For the purposes of our study, the key independent variables are long-term debt in equations (1) and (2), where sales growth and ROA are the dependent variables; and sales growth and ROA in equation (3) where long-term debt is the dependent variable. First, we discuss the situation in which sales growth and ROA are the dependent variables. The results are reported in the first two columns of Table 5.
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The ordinary least squares (OLS) regression results show that when sales growth is the dependent variable, the long-term debt variable is significant at the one percent level and has a positive sign. Consistent with our first hypothesis, this outcome indicates that as New Zealand firms use more long-term debt, their sales growth increases relative to the sales growth of firms in the same industry. If we interpret relative-to-industry sales growth as a reflection of more aggressive product-pricing behaviour by firms, then the result indicates that New Zealand firms use debt to compete more aggressively, which is consistent with the arguments of Brander and Lewis (1986) and with the finding in Campello (2006) that debt-taking is initially associated with sales gains at
the expense of rivals. Moreover if firms are growing faster than their rivals, it must also follow that they are growing their overall share of their industry market.
The OLS regression results show that when ROA is the dependent variable, the long-term debt variable is significant at the one percent level and has a negative sign. This outcome is consistent with our second hypothesis that an increase in the amount of long-term debt used by firms leads to a decline in relative-to-industry ROA. If a decline in relative-to-industry ROAs reflects more aggressive product-pricing behaviour by firms, then the result indicates that New Zealand firms use debt to compete more aggressively. This result is consistent with our finding that higher leverage results in greater relative-to-industry sales growth. It is also consistent with Brander and Lewis’s theory, and with some of the empirical tests in Campello (2007) which show a negative relationship between leverage and ROA.
To confirm whether firms do indeed use debt to compete more aggressively, we rank firms each year into terciles based on the firms’ change in long-term debt from year t-1 to year t. The first tercile contains firms with the lowest leverage growth in a particular year, the second tercile contains firms with average growth, and the third tercile contains firms with the highest growth. For each tercile in each year we then examine the corresponding change in firms’ sales from year t-1 to year t and from year t to year t+1. We wish to determine whether any trends detected across terciles are consistent with the relationship between leverage and sales growth revealed in our previous analysis.
We also examine the corresponding change in firms’ ROA from year t-1 to year t and from year t to year t+1 to ascertain whether any trends are consistent with the relationship found between leverage and ROA. Finally we test whether decreases in ROA are the result of firms aggressively increasing sales, by ranking firms into terciles based on the firms’ change in sales from year t-1 to year t and then examining the corresponding change in firms’ ROA from year t-1 to year t and from year t to year t+1.
The results of the tests are reported in Table 6. We present average results for the whole sample period, and omit results for individual years (these are available from the authors on request). Panel A contains the results for the relationships between change in long-term debt and changes in sales and ROA. As firms’ leverage increases over the three terciles, sales from year t-1 to year t and from year t to year t+1 follow a U-shaped curve, that is they decline and then increase. Sales increase overall from the first to third terciles, consistent with our previous findings on the relationship between leverage and sales growth.
As firms’ leverage increases over the three terciles, ROA from year t-1 to year t also follows a U- shaped curve. ROA decreases overall from the first to third terciles, which is again consistent with our previous findings on the relationship between leverage and ROA. ROA from year t to year t+1 increases slightly from the first to third terciles, which is not consistent with our previous analysis.
Panel B contains the results for the relationships between change in sales and change in ROA. As firms’ sales increase over the three terciles, ROA from year t-1 to year t again follows a U-shaped
curve. ROA decreases overall from the first to third terciles, consistent with our previous findings on the relationship between sales and ROA.
Overall, the results in Panels A and B provide some evidence to confirm the direction of the relationships revealed in our original analysis. However further tests are required to explain the U-shaped curves for the sales and ROA variables.
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