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How financial statements in Mexican firms reflect changes in the financial/economic environment from 1978 to 1996

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How financial statements in Mexican firms reflect changes in the financial/economic environment from 1978 to 1996

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HOW FINANCIAL STATEMENTS IN MEXICAN FIRMS
REFLECT CHANGES IN THE FINANCIAL/ECONOMIC
ENVIRONMENT FROM 1978 TO 1996
by
Gabriel Orozco
A Thesis Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillm ent o f the
Requirements for the Degree
M aster of Arts (Economics)
December 1998
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U N IV ER SITY O F- S O U T H E R N C A L IFO R N IA
T H E G R A D U A T E S C H O O L
U N IV E R S IT Y P A R K
L O S A N G E L E S . C A L IF O R N IA 8 0 0 0 7
This thesis, w ritten by
^ g ^ /v e / _ _ ( 9 p q - £ £ 0 _______
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and approved by all its members, has been pre
sented to and accepted by the Dean of The
Graduate School, in partial fulfillm ent o f the
requirements fo r the degree of
M a s t e r o f A r t s i n E c o n o m ic s
Tint* December 10, 1998
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ABSTRACT
This paper analyzes the ability of different kinds of firms to adapt to the several important
changes in the financial/economic environment in Mexico from 1978-1996.
The firms studied are differentiated as being exporters or non-exporters, and “grupo” (firms
associated to a conglomerate of firms) or “non-grupo” (independent firms).
The responses to macroeconomic and institutional changes are studied using a model
previously used to analyze these kinds of changes in several South-American countries during
the 1970’s and 1980’s. The paper focuses on the extent to which and how these adjustments
differ between different kinds o f firms.
The data was obtained from the balance sheet statements o f firms listed in the Mexican Stock
Exchange (BMV). The firms used in the study are a subset o f firms previously analyzed by
Enrique Rayon (1991) and include only those twenty six (26) firms that are still trading on the
BMV up to 1996. The results show the extent to which the overall performance (earning
ratios) of grupo-firms is better due to easier access to credit (and at a lower cost). The results
also demonstrate how the performance o f exporters differs from than non-exporters, before,
during, and after sharp devaluations of the national currency.
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TABLE OF CONTENTS
PAGE
INTRODUCTION------------------------------------------------------------------------------------ 01
PARTI
THE THESIS------------------------------------------------------------------------------------------03
PREVIOUS STUDIES------------------------------------------------------------------------------- 06
THE CASE OF MEXICO---------------------------------------------------------------------------- LI
PART 2
GRUPOS-----------------------------------------------------------------------------------------------15
GOVERNMENT INTERVENTION----------------------------------------------------------------18
CREDIT MARKETS--------------------------------------------------------------------------------- 20
THE ROLE OF UNCERTAINTY------------------------------------------------------------------ 23
PART 3
FINANCIAL & ECONOMIC DEVELOPMENTS THROUGH THE YEARS----------------- 25
PART 4
DESCRIPTIVE ANALYSIS OF RELEVANT RATIOS TO CALCULATING EARNING RATES
NET EARNING RATE 3 5
GROSS MARGIN-------------------------------------------------------------------------------------36
OVERHEAD EXPENSE----------------------------------------------------------------------------- 37
ASSET TURNOVER---------------------------------------------------------------------------------38
INTEREST RATE, EXCHANGE RATE AND INFLATION RATIOS------------------------- + 0
GEARING RATIO------------------------------------------------------------------------------------ 4 -2
PARTS
THE MODEL------------------------------------------------------------------------------------------4 - 3
HYPOTHESIS-----------------------------------------------------------------------------------------48
RESULTS----------------------------------------------------------------------------------------------49
ANALYSIS OF PREVIOUSLY STUDIED FIRMS NO LONGER TRADING--------------- 62
CONCLUSIONS--------------------------------------------------------------------------------------68
BIBLIOGRAPHY-------------------------------------------------------------------------------------70
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1
INTRODUCTION
The objective o f this paper is to analyze the adjustment process taken by corporate firms during
the macro-economic and financial changes that occurred in Mexico from 1978 to 1996.
The Mexican economy suffered dramatic shocks and underwent considerable institutional
change. During this period, two crises, one in 1982 and another in 19941 , caused GDP to
decline sharply, affecting corporate earnings. As a consequence of the two crises, the Mexican
government implemented economic policies to deal with rising inflation and currency
depreciation in order to improve the economy.
This thesis follows a previous study by Enrique Rayon (1991). The study expands on Rayon's
previous study covering the years 1978 to 1991 by including the latest financial crisis in
Mexico (1994-1995) and the recovery of 1996.
By 1996 only 26 out of the 68 firms previously studied by Rayon were still trading in the
Mexican Stock Exchange. The use of the remaining 26 firms in this study is done in order to
maintain consistency with firms previously analyzed, and enable us to compare and contrast
some of the results obtained by analyzing the new financial crisis o f 1994-1995 to previous
corporate behavior.
1 The first crises in 1982 was due to high levels of sovereign debt, which combined with a sharp fall in
oil prices, Mexico’s primary export good. The second crises in 1994 was due to a highly negative
Balance of Payments.
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2
Macroeconomic and financial shocks can be expected to have differential effects on the
performance o f different types o f firms. For example, we can expect producers of exportable
and importable goods to perform better than, non-tradables when there is a devaluation o f the
national currency. Exportable goods may become cheaper for foreigners to buy, which means
an increased demand for these goods. The relative price of traded goods rises relative to non
traded goods, thereby, raising the profitability of exporting.
A distinction will be made between different lands of Mexican firms in order to analyze their
adjustment to the changing environment:
a) Firms affiliated with conglomerates (grupos)
b) Independent firms (non-grupos)
c) Producers o f exportable goods and
d) Producers o f non-exportables.
The method used to analyze the financial statements o f firms was developed by Galvez and
Tybout (1985), Petrei and Tybout (1985), and De Melo, Pascale and Tybout (1985). After the
debt crisis suffered by many Latin-American countries in the 19807 s, the World Bank supported
these studies to better understand the micro-level effects of the financial crises experienced by
these countries and in order to implement policies to help their economic development.
This paper is divided into 5 different parts:
Part 1 starts with an introduction to the analytic device and explains how the net earning rate is
determined by specific characteristics of the firm. Part 1 also surveys previous studies on South
American countries, including Rayon’s study on Mexico from 1978 to 1991.
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3
Part 2 describes the role o f firm affiliation, government intervention, credit markets, and
uncertainty in determining the profitability o f a firm.
Part 3 describes the macroeconomic as well as the financial setting in Mexico from 1978 to
1996.
Part 4 relates macroeconomic and financial factors to the ratios that determine corporate
earnings.
Part 5 starts with the econometric explanation of the analysis followed by the results. Part 5
also includes a comparison between previously studied firms that no longer trade in the
Mexican Stock Market (BMV) and these previously studied firms still traded on the BMV.
PART I
THE THESIS
The data used to perform this study is obtained from balance sheets o f firms from the Mexican
Stock Exchange’s (BMV’s) annual report (Anuario Financiero). State owned enterprises
(SOE's), as well as private companies in the mining and service sectors, are omitted from the
study because they respond in different ways than other companies due to the especially strong
regulations affecting their performance.
The framework used in the analysis permits a disaggregation of the net rate of return into a
number of components, both real and financial. After one distinguishes different financial
regimes and macro-economic changes, such an analysis allows one to test the significant
differences in firm behavior in light of such changes.
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Moreover, the formula format is designed to include macroeconomic factors that influence the
model, such as interest rates, exchange rates, and inflation. These financial factors affect net
financial costs, and the ability to adapt to financial changes. The firms net earnings are affected
by losses or gains depending on their monetary position, the rate of interest, the rate o f inflation,
and the exchange rate. Furthermore, special attention is given to each firm’s earnings, since
such earnings reflect how well a firm adapts to changes in the financial environment.
The basic framework is:
r=[(a-b) c-(d + e + f ) g ] [ l / ( L - g ) ]
r= net earning rate;
a= gross margin;
b= overhead expense ratio;
c= asset turnover ratio;
d= interest expense ratio;
e= exchange rate loss ratio;
fi= inflation loss ratio;
g= gearing ratio;
(1)
(Net Income/ Net Worth)
(Gross Profit/ Net Sales)
(Operating Expenses/ Net Sales)
(Net Sales/ Total Assets)
(Interest Expense/ Total Liabilities)
(Exchange Rate Loss/ Total Liabilities)
(Inflation Losses/ Total Liabilities)
(Total Liabilities/ Total Assets)
First of all, (a-b)c is the contribution to real factors to the net equity return. "Real" factors are
sales, operating expenses, gross profits and total assets, We can consider ratios a, b, and c as
indicators o f capacity utilization.
Furthermore, (d+e+f) represents the contribution of financial factors to the rate of return. The
financial factors are net interest expenses, net exchange rate losses, and net inflation losses, and
are influenced by the gearing ratio. As a firm’s gearing level increases, the effect of changing
interest rates, inflation, and exchange rates will also increase.
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Finally, the gearing ratio, g, works in equation (1) both as a weight for the financial factors and
as a part of the overall multiplier (l/(l-g)) component. Firms change their gearing ratios,
depending on the availability of external funds and the cost of those funds.
The framework is used in order to analyze the earnings and the adjustment behavior of different
firms across sectors and across different periods of time. It will also help us to understand how
the various explanatory ratios of the firms adapt to a changing environment.
Moreover, to facilitate overall conclusions of the analysis, the individual years of the overall
period 1978-1996 will be aggregated into the following five periods according to their primary
characteristics.
Period I (1978 to 1981). Economic boom, with high investment and high GDP growth rates.
Period 2 (1982 to 1988). Massive capital flight, lack o f access to private lenders,
and complete reliance on official credit sources.
Period 3 (1989 to 1993). Massive returns of capital from abroad, large increases in
direct fund investment, portfolio investment, and bond placement.
Period 4 (1994 to 1995). Capital flight, decreased productivity, and speculative
attack on the currency.
Period 5 (1996). Resumption of expansion in credit and productivity.
Accordingly, the different periods under study characterize periods o f economic stagnation and
economic boom. Low GDP growth, high inflation, and low real interest rates, are
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6
characteristics of periods of economic stagnation. High GDP growth, low inflation, and more
stable rates of interest and return of international credit are characteristics of economic booms.
PREVIOUS STUDIES.
Firm level responses to financial development and economic growth have previously been
studied in other Asian and Latin-American countries. These studies show that firm level
responses depend on the individual circumstances of each country, such as macroeconomic
instability. In some cases, financial repression returns after new macroeconomic polices fail.
The method of analyzing financial statements began with works o f Galvez and Tybout (1985),
Petrei and Tybout (1985),and De Melo, Pascale and Tybout (1985). The studies were part of a
World Bank research project directed to understand the financial crisis experienced in late
1970's and early 1980's which resulted from liberalization and stabilization policis prescribed
for the Southern Cone countries, Argentina, Chile, and Uruguay.
Furthermore, the availability of data motivated the International Finance Corporation (IFC) in
1989 to engage in a major research project to systematically study corporate finance in
developing countries. (Singh and Hammed 1992).
