Editorial Board

A Refereed Monthly International Journal of Management

Relationship between Leadership Behavior and Perceived Leadership Effectiveness of Transformational, Transactional and Laissez-faire Corporate Leaders in Kolkata, India in VUCA World– A Comparative Study

Author

Ayesha Ateeq (Principal author) (M. PHIL Finance), Lecturer, Division of Finance Lyallpur Business School, Government College University Faisalabad aisha.ateeq78@gmail.com

Dr.Ahsan Riaz (corresponding author),Assistant Professor, Division of Finance Lyallpur Business School, Government College University Faisalabad +92-321-8662701 ahsanriaz@gcuf.edu.pk

Dr.Safdar Hussain Tahir Assistant Professor, Division of Finance Lyallpur Business School, Government College University Faisalabad drsafdar@gcuf.edu.pk

Dr.Muhammad Naeem Shahid Assistant Professor of Finance, Department of Management Sciences The University of Faisalabad, Pakistan naeem.shahid@tuf.edu.pk

Muhammad Rizwan Ullah Lecturer, Division of Finance Lyallpur Business School, Government College University Faisalabad, Pakistan mrizwanullah77@gmail.com

The Association among Risk Management, Financial Performance, Financing Decision and Investment Decision Based on Firm Size: An Empirical Investigation of Non-Financial Firms Listed at Pakistan Stock Exchange

Abstract

The study analyzes whether the firm size influences the associations between financial decisions. For this purpose, the data of 60 non-financial firms from 2012 to 2017 are collected. The data are then divided into three categories. The study regards a firm with total asset value falling in the top third of the sample as a large firm, a firm with total asset value falling in the bottom third of the sample as a small firm, and the remainder as medium-sized firms. The results reveal that when we do not consider the firm size, the positive associations are found between risk management and financial performance, between risk management and financing decision, and between financial performance and investment decision. Conversely, the associations between financial performance and financing decision and between investment decision and financing decision are found to be negative. However, when we consider the firm size in the analysis, we found that the smaller is the firm size, the stronger is the association between risk management, financial performance, financing decision and investment decision. It is concluded that the firm size is an important factor in determining the associations between financial decisions.

Keywords: Financial Performance; Risk Management; Financing Decision; Investment Decision; Firm Size.

