Financing Structure and Corporate Strategy

The revealed gap in detecting the causal direction between corporate strategy and financing strategy (section 2.4) formed the basis for the investigation of an interlinkage between these two. Table 5.8 assembles the feedback from interview participants.

Table 5.8: Financing Strategy and Corporate Strategy (Q 2.4)

Element of the corporate strategy Partly interlinked with corporate strategy Determines corporate strategy No connection Rank 1 3 n.a. 2

No. of responses (max. 14) 10 1 3

Manager types

Top level (max. 7) 6 - - 1

Middle level (max. 7) 4 1 - 2

Owner-manager (max. 5) 4 - - 1

External manager (max. 9) 6 1 - 2

Shareholder generation - 1 (max. 6) 3 - - 3 2 (max. 4) 3 1 - - 3 (max. 2) 2 - - - 4 (max. 2) 2 - - - Family trees 1 (max. 4) 2 - - 2 2 (max. 2) 2 - - - 3 (max. 6) 4 1 - 1 >3 (max. 2) 2 - - - Literal/theoretical replication

Literal cases (max. 10) 9 1 - -

Theoretical cases (max. 4) 1 - - 3

Ten out of the 14 interview participants stated that the financing strategy is an element of their business strategy:

Participant 1 (owner-manager, top level, literal replication): “Financing strategy follows the overall company strategy (e.g. the new syndicated loan agreement includes a dedicated basket for further joint venture financing within a specific product sector).”

This particular link between strategy and the selected financing instrument will be further investigated to see whether contractual elements adopt the strategic elements, such as financial covenants (section 5.3.5) or certain limitations in the debt contract design (section 5.3.6).

The view on the interlinkage between the strategies and the causal direction is not specific for owner-managers or top level managers, but also shared by external managers and by middle managers:

Participant 6 (external manager, middle level, literal replication): “[The financing strategy] derives from the overall company strategy.”

However, only one out of four participants from theoretical replication cases shared this view on the linkage between business strategy and financing strategy:

Participant 7 (owner-manager, top level, theoretical replication): “Financing strategy follows the overall vision of the company to maintain its position as a family-owned business with a solid financing structure.”

This finding is consistent with the results on the form of the financing strategy (section 5.2.2), where most of the managers from theoretical replication cases located the financing strategy in the ‘lived experience’ category.

Even though that three participants did not share the view of a connection between these strategic elements, none of the interviewees indicated that the financing strategy would influence or determine the overall business strategy.

5.2.5 Summary

The results from the cases allowed the identification of the existence of a financing strategy, as proposed by the first research proposition (RP1). Table 5.9 provides an overview of the findings from section 5.2.

It became obvious that the term ‘financing strategy’ does not describe a clear set of elements that it should include. This observation substantiates the assumption of Barton & Gordon (1987, 1988), that capital structure decisions do not solely follow a shareholder value maximisation principle, but include a broader perspective that is based on “the values and goals of the management, in combination with external and internal contextual factors which impact the basic concerns of risk and control” (Barton & Gordon, 1988, p. 623). Even though the existence of a financing strategy as well as elements of such strategy have been identified in the cases explored, a heterogeneous set of frameworks was investigated in section 5.2.1.3 that varies by case. The varying degree of formality and involved elements in the financing strategy of the cases can be linked to different manager types and shareholder set-ups, as presented in section 5.2.2.

The following of a pecking order approach could not be falsified in section 5.2.3 (RP2). The cases investigated revealed that retained earnings were the favoured funding source in the refinancing, if available. Senior debt played the second important role in various forms (e.g. syndicated loans, Schuldschein, bilateral loans). Managers followed a financing hierarchy as proposed by Börner et al. (2010) and Koropp et al. (2014). Based on the described preference for the different funding sources, the financing hierarchy follows the same ranking as indicated by the pecking order theory and Barton & Gordon’s (1987, 1988) third proposition.