How Vie Financial Statements o f Argentine Firms Reflected Stabilization and Reform Attempts dunng
1976-81, A. Hubert Petrei & James Tybout (1984)
In early 1970’s, Argentinean policy-makers launched an economic program to remove price
controls, interest rate ceilings and international trade barriers, and at the same time tried to
lower inflation rates. These steps induced economic recovery and were reflected in higher
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7
corporate earnings, but a changing economic environment caused the Argentinean economy to
fall into a recession by L981, lowering corporate earnings.
Tybout and Petrei (1984) analyzed the financial statements of 115 public firms, divided into
three categories: l)Exportable good producers, 2)ImportabIe good producers, and 3)Non-
tradable good producers.
The results in this study indicated that large subsidies in the form o f real peso appreciation in
the early 1970’s, and a exchange insurance program in 1981, combined to lower corporate
financial costs for the industrial sector. The subsidies provoked large incentives to assume risky
financial structures that worked against Argentinean firms when the subsides were removed.
For instance, average earning rates in Argentina increased thanks to an exchange insurance
program in 1981, but the volatility of earnings continued to rise. Both importable and non-
tradable good producers suffered reductions in their capacity utilization which combined with
several mini-devaluations to cause several firms to go bankrupt.
In addition, the earnings decline of 1980 was caused in large part by a large increase in real
interest rates. Also, tradable good producers decreased their gross margins when the peso
appreciated.
How the Financial Statements in Uruguayan Firms in 1973-81 Reflected Stabilization and Reform
Attempts- Jaime de Mei o, Ricardo Pascaie & James Tybout (1985).
These authors divided the Uruguayan experience between 1973 and 1981 into three phases,
each with different economic characteristics. During the first phase, corporate earnings where
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8
low, but firms survived with the help of negative financial costs caused by highly negative
domestic real interest rates. Then, in the second period the financial cost increased sharply, but
operating earnings increased sufficiently to offset the increase in financial expenditures. Finally,
in the third period, firms faced even higher financial costs, and since this time operations
earnings did not increase as rapidly as financial costs, the net earning rate of Uruguayan firms
fell.
The earnings behavior for different types of firms in Uruguay followed different patterns. The
second phase was characterized by export promotion schemes, which served to increase the
operating earnings of export good producers as compared to other firms. Conversely, export
producers lost their edge in the third period when export promotion polices were cancelled;
moreover, the real exchange rate appreciated as the government implemented economic polices
in order to reduce inflation. As a result, import competing sectors experienced boom, while
export good producers experienced decreasing net returns.
How Firms Adjusted to the recent reforms in Argentina, Chile and Uruguay.
Victor Corbo and Jaime de Mei o (1985)
This paper studies, among other issues, how uncertainty complicates an efficient management
o f inventories that might cause a drop on earnings . Also, enterprises may be unsure about how
much capital they will have access to and at what cost, thereby affecting the efficient allocation
o f resources. Corbo and de Melo (1985) noticed that restrictions imposed on the economy
usually include quantity restrictions that result in large rents, which induce economic agents to
expend much o f their effort appropriating rents rather than engaging in activities that would be
more socially productive.
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The liberalization of financial markets in these South-American countries was intended to reach
a new long-run equilibrium position in which existing resources and investments are better
allocated and better used. With less uncertainty and a longer planning horizon, the planning for
resource allocation is much easier and the cost o f making mistakes reduced. In this
environment, firms devote much o f their effort to improving their operations.
Conversely, one of the problems with liberalization is that actors may judge that the reforms are
not sustainable; therefore, postponing adjustment. If the reforms are implemented in a
progression of small pre-announced steps, the short-term adjustment cost to the economy could
be moderated and the credibility of the measures enhanced.
In effect, in each country the goal was to reduce government intervention in the economy and
increase the role of market forces and private firms. This goal was to be achieved by
eliminating quantitative restrictions on trade, lowering tariff barriers, and opening the doors to
international trade and capital flows.
Moreover, because of unusually high rates of inflation, the reform packages included a
combination o f stabilization and liberalization polices. The stabilization polices were primarily
aimed at bringing down the three digit levels of inflation. Indirect deregulation of the product
market was achieved by the privatization of many government owned enterprises.
Deregulation of financial markets was a common feature of the reforms in the three countries. It
was important because these countries had for many years relied heavily on non-price
allocations of credit, accompanied by highly negative domestic real interest rates.
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In Argentina, however, public enterprises were not privatized, the reason given by the military
government being that reforms should avoid creating unemployment and social unrest. This lack
of credibility o f public government reforms in Argentina was pervasive and can be traced to a
history o f unsuccessful liberalization attempts. For instance, during the reforms, a price freeze
was aborted in 1977, and the schedule of announced tariff reductions aimed to reduce inflation
by reducing the prices of foreign inputs was broken; both actions reduced the credibility of the
tariff reforms, impeding the success of Argentinean economic policy.
In Uruguay, price controls were nearly eliminated by the end o f 1979. In 1977 the maximum
tariffs were reduced from 150% to 90%.
In all three countries, domestic capital markets were substantially deregulated in two ways.
First, interest rate ceilings were progressively eliminated. Second, restrictions on financial
intermediaries were reduced, and attempts were made to open the economy to international
capital flows.
Not surprisingly, as the cost of working capital denominated in pesos eventually soared in all
three counties, managers spent more time on inventory management controls. During the pre
announced exchange rate policy, the spreads between the cost of peso loans and dollar loans
increased substantially, following a drop in the cost of the latter. During this period, managers
turned from production management to financial arbitrage to make short-tum profits by
borrowing dollar-denominated funds and lending in pesos. Such arbitrage was not the intent of
the reforms and certainly detracted from the long-run objective of rationalizing production
within firms.
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When doubts about the sustainability o f the exchange rate policy set in, the interest rate spread
between pesos and dollars increased. By this time, the portfolio composition o f firms was often
difficult to adjust and extremely vulnerable to a devaluation.
In Argentina, the appreciation of the real exchange rate was linked to the use of the exchange
rate as an anti-inflationary tool. Volatility in financial cost was accompanied by opportunities
for lucrative financial arbitrage.
THE CASE OF MEXICO
Rayon (1991) distinguished three distinct financial regimes on Mexico (Boom 1978-1981,
repression 1982-1988, and liberalization 1989-1991).
Mexico’s government established FICORCA (Fideicomiso para la Cobertura de Riesgo
Cambiario) in April o f 1983. It was a trust designed for the repayment in pesos of foreign-
currency denominated debt of business. Member companies immediately benefited from
affiliation to FICORCA since the fund was established in order to provide a mechanism for
restructuring and defer their interest and principal payments on foreign debts contracted prior to
December 1982.
Financial factors, such as the funding of FICORCA and ex-bankers’ brokering of “Certificados
de la Tesoreria” (CETES; government securities often paying higher-than-inflation interest
rates), provided firms with the ability to achieve financial gains when used as inflation hedges.
These negative financial costs helped the firms to improve their working capital by way of gains
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from interest and exchange rate devaluation after having successfully reduced their foreign debt
exposure.
The difference between security markets and banking returns on deposits increased due to the
setting of interest rate ceilings on bank deposits. In fact, government deficit financing via
CETES strengthened the development o f the non-bank financial system.
With unprecedented economic uncertainty immediately following 1982, it was not until the
1985 trade reforms and the 1986 accession of Mexico into GATT that the economic planning
horizon of many firms was extended.
Furthermore, financial system experience and learning effects from banking were retained by
grupo-firms after the bank nationalization of 1982, mainly because these and the associated
information networks could not be appropriated by government decree.
The initial shift to an equity-based industry was possible since the return on own real assets was
less than the average real cost of borrowed capital. As a result, the gearing ratio fell, thereby
increasing earnings and the return to equity from 1982 to 1988.
Moreover, a firm's net monetary position, i.e., assets less liabilities (short or long positions),
determined the basis for net financial cost from losses (or gains) realized by the effects of
interest rates changes, currency devaluation, or inflation on earnings.
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The real exchange rate appreciation of 1987 was transmitted to earnings on the financial side of
the model. Non-grupo and exporter firms apparently made significant gains due to their long
position after firms had diminished their foreign debt levels.
Asset turnover and operating asset ratios are viewed as a reflection of capacity utilization which
can grade an economy’s performance. As expected, the minimum ratios were found in 1982
following the bank nationalization and flight of savings abroad.
The interest expense ratio demonstrated a steady increase until 1986, when firms engaged in
foreign-currency denominated debt contracting, leading to lower interest expenses with respect
to total liabilities. Moreover, high inflation rates caused financial gains from short monetary
positions, which reached their maximum by 1986. These were not large enough however, to
counter the increase in other financial expenses.
The significance of the 1982 financial crisis and bank nationalization in Mexico rested
primarily on the inherent ability of the financial sector to undergo structural change by means of
a combination of institutional changes and market forces leading to endogenous financial
development.
The real exchange rate appreciation of 1987 contributed to earnings on the financial side of the
model. Both non-grupo firms and exporters apparently made significant gains due to their long
position after firms had diminished their foreign debt levels.
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Asset turnover and operating asset ratios are a reflection o f the capacity utilization of the
economy. As expected, capacity utilization reached its minimum in 1982, following the bank
nationalization and flight of savings abroad.
The interest expense ratio demonstrated a steady increase until 1986, when firms engaged in
foreign-currency denominated debt contracting, leading to lower interest expenses with respect
to total liabilities.
High inflation rates caused financial gains from short monetary positions. These reached their
maximum in 1986, but were not large enough to counter other financial expenses.
The difference between the returns on security markets and the returns on bank deposits
increased due to the setting of interest rate ceilings on bank deposits. Dis-intermediation in the
banking sector translated into deepening in security-based markets. Li feet, government deficit
financing via CETES strengthened the development o f the non-bank financial system.
Economies of scale in banking were an implicit assumption made by policy makers in the
regulations designated to restructure the commercial banking system in 1976 to allow for
multiple-service universal banks.
The effects of the “North America Free Trade Agreement” (NAFTA2 ) on the financial sector
were to increase competition and efficiency among financial intermediaries of all types. The
concentration o f credit in the hands of a small group o f firms is most likely to be dissipated
since NAFTA allows for a full range of services at the national level involving banking,
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15
insurance, and securities markets, that should extend credit to firms without previous access to
it.
Since L988 considerable growth, was expected in retail lending mainly to small firms and
consumers who had been excluded from the credit market. Rayon considered the possibility
that, as the margins decreased, banks would find higher-risk borrowers more attractive, having
the potential for increasing defaults and non-performing loans. This situation would possibly
result in bank failures. Rayon’s forecast turned out to be realized as a series of non-performing
loans damaged bank’s profitability in 1993.
PART II
GRUPOS
The international integration of the 1970’s in Mexico (First Security Market Law of 1975)
institutionalized brokerage houses and specified minimum capital requirements for such
activities. After the 1977 and 1978 introduction o f petrobonos and CETES, wealth and
financial resources became increasingly centralized and concentrated in the hands of the
relatively small number of conglomerates. These conglomerate-firms are identified as grupo
firms. The “grupo” is a diversified and integrated institution which participates in several
product markets, and the financial market.
Grupo-firms have several advantages in obtaining finance when needed. First, their affiliation
with financial institutions (even after the bank nationalization of 1982). Second, their
production diversification, making them low risk borrowers.
