MINDANAO STATE UNIVERSITY AT NAAWAN

College of Business Administration and Accountancy

9023 Naawan, Misamis Oriental
Department of Accountancy and Business Management

EXAMINING THE EFFECTS OF DEBT

MANAGEMENT ON THE
PERFORMANCE OF SELECTED
COMPANIES IN GINGOOG CITY

Submitted in partial fulfillment of the

requirements in Research Proposal

Lavishly Thea Delos Santos

Lady Mivie Dayanan Nericua
Anna Mae Fabricante Pamisa
Chantelle Quilog
Kim Juabe B. Viña
Bachelor of Science in Accountancy
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2020
TABLE OF CONTENTS
PAGE
1.0 Chapter 1 Introduction 3
1.1 Background of the Study 3-4
1.1.1 Debt Management 4
1.1.2 Business Performance 4-5
1.2 Statement of the Problem 5-7
1.3 Research Objectives 7
1.3.1 General Objective 7
1.3.2 Specific Objective 8
1.4 Theoretical Framework 8
1.4.1 Trade-Off Theory 8-9
1.4.2 Pecking Order Theory 9-10
1.5 Conceptual Framework 10
1.6 Assumptions of the Study 11
1.7 Statement of Hypothesis 11
1.8 Significance of the Study 11
1.9 Scope and Delimitation 12
1.10 Definition of Terms 12
2.0 Chapter 2 Review of Related Literature 13
2.1 Debt 13
2.1.1 Debt Management 13-14
2.2 Business Performance 14
2.3 Relationship between Debt Management
and Business Performance 14-16
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2.4 Other Related Studies 16-18

3.0 Chapter 3 Methodology 19
3.1 Research Design 19
3.2 Subjects of the Study 19
3.3 Sampling Technique 19
3.4 Procedure of Data Gathering 20
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CHAPTER 1

RESEARCH PROBLEM

1.1 Background of the Study

Debt is the amount of taxes incurred during a tax period which are payable to some

type of governmental jurisdiction. Aspen Law and Business in the year 2004, defines debt as

an amount owed to a person or organization for funds borrowed. For the purposes of this

study, debt is defined as any amount due to any authority for which payment has not been

affected. Debt takes many forms and can be represented by a bond, loan note, mortgage as

well as other repayment terms and, when necessary, interest requirements. These different

forms are indications of the intent to pay back the amount owed at an agreed date as is set

forth in the repayment terms (Tantum, 2003). It also includes both short-term and long-term

loans. Debt management is the regulation of the amount and structure of the public debts. In

other terms, it is the process of managing debts (Ferlex 2012).

A company's financial success is influenced by a variety of things. These include the

company's commercial position, development patterns, social context, and policies, among

other things. Internal elements that impact financial performance are generally referred to as

(1) capital structure, (2) working capital, (3) and governance quality. According to Fraser et

al. (2007), a company's capital structure is its long-term financing, which includes long-term

debt, preferred stock, common stock, and retained earnings. An enterprise's finance sources

are separated into two categories: liabilities and equity. According to the aforementioned

capital structure theory, while deciding on capital structure, a corporation frequently analyzes

the following factors: sales stability, asset structure, operational leverage, growth rate,

profitability, and taxes (Parrino et al. 2011).

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A variety of internal and external factors impact corporation financial success. As a

result, the importance of financing and investment alternatives in affecting financial

performance of entities is obvious in dealing with the requirement for financing methods to

promote development and achievement of a firm's goals (Salazar, Soto and Mosqueda, 2012).

According to Memba and Nyanumba in the year 2013, finance decisions lead to specific

resource composition, but non-optimized investing decisions frequently result in business

failure.

1.1.1 Debt Management

Debt management is an act of trying to get one’s debt under control and become

responsible for repaying associated obligations. It can therefore be inferred that debt

management is a conscious measure taken by a debtor or agents hired on their behalf to

reduce the debt burden or strategize to eliminate the debt through acceptable payment terms

(Root, 2019).

