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«Supervisor: Prof. Paulo Jorge Marques de Oliveira Ribeiro Pereira 2014/2015 I Biographical note Joana Sofia Sousa Teixeira was born on June 5, 1989 ...»

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Impact of Troika’s intervention on

Capital Structure of Irish, Greek and

Portuguese Companies

Joana Sofia Sousa Teixeira



MSc in Finance


Prof. Paulo Jorge Marques de Oliveira Ribeiro Pereira



Biographical note

Joana Sofia Sousa Teixeira was born on June 5, 1989 in Matosinhos, Porto.

In 2007, Joana joined the School of Economics and Management, of the University of Porto

(FEP), later completing a Degree in Business Administration in 2010 and re-enrolling in Master in Finance degree in mid-2012.

Joana has been working in Rangel Group since 2010, a multinational freight forwarding company, starting from an internship program, Joana changed to a role within accounts receivable collections team and moved later on to the international affairs department, as financial and administrative support.

i Acknowledgements This dissertation is the culmination of an important stage of my life and there are many people that I am grateful for being by my side.

First of all, I have to thank God and my closest family. My mother – the most loyal friend I would ever had, for being always by my side and all patience she had; my sister for being the best person I ever met; and my father – in posthumous tribute, that even absence his presence was constant through the love and example he left us. They are my pillars of strength and without their support nothing of this would be possible.

I would like to express my deepest appreciation to my supervisor Prof. Dr. Paulo Jorge Pereira for all guidance and tutorship which contributed significantly to this dissertation, as well as Prof. Dra. Natércia Fortuna and all professors of MSc Finance for their dedication and availability to their students.

For all my friends, with a special thanks to Artur Dias and Tiago Loureiro for their friendship, concern and support; Dra. Irene Moreira Barros and her magnificent team for being always by my side during this last ten years. Without all of you this would have been harder.

My co-workers, for everything that they taught me; and to Dr. Helder Correia and Dr. Vitor Cardoso for all advices, guidance and example they both gave me during this last five years.

Finally, I would like to express my gratitude to Prof. Dr. Manuel Oliveira Marques that since my very first lesson of Estudo de Empresas in 2007 captivated me and all his students and passed his passion for corporate finance.

ii Abstract The subprime crises in USA led to a general debt crisis in the European countries. This enabled some countries to refinance their government debt and so an intervention from European Financial Stabilization Mechanism (EFSM), European Central Bank (ECB) and International Monetary Fund (IMF) was needed.

In this dissertation we are focused in analyze how the European Debt crisis and Troika’s intervention affected the capital structure of those assisted countries – Ireland, Greece and Portugal.

This study is based on accounting information of 31.775 companies existing in Amadeus database of Bureau Van Dijk for the period between 2005 and 2013.

The results showed that European Debt Crisis and Troika’s intervention had impact on companies, however it was not uniformed in those three countries.

Key words: European Debt Crisis; Troika; Capital Structure; Trade Credit; Trade-off Theory; Pecking Order Theory JEL-Codes: B26; C10; C12; G30; G32

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Biographical note




1. Introduction

2. Literature Review

2.1. European Debt Crisis

2.2. Capital Structure Theories

2.3. Impact on companies capital structure during crisis

3. Data and Methodology

3.1. Data collection

3.2. Hypothesis

4. Results analysis

4.1. Statistical analysis

4.1.1. Total assets analysis

4.1.2. Capital Structure analysis

4.1.3. Long term debt

4.1.4. Short term debt

4.1.5. Trade credit

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4.2.1. Model

4.2.2. Results

5. Conclusions, limitations and suggestions for future researches

6. References

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Figure 2 Final consumption expenditure of general government

Figure 3 Sum of Total Assets (thousand euro)

Table 1 Descriptive statistics of the sample

Table 2 Average asset evolution by country and companies’ dimension

Table 3 Evolution of debt on companies’ capital structure by country

Table 4 Weight of Debt in capital structure by period, country and companies’ dimension16 Table 5 Evolution of Long term debt/total assets by country

Table 6 Long Term Debt by Total Assets by period, country and companies’ dimension.. 18 Table 7 Evolution of Short term debt/total assets by country

Table 8 Short Term Debt by Total Assets by period, country and companies’ dimension.. 20 Table 9 Evolution of Trade Credit/total assets by country

Table 10 Trade Credit by Total Assets by period, country and companies’ dimension....... 22 Table 11 Effect of financial crisis on leverage ratios – Ireland

Table 12 Effect of financial crisis on leverage ratios – Greece

Table 13 Effect of financial crisis on leverage ratios – Portugal

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During this period, companies faced several restrictions on access to credit (Campello et al.,

2010) which affected companies and financial markets. Some European countries that were unable to refinance their sovereign debt required the assistance of the European Financial Stabilization Mechanism (EFSM), the European Central Bank (ECB) and International Monetary Fund (IMF)1.

The aim of this study is to understand how this financial crisis and Troika’s assistance affected companies in Ireland, Greece and Portugal, specifically how their’ financing decisions were impacted and how they adjusted their capital structure. In addition, it is attempted to assess the reaction of these companies in light of their country and size.

This financial crisis had a worldwide impact, and several researches were undertaken in order to understand its causes and its consequences, however researchers that studied its impact on companies’ financing decisions are limited (Akbar et al., 2013). This serves as the main motivation to develop this dissertation.

The results show that the financial crisis and Troika’s intervention had a significant impact on the companies’ capital structure, noting that such impact was not homogenous, depending on the country and companies’ size.

This dissertation is divided in four main parts. Firstly, it is presented a literature review about financial crisis and capital structure main theories, accompanied by a reference of similar studies. The second part focuses the data and methodology used in the study. It is followed by the applied statistical and econometric analysis, to be latter concluded with the main results and limitations of the study.