2 In 1993
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L6
Mexican banks were able to increase profits by holding the assets of industrial and commercial
companies since earnings from subsidiaries dividends were tax-free. In fact, subsidiary
dividends provided banks with an additional incentive to become holding companies and engage
in preferential lending to grupo firms, frequently at below-market interest rates. The grupo
structure allowed banks to bypass Central Bank rediscounting and credit controls through inter
bank lending at preferred interest rates, facilitating credit rationing in favor of grupo-firms.
Accordingly, these differences among firms gain importance when we note that grupo-firms
have, through most o f Mexico’s recent economic history, owned most of commercial banks and
other financial institutions in the country. Grupo ownership of banks gives them an advantage
over non-grupos if we consider access to credit important for development.
In general, low cost bank finance commonly goes to well connected firms, such as grupo firms.
This contributes to earning differences between the well-connected grupo-firms and independent
ones. High real interest rates affect the cost of production by increasing the price of capital.
Grupo firms with access to lower interest rates can realize lower costs of production, positively
affecting their performance and allowing them to earn higher net returns on investment,
especially in periods of credit scarcity.
The linkage of financial and industrial capital is important for two reasons. It creates a situation
where industrials can finance expansion "internally", meaning that they do not have to rely on
state funds, especially in periods of scarce credit due to government regulation o f funds.
Financially well-connected grupo-firms became relatively immune to state efforts to guide
industrial development by manipulating interest rates or the quantity of money.
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In effect, the architects of the Bank nationalization o f Mexico in 1982 intended to break up the
power of financial-industrial conglomerates. They also intended to increase government control
over investment patterns, and help to improve the state's financial position. The banks were
nationalized in September 1982, but the power of the conglomerates made it difficult for the
government to implement all its polices. After a short time, grupo firms recovered the
ownership of non-bank financial institutions, creating once again, a link to non-govemment-
regulated credit.
Sometimes, governments choose to impose low ceilings on interest rates. Mexico adopted this
strategy in the 1980's, and the ceilings sometimes did not even cover the administrative cost and
potential default risk inherent in small-scale lending, which created negative real returns of
interest after 1982’s Bank nationalization. Under these circumstances, banks had to look for
low risk borrowers to ensure the best loan performance record. In order to accomplish this,
banks had to direct loans to those firms with large visible incomes and asset holdings or low
risk enterprises, i.e., grupo-firms.
Nonetheless, the allocation of new credit faced some difficulties. Expanding financial resources
for riskier investors was not costless. The detailed information required by bank loan officers
can prove expensive to supply in terms of skilled labor. Even so, risk is high, and collateral may
not be available. Accordingly, the expected equilibrium rate of interest charged to non-grupo
firms should reflect lending cost accurately; therefore, the cost of money should have been
higher for non-grupo firms than for grupo-firms.
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18
GOVERNMENT INTERVENTION
Governments often choose to mobilize factors of production by manipulating commodity prices,
imposing trade barriers, or by charging different rates of interest in order to favor some sectors
of the economy at the expense o f others.
As a result, government policy can affect corporate earnings in many ways. For instance, loose
fiscal policy could increase aggregate demand, which would increase firm turnover ratios,
which in turn will increase corporate earnings, ceteris paribus. Another way for governments to
influence corporate earnings is by increasing export barriers, negatively affecting the ability of
export good producers to increase earnings.
The negative effects and inefficiency of financial repression were explored in the works of
McKinnon (1973) and Shaw (1973). Interest rate controls and quantity restrictions on loan
allocations have been shown to be sub-optimal for economic development. In their models, the
financial sector is considered to be of great importance for economic development. McKinnon
(1973) found that distortions in exchange rates and real interest rates originated from financial
policies, reducing the real growth of the economy and the real size of the financial system.
The Mexican government took over the banking system in August of 1982, with the underlying
intention to allow the government to regain control of the monetary system by controlling all
international capital movements and establishing foreign exchange controls. According to
Maxfield (1990), the nationalization of the Mexican banks was provoked by the lack of state
capacity to induce and guide industrial investment.
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19
Mexico showed signs of what McKinnon and Shaw called financial repression in the middle o f
the 1980's when, as shown in Table 1, real rates of interest turned negative. At such very levels
of real interest rates, investment is considered to be positively related to real rates of interest
because the lower the leveL of real interest rates, financial resources may be prevented from
being efficiently allocated into financial activities that can induce growth.
TABLE 1
Real Interest Rates in Mexico
10.00
(10.00)
(15.00)
(20.00)
Real Interest Rates
World Bank (1998)
YEAR
The opportunity to obtain financial gains through favorable government policies created
monopoly rents for the holders o f import licenses and credit. Opportunities for speculative gain
on the foreign exchange market were open for those firms favored by a dual exchange rate
system.
Furthermore, as seen in Table 2, credit rationing by the Mexican government during the 1980's
resulted in funds rationed directly or indirectly through development banks. In most developing
economies, credit rationing is expensive to administer, and vulnerable to corruption.
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20
50.00
TABLE 2
Mexico's Government Credit to Private Sector
40.00
9 30.00 -
20.00
1 0.00 - r
Credit to Private Sector f% of GDP1
World Bank (1998)
YEAR
Shaw (1983) noticed that when financial systems are liberalized, investment opportunities
emerge as firms to put less effort and expense into obtaining loans, export permits, or foreign
exchange allowances, thus allowing the firms to focus their effort on optimizing production,
thereby reducing the cost of transactions and increasing their return to equity.
Nonetheless, liberalizing a country’s financial system is a difficult task because fundamental
disequilibrium is a characteristic of the lagging economies' foreign-exchange markets.
Moreover, unpredictable changes in the relative price of domestic money or unforeseen patterns
of intervention to stabilize may inhibit growth (McKinnon 1973). McKinnon (1973) also
noticed that, where there is a distortion of financial prices, including interest rates and foreign
exchange rates, the size of the financial system fells in relation to the size of non-financial
markets. This is inefficient and inhibits economic growth.
CREDIT MARKETS
Credit markets play an important role in determining firm profits because supplemental
financing from outside the firm is sometimes needed to undertake high-productivity investments.
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21
Government economic policy then affects economic decisions even more heavily by restricting
credit markets.
Organized finance in developing economies is dominated by the banking system, which often
behaves as a high cost, high profit oligopoly. Stock and other parallel markets are limited to
short-term transactions at high risk because of borrower default and government repression. For
example, throughout most of the L980's, in Mexico, credit was directed to the private sector
through the government-owned banks which dominated the financial system.
McKinnon (1973) noticed that real financial growth does not occur unless nominal money is
under control, or unless the inflationary effects of monetary policy are compensated by changes
in relative prices, including interest rates and foreign exchange rates.
Moreover, Rayon (1991) noticed that savers with no taste for negative real deposit rates, and
borrowers excluded from credit rationing, have to look for alternative markets that satisfy their
needs. Sometimes they can find such finance in the stock market, the rate o f return is typically
higher than deposit rates.
In general, the effects of repression of organized finance is to increase the amount of funds
demanded on the stock market at each rate of interest. This is because the stock market often
offers real rates of interest higher than banks (private as well as government own), and credit is
easier to obtain by selling companies' stock when credit is heavily regulated by government
policy.
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22
Stiglitz and Weiss (1981) noticed that increasing the availability o f loans in developing
countries will not decrease the interest rate when the equilibrium rate is a product of credit
rationing. Only until credit rationing disappears will an increase in available loans decrease
interest rates.
Moreover, credit rationing exemplifies Mexico's credit system for most of the 1980's, and again
in 1995. Credit rationing is the result o f the shortage of credit because of excess demand for
available funds. One way to explain this phenomenon is as a short-term disequilibrium; a
temporary disequilibrium induced by an exogenous shock, such as the Chiapas uprising of 1994
(a southern state in Mexico).
Another way to explain credit rationing is as a long-term disequilibrium; caused by
governmental constraints. We can find both long and short-term disequilibrium in Mexico in the
past two decades. A dual exchange rate system, interest rate ceilings, and prohibitive reserve
requirements have caused long-term disequilibrium in Mexico from 1982 to 1988.
Overall, access to foreign credit was made easier to obtain due to technological advances, which
help the economic recovery of late 1980's. However, the easy flow o f funds in the past few
years had a negative effect in Mexico in 1994. Large amounts of financial instruments were
liquidated as instability increased in Mexico. In fact, the dependence on foreign credit could
cause economic stagnation when foreign credit is drawn away from an economy due to the
possibility of a sudden shift in depositors preferences that might draw credit away from one
country to another.
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23
THE ROLE OF UNCERTAINTY
Sir John Hicks wrote in 1904, "It is not only savings that are required, but a channel of
communication between potential savings and potential real investment".
Where there is uncertainty, the desire to avoid risk may make nominal rates of interest look too
high for borrowers and too low for depositors. Since uncertainty is related to time, financial
commitments will be primarily limited to the short term when uncertainty runs high. With
moderate inflation, nominal rates o f interest can be raised from low ceilings to reflect expected
movements on price and risk.
That is, uncertainty shortens the time horizon over which firms will borrow, causing finance to
be of the very short term variety in a repressed economy; therefore, the fear of drastic changes
makes loan terms very short in order to minimize investment risk. For instance, by controlling
the financial system, the government increases the risk of a drastic change and causes the
average length o f loans to decrease, as seen in the following graph (Table 3).
TABLE 3
Mexico's Government Short-Term Debt
35.00
30.00
25.00
20.00
10.00
Short-Term Debt
f% of Total External Debt)
World Bank (1998)
YEAR
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24
Moreover, there are economies o f scale from specialization on the loan function, such as the
improvement in the assessment and distribution of risks, and the flow of information that
reduces uncertainty. That is, the reduction of uncertainty can decrease the financial cost of
production by lowering the amount of paid interest on loans.
Therefore, allocative waste could be reduced, even by modest investment in data banks.
Measures to raise the real rates o f returns on financial assets, to reduce the variance of returns,
and to improve financial technology, along with allied measures in non-financial areas could
extend saver's horizon.
Nevertheless, moderating uncertainty and reducing the fragmentation of capital markets require
careful monetary and financial policy. After more than a half decade of instability, Mexico
established in 1988 a pact called Solidaridad (Solidarity) as part of a new economic package
aimed at decreasing financial restrictions and instability. Solidaridad was a program where
government, consumers, and producers agreed on the reduction of inflation. The program
proved credible.
Financial growth allows capital markets, stock markets, and commercial and national banks, to
be integrated, reducing interest rate differentials. The subsidies obtained on low interest rate
loans from national banks to help '’essential" industries will decrease, thereby, decreasing the
inter-industry difference between investment yields. Policies that induce financial growth could
reduce uncertainty regarding forward rates o f return on financial assets.
Developing economies have greater volatility on macro-economic indicators than developed
ones. This higher volatility affects the exchange rate market by including a risk premium on the
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25
value o f developing economies' financial instruments. The risk premium on developing
economies' currency that increases the real rate of interest, makes access to credit even more
difficult.
hi effect, alternative devices such as forward exchange markets can help in the battle against
uncertainty, but it could also fell short o f optimality from the stand point of the trading
community due to insufficient information. Forward and future markets can diminish the power
o f financial crisis to damage the international financial system and the world economy by
absorbing some of the force of an economic shock.
PART n i
FINANCIAL & ECONOMIC DEVELOPMENTS THROUGH THE YEARS.
