Bio- and regenera- tive Medicine as an important growth Market

14 HHL RESEARCH REPORT 2012 finAnCE, ACCOunTing And CORPORATE gOvERnAnCE 15
cHair oF Financial ManageMent
the value of corporate
debt in the valuation
of companies
There are various theories about how
companies make financing decisions.
They can incur debt in order to obtain
outside capital for important investments
without having to ask the
share holders for equity. On the one
hand, these debts have certain financial
benefits since the interest to be
paid will reduce taxes under certain
circumstances. On the other hand,
high debt may lead a company into
insolvency. This is the basis of the
trade-off theory which concludes that
there is an optimal debt level which
trades the advantages and disadvantages
off against each other and is
therefore ideal for the company. If this
is the case, there should be observable
factors to explain the financing choices
of companies using empirical models.
Evidence for this but also contrary
considerations are found in the
respective literature.
Jens Reinstädt wanted to explore this
more thoroughly in his Master thesis,
supervised by Sven Arnold and
Alexander Lahmann from Prof . Dr .
Bernhard Schwetzler‘s Chair . He examined
the liquidity supply and market
development using various capital
structure theories in a data set of G7
countries between 1999 and 2009 .
His conclusion: “The companies are
going to have to rethink the debt policies
due to the crisis and they will finance
their businesses in a more conservative
manner in the future . More over, it will
become more difficult to obtain outside
capital .” In addition to the Master thesis,
a publication in Corporate Finance biz
will support decision-makers to make
the right choice between corporate debt
and equity .
“Neither the trade-off nor the pecking
order theory can explain all aspects
of capital structure decisions,” says
Alexander Lahmann who holds a degree
in economics . “We were able to confirm
many results of previous studies for the
period of examination but also reassess
statistically significant connections and
show that they are constant over time .”
In detail: Profitability and company size
have a continuous significance . In contrast,
growth, tangibility of assets and
the tax rate lose influence during certain
years . “We were able to test capital
structure theories in a quite interesting
“The companies are going to have
to rethink the debt policies due to the
crisis and they will finance their businesses
in a more conservative manner
in the future. Moreover, it will become
more difficult to obtain outside capital.”
Jens reinstädt (part-time MBA student)
data set . The sample is especially
character ized by the bust of the dot-
com bubble in 2000 and the financial
crisis of 2007/2008,” says Mr . Arnold .
Capital structure
during the crisis
During the dot-com bust and the
recent economic crisis, neither the
trade-off nor the pecking order theory
were reliable; but the profitability of
firms maintained to be statistically
significant . Between 1999 and 2009, it
is remarkable how the highest model
quality was achieved in the year of
crisis 2008 . Profitability and company
size show a constant importance over
time with profitability as an influencing
factor being evidence for the pecking
order theory while size can be considered
to prove the trade-off theory . At the
peak of the crisis in 2008, profitability
was becoming more important while
company size was losing significance .
Additionally, the trade-off theory is
supported by the influencing factors
of growth and tangibility of assets
mainly in the first years of the study .
They are not constant over time and
lose significance with the crisis of the
New Economy with tangibi lity of assets
even becoming a negative factor prior to
the crisis, which supports the pecking
order theory . However, this trend has
not continued . Moreover, the pecking
order theory does explain the financing
choice of large companies throughout
the entire period very well . Since the
present study provides arguments for
both theories during various periods,
it can be assumed that the trade-off
and pecking order theory each explain
a part of the capital structure decision
making and complement one another .
“Interesting is the fact that industry
membership is a very important determinant
of leverage . This is an indicator
that companies position themselves
with respect to their own peer group,”
says Alexander Lahmann .
From this finding, the authors derive
further questions for scientific research:
are there cyclical economic schematics
in the industries or are there industryspecific
characteristics which we have
not understood yet? In any case, the
asset tangibility variable becomes insignificant
when including industries into
the empirical model .
Another result of the data analysis:
prior to the financial crisis, companies
worldwide were not excessively in debt .
“The common statement in the public
debate that excessive debt led to the
crisis is refuted in our global data set of
capital market companies,” says Sven
Arnold, who holds a degree in mathematics
. No differences in the development
of the debt ratio were measured
in the individual countries during the
crises . Generally, Canada and Germany
have the lowest, Japan and Italy the
highest debt ratio over the entire study
period .
cHair oF Financial ManageMent
tax Shield – a topic in
practice and Science
The value of outside financing has
always been a crucial question of
economics which could only be
answered with assumptions far from
reality up to now . The question has
been asked and actively discussed
since the 1960s . However, the work of
Prof . Dr . Bernhard Schwetzler, Sven
Arnold and Alexander Lahmann takes
an advanced look at this valuation
problem in Germany . They examine
the value of tax shields with particular
consideration towards insolvency and
the value of the interest barrier .
Glossary
tax Shield
A tax shield is the reduction in income taxes that
results from taking an allowable deduction from
taxable income. Since a tax shield is a way to
save cash flows, it increases the value of the
business, and it is an important aspect of
business valuation.
“In general, we deal with the value
proposition of outside capital in the
valuation of companies,” says economist
Alexander Lahmann . The interest
on loans taken out by companies
being tax-deductible in the calculation
of the annual net income leads to
tax benefits from outside financing .
“This tax shield is a considerable part
of the market value of a company,”
he adds . Empirical studies showed
that it accounts for 10 percent of the
entire company value on average . This
value proposition may decrease when
including various conditions in the
examinations such as insolvency or
limitations on interest deductibility .
The background: the 2008 company
tax reform introduced the limitation
on the tax deductibility of interest
paid, the so-called interest barrier .
The legislature sought to lower the
fiscal incentive of outside financing .
“The regulation was to prevent
excessive financing through borrowing
by German companies . It resulted
in a number of critics from the practice
raising their voices to warn
about significant losses in value by
the companies affected,” explains
Prof . Dr . Schwetzler . Therefore he,
together with his two colleagues,
examined the economic effects of this
tax barrier regulation for company
owners . The objective was to determine
the tax benefits resulting from
outside financing (tax shield) when
applying this new tax regulation .
The result: the application of the
model set up for the assessment of
tax benefits on the empirical data for
German companies from the Prime
All Index showed that the value proposition
of the tax barrier is negligible .
The recommended procedure for
practitioners therefore is to consider
the tax barrier solely in
extreme cases and to take into
account the insolvency probability
when assessing tax benefits .
Prof . Dr . Schwetzler sees relevance
in this project both for the practice
and for science . “In the practice, you
want to know whether you should
indeed model the interest barrier
and insolvency in the valuation of a
company . The scientists, on the other
hand, want to know how to technically
realize these problems .”
Mathematician Sven Arnold says
about the research process: “One
difficulty was to connect a theoretically
correct point of view with reality
. It was the excellent cooperation
between theoretical stand points
and certain modeling techniques
which greatly contributed to the
solution of the scientific question .”
The research topic required various
types of expertise: company
valuation, model-based theoretical
work, knowledge on stochastic
processes and implementation in
a computer program . By combining
various abilities it became possible
to analyze these questions .