A study on sustainable growth rate for firm survival

• Published date: 01 July 2019
• DOI: http://doi.org/10.1002/jsc.2269
• Author: Rajesh Mamilla
• Date: 01 July 2019

RESEARCH ARTICLE

A study on sustainable growth rate for firm survival*

Rajesh Mamilla

VIT Business School, Vellore Institute of

Technology, Vellore, Tamil Nadu, India

Correspondence

Rajesh Mamilla, VIT Business School, Vellore

Institute of Technology, Vellore, Tamil Nadu,

India, 632014.

Email: raaz.mba@gmail.com

Abstract

Understanding where a company is in its life cycle is important. The sustainable

growth rate (SGR) is an indicator of what stage a company is in, in its life cycle. The

position often determines corporate finance objectives such as what sources of

financing to use, dividend pay-out policies, or overall competitive strategy. The pur-

pose of this study is to analyze the actual growth rate as well as SGR and investigate

the overall effect of selected independent variables on SGR.

1|INTRODUCTION

Firms to survive in a competitive world require sustainable growth.

Sustainable growth for any business involves a situation where

growth happens with no increase in assets, equity issuance, added lia-

bilities, or retained earnings. This helps the investors and analysts to

find the maximum possible rate at which the firm can grow using exis-

ting assets. By mapping sustainable growth rate (SGR) with financial

policies, SGR can help managers to do financial planning efficiently.

The SGR is valuable because it combines operating (profit margin and

asset efficiency) and financial (capital structure and retention rate) ele-

ments into one comprehensive measure. Using SGR, managers and

investors can begin to gauge whether the firm's future growth plans

are realistic. In this way, SGR can provide managers and investors with

insight into the levers of corporate growth. Higgins originally devel-

oped SGR (Higgins, 1989). He demonstrated that SGR is the maximum

rate at which firm sales can increase without depletion of financial

resources. SGR depends on important factors such as financial leverage,

liquidity, asset efficiency, size, and tax. Some companies with high growth

rates will cause to have financial pressures. This will cause the company to

face problems such as financial loss, high costs, higher debt, bankruptcy, and

engage in the decline in market share (Fonseka, Ramos, & Tian, 2012). The

company can maintain their growth by determining the said important fac-

tors that affect sustainable growth, for example, if financial leverage

increases, the sustainable growth tends to increase and if financial leverage

decreases, the sustainable growth also decreases (Srinivasa, 2011). Company

prosperity depends on capital structure. The use of excess debt may result

in company bankruptcy. Initially, company grows through retained earnings

but later uses debt followed by equity as funding sources according to

pecking order theory. To increase SGR, the company needs to reduce divi-

dend when real growth is higher than the SGR. This can affect stock prices.

As per signaling hypothesis, dividend policy affects stock prices. If actual

growth rate (AGA) is less than SGR, it implies that the company has more

than enough capital to meet its investment needs and vice versa.

2|REVIEW OF LITERATURE

The concept of SGR is used by many researchers in various studies, such

as Martani, Mulyono, and Khairurizka (2009) examined the relevance value

of accounting information in explaining stock return; Escalante, Turvey, and

Barry (2006) for farm level evidence on sustainable growth pattern for

grain and livestock farms; Demirguc-Kunt and Maksimovic (1998) used the

concept of SGR for examining differences in legal and finance systems that

affect firm's use of external financing for fund growth; Jarvis, Mayo, and

Lane (1992) used SGR to make a macro marketing decision; Vasiliou and

Karkazis (2002) applied SGR model in the banking industry to measure the

feasibility of its plans for growth; Hyytine and Pajarinen (2005) applied

SGR model to study the relationship between firm level disclosure quality

and availability of external finance to an organization; Geiger and Reyes

(1997) used the SGR concept for supporting small business owners to

determine the appropriate rate of growth for the firm's given cost and debt

level; Phillips, Anderson,andVolker(2010)usedanSGRmodeltoanalyze

the cross-sectional variations in financial ratios among privately held retail

companies at various growth cycle stages; Jin and Wu (2008) applied SGR

model to study the relationship between intellectual capital and sustainable

growth ability; Ashta (2008) in his study made an attempt on analyzing

the financial performance of firms growing very fast as well as those in

financial distress; Pickett (2008) applied SGR model to find the subtle

*JEL classification code: G3.

DOI: 10.1002/jsc.2269

Strategic Change. 2019;28:273–277. wileyonlinelibrary.com/journal/jsc © 2019 John Wiley & Sons, Ltd. 273