Until the 1982 bank nationalization, Mexican economic policy had been shaped by the struggle
between two competing policy alliances: the Cardenas coalition, and the banker's alliance. The
Cardenas coalition was formed of workers alliances, while the banking alliance was made up of
private bankers, many dating to the Porfirian era (1876 - 1911), as well as, large-scale traders
and industrialists, and public sector monetary authorities.
The economic boom of late 1970’s and early 1980’s in Mexico was stopped in part by the fell
in oil prices in 1981, leading to a strong need to devalue the peso. But the resistance to devalue
the national currency occasioned a large outflow of capital between April and December of
1981. Foreign loans allowed the President to delay the devaluation of the peso for a few
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26
months, but the cost o f this delay was financial instability and further capital flight, which
ended in a sharp devaluation of the domestic currency in 1982.
In effect, the outflow of funds in the early 1980’s was partially due to a fall in the real rate of
interest in Mexico, relative to the rest of the world. Investors, looking for a higher return on this
investment portfolios, decided to purchase foreign money instruments in the early 1980's, and
again in 1994-95, In both cases, this pushed the demand for the peso curve to the left, resulting
in a lower equilibrium for the peso.
In September 1, 1982, Mexico’s government nationalized all private banks. With this action,
the state became the owner and administrator of the financial system. The government chose
this action in order to increase its control of the monetary system and the flow of international
funds, thereby, increasing the strength of its economic polices.
Credit allocation by the new banking system created a credit shortage, which drove domestic
interest rates up in 1982, making it more costly for firms without strong links to financial
institutions to obtain credit. Financing obtained through the parallel system (i.e. the financial
system used for inter-firm borrowing) was 20% cheaper, however, this source of financing was
limited to grupo corporations fisted on the Mexican Stock Exchange (Rayon 1991).
In 1983 the Mexican government established a fund to absorb some of the cost of the risk
involved in private sector debt rescheduling. The FICORCA (fund for exchange risk) agreed to
cover the difference between a subsidized exchange rate at which companies borrowed dollars
and the fixture exchange rate at which they have to make debt payments. The benefits of those
companies enrolled in the FICORCA program created significant differences between
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companies that joined and those which did not. FICORCA associated debt payment remained
constant while inflation and revaluation pushed up the value of physical assets.
Furthermore, by the end o f L983, many non-bank financial institutions were sold back to the
private sector. These newly re-privatized institutions quickly began to compete for savings and
create parallel financial markets beyond state control in early 1980's. The development o f non
bank financial institutions aggravated competition for bank credits while saving rates remained
repressed. Non-banking institutions did not have to satisfy the strict regulations imposed by the
government, and were able to offer more attractive rates of interest to depositors.
In addition, in 1985 the government had to offer an unprecedentedly high real return of 9.2% on
CETES in order to raise funds to cover government spending. Grupos, which were candidates
to receive scarce loans at negative real rates of interest, bought CETES (some times with their
low-cost funds), obtaining financial gains from their monetary position.
Not surprisingly, the segmentation of the financial markets and the growth in the circulation of
CETES had negative distributional effects; it privileged large-scale industry, but raised interest
rates for firms without access to formal bank credit.
Real GDP growth recovered from an average of 0.5% over the period 1985-88 to 3.5% in
1989-1992 (Table 4). The inflation fell from 160% in 1987 to 12% in 1992 and to single digits
in 1993. At the end of this period, real interest rates finally turned positive.
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TABLE 4
Real GDP Growth in Mexico
x
o o
1 0 .0 0
(5.00)
(10.00^
YEARS
Real GDP (% change)
World Bank (1998)
The economic strategies of the late 1980's had the goal of the return o f economic stability,
attaining external viability, and reducing the role of government in the economy. The main
elements of such a restructuring policy was to maintain tight financial policies, to restructure
foreign debt, and a program of structural reforms, including privatization and trade
liberalization. Especially in 1989, the main objectives o f the monetary policy undertaken by the
Mexican government were to lower inflation, stabilize the value of the peso, push financial
growth, and facilitate private sector access to bank credit.
In general, from 1988 to 1993, Mexico adopted a strategy of economic development and
financial reforms to strengthened the structural transformation initiated after the 1982 debt
crisis. Besides the economic reforms, the debt-relief package of late 1980's that decreased
Mexico's debt also helped to decrease the instability of Mexico's economy, fueling an inflow of
international savings (Table 5).
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TABLE 5
Net Financial Flows in Mexico
Net Financial Flows (current US$)
World Bank (1998)
YEAR
For instance, in April 1989, Mexico successfully negotiated a debt-relief package with its
foreign, creditors, with an intermediate impact on domestic interest rates, which fell by
approximately 35 percent. In turn, such a sharp fall in interest rates had a positive effect on
growth, and reduced the size of the secondary deficit, thereby increasing price stability.
The debt-relief package with Mexico's external creditors offered three options:
1) Exchange their original claims against new bonds at a floating LIBOR, rate but with the
principal reduced by 35% of its value.
2) Exchange their original claims against new bonds paying a fixed 6.25% interest rate.
3) Keep their original claims but provide new money equivalent to 25% o f the amount brought
under this option. This debt-relief operation amounted to approximately 30% of the Mexican
foreign debt.
Furthermore, interest rates were freed, credit controls and lending restrictions removed, and
reserve requirements and high liquidity ratios for bankers were abolished (1988-89). From mid-
1990 to mid-1992, Mexico's eighteen (18) commercial bank were sold back to the private
sector. Restrictions on foreign investment and foreign ownership were eased, and some key
sectors were deregulated. All of the above helped encourage capital inflows.
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30
The successful restructuring of external debt paved the way for the resumption of access to
international financial markets. Private capital inflows were an average o f over 6% o f the GDP
in the period 1990-1993; by the end o f 1993, the bank o f Mexico's gross international reserves
stood at $25 billion, up from $6 billion at the end of 1989 (Table 6).
30.000.000.000
25.000.000.000
20. 000. 000.000
15.000.000.000
10.000. 000.000
5,000,000,000
TABLE 6
Federal International Reserves in Mexico
CM CO
§ 8 8
1 1 1 1
a m m
p r \ w t
, > S Z '' ■ >
G ross International R eserves
(current USS)
World Bank (1998)
cm
s s
YEAR
During the first years of the 1990’ s there was an absolute and relative rise in the importance of
foreign direct investment. Foreign direct investment as a form of capital inflow is believed to
have advantages in terms of relative stability and the counter-cyclical nature of that associated
service requirements. Portfolio investments increased, but these portfolio investment had a
short-term horizon problem. Large portions of this short-term investment were tesobonos.
A number o f developments in 1993 reduced GDP growth. The main factors contributing to
these developments appear to have been: the ongoing restructuring o f firms in the
manufacturing sector; a tightening of credit conditions by the monetary authorities; a credit
squeeze resulting from the deterioration of loan portfolios; and uncertainty about the approval
ofNAFTA.
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Moreover, the Mexican peso was pegged to the US dollar from March to December 1988 and
allowed to depreciate during the following three years at a pre-announced rate in order to reduce
uncertainty in the exchange rate. In November 1991, the authorities provided greater flexibility
in exchange rate management by creating a publicly announced intervention band; the band
widening gradually from 1.5% at the end o f 1991 to about 9% at the end of 1993.
Income growth (in real terms) continued at 3.5% that year, while the inflation rate continued to
decline, averaging about 7%. Also, the external current account deficit increased to 8% of the
GDP (Table 7).
TABLE 7
Mexico's Current Account Balance
Current Account Balance (% of GDP)
World Bank (1998)
YEARS
Overall, Mexico's financial turbulence was due to different factors, such as rising interest rates
in the United States, and economic recovery around the world, which increased the demand for
funds worldwide. On the domestic front, a series of disturbances that included the uprising in
Chiapas in January of 1994, the assassination of presidential candidate Colosio in March of
1994, and the assassination of ruling parly secretary in September of 1994, and another
uprising in Chiapas later that year. All of these non-economic factors contributed to an
environment of political and economic instability.
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Furthermore, the large capital inflows that followed NAFTA suddenly stopped following the
assassination of the presidential candidate Colosio on March 23, 1994. International reserves
fell by more than 50% during the month of April (from 28 billions to 11 billions). The exchange
rate hit the ceiling o f the band, and short term interests rates on peso-denominated paper
(CETES) doubled to 18%.
Not surprisingly, the government relieved pressure on the peso by letting interest rates rise,
along with the approval of a $6.75 billion short-term credit line. CETES were also replaced by
“tesobonos,” short-term instruments indexed to the US dollar but repayable in pesos.
Political instability increased once more in November of 1994, following rumors about possible
changes in the exchange rate policy, which sparked a flight of Mexican pesos’ and led to a loss
in international reserves of about $3.5 billions. This time interest rates in CETES were
maintained at the 13-14% range while tensions in Chiapas continued.
On December 20, 1994, in the face of heavy losses of international reserves, the Mexican
authorities further widened the exchange rate intervention band that had been in place since late
1991. International reserves had fallen to $10.5 billions. First, the Mexican authorities
attempted to widen the band to 15%. Two days later, after an additional loss of $4 billions in
reserves, the peso was allowed to float.
The collapse of the fixed exchange rate regime brought the peso to its knees for a second time in
two decades. This occasioned strongly adverse effects on financial market expectations. After a
short time, the international community announced a package in support of Mexico.
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In. the Mexican financial crisis of 1994-95, there was no consensus on the nature or the size of
the systematic risk involved. In the absence o f full and accurate information, markets tend to
trade on the basis of false premises, and investors react violently when the truth or new rumors
arise. Until 1995, Mexico announced its international reserve position only three times a year or
when otherwise convenient.
In 1995, after the collapse of the exchange rate regime, the inflow of international loans stopped
after a series o f non-performing loans creating, once more, credit rationing. This time, however,
international credit returned in a matter of months.
Finally, it can be argued that the large current account deficits and real exchange rate
appreciation that Mexico suffered before the 1994-1995 financial crisis were, at least to some
extent, equilibrium responses to the process of stabilization and structural reforms. External
deficits can not be sustained forever; there is a need for improvements in productivity in order
to increase the competitiveness of exports, with no need for devaluation. But low productivity
resulted in an abrupt adjustment that was not properly anticipated, and caused economic
stagnation in 1995.
Growth sustainability ultimately depends on the level of domestic savings. The transition to a
sustainable growth path is unlikely to be smooth, as the slowdown in consumption growth
(associated with the improvement in domestic savings) is likely to be contractionary. The
outcome will depend on how investments and net exports respond.
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Except for the rise in interest rates after the Colosio incident, interest rates did not adjust to the
incidents of 1994. The vulnerability of the financial system increased with the decision to create
Tesobonos, indexing short-term debt to US dollars.
The objective of the Tesobono program that was adopted in 1995 was to restore confidence and
reduce the dependence on foreign savings through a strong stabilization effort. The program
also tried to su sta in the substantial progress made by Mexico in recent years in the areas of
structural reforms and the liberalization of trade and capital flows.
Holders o f equity securities suffered losses, or at least paper losses. The Mexican stock market
fell by two-thirds in dollar terms between December 19, 1994, and March 9, 1995. Holders of
Tesobonos did not in the end suffer losses, and indeed were well rewarded for the small risk
taken. In the end, the wealth of Mexico's external creditors as a group was only marginally
affected by losses following the peso crisis. Also, some investors benefited from the actions
taken by the Mexican government to avoid a large crisis. High or rising yields in debt
instruments should serve as signals to their holders that compensation is being paid in advance
for the cost of possible default or capital losses.
