Nonprofit Leaders’ Capital Structure Decisions in times of Fiscal Shock

Faculty Advisor Name

Dr. Margaret Sloan

Department

School of Strategic Leadership Studies

Description

Abstract

This paper evaluates the decisions Nonprofit leaders’ make in times of fiscal shock. It addresses the question how nonprofit leaders make spending and saving decisions in times of fiscal shock. It states that static trade off and pecking order literature depends on the 990 Form which may or may not be accurate. An experimental survey was designed together with three randomized scenarios. The survey was sent out to 2882 nonprofit leaders through the Nonprofit Organization Research Panel housed at George Mason University. We hypothesized nonprofit leaders’ conformity to the dynamic trade off strategy along with other influences of saving and spending decisions. Results indicated that most nonprofit leaders prefer to source finances internally before seeking for external finances.

Theory

The capital structure has been dominated by two broad theories: trade-off theory and pecking order theory. Pecking order theory predicts the order of financial sources whereby a hierarchy of costs is created by asymmetric information so that internal financing is more preferrable over external financing (Shyam-Sunder & Meyers, 1999; Frank & Goyal, 2003).

Static trade-off theory states that a firm whose goal is to maximize value will aim for an optimal capital structure. This means that nonprofit aims to achieve an optimal mix of equity(net assets) and debt while taking into consideration the benefits and cost of each alternative (Flannery & Rangan, 2006; Modigliani & Miller, 1963). A third option known as dynamic trade-off advocates for a theory that recognizes both pecking order and static trade off decisions (Yetman, 2007).

Literature

Several studies have examined the pecking order theory and the static trade off theory but there is no consensus on the superiority of one of the theories. The pecking order theory, Shyam-Sunder and Meyers (1999) estimate a simple regression of a firm’s net debt issued on the financing deficit and find out that for a small sample of firms that survive the entire 1971-1989 period, the pecking order model is an excellent first-order descriptor of financing.

Evidence on the static tradeoff theory is also mixed, as some evidence find that firms move relatively quickly towards their target debt ratio (Flannery and Rangan,2006). While other studies conclude that mean reversion happens at a snail’s pace (Fama and French, 2002).

Hypotheses

H1: Experienced nonprofit leaders will use a nuanced capital structure decision pattern that conforms to a dynamic trade off strategy rather than pecking order or static trade off behaviors alone.

H2: Financial security perceptions and prior experiences will impact spending and saving decisions.

H3 phase 2 : Areas of mismatch exist between spending and saving behaviors as interpreted by 990 data and responses made by decision makers.

Method

An experimental survey was designed including three randomized fiscal decision-making scenarios. The three scenarios were randomized and included: COVID 19, recession and political instability. The survey was distributed to 2882 nonprofit leaders in October 2021 via the Nonprofit Organization Research Panel housed at George Mason University.

Results

Results indicate that nonprofit leaders tend to utilize the internal finances first before sourcing externally.

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Nonprofit Leaders’ Capital Structure Decisions in times of Fiscal Shock

Abstract

This paper evaluates the decisions Nonprofit leaders’ make in times of fiscal shock. It addresses the question how nonprofit leaders make spending and saving decisions in times of fiscal shock. It states that static trade off and pecking order literature depends on the 990 Form which may or may not be accurate. An experimental survey was designed together with three randomized scenarios. The survey was sent out to 2882 nonprofit leaders through the Nonprofit Organization Research Panel housed at George Mason University. We hypothesized nonprofit leaders’ conformity to the dynamic trade off strategy along with other influences of saving and spending decisions. Results indicated that most nonprofit leaders prefer to source finances internally before seeking for external finances.

Theory

The capital structure has been dominated by two broad theories: trade-off theory and pecking order theory. Pecking order theory predicts the order of financial sources whereby a hierarchy of costs is created by asymmetric information so that internal financing is more preferrable over external financing (Shyam-Sunder & Meyers, 1999; Frank & Goyal, 2003).

Static trade-off theory states that a firm whose goal is to maximize value will aim for an optimal capital structure. This means that nonprofit aims to achieve an optimal mix of equity(net assets) and debt while taking into consideration the benefits and cost of each alternative (Flannery & Rangan, 2006; Modigliani & Miller, 1963). A third option known as dynamic trade-off advocates for a theory that recognizes both pecking order and static trade off decisions (Yetman, 2007).

Literature

Several studies have examined the pecking order theory and the static trade off theory but there is no consensus on the superiority of one of the theories. The pecking order theory, Shyam-Sunder and Meyers (1999) estimate a simple regression of a firm’s net debt issued on the financing deficit and find out that for a small sample of firms that survive the entire 1971-1989 period, the pecking order model is an excellent first-order descriptor of financing.

Evidence on the static tradeoff theory is also mixed, as some evidence find that firms move relatively quickly towards their target debt ratio (Flannery and Rangan,2006). While other studies conclude that mean reversion happens at a snail’s pace (Fama and French, 2002).

Hypotheses

H1: Experienced nonprofit leaders will use a nuanced capital structure decision pattern that conforms to a dynamic trade off strategy rather than pecking order or static trade off behaviors alone.

H2: Financial security perceptions and prior experiences will impact spending and saving decisions.

H3 phase 2 : Areas of mismatch exist between spending and saving behaviors as interpreted by 990 data and responses made by decision makers.

Method

An experimental survey was designed including three randomized fiscal decision-making scenarios. The three scenarios were randomized and included: COVID 19, recession and political instability. The survey was distributed to 2882 nonprofit leaders in October 2021 via the Nonprofit Organization Research Panel housed at George Mason University.

Results

Results indicate that nonprofit leaders tend to utilize the internal finances first before sourcing externally.