Besides the support for a pecking order approach of the cases examined, aspects were explored that could be explained by other capital structure theories. Even though six out of the seven cases achieved a refinancing via debt instruments, not all aspects are attributable to a pecking order. Case 4 received temporary debt and mezzanine financing. Banks requested an equity injection by the shareholders and forced the company to think about solutions that could include a minority equity provider. Based on its deteriorating profitability, this case was not able to refinance via retained earnings or external debt. The reduced profitability caused a tax-reducing financing

instrument like a loan being less important. Banks were not willing to offer additional debt facilities because of the increased operational risk that leads to higher cost of insolvency, resulting in higher interest rates or in refusing the request. Therefore, in this case, an optimal capital structure could be anticipated and the current financing did not represent the optimal capital structure for Case 4. This could be explained by tradeoff theory.

The mixed investigation regarding the potential explanation by various capital structure theories is supporting the results by Brüse (2011) and Nohtse (2012) with regard to standard mezzanine refinancing as well as by Ampenberger et al. (2013) with regard to financing decisions in German family firms.

Furthermore, the identified dividend limitations in the financing contracts could be based upon asymmetric information. Management uses the financing to discipline the shareholders. Even though research primarily sees external debt to act as disciplining element for company management (Malmendier & Tate, 2005), the observation relates to a principal-agent-problem between shareholders and management. Consequently, it was observed in cases with external management (Case 2, Case 3 and Case 7), or with one external manager and a complex shareholder structure (Case 1).

Asymmetric information between banks and management could be anticipated in cases, where the management did not perform a request for proposal. Case 6 and Case 7 – both being smaller cases in terms of sales and by number of employees – primarily discussed the refinancing with their core bank. This would follow the analysis of Lichtblau & Utzig (2002), that for smaller firms a relationship lending could be a rational decision to mitigate information asymmetries with financing partners.

Finally, the participant feedback on the research proposition RP3a could not disprove the existence of an interlinkage between corporate strategy and financing strategy. The participants that acknowledged the interlinkage between the two strategies consistently stated that the overall business strategy influences the financing strategy. This result supports Barton & Gordon’s (1987) first two propositions of strategic capital structure theory and adds to the research of Ginn et al. (1995).

Feedback allowed to explore a causal direction in the investigated cases. However, the results so far do not allow to investigate whether there are differences based upon

education and former job experience as proposed by Bertrand & Schoar (2003) and by Malmendier et al. (2011).

Table 5.9: Findings on Research Propositions from Section 5.2

Research proposition Aspect Finding

RP1: A formulated financing strategy exists and has been applied to in the refinancing process.

Confirmation of existing research

Existence of a financing strategy that is based on the goals and the strategy for the firm (Barton & Gordon, 1987).

Financing strategy represents not a clear set of elements, but varies from case by case, based on different manager types and shareholder set-ups (Meier & Esmatyar, 2015).

Owner-managers and firms that involve a little number of family trees or shareholders show a less formulated or integrated financing strategy and are less strict in following this strategy (Speckbacher & Posch, 2010). Contradictory

findings

None

New/additional findings

Elements of the financing strategy might not primarily been driven by a differentiation between owner- managers and external managers, but relating to a more complex strategic approach

Limitations None

RP2: A targeted optimal financing structure exists and refinancing of the standard mezzanine has been based on a pecking order approach.

Confirmation of existing research

Financing decision was based on a pecking order approach (Barton & Gordon, 1987; Börner et al., 2010; Brüse, 2011; Koropp et al., 2014; Nohtse, 2012). Further elements would support tradeoff theory or findings on asymmetric information/agency theory (Ampenberger et al., 2013; Brüse, 2011), but could not be proved in the cross-case analysis.

Contradictory findings None New/additional findings None Limitations None

RP3a: The corporate strategy and the characteristics of the management team influence the determination of the refinancing instrument.

Confirmation of existing research

Existence of an interlinkage between corporate strategy and financing strategy (Barton & Gordon, 1987; Ginn et al., 1995). Contradictory findings None New/additional findings

Causal direction between business strategy and financing strategy (Ginn et al., 1995): Overall corporate strategy influences the financing strategy. Limitations Not observable, if differences based upon education or

former job experience (Bertrand & Schoar, 2003; Malmendier & Tate, 2005).

5.3Refinancing Process

Following the discussion on the overall existence of a financing strategy and hierarchy, the subsequent section will investigate the process executed and the decisions taken in the refinancing of the standard mezzanine instrument. Several categories have been identified through the coding process and are forming the main topics for this section.