Massive privatization programs caused portfolio investments in equity securities to become
more attractive in early 1990’s. The problem with this kind of inflow is that funds that easily
flow in during a current account deficit can also disappear suddenly when perceptions of the
economic environment change, creating a painful lack of resources, that most likely will be
accompanied by economic recession.
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PART IV
DESCRIPTIVE ANALYSIS OF THE RELEVANT RATIOS FOR CALCULATING
EARNING RATES.
The basic framework:
r = [ ( a - b ) c - ( d + e + f)g]
r= net earning rate;
a= gross margin;
b= overhead expense ratio;
c= asset turnover ratio;
d= interest expense ratio;
e= exchange rate loss ratio;
f= inflation loss ratio;
g= gearing ratio;
NET EARNINGS RATE
There are many factors that affect the profit level of firms. We focus on the "financial" and
"real" factors included in our model. Our expectation is that earning rates should change in the
face of changes in financial and economic conditions through the years (H-2).
For instance, real GDP growth has a positive effect on corporate earnings. An increase in real
GDP increases disposable income, fueling consumption, which consequently increases net sales;
moreover, an increase in net sales will cause higher net income for all firms.
[ I / ( 1 - g ) ]
(Net Income/ Net Worth)
(Gross Profit/ Net Sales)
(Operating Expenses/ Net Sales)
(Net Sales/ Total Assets)
(Interest Expense/ Total Liabilities)
(Exchange Rate Loss/ Total Liabilities)
(Inflation Losses/ Total Liabilities)
(Total Liabilities/ Total Assets)
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In addition, in times when domestic credit is hard to obtain, an economy depends relatively
heavily on its government fiscal budget and on its international capital to obtain the necessary
resources to operate. This allocation of scarce resources can help firms to obtain higher earning
levels.
Moreover, profits also depend on the business nature of the firm. N et income of exporters will
decrease when there is an appreciation of the domestic currency, which in turn increases the
price of goods produced domestically, lowering their competitiveness on international markets.
During the 1994-1995 financial crisis in Mexico, the peso suffered a pronounced depreciation,
which should widen the difference in the profit levels in favor of firms producing exportable
goods.
Grupo firms, given their easier access to loanable funds, should reflect higher profit levels than
non-grupo firms during periods o f economic stagnation.
GROSS MARGIN
Gross margin is the ratio of gross earnings to total sales. This ratio reflects the changes in
relative prices of inputs and outputs; therefore, it is a basic indicator of the extent to which
wage controls, commercial policy and exchange rate systems affect the firm’s ability to produce
income (Table 8).
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37
TABLE 8
Gross Margin Determinants
40.00
35.00
30.00
25.00
20.00
15.00
10.00 ■■
CM TT
S §
-Taxes on income, profits and
capital gains (% of current
revenue)
-Wages and salaries (% of
total expenditure)
World Bank (1998)
The peso appreciation reflects not only a different speed of adjustment of traded and non-traded
good prices, but also, and more importantly, the effects on aggregate spending of the implied
increase in the private sector wealth. The removal of credit constraints resulting from financial
liberali2ation and other structural reforms tend to amplify these trends.
Mexico's rapid growth of consumption after 1988 may have been the result of an over
appreciation of permanent income. This excessive optimism during the good times may have
caused excessive pessimism when the country fell into a recession at the end of 1994.
OVERHEAD EXPENSES
The overhead expense ratio (Overhead cost divided by net sales) is the second source of
earnings fluctuations. As with gross margins, there are several sources of changes in overhead
expense ratios. The numerator of this ratio is relatively stable given changes in sales. Overhead
expenses reflect capacity utilization. This ratio reflects how well firms respond to changing
economic environments.
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38
We should expect the overhead expense ratio not to change dramatically from period to period,
as producers adjust to changing demand for goods by adjusting their fixed assets. But we could
expect an increase on overhead expense right after a major decrease (or increase) o f the GDP
due to lower (or higher) net sales during economic recession (boom). Changes in overhead will
reflect the time it takes for overhead expenses to adjust to changes in net sales. Overhead
expenses take longer to adjust to changes in macroeconomic conditions, while net sales adjust
immediately after consumers perceive a change in the economic environment.
ASSET TURNOVER
The asset turnover ratio is obtained by dividing net sales by total assets. This is another
indicator of capacity utilization. There is a positive relationship between asset turnover ratios,
net sales and output prices, and a negative relationship between asset turnover ratios and both
input prices and the book value of total assets.
That is, inflation decreases the purchasing power of consumers if salaries do not increase
accordingly. In periods o f high inflation (1982 to 1987), we should expect net sales to decrease
since the purchasing power did not adjust accordingly.
One way in which increases in interest rates can negatively affect asset turnover is by making
consumers reallocate their resources to financial instruments in the future (if expectations of
future real interest rates are lower) in order to maximize their life time consumption. Consumers
will find a new inter-temporal allocation of resources by investing more heavily in the future,
thus, reducing consumption and turnover ratios on the present.
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39
The large capital inflows after 1990 had a much larger impact on consumption than on
investment, resulting in the sharp decline of national investment rates, and a positive impact in
asset turnover ratios for the firms being analyzed (Table 9).
TABLE 9
)
Domestic absorption (% of GDP)
Gross domestic investment (% of
GDP)
World Bank (1998)
In addition, private sector spending increased rapidly, while private savings fell by 10%. Total
imports grew at an annual rate of 24% during 1989-1992 as a result of both appreciation of the
peso, and inflow of money into the economy. These factors, together with the maintenance of
the exchange rate as anchor policy, led to a real appreciation of the peso of over 60% from
1987 to 1992. The appreciation of the peso in consequence, decreased the turnover ratio of
exporters compared to non-exporters.
Furthermore, uncertainty negatively affected Mexico in December 1994. Aggregate demand
collapsed in the most important shopping period of the year (Christmas season), and merchants
either hid or hiked the prices of foreign goods due to the lack of information regarding the value
o f those goods in the near future. The high variability o f the foreign exchange rate, and
consequently, the large expected variation on the price of foreign goods reduced aggregate
demand and lowered the turnover ratio.
110.00
Investment Vs. Consumption in Mexicc
30.00
-- 25.00 105.00 --
20.00 100.00 --
- 15.00 95.00
-- 10.00 90.00 -
-- 5.00 85.00 --
80.00
YEAR
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F in a lly , during the first years o f the 1990's, consumption increased faster than any other
economic indicator (Table 10). According to Rayon (1991), much of these increases were due
to increases in the purchases of durable goods. Durable good consumption growth was indeed
faster than non-durable consumption growth, suggesting that the decline in private savings may
not correspond to a real decline (Rayon 1991).
TABLE 10
Domestic Absorption
Dom estic Absorption (% of GDP)
World Bank (1998)
C O O C V ^ t O C O Q C N T T C O
r ^ c o c o c o a a o o o i c n o ^ o )
0) 0 0 0 ) 0) 0) 0) 0)0 o
YEAR
FINANCIAL COST: (INTEREST RATE. EXCHANGE RATE & INFLATION RATIOS')
Interest rates, exchange rates and the rate of inflation are the components of the financial cost of
a firm. These ratios can be either negative or positive, depending on the net monetary position
o f the firm.
The cost of money (real interest rates) can result in financial gains when the real interest rate is
negative, as ocurred in Mexico when the government imposed interest rate ceilings, making real
interest rates turn negative during most of period 2. Another way to obtain financial gains is
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41
when, the firm is a net creditor or when the firm is able to obtain loans at a lower interest rate
than the loans they offer.
Also, the exchange rate loss ratio of a firm (exchange rate loss over total liabilities) can be
affected by macroeconomic factors, and the net foreign monetary position of the firm. If a
firm’s foreign liabilities are higher than its foreign assets, a large devaluation can result in
substantial earnings losses. The inflow o f money in period from 1988 to 1993 increased
available foreign credit, which worked against firms with liabilities indexed in foreign currency.
We should expect the exchange rate loss ratio to increase in 1993-1994 for two reasons. First,
total liabilities decreased as funds were leaving Mexico for more attractive markets. Second, in
nominal terms, the liabilities indexed in dollars became valued higher due to the exchange rate
devaluation.
Moreover, an increase in the real rate of interest of a domestic market (given no restrictions on
capital flows and similar risk factor) could increase the demand for national currency. This was
the case in Mexico, and resulted in an appreciation of the peso from 1988 to 1993.
In effect, market reactions to establish an equilibrium for the demand/ supply of currency
induce changes in the exchange rate. Large capital inflows can be viewed as part of a portfolio
stock adjustment mechanism that induces large inflows in the beginning only. With this idea in
mind, the real exchange rate initially appreciates and, if anticipated, real interest rates fall.
What is required, however, is a real depreciation which could be expected to result in higher
real interest rates.
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42
Inflation loss is another components in the determination o f financial cost. Low variance in
inflation decreases the risk involved in investments of financial assets. Mexico successfully
reduced, its inflation rate from close to 100% in 1988 to single digits by 1991. As a result, we
can expect inflation losses to decrease in period 4 (1989 to 1993), when the average inflation
rate was at its lowest.
Inflation and exchange rates will normally move in opposite directions. A falling exchange rate
makes foreign goods and materials more expensive for the domestic producer to buy, thereby,
driving up the cost of finished goods, and quite possibly raising the rate of inflation.
High inflation rates can hurt firms that find themselves with large amounts of foreign currency
loans by increasing the loan cost. This is because the local currency tends to depreciate during
periods o f high inflation.
GEARING RATIO
Assets do not rise in value as fast as liabilities do in times of high inflation, at least on the
balance sheet; liabilities will adjust faster than assets on the books since they are basically
linked to the cost o f money. The nominal value of assets does not increase at the same speed
that a liability does, given that prices for goods react more slowly than asset prices. The
adjustment in nominal values could cause a decrease in the net worth of a firm since net worth
is calculated by subtracting liabilities from assets.
Therefore, we should expect gearing ratios to decrease in periods of high real interest rates (H-
6), and for loans to become harder to obtain. This level should also be higher for grupo-firms
due to their easier access to funds.
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43
The indebtedness ratio is also relevant to the firm’s financial cost. Given that financial cost
ratios are divided by total liabilities, the higher the gearing ratios, the stronger the influence of
the exchange rate, interest rates, and inflation.
PA R TY
THE MODEL
All the ratios (r, a, b, c, d, e, f and g) will be statistically compared across time and firm
affiliation (grupo, exporters, etc.) i.e., cross-section and time series observations.
The explanatory variables used to analyze firm behavior given certain changing economic
environment are: grupo, exporter, and years (periods).
The sample of firms cannot be characterized as a random sample taken from the larger
population of all firms since only the large firms listed in the MBV were included in the sample.
Our model was designed to control for the individual characteristics of each firm, and such
effects are assumed to remain constant over time. Also, for specific time periods so as to
identify macroeconomic effects of every specific period of time.
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44
The model:
Y = DfBf + DyrByr + ■ DxBx + E
where:
Y is a NT x 1 vector of the ratios of the measure being analyzed.