Introduction

The financing and investment decisions of a company are independent in a perfect capital market. It posits that the company will be impotent to achieve success, with respect to reducing its weighted cost of capital and increasing its value (Modigliani-Miller theorem, 1958 and 1963). Although it is confirmed that imperfections also exist within the capital markets, there exists an implied interaction between investment and financing decisions (Lin et al., 2008; Lin and Smith, 2007; Ross, 1996). It also posits that investment and financing decisions positively affect firm performance (Ho et al., 2006). The financial decision is a cogent process for selecting the optimum alternative allied with investments and financing. The purpose of each financial decision has a financial character that aims in increasing firm profitability (Dawar, 2014). Every organization needs resources for the development of financing activities. The authentication of the organization’s financing decision has the following aspects: the period in which the financing sources are needed, the flexibility of financing contracts, the cost of financing resources, the impact of financing decision on financing policy and the problem of information asymmetry. The financing decision makes possible the investment decision (Bhatt, 2007). The investment decision is the administration and constitution of the asset’s portfolio (Bhatt, 2007). Investments are assets; one puts his money to get profitable returns. In the rapidly growing economy, numbers of options of investment are available to meet one’s needs, requirements and investment capacity. When someone thinks of putting his money in, some major aspects (like returns, risk, time frame etc.) clicks in his mind (Bagla, 2017). Decision making concerning the utilization of an organizations’ funds, there are some differences in the interests among the shareholders, employees, debt holders and managers (Akdogu and MacKay, 2012; Laksmana and Yang, 2015). Similarly, when a corporate entity takes an investment decision, the same thing happens. Investment decisions are also important for a corporate entity in growing its business and in maintaining its sustainability. These decisions are important because they are related to the company’s financial performance (Nugroho et al., 2018). Financial performance is a subjective measure of how well a firm can use assets from its principal mode of business and produce revenues. This term is also used as a general measure of the overall financial health of a firm over a period and can be used to compare parallel firms across the similar sectors or industries in accumulation. Investors or financial analysts wish to look closely into the financial statements and search for any decreasing debt or margin rates of growth. There is a positive interaction between total risk management and firm performance (Muhammad and Knapkova, 2016). An integrated and effective system of risk management improves the financial performance of an organization. The implementations of effective and integrated management of risk need a mobilization of huge resources. Henceforth, an organization expects improvement in the financial performance resulted from the employment of risk management system (Pagach and Warr, 2011). Risk management is a process by means of which companies identify measure, line up and minimize the adversarial impacts of reservations (Chapman et al., 2003). Consequently, it is a systematic technique to lessening the opposing effects of any particular phenomenon. The method that describes the risk only from down perspective leads to the aversion of risk. There is a strong inspirational effect of risk management of major stockholders to invest further in a company. These investments are considered as a weapon for an organization to offer better opportunities for business which leads to the enhancement of competitive advantage. Ineffective management of risk leads to an increase incosts (Andersen, 2008). There are two main concepts of risk management. The first view is the management of opposing impacts of risk instead of the opportunities linked with it. The other one is the management of risks independently by categorizing the risk into various grain stores (Lam, 2001 and Davenport and Bradley, 2001). For instance, the happening of an event negatively affects one unit of an organization but at the same time, it might also be an opportunity for the other unit of the entity (Miller and Waller, 2003). Though, the risk management topic is a dynamic concern amongst the greater level corporate executives, because of theoretical complications of risk management (Jafari et al., 2011). Previous studies explore the relationship between different financial decisions. Especially, the interaction between risk management and investment decision is explored by (Lin and Smith, 2007), between risk management and financing by (Chava and Roberts, 2008) and between financing and investment decision by (Spano, 2003). However, Mohammed and Knapkova (2016), Lin and Smith (2007) and Ross (1996) closely analyzed the associations among risk management, financial performance, financing decision and investment decision, but none of them takes into consideration the impact of firm size. As opposed to the above-mentioned studies, we argue that the associations between the various financial decisions would found differ in the firms with different sizes. Particularly, we believe to find that these collaborations between the different financial decisions will be much stronger in the firms with a smaller size.

1.1 Research Objectives

Followings are the key objectives of the study:
•	To analyze the associations between financial decisions.
•	To identify the strengths or weaknesses of the relations between financial decisions on the basis of firm size.
•	To provide the appropriate guidelines to the key officials, policymakers and management in non-financial firms for making fruitful decisions after considering the selected set of variables

2. LITERATURE REVIEW AND HYPOTHESES

This section presents the previous related literature on the associations between financial performance, risk management, financing decision and investment decision and develops the hypotheses relating to the impact of firm size on the association between different financial decisions.

2.1 Risk Management and Financial Performance

Setiyono and Ernawati (2018) studied the impact of risk management and working capital management on the firm financial performance of the listed companies in Indonesia. They applied multiple linear regression models to analyze the results and found a positive impact of risk management on financial performance. Mohammed and Knapkova (2016) also checked the impact of total risk management on financial performance and found a positive impact of risk management on financial performance. They suggested practising risk management techniques to protect the interest of stakeholders. Ariffin and Kassim (2013) also found a significant interaction between liquidity risk and profitability. Kokobe and Gemechu (2016) studied the risk management techniques and the company’s financial performance by using both primary (questionnaires) and secondary (end year reports) data. The outcomes of multiple regression analysis showed no correlation between risk management and firm performance. Based on the above debate, the following hypothesis is developed:

H1:There is a positive relationship between Risk Management and Financial Performance