Debt management also comprises monitoring and controlling risk exposure as a result

of financial responsibilities accumulated. Debt management, according to Rajan and Zingales

year 2012, is an agreed-upon strategy between a debtor and a creditor that addresses the terms

of an outstanding debt. Proper debt management comprises techniques used to ensure

effective and efficient debt repayments, which may involve restructuring of the loan given.

The breadth of institutional and technological procedures in molding a country's liabilities

such that the debt service burden is kept within a manageable level is referred to as efficient

debt management (Islam & Nishiyama, 2016).

1.1.2 Business Performance

Economic returns and the achievement of a firm's long-term goals are of critical

importance to any corporate management or owner (Parker, 2000). Financial performance is a

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measure or assessment of a company's effective use of assets and resources derived from its

primary operations in order to generate revenue (Mesquita and Lars, 2003) According to

Syafri in the year 2012, financial performance refers to the entity's economic returns during a

certain trading time. Evaluating the financial performance of the business in terms of return

on equity (ROE) and return on assets is a critical way of scrutinizing monetary execution of

organizations (ROA). ROE is a ratio that refers to the amount of income a corporate business

earned in relation to the total quantity of investor stock in the venture and is calculated based

on economic announcements. This ratio measures the amount of revenue generated by the

owners in relation to the amount of equity invested in the company's activities (Fredric,

2014).

The return on assets (ROA), which is the internationally accepted measure of return

by investors in a corporate institution, is used to proxy financial performance in this study

(Rajan and Zingales, 2012). The return on assets evaluates the revenue generated by the

overall organizational assets. ROE is commonly used as an aggregate productivity metric,

and investors favor higher values that suggest more financial advantages to owners. ROA is a

critical relative measurement of a company's income and revenues. It is a profit percentage to

total resources (Khrawish, 2011). ROA establishes the capacity of a firm's administration to

create revenue by exploiting the business assets within their operations.

1.2 Statement of the Problem

Debt management is any strategy for assisting an individual or corporation in

managing its debt. Debt settlement, bankruptcy, debt consolidation, personal loans and other

measures that help firms service outstanding obligations are included in this description

(Wallitsch, 2007). In regards to that, if these organizations want to thrive, managing their

debts has become a requirement. This means that the management of such businesses must
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understand the implications of using debt to fund their operations. Debt management is

becoming increasingly important (Akorsu and Agyapong, 2012).

More and more firms refrain from investments using debt because of the decreased

growth of the macro economy. It is said that at the same time, this situation becomes a factor

of the stagnation of the macro economy. Among practitioners and researchers of accounting

and finance, it was a common recognition that debt harmed the stability of firms and that

equity should be strengthened. But on the other hand, microeconomic research shed light on

the fact that high growth firms had rather strong equity because of their high profitability. If

high growth is not against the lower use of debt, growth and stability are consistent. In this

paper, we want to find the relationships between the use of debt and a firmsʼ growth and

stability in the long run.

In firm’ management decision making, capital structure is key in ensuring maximum

financing mix to achieve the maximum market value of the firm (Borgia &Yan, 2013).

however, one area of concern in the corporate finance management arena for a nearly half-

century is capital structure. Management are concern about optimal debt ratio to be included

in firm’ capital structure (Borgia &Yan, 2013) and the management final decision on

financing mix give rise to different forms of agency costs. Forms of agency costs / agency

relationship caused by firm financing mix include relationships between shareholders and

managers, relationship between debt holders and manager as well as relationship between

debt holders and shareholders (Jensen & Meckling, 1976). Accordingly, the capital structure

of a firm determines the firm’ debt ratio, asset tangibility and asset turnover (Jensen &

Meckling, 1976). Hence the main objective of this study is to examine whether debt ratio and

the financial performance of firms are related.