D f is a NT x N matrix of dummy variables which represent the effects o f each firm i,
i=l,2,...,N, on the sample, its Jth column consisting of the value L for firm i, and 0 otherwise.
B f is a N x L of the corresponding coefficients to be studied
Dyr is a NT x T matrix of dummy variables indicating time period effects, its jth column
consisting
o f the value of 1 for period t (1978-1981, 1982-1988,..., 1996) and 0 otherwise.
Byr is a T x 1 vector of the corresponding coefficients to be studied.
Dx is a NT x T matrix of dummy variables where the ith element of the jth column assumes a
value o f 1 or 0, depending on the explanatory institutional or financial balance effect being
modeled.
Bx is a T x 1 matrix of the corresponding coefficient to be studied.
E is a NT x 1 vector incorporating a normally distributed error term.
The Dx dummy variable was assigned values according to the type of institutional trait being
modeled. Hence, to account for grupo affiliation effect, the Dx matrix was labeled “grupo”, and
its elements assumed values of I if a firm was affiliated with a grupo, and 0 otherwise. The
same holds when trying to account for an exporter effect; the DX dummy variable was label
“exporter”, and its elements assumed the value of 1 if the firms is a exporter, and 0 otherwise.
To categorize exporter-firms, exports must exceed five-percent of total sales. Similarly, the
status o f a grupo-firm relies on the ownership consistency throughout the time period, given the
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45
long-standing character of the firms in our sample. Grupo-firms are affiliated to a conglomerate
and are engaged in more than one industrial classification.
To estimate the regression coefficients, the last column of each, of the matrices was omitted in
order to avoid perfect collinearity. The remaining coefficients measure the change in the cross-
section and time-series intercepts relative to the first firm in the last period.
The different financial regimes under analysis can be identified separately by :
PI (1978-1982) The period before the bank nationalization.
P2 (1983-1988) A period o f financial repression.
P3 (1989-1993) Bank re-privatization and easy access to foreign loans.
P4 (1994-1995) Second period of financial repression.
P5 (1996) New financial liberalization period.
Two sets of regressions were run originally, one using the whole sample, and another omitting
outliers on earning ratios. The outliers were found using own judgment in order not to include
extraordinary earning ratios not characteristic o f a period’s pattern. The outliers were remedied
by excluding the observation; then, the regressions were run again.
The results used to analyze the hypotheses are drawn from the regression results without
outliers. This is because regression results corrected for outliers yielded more significant results
for net earning ratios than when including outliers. Since earning ratios yield better information
on how firms adapt to changes in the financial/economic environment, we will use these
regressions corrected for outliers. Earning ratios are significantly lower in the second, third, and
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46
fourth periods when omitting outliers, but only period 4 is shown to be significantly lower than
when we include outliers (Table 11.)
TABLE 11
Regressions with and without outliers
Eamina Ratio Gross Marain Gearina Ratio
W ithout W ithout W ithout
Unrestricted outliers Unrestricted outliers Unrestricted outliers
(■iiiiiyiipl
Period 2 Prob > F 0.403! 0.050 0.040! 0.129 0.672! 0.469
(1982-1988) Parameter
Estimate
Period 4 Prob > F
(0.020)1 (0.040)
0.002: 0.000
0.051! 0.037
0.381! 0.474
(0.018)! 0.029
BW HM M M
0.602! 0.826
11994-1995) Parameter
Estimate
(0.083)1 (0.086) (0.025)! (0.020) (0.025)! (0.010)
When we include outliers in the regression, some of the other ratios besides earnings became
more significant than without outliers, but the parameter signs o f these ratios did not change
when omitting outliers, for example:
Gearing ratios are.only significant in periods of high real GDP growth when restricting the
regressions. When we include outliers, the average gearing ratio for all firms also became
significantly higher in the third period. As with gearing ratios, gross margins are also
significantly higher in periods of high real GDP growth, with and without including outliers in
the regressions. But, only when outliers are included in the regression is when gross margins are
shown to be significantly higher in periods 2 and 3 (1978-1988) for all firms, as seen in Table
11, and especially higher for grupo-firms and exporters.
Gross margins and gearing ratios seemed to be the most affected by restricting the analysis, but
the increase in the number of significant parameters for earning rates makes up for this.
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47
A third set of regressions was run, this time isolating specific periods of time (Periods I to 5) in
order to study the influence that grupo-firms and exporters have when analyzing these periods
one at a time. This set or regressions are referred to as ‘'regression by period”.
The reason to include “regressions by period” is the following: As seen in the regression results
in Table 13, the parameter estimate on the gearing ratios of grupo-firms in the third period is
negative (grupo/period column), conversely, the parameter estimate on the gearing ratios of
grupo-firms is positive in the column “regression by period”. The signs o f the parameters
estimate change when analyzing the interaction of grupo/period 3 against the whole sample of
observations (Tablel2) we notice that indeed, the gearing ratios are lower. But, if we analyze
only the third period, grupo-firms score higher gearing ratio levels than non-grupos (Table 13).
TABLE 12
Grupo/Period Grupo
Regression Regression
without outliers by period
f l B
idlllilllill
m
1 1 1
Period 2
(1982-1988)
Prob > F
0.617 0.509
Parameter
Estimate
0.023 0.024
W m m m .
lliillt iij li
Period 4
(1994-1995)
Prob > F
0.972 0.024
Parameter
Estimate
(0.002) 0.163
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48
TABLE 13
Gearing Ratio (Grupo / Non-grupo)
^ ■ 1 GRUPO
NON-GRUPO
—♦ —GEARING RATE
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
HYPOTHESES
L - Grupo firms should perform better than, non-grupos due to their better access to loans,
especially in periods of economic repression, when loans are especially hard to obtain.
2- Earning rates should vary across periods due to changing financial/economic environments.
3- Earning rates should be higher on average for all firms during periods of high economic
growth (periods 1 and 5).
4- Exporter earnings should be higher during periods of substantial exchange rate depreciation
(periods 2 and 4).
5- Turnover ratios of exporters should decrease when there is an appreciation of the national
currency (period 3).
6- Gearing ratios should decrease in periods of high real interest rates.
7- Earning ratios should be lower in periods of high real interest rates.
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49
RESULTS
The results are divided into three different parts. Part I analyzes the adjustment process taken
by all firms during specific periods of time. Part II analyzes the importance o f being a grupo-
firm over the whole period under study, as well as the interaction between grupos and specific
periods of time. Part III focus on exporters and the interaction between exporters and periods.
I. All firms by periods.
The graphical difference in earning ratios across periods presented in Table 15 is complemented
by the results o f the regression test given in Table 14.
TABLE 14
R eg ressio n s w/o o u tliers
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
Period 1 Prob > F %
(1978-1981) Parameter
Estimate
0.973
0.000
0.010
0.046
0.286
0.044
0.569 0.100
0.012 0.041
0.305
-0.028
0.022 0.418
0.020 0.241
Penod 3 Prob >
(1989-1993) Parameter
Estimate
0.024 0.213
0.047 -0.031
0.242
0.032
0.333
0.100
0.348
0.010
0.141 0.184
0.025 -0.054
0.605
0.013
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
Periods of Prob >
High GDP Parameter
Estimate
0.000 0.025
0.051 0.027
0.069
-0.024
0.001 0.004
0.167 -0.035
0.024 0.404 0.093
-0.012 -0.007 0.033
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50
That is, we can accept hypothesis 2 (H-2), earning rates vary across our five periods.
Net earning rates are significantly lower for all firms during the second, third and fourth periods
than in the first and fifth periods.
TABLE 15
Net Earnings by Period
□ SAMPLE
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
Conversely, we can also accept hypothesis 3 (H-3), which indicates that earnings ratios are
higher in periods of economic boom (1978-1981, and 1996), periods 1 and 5. The regression
results indicates that the earning ratios during periods of high real GDP growth are 5% higher
than during other periods. This result is significant at the 99% confidence level (Table 14.)
The rapid inflow of savings into the Mexican financial environment caused a real overvaluation
of the peso between 1989 and 1993 (Period 3), but the increase in available credit did not result
in higher net earnings rates (Table 15). Among other reasons, this was because the financial
cost of production rose as the exchange rate loss ratio increased.
Aside from the increase in the average financial cost of all firms in the third period, the average
gross margin ratios increased, and the average overhead cost ratios decreased. By this,
offsetting the opportunity to increase earning ratios following the increase in the turnover ratios
from 1989 to 1993. That is, the rapid inflow of money starting in the late 1980's increased the
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51
average turnover ratios for all firms. But, in. the third period, increases in real, as well as
financial costs, combined to keep earning rates as low as in the previous years of economic
recession.
Furthermore, since the real interest rate in period 2 was mostly negative, we can assume that,
on average, the currency assets of firm’s were higher than their currency liabilities (long in
currency), creating an increase in their financial cost due to their net monetary position. It is
also important to notice that grupo-firms scored lower interest losses in all periods than non-
grupos. This difference, however, was not significant at the 90% confidence interval, as seen in
Table 14.
This lower interest loss ratios (sometimes negative) for grupos could mean that grupo-firms
obtained gains from their net financial position and their ability to obtain loans at a lower
interest rates than non-grupos. However, this condition was not sufficient for grupo-firms to
significantly increase their earnings ratios relative to those o f non-grupos.
In addition, firms increased their liabilities denominated in foreign currency during the third
period, (Rayon 1991) which accentuated an increase in exchange rate losses with the sharp
devaluation of the national currency in the fourth period. Also, the increase in financial losses in
1994-95 was further aggravated by increasing the average gearing ratios.
Period 4 had the lowest average net earning rates of all periods. The regression result shows the
fourth period to have significantly lower earnings at the 99% confidence interval. Corporate
earnings ratios were only 3%, which is significantly lower than for any other period, hi effect,
almost all other ratios for period 4 have been working against higher earnings. Gross margins
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52
were lower, overhead expenses increased and the turnover ratio fell (Table 17), bringing earning
from enterprise operation’s to their lowest point. The financial cost was at its highest during
this period with increases in all the components of financial cost, especially the exchange rate
loss ratio.
Moreover, periods of high real interest rates (rates higher than 5%) had a negative influence on
earnings. That is, we can accept Hypothesis 7 (H-7), which indicates that average net earnings
are lower during periods o f high real interest rates. This result proved to be significant at the
95% confidence level.
Gross margins decreased from 1983 to 1991, increasing again in 1996 (Table 16.) The sharp
decrease in aggregate demand after the oil crisis o f 1982 maintained gross margin levels
somewhat high (net sales is the denominator portion of the formula to obtain gross margin
ratios).
TABLE 16
Gross Margin by Period
0.40 ............. ........................ ..............■ ........................................
0 GROSS MARGINS
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
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53
TABLE 17
Turnover by Period
1.20 . • - ... .......
□ TURNOVER RATIO
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
Although, changes in the gross margin ratio are not significant in the regression results of Table
14, we can see a graphical increase in these ratios during the second period in Table 15, and a
fall in gross margin ratios in the third period. The jump in gross margins after the 1982 crisis
can be explained by a sharp fall in total sales as a consequence of falling aggregate demand
(total sales being the denominator to obtain gross margin ratios). The subsequent fall after 1988
could be explained by the increase in total sales after the financial liberalization that started in
1988, and the decelerated growth o f gross earnings for the recent years.
