title: The effect of the recent financial crisis on the financial and investment policies of UK private and public firms
Creators: name: ur Rehman, Shafiq
Publisher: name: University of Liverpool Repository
Year: 2023

description: Abstract The recent financial crisis, sparked as a result of the subprime market in the United States, is regarded by many researchers as the most severe financial crisis to happen since the Great Depression. This crisis has raised the important issue of the spill-over effect of the financial crisis into other sectors of the economy. However, evidence of the effect on firms' behaviour with respect to their financing and investment decisions is limited, and the existing research has mainly concentrated on the publicly listed firms in the US. It is also evident from the findings of existing published studies that the majority of studies do not reach a unanimous conclusion (Alien and Carletti 2008; Bakke 2009; Duchin, Ozbas and Sensoy 2010; Leary 2009; Lemmon and Roberts 2010; Lin and Paravisini 2010 a). Further, the focus of the majority of the existing studies is very narrow with respect to the components of capital structure. As a result, it is not clear from the existing literature which component of the capital structure is more sensitive to credit supply contractions than any other. Moreover, accounting regulations, financial reporting requirements and institutional features are different between the US and the UK, which high!(gl1Js the need for more research in this area. In addition, no systematic investigation into the financing and investment decisions of private firms during the crisis has ever taken place in the UK. The main purpose of this study is, therefore, to investigate the financial and investment decisions of both private and public listed finns during the time of the recent financial crisis in the UK. More specifically, this study investigates whether shocks to the supply of credit affect firms' leverage and determines which components of capital structure are affected by credit supply contractions. Further, the study investigates how firms manage their finances during a crisis period. In other words, how firms minimize the effect of credit contractions by resorting to alternative sources of finance such as internal funds, net debt issues, net trade credits and net equity issues. The study also examines whether firms manage their dividend payouts to maintain their financial slack. Finally, the study investigates the effect of the credit crisis on firms' performance and investment decisions. To investigate these issues, the study adopts a comprehensive strategy which consists of three elements, namely, identification of exogenous credit crisis, the use of film fixed effects model and the use of firm level control variables. Data for the analysis are extracted from the FAME and the Datastream databases for the period 2004-2009. A total of 4973 private firms are extracted from the FAME database and 2039 public firms are extracted from the Datastream database. The fixed effects analyses highlight that the financial crisis has adversely affected the total debt ratios of both types of firms. This effect is most significant on the short-term financing channel (such as short-term debt and trade credit) in the sample of private firms; while it is the trade credit channel that is negatively affected by the credit crisis in the sample of public firms. The effect on long-term and short-term debt is statistically insignificant in the sample of public firms. There are also differences in the way both types of firm responded to the credit crisis. Private firms, for example, issued more equity and held cash in response to the credit shortage. These firms do not move to net debt issues and net trade credits; nor do they adjust their dividend payout policies during the crisis period. The results further reveal that public firms use more internal funding and repurchase equity in response to the credit drought. These firms also reduced dividend payout to preserve their financial slack. In addition, public firms do not change to net debt issues and net trade credits in response to the credit supply shocks. Moreover, the results reveal that the performance and investment of both types of firm are adversely affected by the credit crisis. This highlights that the inability to obtain external credit and the relative lack of substitution towards alternative sources of finance have negatively affected the performance and investment of both types of firm. Further, in the private firms' sample, the increase in cash holdings and decline in investment suggest that funds raised through the equity issue may have been used to fmance the cash holdings of these firms. In the public firms' sample, decrease in cash reserve, dividend payout and investment in tangible assets suggests that internal funds may have been used to fmance the equity repurchases. Overall, the results suggest that financial and investment policies of private and public firms are sensitive to the credit supply shocks. 11