THE DETERMINANTS OF COMPANIES’ INVESTMENT ATTRACTIVENESS

Introduction

The investment attractiveness in the framework of current business is one of the most important characteristics of the company’s performance as it has a straightforward influence on the perspectives of a firm for future development, competitive strength, and financial stability. The investor’s decision about the investing should be based on the assessment of the investment attractiveness of a firm. The purpose of this paper is to assess the relative importance of the factors determining the investment attractiveness of Russian companies.

Selection of Explanatory Variables and Hypotheses

According to the “theory of dividend preferability” by Gordon and Linter every unit of income, which is paid to the investors as a dividend, is worth more than the income, which is reserved for the future, as the former is purified from the risk. Thus we take dividend payout as a proxy to measure the investment attractiveness.

The following determinants are used as variables for assessment of investment attractiveness:

Hypotheses:

1.     ROA has a positive effect on the investment attractiveness.

2.     D/E ratio has a negative effect on the investment attractiveness.

3.     Liquidity has a positive impact on the investment attractiveness.

4.     There is a positive relationship between size and the investment attractiveness.

5.     The relationship between ROS and the investment attractiveness is positive.

6.     Tax and the investment attractiveness are negatively related.

7.     The relationship between ROE and the investment attractiveness is positive.

8.     The life cycle of a company affects the investment attractiveness.

To test the influence and significance of the selected determinants an econometric approach will be applied. The initial sample comprises around 3000 observations. They include 3000 Russian companies from the coal mining, oil and gas production, metallurgy, machinery construction and chemical industries for the year 2013. The cross-sectional data was collected from Fira.com.

Econometric model

The multiple regression looks like:

LOG (DIVIDEND+1) = b0+b1*CURRENT_RATIO + b2*D_E + b3*ROA + b4*ROE + b5*ROS + b6*SIZE + b7*TAX_EBT + b8*BIRTH + b9*GROWTH + b10*DIVERSIFICATION + b11*RECESSION + b12*ROA^2 + u

For this set of factors, we choose non-linear relationship, so the model is linear in parameters and non-linear in independent variables (ROA). Besides, our dependent variable will be log(dividend+1) in order for logarithm index not to be equal to 0. This will help to assess the changes of dividend payout in percentage, without any bias (as the absolute values are not modified significantly).

We also include squared ROA ratio in our model, as we presuppose that till a certain point of increasing ROA the dividends decrease, because the company wants to direct its funds on some other business projects. But then it gains additional flow of money and the dividend payout increases.

VIF does not detect multicollinearity problem, so there is no need for model reparametrization. The results of model estimation are given in the table:

Model identification

Notes: *** significant at 1%. ** significant at 5%. *significant at 10%.  Standard errors in parentheses. The estimation with “White-form” adjustment. Number of observations: 2890.

The model is statistically significant at 1%. And it explains 30% of total variation (R2 ). All Gauss-Markov assumptions hold true.

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In this paper the life cycle of a company is included as a determinant of the investment attractiveness. However, it is necessary to find out, whether the life cycle stages jointly affect the dependent variable. For this purpose the Wald test is conducted:

Wald test for the second model specification

As p-value<α we accept the alternative hypothesis that there is joint effect on the dividend payout. To test whether the model is correctly specified we run Ramsey Reset test.

Ramsey test for the model specification

All coefficients are statistically significant except for recession and ROE.

Considering the coefficients for ROA we can conclude that there is a quadratic form of relationship between ROA and dividend payout - as this ratio increases it leads to the reduction in dividend payments. However, reaching some point (ROA=0.05/0.0006=83.3) dividend payments begin to grow.

As dividend payout was taken as a proxy variable for investment attractiveness, the values of the estimated coefficients are not the main issues to be interpreted. More purposeful is the interpretation of the coefficients’ signs (i.e. the direction of the effect) in response to our initial hypotheses.

Confirmation of the hypothesis

Conclusion

The aim of this paper was to assess the influence of various determinants on the investment attractiveness of a company. Currently this issue is quite relevant due to the presence of investment processes in the country’s economy. Besides every potential investor faces the question of appropriateness of investing in this or that enterprise. In other words, this is the issue of selecting the most attractive company to gain the future return.

The best model for estimation has log-linear specification and includes a squared ROA ratio. Most variables (except size of a firm) showed their statistical significance, as well as the model itself.

The further research in this sphere may be conducted by using more explanatory variables, which are related to the topic. Moreover, there are plenty of approaches to measure the investment attractiveness and other proxy variables can be used instead of dividends. Using more or other variables can change the model specification, when it is economically justified. Moreover, panel data can be included to flatten the figures and to avoid abnormality.

List of references

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2.     Dickinson V. (2007) Cash Flow as Proxy for Firm Life Cycle; PhD ; CPA. Fisher School of Accounting Warrington. College of Business; University of Florida, Pp. 1-35.

3.     Fumey, A., Doku, I., (2013) Dividend payout ratio in Ghana: does the pecking order theory hold good?, Journal of emerging issues in economics, finance and banking, Vol. 2, pp. 616-637

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5.     Goncharuk, A.G., Karavan, S.  (2013) «The investment attractiveness  evaluation methods  and measurement features», Polish Journal of Management Studies, Vol. 7, pp. 160-166.

6.     Gordon, M.J. (1959), Dividends, earnings and stock prices, Review of Economics and Statistics, pp. 99-105.

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