Surprisingly, the turnover ratio was found to be higher in periods of high real interest rates, but
not significantly. This could be due to scarce monetary resources when the real interest rate was
negative during periods of economic recession (especially the second period).
Borrowing played an increasing financial role in the 1980's (Rayon 1991). The interest loss
ratio exhibited financial gains in periods of recession due to negative real rates of interest.
Interest expense ratios have declined for all firms. From 1978 to 1988, the decrease could be
explained by low, sometimes negative real rates of interest. The decrease after 1988 could be
explained by increasing gearing ratios that kept interest loss ratios low until 1996. Surprisingly,
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54
periods of high, real interest rates did not show significant increases in the interest loss ratios,
which might be explained by the average net monetary positions of all firms.
In addition, as shown in Table 18, the gearing ratios of all firms do not fall after the debt crisis
of 1982. Such a fell would have been expected as credit markets shrink and available funds are
reallocated into foreign markets, which should decrease the total liabilities of firms.
Furthermore, the gearing ratio o f all firms decreased in periods of high real interest rates, but
the regression results show this change not to be significant at the 90% confidence interval.
Thus, we reject Hypothesis 6 (H-6), that gearing ratios would be higher in periods of high real
interest rates. Although gearing ratios were not significantly lower on periods of high real
interest rates, we should notice that this ratio increased in periods of high real GDP growth.
This result is statistically significant at the 90% confidence interval.
o
t-
2
o
z
O '
« t
iu
O
TABLE 18
Gearing Ratio by Period
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
M
Period Period Period Period Period
3
PERIOD
0 GEARING RATE
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55
II. Grupo/Period interaction.
In general, we can accept Hypothesis L (H-L), that grupo-firms obtain higher earnings than non-
grupo-firms. The overall earnings o f grupo-firms were significantly higher than for non-grupos,
with an estimate .043 higher returns for the former (Table L9). The difference in earning rates
for grupo-firms was significant at the 90% confidence level.
TABLE 19
R e g re s sio n s by G rupo/Period
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
0.434
Grupo/
Period 1
Prob > F
0.503
- 0.022
0.032
0.262
0.452
0.022
0.912
0.001
0.081
0.036 0.038
0.658
0.011
0.188
0.039
P aram eter '4 .
g
Estim ate
Prob > F
Param eter
Estim ate
0.668
0.012
0.088 0.451
0.042 -0.022
0.472 0.455
-0.036
0.412
0.010
0.327
0.020 0.112
Period 3
0.023
j V S S / S
m m
MARG
IN
OVERH
EAD
TURNOV INTERE EXCHAN IN FLA TI
ER ST GE ON
Prob > F %
P aram eter
Grupo
High GDP
0.000
0.047
0.193
0.019
0.367
0.014
0.006
0.161
Estim ate
0.018
0.034
0.117
- 0.010
0.500
-0.007
0.235
0.027
Even though the earnings obtained from operations were not significantly higher for grupos than
for non-grupos during the whole period under study, all of the components of financial cost
were lower (gains higher), which improved the ability to increase earning ratios for grupo-firms.
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56
TABLE 20
Net Eamings (Grupo/ Non-grupo)
0.20
GRUPO
C = 3 NON-GRUPO
—• —SAMPLE
Period 1 ' Period 2. Period S' ' Penod 4 - Period 5;
-0.05
PERIOD
For instance, the grupo-firm classifications earned almost 50 % more eamings that their
counter-part in the first period (1978-L981) as seen in the first period of Table 20. Grupo-firm
earning ratios were higher than 15%, while non-grupo-firms eamings were just over 11% for
the first period. This difference was not significant, however, as indicated in the regression
results of Table 19. Also in the first period, the turnover ratio for grupos was significantly
higher and exchange rate losses significantly lower, this being the only differences between
these two kinds of firms from 1978 to 1981.
When analyzing the “regressions by period” in Table 21, grupo-firms had significantly higher
eamings ratios only during the third period (1989-1993). Contrary to our expectations, there is
not a significant increase in the eamings for grupos in periods of economic recession (Periods 2
and 4). Therefore, we reject Hypothesis 1 (H-l) which indicates that eamings ratios are higher
for grupo-firms in periods of economic recession (Table 21.)
Furthermore, gearing ratios were only significantly higher for grupos in periods 3 and 4.
Conversely, these ratios were not significantly different in the second period, as expected (Table
22). The second period was characterized by a lack of credit, and the limited available credit
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57
was thought to be allocated to grupo-firms, but the regression results do not seem to
corroborate this assumption.
TABLE 2 1 ________________
Grupo re g re s sio n s by period
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
0.509
0.024
0.387
0.010
PERIOD=2 Prob » F
Param eler
Estim ate
0.729
0.006
0.119
0.012
0.157
0.026
0.856
0.003
0.800
0.005
0.029
0.155
PERIOD=4 Prob > F
P aram eter \
Estimate
0.269
-0.035
0.024
0.163
0.206
0.055
0.492
0.034
0.347
-0.049
0.715 0.516
0.016
0.483
0.018 0.043
TABLE 22
Gearing Ratio (Grupo/ Non-grupo)
r a r a GRUPO
d T D NON-GRUPO
—♦—GEARING RATE
Period Period Period Period Period
1 2 3 4 5
PERIOD
The increase in grupo-firm eamings ratios in period 3 seems to be a result of more efficient
production as their gross margins increased, overhead costs decreased, and turnover ratios rose
in relation to non-grupo firms, as shown in Table 21.
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58
Overall, grupo-firms performed better than non-grupos in periods of high real GDP growth at
the 90% confidence interval (Table 19, Grupo/High GDP Growth). Significant positive
differences in their turnover, and interest expense ratios combined to produce these higher
eamings ratios for grupo-firms.
In Rayon’s regression results, gearing ratios were significantly higher for grupo-affiliated firms
than for non-grupo, and increasingly so, but not significantly so during the latter non-repressive
regime (1988-1991).
In effect, the graphical difference in gearing ratios between grupo and non-grupo firms from
L989-1991 was statistically higher with a probability value of 0.0006. Grupos (on average) had
higher gearing levels than non-grupo firms from 1989 on, as a result, accepting Rayon’s
hypothesis, which tests the difference in average gearing levels for these two types of firms.
This trend continued for the next few years (1992 to 1996), the difference between gearing
ratios increased, once in 1994 and, again in 1996. Period 4 (1994-1995) shows significantly
higher gearing ratio levels for grupo-firms. This result can be accepted at the 95% confidence
interval.
Gross margins for Grupo-firms were higher than for other firms from 1991 to 1995, which
shows better capacity utilization by grupo-firms. The same is to be said for exporters, who
reflected higher margin ratios from 1987 to 1996.
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59
m . Export/Period interaction.
Exporters income levels are significantly higher than non-exporters during the whole sample
under study (Return column in Table 23). That is, exporters earning ratios were higher than
non-exporters at the 90% confidence interval. Also, higher eamings for exporters in Period 1
were accompanied by significantly higher gearing ratios at the 95% confidence interval.
Exporters had net earning rates of 0.167 on average during the first period, but this rate
decreased to only 0.080 in the second period.
TABLE 23
R e g ressio n s b y E xporter/Period
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
0.284
0.058
0.437
0.028
0.097
0.220
0.191
0.042
0.938
0.001
0.043
0.046
Exporter/
Period 1
Prob > F
.947
0.002
0.400
0.028
Param eter
Estimate
Prob » F
0.618
0.011
0.449
-0.040
0.637
0.062
0.555
0.019
0.474
0.010
Exporter/
Period 3
0.007 0.044
P aram eter | -0.076 -0.065
Estimate
0.063
0.065
i RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
m
Q.590
-0.006
0.164
0.036
Exporter/
High GDP
Prob > F
Param eter
Estimate
0.065
0.032
0.011
0.164
0.004
-0.047
0.229
-0.009
0.000
0.063
0.047
0.032
Conversely, Period 2 (1982 to 1988) did not result in higher earning ratios for exporters (Table
24). On the contrary, there was a sharp decrease in the average earning ratios for exporters in
this period. The inability of exporters to increase their eamings levels after a sharp devaluation
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60
o f the peso in 1982 may have been caused by the fell in the terms o f trade, which declined after
1982.
TABLE 24
Net Eamings (Exporter/ Non-exporter)
0.20
O )
0 0.15
1 0 . 1 0
U l
iu 0.05
z
0.00 .
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
Exporters, who had an earning advantage over non-exporters in the first period, lost this edge as
their financial cost increased in Period 2, negatively affecting their ability to increase net
earning ratios. As found in the regression results of Table 25 for export/period interaction, we
can reject Hypothesis 4 (H-4) at the 95% confidence interval, which indicates that earning
levels are higher for exporters in periods of economic recession (Periods 2 and 4, 1982-1988
and 1994-1995). On the contrary, exporter income levels decreased in the second and four
periods; periods which were characterized by a sharp fell in the real exchange rate.
In addition, exchange rate losses did not seem to play an important role until the financial crisis
in 1994 (Table 26), when the increase in this ratio increased the financial cost for all firms, and
especially for non-exporters.
■■■EX PO RTER
r~ ~ n NON-EXPORTER
—• — SAMPLE
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61
TABLE 25
E x porter re g re ssio n s b y period
RETURN MARGIN OVERHEAD TURNOVER INTEREST EXCHANGE INFLATION GEARING
PERIOD=2 Prob > F | 0 .1 0 4 0.765
P a ra m e te r! -0.027 -0.005
0.088
0.033
0.000
0.238
0.001
0.056
0.894
- 0.001
0.354
0.010
0.226
0.039
Estim ate
p e r io d = 4 Prob > f | 0.588 0.235 0.097
Param eter 0.021 -0.053 0.078
Estim ate %
0.247 0.023
0.121 -0.066
0.097
-0.038
0.939
- 0.002
0.029
0.141
m m m m T S e m s s t
TABLE 26
Exchange Rate Loss (Exporter/ Non-exporter)
0.10
CO
g 0.08
_j
£ 0.06
U a04
0
1 0.02
X
£ 0.00
lii
- 0.02
PERIOD
The lack of earning ratio increases for exporters in the second and fourth periods are partially
due to their failure to increase their turnover ratio. We were expecting the turnover ratio of
exporters to increase in periods o f economic recession (Table 27.)
This latest observation leads us not to accept the null Hypothesis 5 (H-5), that turnover ratios
of exporters increase in periods when the domestic currency devaluates. Although the national
Period Period Period^ Period:
EXPORTER
NON-EXPORTER
-EXCHANGE RARE
LOSS
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62
currency sharply devaluated in periods 2 and 4, other factors influenced the decrease in the real
terms of trade that worked against exporters during this periods.
TABLE 27
TURNOVER (EXPORTER I NON-EXPORTER)
1.20
0 1.00
$ 0.80
a:
uj 0.60
1 0.40
O '
S 0.20
0.00
Period 1 Period 2 Period 3 Period 4 Period 5
PERIOD
ANALYSIS OF PREVIOUSLY STUDIED FIRMS THAT NO LONGER TRADE IN BMY
Net Eamings.
The net earnings rate graphs shows what is expected for these firms (Table 28,) which is a
lower earning ratio levels for those firms that stop trading on the BMY (Mexican Stock
Exchange) as compared to these firms that are currently trading. Firms whose shares ceased to
be traded by 1995 will be described as gone-firms, while those firms whose shares are still
traded in the BMV will be described as current-firms in order to facilitate the analysis.
