RDP 9216: The Evolution of Corporate Financial Structure: 1973–1990 2. The Data and Methodology

2.1. The Database

The financial statements for a sample of 224 companies have been collected, where available, for the period running from 1973 to 1990 inclusive. The data from 1973 to 1986 was obtained from records used in the compilation of the Company Review Supplement published by the Reserve Bank of Australia until April 1988. The original sources for the Company Review Supplement were the Company Review Service published by the Australian Stock Exchange and annual reports released by the individual companies. The annual reports were only used for unlisted companies. For the period from 1987 to 1990, the database had to be extended using the Company Review Supplement sources directly.

For each company, in each year, the balance sheet and the profit and loss statement were summarised into a standard form. The number of companies that existed throughout the sample period is 110. Of the 114 for which incomplete data exist, 22 companies commenced operations after 1973, while the remainder ceased independent operations prior to 1990. Appendix 1 lists all companies; asterisks mark those with incomplete data. The remainder of the paper uses the constant sample of 110 firms although Appendix 2 presents selected results using data from all 224 firms[5].

Not all companies share the same reporting date and, on occasions, companies change their reporting dates. On average, slightly more than half of the companies have a reporting date in the June quarter. The bulk of these report as at the end of June. Over a quarter of firms report as at the end of December with the remaining companies reporting at various times throughout the year. These various reporting dates make it difficult to line up the yearly figures with year to year movements in macro-economic variables. When comparing changes in financial behaviour with developments in the macro-economy, we generally treat the figure for a particular year as representing the end of the financial year.

2.2. The Ratios

In this paper we examine four key ratios calculated from firms' financial statements. These ratios are the debt-asset ratio, the interest cover ratio, the dividend pay-out ratio and the ratio of creditors to total debt.

The debt-asset ratio is defined as the net liabilities of the firm divided by its total assets (A) where net liabilities are equal to total assets less shareholders' funds (E). That is, the debt-asset ratio (D/A) is given by:

Included in debt are all non-equity sources of finance. This definition of debt is quite broad. It includes both interest bearing and non-interest bearing debt. This ratio is often referred to as a measure of gearing or leverage. Another popular measure of leverage is the ratio of debt to equity. In this paper we use the debt to assets ratio as our measure of leverage principally because it bounded between zero and one (for firms with non-negative equity). In contrast, the debt-equity ratio is bounded between zero and infinity. If equity is relatively low, then small changes in equity will lead to large changes in the debt-equity ratio. This may make it more difficult to detect important economic changes. The debt-asset ratio is much less sensitive to small changes in equity and allows a more straightforward presentation of the data.

The interest cover ratio (C) is defined as gross profits (π) divided by interest payments (I). That is:

Gross profits are equal to profits before interest, depreciation and tax have been deducted. The interest cover ratio represents the number of times that interest can be paid out of gross profits. The ratio can range between plus and minus infinity. Sustained deterioration in interest cover makes the firm more vulnerable to earnings shocks. Unlike dividends, interest payments must be made regardless of the firm's operating profits. Given a constant volatility of operating profits, the lower is interest cover, the higher is the probability that the firm will be unable to meet its interest obligations out of current profits.

The third ratio that we examine is the dividend pay-out ratio. It is defined as total dividends divided by net profits. Total dividends include both ordinary dividends (DO) and preference dividends (DP). Net profits are defined as gross profits less interest payments (I), tax (T) and depreciation (d). Thus,

One minus the dividend pay-out ratio gives the share of net profits that are retained by the firm. For many firms, these retained earnings are a major source of equity finance. Changes in the pay-out ratio reflect a variety of factors, amongst which taxation changes are perhaps the most important. Changes in the pay-out ratio by a firm may also reflect a desire to change the current share of debt on its balance sheet. For example, if a firm wishes to lower its debt-asset ratio or to improve its interest cover, it may elect to retain a higher proportion of its earnings than would otherwise be the case. For some firms retained earnings may be a more effective method of achieving balance sheet reconstruction than raising new equity directly.

The ratio of “trade creditors” plus “other creditors” to total debt indicates the relative importance of credit extended through sources other than financial intermediaries. The creditors to debt ratio shows how the increased availability of credit from financial institutions has impacted upon the usage of trade credit by firms. A-priori, one would expect trade creditors to become less important as financial liberalisation occurred.

It is a difficult task to summarise each of the ratios for all of the firms in a set of simple summary statistics. Amongst other alternatives, it is possible to use a simple average of the individual ratios, to take some form of weighted average or to use the median. Each statistic has its own advantages and disadvantages. We have chosen to examine a weighted average for each of the ratios across the individual firms. Using simple averages can lead to considerable volatility in the summary statistics when the individual ratios can take values approaching infinity. For example, if a firm has no debt then its interest cover ratio is infinite and the average across all firms becomes undefined. In calculating the weighted averages, each firm's ratio is weighted by the firms share in the sum of the individual firms' ratio denominators. For example, the weight for each firm in the debt to asset ratio is the firm's share of total assets.

It is possible that, in some cases, changing the weights could alter, in an important way, the behaviour of the average ratio. To ensure that our results are not driven by changes in just a few firms we also present graphs that show the “across firm” distribution of ratios. In particular, we graph the ratios for the 10th, 25th, 50th (the median), 75th and 90th percentiles of the distribution. This also allows some examination of whether changes in the weighted average reflect developments that are common to all firms or simply reflect large changes in small parts of the distribution.


In 1989/90, the total assets of our sample of 110 firms equalled $207 billion. In comparison, the aggregate liabilities and equity for the combined private corporate trading enterprises (from the Australian Bureau of Statistics Flow of Funds) was $437 billion in 1989/90. This figure of $437 billion excludes intra-sector liabilities and thus understates the true total assets of the sector. Also in 1989/90 aggregate earnings before interest payments and taxation (EBIT) is $22 billion for our sample of firms which compares to the National Accounts net operating surplus of $45 billion in 1989/90. (Net operating surplus is defined as income after depreciation.) [5]