Challenges in the Era of Globalization - iaabd

Challenges in the Era of Globalization
Edited by Emmanuel Obuah
accumulation is both infeasible and sub-optimal. The economic reality facing the country today requires
a shift in emphasis to factor efficiency, and finally, higher productivity is a key to poverty reduction.
In the study of determinants of productivity growth of firms, financial pressure created through debt either
by shareholders or managers of firms has been identified as a major factor. Shareholders can increase the
debt ratio to commit the management to obligatory debt service payments so that excess cash flow will
not be diverted by managers to projects with negative Net Present Values (NPV) so as to enhance
managerial utility (Jensen, 1986). Self-interested managers also could use debt as a bonding mechanism
to pursuing no other objective aside from profit maximization (Grossman and Hart, 1982). Empirical
works however on the impact of financial pressure on productivity growth of firms have been limited to
developed countries. It is very pertinent to understand the role of financial pressure in developing
countries with imperfect capital markets whether it could serve as an alternative governance mechanism.
Having looked at the introduction, the remaining part of this paper is divided into four sections. Section
two takes a look at the theoretical framework and literature review while the third section presents the
methodology and section four presents data analysis and results while section five summarizes with
conclusions.
Theoretical framework and literature review
Analytical Framework
Our analytical framework derives from the Agency theory of Jensen and Meckling (1976). In this
framework, the separation of ownership and control in the modern form of business organizations gives
room for agents (managers) to pursue non-profit maximizing objectives at the expense of the owners
(principal). The realization of this possibility has led the principal to taking some necessary measures in
protecting their interests. Financial pressure which results from higher level of debt service payments
relative to the average level of earnings is one of such measures adopted by shareholders (principal) in
ensuring that managers’ interests are aligned appropriately with those of the owners.
Firms with free cash flow and limited growth opportunities, managers may engage in self serving and
opportunistic behavior by investing free cash flow in projects that are not associated with the firm’s
current lines of business. Jensen (1986) explained that the opportunistic behavior of the managers in this
respect can be controlled by increasing the proportion of debt in the capital structure which increases the
debt burden and consequently debt service obligations which managers are compelled to meet failure of
which may lead to bankruptcy and which will not be in the interest of the managers. Hence, putting
managers under financial pressure of meeting debt service obligations enables them to adopt measures at
improving the productive use of resources, more so this can be more effectively achieved when a higher
proportion of the debt service is from the bank (Jensen, 1986; Aghion and Howitt, 1996). It has also
been observed that creditors are not much concerned about firm monitoring, but rather on avoiding failure
of loans provided Stiglitz (1985), hence, it is expected that banks will interfere more in firms in which
they have much loans and whose performance are poor.
Following from the above framework, we formulate the following hypothesis for Nigerian firms.
Hypothesis 1: High borrowing ratio has a positive impact on productivity growth
Hypothesis 2: High Debt ratio has a positive impact on productivity growth
Hypothesis 3: High bank debt has a positive impact on productivity growth
Hypothesis 4: Firms going through financial distress increases productivity
Hypothesis 5: Bank debt increases productivity growth of firms going through financial distress
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