© 2000 John Petroff
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© 2000 John Petroff |
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3)- Leveraged industry types
The sector that has the largest debt to equity ratio is by far the banking and financial sector because the core of its business is to receive deposits (i.e. loans) from small depositors. On average, the majority of nonfinancial firms use from two thirds debt to one third equity. Debt is further divided between two thirds short term and one third long term. The aggregate average normalized balance sheet of 80,000 non-financial and non-agricultural firms was shown in Table T-10.3 broken down into eight sectors.
The major determinant of the use of debt and financial leverage is the need to carry fixed assets. The need for short term debt is determined by the type of working capital the firm should carry for marketing purposes. One will note in Table T-10.3 that wholesale, construction and retail carry the largest proportion of short term debt because they have large inventory and/or receivables. Conversely, utilities and transportation have little or no inventory and receivables, which justifies their small proportion of short term debt. Since fixed assets should never be financed by short term debt, the financial leverage decision is essentially pertaining to the size of long term debt to use. Table T-10.3 reveals a clear parallel between percent of fixed (FA) and assets and the percent of long term debt (LTD) in total assets. Using RMA data, an OLS regression on equation FA = a + b LTD gives an R2 of 0.81 and a t statistic for b coefficient of 5.
The industries that use debt the most and equity the least are in the information and service sectors with average of 26% and 30% respectively for the equity to total assets ratio in 1999, as shown in Table T-11.15 - Proportion of equity by company size in eight US sectors in 1999. These averages are, however, distorted by the large proportion of small firms in difficulty in these sectors. If firms with sales of less than one million dollars are excluded the averages for these sectors jump to 29% and 35%. After excluding small firms from all sectors, the sector that has the least equity is the information sector with an average of 29%. Further investigation of the information sector reveals that several industries (such as periodicals, publishing and communication services) have large firms with negative net worth (i.e. not just small firms). In some industries such as cable and pay television, firms have equity to total asset ratio of 21% or less, long term debt to total assets of 41% or more, which is all the more disturbing because fixed asset are large (averaging 49% for fixed assets, plus intangibles of 20% and other of 6%, totaling 75%), with the consequence that many are technically insolvent (i.e. negative net worth and negative net working capital).
One would suspect that the turmoil in the information sector is brought on by the increasing role of the internet. Three industries related to the internet are reported: software, computer services and information retrieval. The median proportions of equity in total assets is 27.9%, 35.9% and 30.5% for the three industries, respectively. This is surprising. As justified by the corporate life cycle theory, firms in the peak of expansion should rely almost entirely on equity for their expansion. But, this sector uses less equity than mature industries such as manufacturing (38%) and wholesale trade (35%). The proportion of equity rises sharply for the very large firms (with sales over 25 millions) to 45% or over. Comparing with the previous five year (reported in RMA Annual Statement Studies) shows that equity financing has decreased significantly (form 42.9% to 27.9% for software packages, 41.6% to 35.9% for computer services, and 45% to 30.5% for information retrieval), and that there are about 10% to 30% more firms in each industry. This suggests that the competition is fierce and many firms have serious difficulties. In 1999, one can predict that concentration and restructuring are imminent.
See review question Q-11F3.1.
See research assignment R-11F3.1.
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