Capital structure : a value–based management framework in the healthcare sector

Abstract

In this paper the author attempts to provide a management framework within which the top management can manage the capital structure to create and then optimize firm value. It was found that capital structure is dynamic rather than static and dependent on the industry and economic condition the firm is operating within. A theoretical overview of the Modigliani and Miller (M&M) propositions, capital structure models and the most important factors determining an appropriate capital structure for a company are entertained. Empirical research has been done on the healthcare sector companies listed on the JSE for the period 2006 - 2010. Only six healthcare sector companies were listed on the JSE when this dissertation was started. A very small data pool was an unfortunate limitation of this study. Capital structure determinants and Share price and Change in share price (representing sustainable value creation) have been statistically analysed to observe the relationship between capital structure and sustainable value creation. The higher the amount of variables that can be included in the factor model, the higher the success rate of the factor model. Keeping that in mind, only two independent variables (NOPAT and Price/NAV) highly represented Share price and only one independent variable (D:E) represented the Change in share price for the years 2006 - 2010. An interesting observation was that during 2007 - 2009 which includes the recession (Arieff et al., 2010; Davies, 2012) NOPAT and P:E were highly representative of Share price and D:E and EVA were highly representative of Change in share price. Due to the Change in Share price being more representative than the Share price it was concluded that especially during times of economic downturn sustainable value could be created by managing the Change in share price well. A negative change in share price will obviously reflect negatively on value creation and will decrease the firm value. D:E ratio and EVA within the ranges as applicable for the specific industry in which the company is operating should be used as a guide to manage the Change in share price well. Thinking about it, it makes good sense to manage your D:E ratio well during economic trying times because as recently experienced in South Africa and actually world wide; it is usually the companies with the greater debt that suffer because they are unable to honor their debt commitments. EVA can be seen as a good measure of performance as part of a Value Based Management system especially during times of economic downturn due to being an indication of the residual income created. Having residual income and savings during financially difficult times is like having a life jacket in the middle of a sea storm. Companies in the healthcare sector have many ethical and legal considerations that are special to the industry and possibly complicate the industry but should be used as leverage to compete more intelligently in the industry. Companies in the healthcare industry in South Africa should be encouraged to get listed on the JSE. More information would then be available for further research and the company can benefit due to having more capital available for larger projects and expansions (within their target D:E range). The results of the further research might then be more reliable due to a larger, more representative data pool.