Hereafter the set of these three entities will be designated as the commonly attributed name of Troika.

2. Literature Review

2.1. European Debt Crisis The European debt crisis is a multi-year debt crisis that affected several states. Some of those states were unable to refinance their government debt or to rescue over-indebted banks under their national supervision without the assistance of EFSF, ECB or IMF (Bruyckere et al., 2013) According Figures 1 and 2 impacts of crises could be perceived by the behavior of the Gross Domestic Product (GDP) growth rate or government behavior.

In average, the real GDP growth rate between 2003 and 2007 for EU was 2,5% (4,7% for Ireland, 4,4% for Greece and 1,2% for Portugal). After 2008, this situation worsens and in 2009, according Eurostat, the EU had a real GDP growth rate of -4,4%, -6,4 for Ireland, for Greece and -3% for Portugal.






–  –  –

Own preparation; Source: Eurostat (2015b) According to Figure 2, the expenditure of governments had consistently increased until

2009. In addition to the negative GDP growth rate, this led to an increase of the public deficit.


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The effects of the crisis, allied with the fact that Ireland, Greece and Portugal had already a highly external debt, led these countries ask for foreign support between 2010 and 2012.

2.2. Capital Structure Theories Capital structure is the combination of equity and debt a company uses to finance its assets and it is one of the most studied and controversial topics in finance. The basis of this topic is the traditional approach, where it is defended the existence of an optimal capital structure. This topic gained significant relevance with Modigliani and Miller (1958), noting however that some strong assumptions considered in their research were later discarded allowing the rise of new theories, such as the trade-off theory and the pecking order theory.

Own preparation; Source: Eurostat (2015a) Durand (1952) was the first known author that used in a more strict and analytic way the capital structure topic, creating two new significant approaches within the field: the Net Income approach (NI) and Net Operating Income approach (NOI).

The NOI approach defends that the firm’s value is not dependent on capital structure, or in other words, the value of the company is the same regardless of the proportion of bonds and stock. It assumes that cost of debt is constant and when a company increases its financial leverage it will increase its risk and shareholders will expect a higher return. This leads to an increase of cost of equity. Through this point of view, one can say that the value of a company depends on its operating income and business risk, but not from the proportion of debt and equity (Durand, 1952).

In contrast, the NI approach argues that companies’ value increase with the proportion of debt in capital structure (Durand, 1952). In this method, it is assumed that cost of debt is lower than cost of equity. Thus, increasing the proportion of debt will decrease the overall cost of capital and resulting in an increase of the value of the company.

The traditional approach is somewhere between the previous two methods. It defends the existence of an optimal combination between equity and debt that minimize the capital cost and maximizes the value of the company. This optimal structure is specific to each company.

The article published by Modigliani and Miller (1958) “The cost of capital, corporation finance and the theory of investment” is a reference in capital structure studies and it is considered as a cornerstone article within the field.

According Modigliani and Miller (1958), and assuming that markets are efficient, capital structure is irrelevant for firm’s value and cost of capital. The market value of a leverage firms is similar to the equivalent cost of capital of a non-leveraged firm added of a financial premium.

The method, however, is consider valid only through the use of strong assumptions, such as unlimited leverage, no frictions (no taxes, no agency costs, no transaction costs and no bankruptcy cost), and investors have homogenous expectations and information.

Such assumption is referred to as the capital structure irrelevance principle, which means that managers are not able to create or destroy value with its financing decisions since the cost of capital is similar to any leverage level (Modigliani & Miller, 1958).

Later on, Modigliani and Miller (1963) published a correction to the previous paper where they relaxed the assumption of no taxes. The authors introduced the tax benefit due to the payment of debt interest, which reduces the cost of capital and so increases firm value.

With this reformulation, the capital structure became relevant for firm’s value, reaching its maximum when the firm is only financed by debt.

Although its theoretical conclusions, it is considered in practice to be an extreme position that would raise some problems, such as bankruptcy costs (Altman, 1984), increasing of the cost of capital and reduction of the total value of the firm (Baxter, 1967).

In contrast to Modigliani and Miller (1958) that assumes a complete and perfect capital market, the trade-off theory accepts the fact that markets have some imperfections, such as taxes (Kraus & Litzenberger, 1973), bankruptcy costs (Baxter, 1967; Altman, 1984) and agency costs (Jensen & Meckling, 1976; Jensen, 1986).

The trade-off theory has for basis to choose the amount of equity and debt for a company taking into account its costs and benefits (Myers, 1984). In other words, the increase of debt may result in tax savings, but it also may cause increase of bankruptcy costs and agency costs.

Although, Miller (1977) maintains the opinion that even with a capital market with taxes the capital structure remains irrelevant due to investors personal tax that would compensate the firms tax benefit.

According Kraus and Litzenberger (1973) it is the choice of firm’s financing mix that determines its debt obligations and, by consequence, its taxes savings. On the other hand, it is also the amount of debt of a firm that determines the states in which the firm will incur in bankruptcy penalties. The bankruptcy costs will affect negatively the net operating earnings and will cause some embarrassments with firm’s stakeholders, along with affecting the integrity of the firm (Baxter, 1967). The company will ultimately incur in a cost of capital increase. Thus, when bankruptcy costs exceed the tax benefits, the firm had reached its optimal capital structure (Altman, 1984).

Concerning agency costs Jensen and Meckling (1976) and Jensen (1986) defend that the optimal capital structure also depends on agency costs. The argument is that the issue of debt limits managers’ behavior in order to guarantee futures obligations, decreasing the agency costs. Thus, the optimal capital structure will be the one that maximize firm’s value and as the point where the marginal costs of debt will reimburse its marginal benefits.

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