being members of larger business groups.

Notwithstanding this arising evidence, Hearn (2014) and Hearn and Piesse (2013)

stress the equally increasing importance of internal capital markets for domestic

firms. For both classes of firms, the choice between equity and debt financing or

between internal and external sources remains strategic for a number of reasons,

including, on the side of external capital, the overriding need for tax shielding and

for the mitigation of agency-related problems; and on the side of internal capital,

the need to moderate the overall cost of capital. Rather than relying on internal

funding from business groups, a foreign firm, for example, might go for a strong

third-party mechanism (such as the monitoring role of banks) that helps to

moderate the activities of managers and government agents.

No doubt, resolving issues relating to the differential impact of internal firm

characteristics, as contextualized here in this paper, is capable of deepening our

understanding of the corporate financial practices and providing useful evidence to

guide policies in the emerging market economies in Africa. To contribute to the

global literature on corporate finance, this study investigates how the likely

differences in the internal structures of domestic and foreign firms operating in

Africa respectively affect their financial structure decisions; as well as the sensitivity

of the impact of the internal firm characteristic on changes in the level of

exogenous factors like marginal tax structure and financial system development.

In doing this, the study makes use of a panel dataset of 351 firms listed in twelve

major African stock exchanges. Financial and governance data for each of the 351

850 Abel Ebeh Ezeoha

©2016 John Wiley & Sons Ltd