Capital structure in Brazilian credit unions: which factors are really determinants?
| Autor | Zancan, Flavia |
Introduction
According to the modern financial literature, the study of capital structure began with Modigliani and Miller (1958), who stated that in a frictionless world, with full information and complete markets, the value of firms is independent of their capital structure, and there are no incentives for managers to implement specific capital structures in their firms. Since then, studies have focused on investigating assumptions that were not considered by Modigliani and Miller (1958) to explain patterns observed in the capital structure of companies. Noteworthy are the trade-off theory, which suggests an optimal combination of debt and equity for value maximization, and the pecking order theory, where managers have a preference for specific types ofcapital due to information asymmetry and depending on transaction costs (Myers, 1984; Myers & Majluf, 1984).
However, even though knowledge about capital structure, especially about its determinants, has advanced from the realm of non-financial companies to financial institutions, little has been investigated regarding the case of Brazilian credit unions. Thus, we seek to answer the following question: Which factors are determinants of the capital structure of Brazilian credit unions? Therefore, the objective of this paper is to evaluate the determinants of capital structure in Brazilian credit unions. To this end, a sample of individual credit unions between 2008 and 2021 was used, for which the association of leverage with profitability, size, tangibility and risk was tested, these being the determinants identified by Gropp and Heider (2010) for banks, based on the literature for non-financial firms.
Although both are financial institutions, it is important to emphasize that the quotas of unions, similar to the shares of banks, cannot be traded, are only redeemable, have their price determined in the bylaws, and can be acquired by any individual who meets the requirements for membership, which may make managerial decisions regarding the capital structure of unions different from those of banks. Otherwise, one could suggest the similarity of the case of credit unions to that of commercial banks, and consequently to non-financial firms, suggesting that the preferences of managers for the types of capital are also the same, even though they are different firms.
In recent decades, the vast majority of studies, international or national, that have investigated determinants for capital structure have been developed for non-financial firms (Rajan & Zingales, 1995; Frank & Goyal, 2009; Graham et al., 2015; Serfling, 2016; Ramli et al., 2019), justifying that financial institutions should not be considered for these studies because regulatory requirements, such as the minimum capital requirement, can directly affect their capital structures. However, Gropp and Heider (2010) demonstrated that the theoretical logic applied to non-financial firms is also valid for financial firms, subsequently receiving support from evidence from papers such as those of Teixeira et al. (2014) and Hoque and Pour (2018). If it was previously believed that regulatory requirements were sufficient to determine the capital structure of financial institutions, it is now understood that factors such as profitability, size, tangibility, and risk are also considered by their managers when making financing decisions.
However, although knowledge about determinants for capital structure has advanced for financial institutions, the research has focused on the case of banks. Little has been investigated regarding the case of credit unions, whose importance is growing given their increasing participation within the National Financial System. In fact, the Banking Economy Report released by Banco Central do Brasil (2020) points out that the National Credit Union System has grown more than the rest of the National Financial System in the last five years, mainly due to the increase in the number of members, which reached 11.9 million in 2020 (9.4% more compared to 2019 and 42.1% more compared to 2016), causing credit operations carried out in unions to reach 33.4% in 2020 (an 8.4% increase compared to 2019).
The study presents theoretical, practical, and social contributions. As for the theoretical aspects, financial institutions, such as credit unions, are usually excluded from investigations on capital structure. Thus, this study sought to deepen the knowledge about capital structure in credit unions, which are even less studied than banks (Oliveira, 2018; Zancan, 2021). In practical terms, since the capital structure of credit unions is associated with the risk taken by them (Froot & Stein, 1998), identifying the determinants can contribute to regulators in designing public policies aimed at protecting unions from too much exposure to risk, which can eventually harm them, in order to promote the sector (Mishkin, 1998). As for the social aspects, they are related to the importance of credit unions, whether for the role they play with their members or for their representativeness in regions where traditional banks have no interest in operating (Fontes Fo et al., 2008), which qualifies these institutions as important agents of social and economic development.
2 Literature review
2.1 Credit unions and capital structure
Credit unions have peculiarities arising from the characteristics of their ownership. The members (or associates) are owners and customers of the union at the same time. Thus, while they join the union as customers in search of products and services with advantageous interest rates compared to other options in the market, they are also owners who can exercise control over the managers they elect so that they take decisions aimed at meeting their needs as customers. To become members, individuals must purchase a certain amount of quotas as stipulated in the union's bylaws. Unlike bank shares, which are tradable and can be issued at the managers' discretion, albeit with shareholder approval, union quotas are not tradable and have their value stipulated in the bylaws, and can be acquired by any individual who meets the requirements for membership also stipulated in the bylaws. Traditionally, credit unions have imposed occupational and territorial requirements for those interested in joining, but since 2003 they have been able to remove occupational requirements, in the so-called free admission of members. Since then, the amount of members in credit unions has been increasing (Canassa et al., 2022; Pinheiro, 2008; Hansmann, 1996).
Like any company, the capital structure of financial institutions is made up of third party capital, also known as leverage or indebtedness, and own capital, represented by shareholders' equity. It is noteworthy that in the Accounting Plan for Institutions of the National Financial System (Banco Central do Brasil, 2022) there is no separation between short- and long-term operations in liabilities, which leads to conceptualizing capital structure based on the totality of the accounts that belong to the right side of the balance sheet.
The capital structure of credit unions is usually measured by the ratio of total third party capital to total assets (Oliveira, 2018; Zancan, 2021), revealing how much of the assets are being financed by non-equity resources. On the one hand, the higher the indebtedness, the greater the risk assumed by the union. On the other hand, the lower the indebtedness, the greater the financial security in the long term. Furthermore, the capital structure of credit unions includes deposits and this differentiates them from non-financial companies. Thus, it is important to also consider leverage from deposits and non-deposit liabilities, as proposed by Gropp and Heider (2010), and also applied by Hoque and Pour (2018) and Oliveira and Raposo (2021).
2.2 Trade-off, pecking order and the case of credit unions
Since the seminal works of Modigliani and Miller (1958, 1963), difficult-to-reconcile theories have competed in trying to clarify the decisions made about capital structure. The trade-off and pecking order theories stand out in many empirical works (Rahman, 2019; Guizani, 2021; Khan et al., 2021), assuming that managers implement capital structures and have incentives to determine the amount of capital, whether third party or own capital.
The trade-off theory reports the existence of an optimal capital structure, in which a firm's value is maximized by debt through its tax benefit, restricted to not being large enough to increase the probability of causing financial distress. Thus, the optimal point is one at which the marginal benefit of debt equals its marginal cost. The trade-off theory assumes that a firm's capital structure would therefore reflect the search for this value-maximizing optimal point. Contestations exist because little consideration is given to intrinsic characteristics of firms in financing decisions, which has contributed to the literature focusing on issues such as the role of information asymmetry, transaction costs, and agency costs. According to Albanez et al. (2012, p. 78), in information asymmetry it is assumed that "managers or insiders have private information about the flow of returns of the company or its investment opportunities, which characterizes the informational difference (or asymmetry)." That is, managers who have inside information about the company have their own interests and have the authority to implement the capital structure, and may determine it as different from the optimal one.
The pecking order theory indicates that managers have distinct preferences as to the sources of corporate financing, with there being a hierarchy in which internally generated capital from retained earnings is preferred to third party capital, which is preferred to external capital from the sale of shares (Myers, 1984; Myers & Majluf, 1984). The preference for internal over external financing is due to the...
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