Debt and Financial Performance of REITs in Malaysia: A Moderating Effect of Financial Flexibility

Abstract

Curiosity in bank debt financing decision was primarily inspired by the perceptible contradiction between the REITs’ unique operational business structure particularly REITs in Malaysia (M-REITs) and the finance theory of capital structure decision. The Trade Off Theory implies that the financing strategy of using debt provides no value in REITs entity with a marginal tax rate of zero. The use of debt by REITs entity is seen to be a puzzle in numerous REITs literature as REITs do not have tax shield benefit of using debt. High dividend payout requirement constraints REITs ability to retain its internal earnings and have to use debt to undertake growth strategies. The moderating effect of financial flexibility in a relationship between bank debt financing and the financial performance are examined and presents new empirical evidence on the role of the financial flexibility. The study offers some important insights into the debt financing decision for M-REITs. Using the unbalanced panel data from all M-REITs for the period from 2005 to 2014, this study reveals that size has strong positive relationship with debt financing, smaller M-REITs prefer to use short term debt, diversified M-REITs is found to have lower debt as compared to focused M-REITs, growth in investment and liquidity has positive relationship with bank debt financing while internal cash constraints and cash flow volatility has a negative relationship with debt financing. The results of this study indicate that both Pecking Order Theory and Trade Off Theory complements each other in explaining the M-REITs debt financing decision and less supportive for Agency Theory. This suggests that the use of debt as a disciplinary tool seems to be less crucial for M-REITs entity with high mandated dividend payout requirement. Indeed, the high payout requirement behaves as a “disciplinary tool” in M-REITs. The results on the relationship between debt and financial performance reveal that both short term and long term debt are negatively related to financial performance, liquidity is found to be an important factor on M-REITs’ financial performance and size have no relation with financial performance. Financial flexibility positively moderates the relationship between debt and financial performance. The findings retrieved from this study serve as a useful guide to M-REITs’ managers to manage the financial flexibility as it has important moderating effects on debt and financial performance relationship.

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