EXPORTER
I ~ 1 NON-EXPORTER
—♦—TURNOVER RATIO
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63
TABLE 28
Net Eamings (Gone/ Current)
0.3
0.2
™ 0 ....
£ -0.C— §. 5
(3 -0.2 -
C S l . . ( O fc . - T i n . ,<&
< 3i a> f t < 3 > OJ ,, S k O )
« -0.3
-0.4
-0.5
Y ears
-Eamings-gone
- Eamt'ngs-96
The average ea r n in g rate average for gone-firms was higher than the rest of the sample from
1987 to 1988. But after those two years, their net earning rate declined continuously, with the
exception of 1991, when their rate was slightly higher. After 1991 the net earning rates of gone-
firms declined sharply on average, and from 1992 to 1994 this rate turned negative, most likely
causing these firms to stop trading.
The lower performance of gone-firms after 1988 can be attributed to lower gross margins and
higher overhead ratios, which more than offset their higher turnover ratios. For instance, it
seems likely that the difference between gone, and current-firm’s gearing ratios, which was very
stable from 1988 to 1994, played a role in determining the earning capacity of many firms. It
can be stipulated that gone-firms obtained non-operating eamings from lending their funds to
other institutions that paid a higher return on loans prior to the financial liberalization on early
1990's, but once interest rates turned positive, the non-operating eamings were not longer
available.
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64 -
Gross Margins.
Gone-firms had lower gross margin ratios during the period under study (1987 to 1994) with
the exception of 1991 (Table 29). As we noted above, 1991 was also the last year when gone-
firms scored higher net earning ratios than the rest o f the sample.
TABLE 29
Gross Margin (Gone/Current)
0.4
O
CO
T j-
CO
< o
0 0
CM
O )
CO C M
CO
CO
CO
•Margin-gone
-Margin-96
Year
Gross margin is the ratio o f gross profits over net sales, which indicates that either gross profits
for gone-firms decreased, or that net sales increased without increasing the gross profits. We
should presume that it was lower gross margins which adversely affected the firm's ability to
increase net eamings given our results.
Overhead Expense.
Overhead expense is another ratio that shows significant differences between the two lands of
firms (Table 30).
| 0.8
1. 0.6
x
I U
■ a 0. 4
W
0 )
£ 0.2
a >
>
O 0
TABLE 30
Overhead Expense (Gone/Current)
it
k . _
----f —i—b— f—j-
----------
— i —i —
•Overhead-gone
•Overhead-96
C M
C O
c o
CO
CM
O )
M *
o >
Year
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65
If eamings is defined as profits minus cost, and overhead as an important element of cost, one
should expect high, overhead expense levels to negatively affect a firm's ability to increase their
eamings. Conversely, the overhead expense ratio was found to be lower for gone-firms, which
will partially explain the lower net earning rates found in gone-firms.
Asset Turnover.
Turnover ratios are net sales over total assets. This ratio was higher for gone-firms for all
years. We could expect to find higher net eamings for firms that have higher asset turnover
ratios, but, as seen in Table 31, this was not the case.
TABLE 31
Turnover (Gone/Current)
1.4
.2 1.2
"3 i
K 1
5 0.8
g 0.6
E 0.4
0.2
3
(-
CO
CO
CO
r-~
co
co
o
O )
CM
O )
Year
-Turnover-gone
-Turnover-96
The possible increase in net eamings for gone-firms is due to higher asset turnover ratios offset
by these firms’ higher overhead expense ratios and lower gross margins. This means that the net
eamings per unit sold for gone-firms was lower than for other firms. Higher asset turnover
ratios did not help gone-firms to stay alive on the average.
Interest Expense
The interest expense ratio is obtained by dividing interest rate expenses by total liabilities. This
ratio is found to be negative for gone-firms for all years with the exception of 1987.
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66
Negative interest expense ratios could mean that firms were "long" in currency, and they were
obtaining interest from lending to other institutions.
One way to consider how negative interest expenses could negatively affect net eamings, is
when we consider a firm "long" in currency as not being able to efficiently allocate its resources
into production. L a. this case firms lend their resources at present to others that are willing to
pay interest on it. This would explain why firms with lower (negative) interest expenses also
happen to have lower net eamings.
Exchange Rate Loss
Exchange rate losses are practically non-existent for gone-firms (with the exception of 1989,
which looks more like an outlier) until 1994-1995.
The exchange rate loss ratio, which is exchange rate losses divided over total liabilities, is high
for both kinds of firms in 1994, especially so for gone-firms, this indicates that a higher portion
of their liabilities were denominated in foreign currency.
The financial crisis and the collapse of Mexico's fixed exchange rate regime sharply drove down
the value of the peso, and adversely affected those firms with high levels o f liabilities
denominated in foreign currency. High levels of exchange rate losses may have played an
important role for gone-firms decision to stop trading on the BMV.
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67
Inflation Expenses.
The graphs for inflation loss ratios do not seem to yield any relevant information linked to net
eamings or other ratios. This ratio does not seem to follow any noticeable differences between
the two kind o f firms.
Gearing Ratios
Gearing ratios are the result of dividing total liabilities over total assets. There seems to be a
negative relationship between gearing ratios and net eamings; those firms with higher gearing
ratios (gone-firms) are also the ones that have the lowest net eamings.
TABLE 32
Gearing Ratio (Gone/Current)
0.6
0.5 -
o
0.4
(9
I* °-3
I 0 2
0.1
GO
CO
GO o
CO
w
GO
CO
CO 8
CM
O )
CO
a t
Y ear
-Gearing-gone
-Gearing-96
Both current and gone-firms show increases on their levels of indebtedness from 1987 to 1994
(Table 32,) but these levels were constantly higher for gone-firms.
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68
CONCLUSIONS
By analyzing the behavior of Mexican firms during the five different time periods, we have
identified some common characteristics of the adjustment process o f corporate firms in order to
cope with a changing economic environment.
Particular financial factors, such as the founding of FICORCA and the brokering of CETES,
provided firms with inflation hedges, and a way to fight decreasing aggregate demand levels
from 1982 to 1988. Also, a fixed (pegged) exchange rate regime helped to mobilize funds into
Mexico in the late 1980’s, increasing the indebtedness ratio that had decreased in previous
years. But the collapse of this exchange rate regime in late 1994 raised financial losses for
many firms with foreign debt contracts, lowering once more the earning levels of Mexican
firms.
Starting in late 1988, the international financial outlook of Mexico improved due to new
economic policies by the government of Salinas de Gortari. One of the key polices was the
selling of banks back to the private sector. With this action, available national, as well as
international funds were allocated to firms previously excluded from the loan market, on
average, increasing the gearing ratios of all firms from 1988 to 1996.
With regards to the study of the institution of conglomeration referred to as grupo-firms, these
firms were shown to obtain higher earning ratios during the whole period under study, but the
favorable net earning ratio difference for grupo-firms decreased when banks were owned by the
government, i.e., the second period. Significantly higher earning ratios for grupo-firms were
observed right after the Mexican government re-privatized the banking sector.
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69
Bank management polices before 1982 directed funds at investments in stocks owned by grupo-
affiliated-firms, which, reinforced the institutional strength o f grupos. This pattern was intended
to be stopped by the Mexican government with its nationalization of banks in 1982, which
attempted to change the institutional status quo by redirecting the flow of funds into other non-
grupo firms ranking higher in national priority. But the re-privatization of banks in the I990’s
brought back preferred finance for grupo-firms.
Exporters were surprisingly found to have lower average net earnings ratio when the peso
devalued in the second and fourth periods (1982-1988 and 1994-1995). Moreover, earnings
decreased faster for exporters than for non-exporters in the recession period o f 1982-1988. In
both of these periods, exporter’s overhead expense ratios increased significantly as compared to
non-exporters. The sharper decrease in operation earnings during the second period, however,
seems to have been magnified by the increasing financial costs of exporters.
At the firm level, credit rationing and high real interest rates (which induce a fall in the debt-
equity ratio) increase earnings and the return to equity as lower gearing ratios reduce financial
costs.
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70
BIBLIOGRAPHY
Armendariz de Aghion, Beatriz, and Armendariz de Hinestrosa, Patricia, “ Debt relief, growth
and price stability in Mexico, ” 1987.
Bolsa Mexicana de Valores (1982-1996), “ Anuario Financiero, " (Mexico, D.F.: Bolsa
Mexicana de Valores, S.A. de C.V.)
Corbo, Victtorio, and de Melo, Jaime, “ How Firms Adjusted to the Recent Reforms in
Argentina, Chile and Uruguay, " World Bank Staff Working Papers (764) 1985.
de Melo, Jaime; Pascale, Ricardo; andTybout, James, “ How the Financial Statement o f
Uruguayan Firms in 1973-81 Reflected Stabilization and Reform Attempts, ” World Bank
Staff Working Papers 1985.
Fry, Maxwell J. (1978) “ Money and Capital or Financial Deepening in Economic
Development? ’’ Journal of Money, Credit, and Banking, 10(4), November 1978, pp.464-475.
Galvez, Julio, and Tybout, James, (1985), “ Microeconomic Adjustments in Chile during 1977-
81: The importance o f Being a Grupo, ” World Development, 13(8), 1985, pp. 969-994.
IMF, World Economic Outlook (May 1995.)
Lucas, Robert E., “ Interest rates and currency prices in a two-country world" 1982.
Maxfield, Silvia (1988). “ International Finance, The State and Capital Accumulation: Mexico
in Comparative Perspective, ” (Cambridge; Harvard University. Ph.D. Dissertation, 1988.
McKinnon, Ronald I. (1973) “ Money and Capital in Economic Development, ” The Brookings
Institution, 1973.
North, Douglass C. (1990), “ Institutions, Institutional Change and Economic Performance, ”
Cambridge University Press, 1990.
Oaks, Daniel, and Sweder Van Wijnbergen “ Mexico after the debt crisis: Is growth
sustainable?" 1992. -
Rayon, Enrique, “When Financial Repression Cause Financial Market Development: The
Case o f Mexico, " 1991.
Shaw, Edward S. (1973), “ Financial Deepening in Economic Development, " Oxford
University Press, 1973.
Stiglitz, Joseph E., and Weiss, Andrew, (198IJ “Credit rationing in markets with imperfect
competition, " American Economic Review, 71(3), June 1981, pp. 393-410.
Truman, Edwin, “The peso crisis: Implications fo r international finance, ” 1995.
R eproduced with permission of the copyright owner. Further reproduction prohibited without permission.
Tybout, James, and Petrei, Humberto A., “ How the Financial Statements o f Argentine Firms
Reflected Stabilization and Reform Attempts during 1976-81, ” World Bank StaffWorking
Papers (706), 1984.
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Asset Metadata

Creator Orozco, Gabriel Medina (author)

Core Title How financial statements in Mexican firms reflect changes in the financial/economic environment from 1978 to 1996

School Graduate School

Degree Master of Arts

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Commerce-Business,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Nugent, Jeffrey B. (committee chair), Betts, Caroline Marie (committee member), Perrigne, Isabelle (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c16-27649

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Legacy Identifier 1394773.pdf

Dmrecord 27649

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Rights Orozco, Gabriel Medina

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA