Financial Flexibility in agricultural investment decisions: A discrete choice experiment

(ProQuest: ... denotes formulae omitted.)I. IntroductionEuropean farmers are constantly faced with changing framework conditions. In order to stay competitive, entrepreneurial adaptations are imperative. The associated investments predominantly are of increasing volumes and, consequently, farms' capital intensity increases. Therefore, comprehensive internal financing is hardly possible. In several European countries, this results in decreasing equity ratios for farms (Myrra et al., 2011). For example, average equity ratio of test farms of German BMEL, which generate their income mainly from agricultural activity, was 84.3% in financial year 2000/2001 (BMEL, 2001) and 79.6% in financial year 2010/2011 (BMEL, 2011a). On average, equity ratio of test farms of German BMEL owned by legal persons in East of Germany is with 64.6% (58.8%) below national average in financial year 2000/2001 (2010/2011) (BMEL, 2001, 2011a). Especially farms, which invested in livestock rearing, have occasionally an equity ratio of only 20% to 40 % (Bahrs et al., 2004: 12-13). In contrast, average equity ratio of German small and medium-sized enterprises was 15% in 2004 (Deutsche Bundesbank, 2006: 55). As a consequence of low equity ratios, farms' financial flexibility may become limited. In this context, financial flexibility is referred to as the degree of capacity and speed at which firm can mobilize its financial resources in order to take reactive, preventive and exploitive actions to maximize firm (Byoun, 2007: 2).Baker (1968), Barry and Baker (1971) as well as Baker and Bhargava (1974) investigate role of credits in liquidity management of farms. These authors came to conclusion that credit raising is associated with a loss in liquidity which involves opportunity costs and must be considered for operational decisions. Barry et al. (1981) ask agricultural bankers to decide about several hypothetical credit inquiries while farm's financial situation varies. The authors show that credit costs - sum of credit interest rate and opportunity costs for reduced credit reserves - negatively correlate with farm's income situation. In other words, if farm's maximum debt limit decreases due to a negative income situation of farm, remaining credit reserve diminishes, and resulting opportunity costs increase. Sonka et al. (1980) carried out a similar simulation experiment with agricultural bankers as well. The authors examined correlation between financial situation of a potential borrower and credit amount offered by a bank. From results of experiment, they derived that farms which had nearly reached their maximum debt limit jeopardize their access to bank credits and, thus, their credit reserves. Furthermore, agricultural bankers consider debt equity ratio and, therefore, farm's risk-bearing capacity, as an important and decisive factor for lending. However, in context of investment decisions, opportunity costs of debt capital or term 'financial flexibility' have not been discussed in recent agricultural economic publications.Relevant literature to aforementioned subject can primarily be found in field of economic sciences. Qualitative studies, for example by Graham and Harvey (2001), highlight maintenance of financial flexibility as an important decision-making factor for investment decisions. Gamba and Triantis (2008) develop a model and show by means of a simulation that value of a firm's financial flexibility can be measured. Here, costs of external financing of firm are influential for value as well as expectations regarding future financial needs and investment options. DeAngelo et al. (2011) develop a capital structure theory which is based on financial flexibility. They consider debt capital as a scarce resource that involves increasing costs more frequently it is used. …