Capital structure expressed how firms’ assets have been finance by debt financing and

equity financing. Finance theories defers on whether using more equity financing than debt
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financing can help firms to maximize firm’ value. Whenever a firm needs additional finance

for financing its assets, Miller-Modigliani (MM) theory is of the view that more debt

financing would help firms’ maximize it value through tax shield benefits and that debts ratio

and performance of firm are positively related (Modigliani and Miller, 1963). It mean debt

ratio determine the performance of firm. The performance of firm in this study is proxied by

return on assets (ROA). However, pecking order theory is of the view that in terms of raising

additional finance to finance firm’ assets , funding by the use of retained earnings is most

preferred while financing through raising the debt level is next and the last option is issuing

of additional equity (Myers & Majluf, 1984; Margaritis & Psillaki, 2007). Both of these

theories (i.e. Miller-Modigliani (MM) theory & pecking order theory) demonstrate the

importance of using debt financing to raise additional capital to fund the firm’s assets and in

both cases it is prefer to issuing of additional equity. It is for this reason that this examined

whether debt ratio is related to firms’ performance and if so, is it a positive or negative

relationship.

The above statements triggered the desire to engage research on debt management so

as to help provide remedies to the above problems. Upon the above statements, the

researchers sought to answer the following questions:

1. How does debt management affect the performance of selected companies in Gingoog

City?

2. How does debt ratio affect the performance of selected companies?

1.3 Research Objectives

The continuing issues of debt management by companies must be researched in order

to elicit insights that may be used to solve the financial challenges that these organizations

experienced.
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1.3.1 General Objective

To examine the effects of debt management on the performance of companies in

Gingoog City.

1.3.2 Specific Objective

To determine the effect of debt ratio on the performance of companies in Gingoog

City.

1.4 Theoretical Framework

1.4.1 Trade-Off Theory

This theory is founded on the principle that an organization chooses between equity

and loans finance by proposing to achieve an equilibrium of the advantages/savings and the

related expenses in both scenarios. This theory is accredited to Kraus and Litzenberger year

1973, who inculcated the high operating costs of insolvency and the tax credits/saving

rewards of debt in influencing the most optimum combination of capital structure (Hackbarth

et al., 2007). The trade-off theory posits that organizations’ fund their activities partially with

debt and partially with equity.

In keeping with the idea, when the amount of loans (external funding) rises, the result

is a decrease in the overall marginal benefits, whereas the marginal price of debt will

increase. Fundamentally, an organization seeking to maximize its share price will centralize
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its effort on trade-off whilst figuring out the balance of equity and debt to adopt in order to

fund their operations (Frank and Goyal, 2005). Trade-off theory further argues that a positive

relationship exists between company age, asset base, growth pace and capital base structure.

It argues that big organizations have lower threats of insolvency given their relatively low

predicted financial disaster expenses, lesser corporation charges, much less risky cash flows,

easier access to the debt market and the need for extra liability to benefit from the tax shields

(Alkhatib, 2012).

Still, in alignment with the trade-off theory of capital structure, optimal debt level

increases the returns to equity since the additional cost of debt is offset with the extra income

generated by employing the additional debt capital (Frank and Goyal, 2009). Additional debt

capital allows firms to take tax advantages in the income statement which reduces the tax

obligations and thus is a reward to the equity holders. It indicated that financial leverage is

favorable whilst the uses to which debt can be employed generate more returns than the

interest cost related to the debt. Since the capital structure of an organization is directly

related to its debt management and hence financial performance, trade theory is observed to

be an influential hypothesis that explains the deviations in financial performance with respect

to its solvency ratio and capital structure (Kim, 2012). Given that the level of accounts

payable and accounts receivable may be influenced by capital consideration, it seems

appropriate to use trade-off theory in measuring the relationship between solvency ratio and

financial performance.

1.4.2 Pecking Order Theory

According to Watson and Wilson year 2002, pecking-order theory or POT

summarizes the way small business holders behave in stabilizing their operations. Initially,

small business entrepreneurs attempt to employ their own money to commence operations

and when this is sunk into the business, arrangements are then established to secure external
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funding to strengthen business activities. A number of scholarly papers explained the extent

to which theories of financing appear to indicate the texture of financial structure of small

businesses. Abor (2005) notes that business establishments of various categories do select

their finance structure, considering such factors as the cost, nature, and availability of

financial alternatives. The source further argues that the ratio between the debt and equity in

small businesses is often based on the experience and skills of the manager. Lawless and

McCann (2012) also corroborates this view, indicating that in most private organizations the

owners’ perception towards risk determines the relationship between the amounts of debt and

equity that are acceptable for strategizing the financial direction of the business.