2.2 Risk Management and Financing Decision

Lin et al. (2008) examined the association between risk management, investment and financing decisions by using a simple equilibrium model. They found a positive association between risk management and financing decision and concluded that risk management and financing decision could be jointly determined. Lin and Smith (2007) quantified the interaction among financing, hedging and investment decisions. They argued that the way in which hedging influenced financing decision differs for the firms with different growth opportunities. Firms with fewer investment opportunities increased their financing using hedging. Byounet al. (2013) analyzed the capital structures of 2,572 project-financed investments in 124 countries. They used the data for the period of 1997 to 2006. They found that in the highlyrisk projects, firms used more leverage, but less leverage was used in the presence of risk-reducing features.Elbadry (2018) analyzed the effect of financial stability on the risk management of banks in Saudi Arabia. The data ranging from the period of 2001-2014 were used. Their results of regression analysis showed a positive effect of leverage (financing) on credit risk. The above arguments lead to construct the following hypothesis:

H2: There is a positive association between Risk Management and Financing Decision.

2.3 Financial Performance and Investment Decision

Mukhtar et al. (2016) explored the interaction between investment decision and financial performance. They used the data of 30 chemical sector firms and applied panel data regression model to analyze the impact. They found a positive impact on financial performance on investment decision. Kose and Kose (2016) analyzed the impact of technology investment on the financial performance of 383 hospitals. To analyze the data, structural equation modelling and confirmatory factor analysis were applied. They revealed a positive impact of investments on financial performance. Handriani and Robiyanto (2018) studied the effect of investment opportunity on firm profitability. Data of 94 firms from the period of 2005-2011 were analyzed through multiple regression models. They revealed a positive impact of investment opportunity on firm profitability. Riahi-Belkaoui (2002) also revealed a positive association between investment decision and firm profitability. The following hypothesis is developed based on the above discussion:

H3: There is a positive interaction between Financial Performance and Investment Decision.

2.4 Financing Decision and Investment Decision

Lin et al. (2008) examined the association between risk management, investment and financing decisions by using a simple equilibrium model with costly financial distress to analyze the association. They suggested a negative association between financing decision and investment decision. It was concluded that financing and investment decisions could be jointly determined. Mauer and Triantis (1994) analyzed the relationship between investment, operating and financing decisions and observed an insignificant impact of financing decision on investment decisions. On the contrary, Froot et al. (1993) found a positive interaction between financing and investment decisions. Mukhtar et al. (2016) explored the impact of financial leverage on Investment decision. They used the data of 30 chemical sector firms from the period of 2001 to 2013 and applied panel data regression model to analyze the impact. They found a negative impact of leverage on investment decision. They suggested not treating investment decision separately. Bruinshoofd and Letterie (2003) investigated the interaction between risk management, financing and investment decisions and found a negative association between investment and financing decisions. Kaaro (2001) examined the relationship between investment and financing decisions by controlling the effect of firm size. He found a positive relationship between investment and financing decisions in less risky conditions while in high-risk conditions the relationship was reversed. The above discussion permits us to develop the following hypothesis:

H4: There is a negative relationship between the Financing Decision and Investment Decision.

2.5 Financing Decision and Financial Performance

Fama and French (1998) studied the relationship between taxes, financial performance and financing decision. They found that financial performance and financing decision is positively correlated. Das and Swain (2018) studied the determinants of capital structure and analyzed its impact on firm profitability. The data of the top 50 manufacturing firms were analyzed through multiple regression models. They found a significant negative effect of financing decision (capital structure) on financial performance. Financing decision was considered as one of the important areas in financial management to maximize stockholders' wealth. Zainudin et al. (2017) analyzed the relationship between debts and financial performance of Malaysian firms. They observed a negative relationship between debt financing and firm performance. Likewise, Pinto et al. (2017), Rajkumar (2014), Vitor and Badu (2012) and Velnampy and Niresh (2012) also found a negative relationship between financing decision and financial performance. In contrast to the above, Mujahid et. al., (2014) and Goyal (2013) found a positive interaction between financing decision and financial performance. Based on the above literature, the following hypothesis is developed:

H5: There is a negative interaction between Financial Performance and Financing Decision.

2.6 Risk Management and Investment Decision

Bruinshoofd and Letterie (2003) investigated the interaction between risk management, financing and investment decisions by using the sample of 206 Dutch companies. They found a positive impact of risk management on investment decision. Similarly, Barbier and Burgess (2018) also found positive interaction between risk management and investment decision. Kumar et al. (2016) said that risk management is associated with plant investment decisions. Alternatively, Miao and Wang (2004) concluded a negative association between risk and investing. Goldberg (2018) studied the macroeconomic impacts of shocks to idiosyncratic risk in the economy of a country. He developed a model in which companies face idiosyncratic risk and acquired insurance from intermediaries through contracts. He concluded that in a parameterized version of the model, a rise in idiosyncratic business risk could generate a large increase in uncertainty about aggregate investment. Lin and Smith (2007) quantified the interaction among financing, hedging and investment decisions. They argued that the way in which hedging influenced investing decision varies for firms with different growth opportunities. Firms with higher investment opportunities increased their investment by hedging the risk. Firms with fewer investment opportunities increased their financing using hedging. The above arguments lead to construct the following hypothesis:

H6: There is a positive association between Risk Management and Investment Decision.

2.7 Firm Size and Financial Decisions

Firm size has always been regarded as an important factor in exploring those elements that are likely to affect financial decisions, with some studies finding a negative association between financial decisions and the influence of firm size; as for concern, Warner (1977) noted that smaller firms had a strong association among financial decisions as compared to larger firms. The empirical evidence of other previous studies (Froot et al.,1993; Nance et al., 1993) also showed that the smaller firms had a strong association between financial decisions. The above discussion leads us to construct the final hypothesis:

H7: The smaller the firm size the stronger will be the interactions between financial decisions.

3. METHODOLOGY

The study attempts to analyze whether the size of the firm has different impacts on the associations between risk management, financial performance, financing decision and investment decision in firms with different sizes. 60 non-financial firms listed in Pakistan Stock Exchange are selected as sample. The sample is then divided into three categories i.e. small firms, medium firms and large firms. The data ranging from 2012 to 2017 are gathered from annual financial reports of selected firms. Additionally, we follow different previous studies (like Lin et al., 2015; Hubbard, 1998;) to construct the risk management, financial performance, financing decision and investment decision equations. We also include cash flow, asymmetric information and firm size as the control variables in each equation. We use the Generalized Methods of Moments (GMM) approach to obtain consistent and asymptotically unbiased estimates while estimating the simultaneous equations’ parameters. The simultaneous equation for risk management, financial performance, financing decision and investment decision are presented by equations (1), (2), (3) and (4) respectively.

Risk Management Equation
TRMit = α0 + α1ROAit +α2CAEXit + α3LEVit + α4CFit+ α5ASINit+ α6SIZEit + ɛit----- (1)
Firm Performance Equation
ROAit = β0 + β1TRMit + β2CAEXit +β3LEVit+ β4CFit+ β5ASINit+ β6SIZEit+ µit  ----- (2)
Financing Decision Equation
LEVit = γ0 + γ1TRMit +γ2ROAit +γ3CAEXit + γ4CFit+ γ5ASINit+ γ6SIZEit+ ʋit----- (3)
Investment Decision Equation:
CAEXit = λ0 + λ1TRMit +λ2ROAit + λ3LEVit+ λ4CFit+ λ5ASINit + λ6SIZEit +éit  ----- (4)

Where; α0, α1,..….α6, β0, β1…… β6, γ0, γ1…… γ6 and λ0, λ1,……λ6 are the regression coefficients and ɛ, µ, ʋ and é are the residual terms of equations (1), (2), (3) and (4) respectively. TRMit, which is proxy for risk management, is measured by the standard deviation of yearly sales divided by return on assets of firm iin year t (Mohammed and Knapkova, 2016). ROAit, which is a proxy of financial performance, is calculated as the net income divided by total assets of firm iin year t (Tahir et al., 2015). CAEXit, which is a proxy for investment decision, measured as the ratio of capital expenditure, and is measured by the change in fixed assets plus depreciation divided by total assets of firm iin year t (Lin et al., 2015). LEVit, which is a proxy for financing decision, calculated by the change in debt divided by total assets of firm iin year t (Tahir et al., 2015). CFit is a proxy for cash flow and is measured as (Operating Profit + Depreciation – Income Tax – Interest Expense – Dividend) / Total Assets of firm iin year t (Hubbard, 1997). ASINitrepresents asymmetric information of firm iin year t and is measured as the percentage of shares held by the management; the greater the ratio, the higher the ASIN (Tufano, 1996; Breeden and Viswanathan, 1998). SIZEit is the firm size measured as the natural logarithm of total assets of firm iin year t. We regard a firm with total asset value falling in the top third of the sample as a large firm, a firm with total asset value falling in the bottom third of the sample as a small firm, and the remainder as medium-sized firms.

4. RESULTS AND DISCUSSIONS

This section provides the results of descriptive statistics as well as the results of simultaneous equations. Table 1 (see appendix) represents the descriptive statistics of all the variables used in the study. It shows the means, medians and standard deviations of all the variables of large, medium and small-sized firms. Table 2 (see appendix) shows the comparison of selected firms on the basis of size as well as acceptance and rejection of hypothesis for the relationship between total risk management, investment decision, financing decision and financial performance.

4.1 Association between Financial Decisions Regardless of Firm Size

It can be seen from Table 2 that there is a significant positive relationship between total risk management (TRM) and firm financial performance (ROA). Previous studies (Setiyono and Ernawati, 2018; Mohammed and Knapkova, 2016; Kokobe and Gemechu, 2016; and Ariffin and Kassim, 2013) also present a positive association between TRM and ROA. There is also a positive relationship between TRM and leverage (LEV). The results are similar to (Elbadry, 2018 and Lin et al., 2008). The association between ROA and CAEX is found to be positive. These results are in accordance with (Handriani and Robiyanto, 2018; Kose and Kose, 2016; Mukhtar et al., 2016; and Riahi-Belkaoui, 2002). The interaction between LEV and CAEX is found to be negative accepting the results of previous researchers (Mukhtar et al., 2016; Lin et al., 2008; Bruinshoofd and Letterie, 2003; and Kaaro, 2001). There is an indirect relationship between LEV and ROA. These results are in line with the previous studies (Das and Swain, 2018; Zainudin et al., 2017; Quadras and Joseph, 2017; Rajkumar, 2014; Vitor and Badu, 2012; and Velnampy and Niresh, 2012). But the results are dissimilar with (Mujahid et. al., 2014; and Goyal, 2013) who present a direct association between LEV and ROA. There is an insignificant relationship between TRM and CAEX. In contrast, (Goldberg, 2018; Barbier and Burgess, 2018; and Lin and Smith, 2007) find a significant association between the said variables.

4.2 The impact of Firm Size on the association between Financial Decisions

Table 2 also depicts the results of selected firms of different sizes (i.e., large, medium and small). We first consider the relationship between TRM and ROA. As shown in the table, the results of TRM and ROA present a significant positive relationship in large, medium and small firms. It supports the first hypothesis of the study. It represents that firms are more likely to hedge in order to reduce financial risk. Customary approach to managing the risk is highly focused on the defensive side. The defensive approach established by restraining the practice and concept of managing the risk only in defending the firm from threats or danger. Firms need to see risk management not only from a defensiveapproach but also as a key successes factor for sustainability of earnings and improvement in the whole performance of the corporations. Effective management of risk has direct allegation on the financial performance of the firm. The results also indicate that the relationship is different in firms with different sizes. For instance, the relationship is significant in large and medium-sized firms at 5% level, but it is significant at 1% level in small firms, therefore supporting our seventh hypothesis i.e., the smaller the firm size the stronger will be the interactions between financial decisions. Second, we consider the association between TRM and LEV. The empirical results show a positive association between TRM and LEV. It posits that the firms should manage their risks more to decrease the financial risk resulting from higher ratios of debts. From the empirical results given in Table 2, we find that there is no significant interaction between TRM and LEV in large size firms. But the relationship is significant in medium and small firms at 5% and 1% level of significance, respectively. It implies that small firms reduce their risk of financial distress through hedging and further increasing their debt capacity. Here, in the case of medium and small firms, the second hypothesis is accepted. However, the coefficients are higher in small-sized firms as compare to medium-sized firms. It again supports our seventh hypothesis. Now, we go on to observe the empirical results for the interaction between financial performance and investment decision. As shown in Table 2, investment decision (CAEX) shows different impacts with financial performance (ROA). For instance, CAEX has a positive impact on ROA at 5% level of significance in the large and medium-sized firm. But the impact is significant at 1% level in small-sized firms. Companies with positive performance have higher investments opportunities. Firms with higher investment opportunities take better investment decisions to increase their investments and to enhance financial performance. The interaction is much stronger in smaller firms showing that small firms take better decision to increase their investment as compared to medium and large-sized firms. The above results support our third as well as seventh hypotheses. Meaning that smaller is the firm size stronger is the association between investment decision and financial performance. We further move to analyze the results for the relationship between financing decision (LEV) and investment decision (CAEX). The empirical results in Table 5 indicate that there is an inverse association between LEV and CAEX. The results indicate that hypothesis-4 is accepted. But large-sized firms show an insignificant relationship. Also, in medium-sized firms the impact is significant at 10% level while in small-sized firms the impact is significant at 1% level. Here, the hypothesis-7 is sustained. The above results indicate that small-sized firms use fewer debts to finance their investment projects while the medium and large sized firms use more debts as compare to small-sized firms to finance their investments. Finally, we consider the outcomes for the linkage between financial performance (ROA) and financing decision (LEV). The results in Table 5 present an indirect interaction between ROA and LEV, which posits that the hypothesis-5 is accepted. The results represent that the firms should avoid the use of debts as leverage is inversely related to financial performance. The chances of bankruptcy and risk of financial distress are higher with the firms having excessive debt ratios. Again, the empirical results of large-sized firms show an insignificant association between ROA and LEV. Although, the impact is significant at 10% and 5% levels for medium-sized and small sized firms, respectively. The hypothesis-7 is still sustained. The above arguments posit that smaller firms avoid the excessive use of debts to enhance their profitability. We find an insignificant interaction between risk management (TRM) and investment decision (CAEX). The outcomes do not support the sixth hypothesis of the study. The firms do not likely to increase their levels of investment through risk management. To avoid the cost of external financing and costs of higher bankruptcy, the firms with all sizes have less motivation to engage in the management of risk and to increase their investment projects.

5. CONCLUSIONS

The financial decision is a cogent process for selecting the optimum alternative allied with investments and financing. The purpose of each financial decision has a financial character that aims in increasing the firm financial performance (Dawar, 2014). The study, therefore, analyzes the associations between risk management, financial performance, financing decision and investment decision in the firms of different sizes. The required data are gathered from 60 firms covering the period from 2012 to 2017. The sample is then divided into three categories i.e. small, medium and large firms. The results reveal that when we do not consider the firm size, the positive associations are found between risk management and financial performance, between risk management and financing decision, and between financial performance and investment decision. Conversely, the associations between financial performance and financing decision and between investment decision and financial decision are found to be negative. It implies that firms with higher opportunities of growth are more likely to hedge in order to minimize underinvestment problems. However, when we consider the firm size, as expected the associations between financial decisions are found to differ in the firms of different sizes. The study finds a positive association between risk management and financial performance and between financial performance and investment decision while the association between financing decision and risk management found to be significantly positive only in medium and small-sized firms. The associations between financing decision and financial performance and between financing decision and investment decision are found to be negative only in medium and small-sized firms. The study concluded that the smaller is the firm size, the stronger is the associations between financial decisions (i.e., risk management, financial performance, financing decision and investment decision). The empirical result supports the belief that firm size is not only an important factor that determines the firm’s financial decisions. It also affects the association between these financial decisions.

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