The determinants of capital structure Evidence on UK property companies
| Published date | 01 December 1999 |
| Date | 01 December 1999 |
| Pages | 464-480 |
| DOI | https://doi.org/10.1108/14635789910294886 |
| Author | Joseph Ooi |
| Subject Matter | Property management & built environment |
JPIF
17,5
464
Journal of Property Investment &
Finance, Vol. 17 No. 5, 1999,
pp. 464-480. #MCB University
Press, 1463-578X
Received October 1998
Revised July 1999
ACADEMIC PAPERS
The determinants of capital
structure
Evidence on UK property companies
Joseph Ooi
School of Building and Real Estate, National University of Singapore,
Singapore
Keywords Capital, Property companies, United Kingdom
Abstract Employing the panel data methodology, we examine the capital structure
determinants of 83 property companies quoted in the UK. The empirical test reveals how the
debt-equity structure of the companies is influenced by the various firm-specific attributes and
macro-economic factors. In particular, the evidence shows that asset structure, business
orientation, and the level of involvement in property development are significant determinants of
the corporate debt policy of property companies. Financial distress consideration also has a
significant influence. In addition, the empirical evidence shows that corporate property managers
take into consideration the prevailing market sentiment and borrowing costs when making the
debt-equity choice. Corporate performance and tax burden, however, do not appear to have any
significant effect on the capital structure decision of property companies.
1 Introduction
The literature on corporate finance has seen some significant progress since the
seminal works of Modigliani and Miller (1958; 1963). Theoretical advancement,
particularly development of capital structure models based on tax balancing
and asymmetric information, and more recently, on product-market and
corporate control considerations, have managed to shed some light on the
financing behaviour of corporations. The validity of the modern theory of
finance has been tested by many researchers. Numerous studies have also
investigated the capital structure of firms in various sectors of the economy,
such as manufacturing firms (Long and Malitz, 1985; Titman and Wessels,
1988), electric-utility companies (Miller and Modigliani, 1966), non-profit
hospitals (Wedig et al., 1988) and agricultural firms (Jensen and Langemeier,
1996). One of the main conclusions of empirical studies is that industrial
classification is an important determinant of capital structure.
The capital structure of property companies is, however, still a relatively
under-explored area in the property literature. Currently, we do not have a clear
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This paper constitutes one of the chapters in the author's doctoral thesis with the Manchester
School of Management, UMIST. The author would like to acknowledge the guidance of his
supervisor, Dr Mike Bowe, and the helpful comments of Professor Gerald Brown and Dr K.H.
Liow. An earlier version of this paper was presented at the 2nd Pacific Asia PropertyConference
(Singapore, March 1997) organized by the School of Building & Estate Management of the
National University of Singapore and the Royal Institution of Chartered Surveyors (RICS), UK.
Academic papers:
Determinants of
capital structure
465
understanding on how the companies choose their capital structure and what
factors influence their corporate financing behaviour. Given the unique
product-market environment property companies operate within[1], there are
strong grounds justifying a separate study on the capital structure
determinants of property companies. Event studies by Howe and Shilling
(1988) and Allen and Rutherford (1992) have also shown that stock prices of
real estate organisations in the USA do not react to debt issues in the same
manner as share prices of other corporations. Contrary to the theoretical
predictions of corporate finance literature, the two studies observe that
companies engaged in the property business are perceived by the market as
benefitting from additional leverage.
Gau and Wang (1990) were amongst the first to apply the theory of capital
structure directly to real estate investment decisions at the project level. Their
optimization model illustrates how certain characteristics of the property may
affect the investor's choice of loan-to-value ratio. Based on a sample of 1,423
apartment and commercial property transactions in Vancouver between 1971
and 1985, Gau and Wang observe that the level of debt employed in a property
acquisition is directly related to the cost of the investment and inversely to the
size of its depreciation tax shield, expected costs of financial distress and
market interest rates. The applicability of Wang and Gau's results to the
financial context of property companies at the corporate level has not been
tested. There are, nevertheless, two existing studies in the USA that have
examined the capital structure of property organizations in a non-tax
environment. Maris and Elayan (1990) and Allen (1995) study the financial
structure of tax-exempt real estate investment trusts (REITs) and real estate
limited partnerships (RELPs) respectively. Both studies yield results which
indicate that the nature of the assets owned by an organization has a
significant impact on its capital structure.
In a recent study, Barkham (1997) examines the financial structure and ethos
of property companies in the UK. The main conclusion of the study is that the
classification of property companies as property investment companies (PICs)
and property trading companies (PTCs) is valid. PTCs buy and develop
property assets with a view to selling them on in the short term, while PICs
engage in the acquisition and development of property assets to augment their
portfolio which is held for long term. Barkham notes that the PTCs are more
focused on profits whereas the PICs are more concerned with delivering returns
to their shareholders via share price movements. He also observes that the
PTCs operate against the constant danger of insolvency and indeed when the
market turns they become unable to meet interest payments almost
immediately. Due to their different ethos, the capital structures of property
companies in the two categories are not the same. In particular, Barkham
observes that during the study period (between 1987 and 1991) the PTCs are on
average more highly-geared than PICs. This observation, however, contradicts
the prediction of the conventional trade-off models of capital structure that
risky firms should employ less debt in their capital structure.
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