As stated by the Pecking Order Model, when internal finances are not sufficient,

resulting into seeking external sources of financing, debt is more preferred to equity (Mayer,

2001). The theory therefore has suggested an order in which firms follow in financing their

investment starting with internal funds, debt and finally equity. De Matos (2001) indicated

that the deficit in internal financing can be used to identify the financing gap in internal

finances that may trigger the use of debt. The theory can therefore be employed in this study

to explain how listed firms can determine the composition of their debts and debt structure in

conformance with their respective fiscal policies (Kayo and Limura, 2010).

1.5 Conceptual Framework

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The table shown above is the conceptual framework of the study. It illustrates 2

variables; Independent variable and Dependent variable. Under the Independent variable is

the Debt Management, in which Debt Ratio will be used as a mean of measurement. This

Independent variable will give an effect towards our Dependent variable which is the

Business Performance, which will be measured later on using the ROA Ratio.

1.6 Assumptions of the Study

1. The financial statements items reported in the Securities and Exchange Commission

are not materially misstated.

2. The values reported in the financial statements or annual reports of the companies

capture all the activities made during the calendar year or the fiscal year.

1.7 Statement of Hypothesis

Given the theoretical principles and background of the research, the research

hypotheses are expressed as follows:

Ho: Debt Management has no significant effect on the Business Performance.

Ha: Debt Management has a significant effect on the Business Performance

Ho: Debt Ratio has no significant effect on the Business Performance.

Ha: Debt Ratio has a significant effect on the Business Performance.

1.8 Significance of the Study

The research findings will:

1. Assist companies to improve their skills on debt management.

2. Add to the body of knowledge and complement what other researchers have studied

on the similar topic.

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3. Give justification that debt management and business performance have significant

relationships.

4. The study helped the researcher to better understand debt management settings in

relation to business performance.

5. The research paved the way for another researcher interested in this field to learn from

it and expand upon their research.

1.9 Scope and Delimitation

This study focused on the Effects of Debt Management on the Performance of

Selected Companies in Gingoog City. The respondents of the study were composed of 152

randomly selected companies which comprise 59% of the total population. The study relied

on the financial statements of the companies taken from the Securities and Exchange

Commission.

1.10 Definition of Terms

Debt - defined as any amount due to any authority for which payment has not been

effected.

Debt Management - any approach that is adopted to guide an individual or business

organization to manage its debt

Business Performance - the ability of a firm to make the most of the resources it

manages in its business operations.

Debt Ratio - refers to a financial ratio that measures the extent of a company’s

leverage.

Return on Asset Ratio - refers to a financial ratio that indicates how profitable a

company is in relation to its total assets.

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Company - is a legal entity representing an association of people, whether natural,

legal or a mixture of both, with a specific objective.

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CHAPTER 2

REVIEW OF RELATED LITERATURE

2.1 Debt

A debt is a commitment to pay, deliver goods, or provide services in line with a

written or unwritten agreement. A debtor is someone who owes money, while a debtee,

creditor, or lender is someone who is owed money (Senyonga, 2000). Because interest paid

on debt can be written off as an expense, using debt in an organization's financial structure

can provide financial leverage that can quadruple yields on investment when the produced

returns exceed its cost, making debt the cheapest source of long-term financing (Vox, 2014).

Financial institution loans, peer-to-peer lending, credit cards, home equity loans, and lines of

credit are just a few examples of debt financing (Pandey, 2010).

2.1.1 Debt Management

Debt management is described as a set of strategies that help borrowers better manage

or repay their debts. It comprises working with creditors to restructure debts and assisting

debtors with payment management (Fer lex, 2012). Credit and debt are intrinsically

intertwined, according to CIMA year 2015. The amount of debt you have, as well as how you

manage it and make payments, have an impact on your credit score. You must realize that

your credit history and credit score are not synonymous. As a result, when considering credit

or debt management, it is critical to keep in mind that the two concepts are inextricably

linked and intertwined. (Keown and Petty, 2014) (CIMA, 2015).

According to Nancy, debt management is a difficult task for any financial institution,

and it is becoming increasingly important in a world where economic events and financial

systems are interconnected, as she remarked in 2001. Global financial institutions have
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emphasized debt management as a vital component of long-term profitability. Management

and regulators are now focusing on an organization's ability to detect and manage future risks

as the best indicator of long-term success, rather than current or historical financial data or

performance.

2.2 Business Performance

In corperate reporting financial performance are usually measure by profitability

ratios and profitability ratios includes return on assets (ROA) and returns on owner’s equity

(ROE). According to Muhammad, Rashid, Ammar , Naveed, Syeda and Khalil (2015:124)

“Profitability of the firms is the return for the firms on their investment. Earnings of the firms

are reward of the management’s efforts and return of shareholders for their investments.

Profitability of the firms can be measured through different methods. Return on assets (ROA)

and return on equity (ROE) are used commonly to measure the profitability of the companies.

Return on assets is the return of the organization forusing short term and long term assets to

generate the revenues. Return on equity is the return on the investmentfrom the shareholders

of the organizations.” Pevoius reseacher that found that there is a relationship between debt

ratio and return on assets in Mauer and Triantis (1994), Barclay, Smith and RWatts (1995) as

well as Geske and Robert, (1979).

2.3 Relationship between Debt Management and Business Performance

Based on pecking order theory, debt financing and profitability are negatively related.

Profitable firms make sufficient profit which inturn can be employed as source of internal

financing. Hence the more a firm is profitable, the less debt financing would be needed and

vice-vica (Titman & Wessels, 1988; Hovakimianet al, 2004). On the other hand, trade-off

theory predicted that there can be positive relationship between profitability and debt

financing. According to Hsu and Hsu (2011:6529) “trade-off theory asserts that the fact that

firms usually are financed partly with debt and partly with equity. The marginal benefit of
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further increases in debt declines as debt increases, while the marginal cost increases, so that

a firm that is optimizing its overall value will focus on this trade-off when choosing how

much debt and equity to use for financing.” It means that as debt financing is increasing and

the marginal benefit is increasing, there is positive relationship between profitability and debt

financing. When the marginal benefit from additional increases in debt financing declines as

debt financing increases, there is negative relationship between profitability and debt

financing. Hence trade-off which is the optimum financing mix is where the marginal benefit

equals marginal cost.

Firms using debt grow in two ways. First, they can execute investments easily by

raising funds through debt; second, their corporate value elevates due to the increase in sales

or cash flow through those investments. In empirical research, the former is verified mainly

in the context of estimating investment functions, and the latter in research of corporate

value.

There are many theoretical and empirical studies about the relationship between the

use of debt and the firmsʼ growth, but many of them have been conducted with U.S. data.

One stream of these studies examines whether leverage affects the firmsʼ growth. Lang et al.

(1996) and subsequent studies show that there is a negative relationship between leverage and

the increasing rate of fixed capital as the proxy variable of a firmsʼ future growth. The other

stream of these studies examines how growth opportunities affect the level of capital

structure. A good quantity of prior evidence shows that the market-to-book ratio as the proxy

of a firmsʼ growth opportunities is negatively correlated with leverage (for example, Rajan

and Zingales, 1995).

Koyama (2011) surveys prior studies focusing on Japanese firms. He says it is

commonly viewed that firms with valuable growth opportunities used more debt to finance

growth during the high economic growth period, so that their leverage ratio was higher than
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firms with poor growth opportunities. Debt financing was more easily available than equity

financing during the high economic growth period, which is characterized by indirect

financing. On the other hand, after the oil crisis, it is presumed that firms with valuable

growth opportunities donʼt use debt so much.

Wakasugi (1987) examines the relationship between the growth rate of total assets

and the equity ratio using a sample of Japanese firms listed on the first and second sections of

the Tokyo Stock Exchange over the period 1965-1984. The number of firms whose data was

available over the entire period was 826. A positive correlation is observed for the entire

manufacturing industry, chemical industry, and electrical machinery industry. This means

growing firms in these categories use more equity and less debt, though the coefficient of

determination is small.

Koyama (2011) examines the determinants of the equity ratio of 60 Japanese firms

over the period 1976-1985, and finds that the debt ratio of growing firms is lower. He

presumes that this is because firms with a high growth rate canʼt heighten their debt ratio to

restrain financial risks, and it is also unnecessary for them to do so as they have enough

internal funds.

Fukuda and Hirota (1996) analyze the determinants of the debt ratio and the main

bank loans to know how bank relationships affect corporate finance in Japan. Their sample

consists of 582 Japanese manufacturing firms listed on the first section of the Tokyo Stock

Exchange. They found that there was a negative relationship between the growth rate of sales

(1984-1987) and the debt ratio, but a positive relationship between the growth rate and the

main bank loans.

2.4 Other Related Studies

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A research study entitled Business performance of firms using debt by Ando,

Matsukoto K. and Matsumoto Y., year 2017 they concluded that firms grow more with a low

debt ratios of a firm. And according to the researchers, firms can grow even with the presence

and availability of debt, and when it grows the use of debt will become lower. In addition,

researchers didn't find important relationship between debt ratio and firms' growth in some

cases.

As stated by Pouraghajan, Malekian, Emamgholipour, et.al in the year 2012 in their

study entitled The relationship between capital structure and firm performance evaluation

measures: Evidence from the Tehran Stock exchange, using financial performance metrics,

the findings reveal that there is a substantial negative association between debt ratio and

company financial performance, and a significant positive relationship between asset

turnover, firm size, asset tangibility ratio, and growth opportunities However, there is no

substantial link between ROA and ROE measurements and firm age. In addition, several of

the industries analyzed have an impact on company performance. A reduction in debt ratio,

according to study, increases the company's profitability and hence the quantity of financial

performance measures, as well as increases shareholder wealth.

Gross Margin Profit, Return on Assets (ROA), Tobin's Q Ratio, and Debt Ratios are

all financial performance measures (Current Debt, Non-Current Debt, and Total Debt).

Control variables include "size" and "growth rate." Increases in current debts, non-current

debts, and overall debts have a detrimental impact on company performance (Sadeghian,

Latifi, Soroush, et.al, 2012).

Debt ratio and financial performance are positively and significantly associated,

according to the regression analysis. Asset turnover and financial performance are negaitively

and not substantially associated, but asset tangibility and financial performance are positively

and significantly related, according to the findings (Otekunrin, Nwanji, Abiodun, et.al, 2018).
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A study found out that if firms/companies are separated in accordance to their size,

one can state that: Increase in debt leads to decrease in profitability; Increase in short term

debt decreases profitability more than an increase in long term debt; Negative relationship

between debt and profitability decreases as company grows. In some other cases, when debt

ratios increases by one percent , it will lead to a profitability ratios decrease by more than one

percent (Zelgalve and Berzkalve, 2015).

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CHAPTER 3

METHODOLOGY

3.1 Research Design

A descriptive research design and panel regression was used in this study. Descriptive

studies show characteristics of the target population. Financial performance, liquidity,

leverage, solvency ratio, and business size are examples of variables that may be described

and explained using descriptive research designs. The idea in panel regression is to use an

individual unit as its own comparison group by comparing changes over time or some other

dimension instead of comparing units that are fundamentally different, some of which are

treated and some not. The researcher was able to describe the link between debt management

and financial performance over time and make recommendations for additional research

owing to the design.

3.2 Subjects of the Study

This study will be conducted to selected companies in Gingoog City. The subjects of

the study are represented by the company owners and/or managers in the specific area. A

total of 152 respondents will be randomly selected for the study.

3.3 Sampling Technique

This study used Simple Random Sampling in determining the samples of the study.

The critical attribute of simple random sampling is that each member of the target population

has an equal and independent chance of being included in the sample. Independence in this

sense means that the selection of a member of the population.

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3.4 Procedure of Data Gathering

The researchers will collect the respondent’s financial statements from the Securities

and Exchange Commission. The said researchers will go to the nearest SEC office to do such

collection of data.