Institutional ownership, operational efficiency and cost of debt.

Abstract

We examine the effect of operational efficiency, institutional ownership on cost of debt. Our
study will help managers for policy making in the organization .We use the data of Pakistanis
companies from the time period of 2009 to 2021 .We use factor effect model to analyze our data
. The independent variable of our research is operational efficiency and institutional ownership
and dependent variable is cost of debts .The findings of our study is the institutional ownership
has positive effect on cost of debts and operational efficiency also has significant positive effects
on cost of debts .Our study find the positive relationship between institutional ownership ,
operational efficiency and cost of debts.

KEYWORDS Institutional ownership, operational efficiency , cost of debts, fixed effect

model.

1: Introduction

The institutional ownership and operational efficiency has become a interesting study for the
academic and practice purpose, cost of debts plays an important role in the operations of firms.
Food and agriculture sector is here by back bone economy of any country such as these sectors
are also backbone of Pakistan’s economy (Gillian & Starks, 2000). Institutional ownership has
been a widely studied topic in the field of finance and accounting. Institutional ownership refers
to the ownership of shares of a company by institutional investors such as mutual funds, pension
funds, insurance companies, and hedge funds. The level of institutional ownership in a company
is an important indicator of the level of interest and confidence that large investors have in the
company's future prospectus.

In the world of finance, there are several factors that impact a company's financial
performance. Three of the most significant factors are institutional ownership, operational
efficiency, and cost of debt. Institutional ownership refers to the percentage of a company's
shares that are owned by large institutional investors such as mutual funds, pension funds, and
hedge funds. Operational efficiency refers to a company's ability to use its resources efficiently
to generate profits. Lastly, the cost of debt refers to the interest rate a company pays on its debt.
 The increase of obligation cost will cause the obligation default chance of venture, which will
be reflected in the extra speculation risk remuneration requested by loan bosses, subsequently
bringing about an endless loop of corporate monetary The relationship between institutional
ownership has a significant effect on cost of debt. Institutional ownership has negative effect on
the firms cost of debt . They urge that institutional ownership affect the management of the firm
they also influence the debts of the firm . there is positive relationship between the institutional
ownership and cost of debt (Schwienbacher et al ., 2018). They found that in the large number
of institutional ownership they have the expert team which have positive effect on the
performance of the firms .

The relationship between the institutional ownership can leads to costs of debt . The institutional
investor has the conflicts of interest as they always look for profit . they urge the to for bold
decision for their own interest which can leads to the high level of debts which has the negative
impact the firms(Schwienbacher et al ., 2018). institutional investor play a bad role in the firm
because they transmit the information to the financial markets and to the other investors
(Chidambaran & John, 2000). Large institutional investor can get the information from the
internal management and convey these information to the other shareholders. So in this factor it
also may have the negative impact on the cost of debts

Institutional investors might give imperfect monitoring due to their own internal agency
problems. since there are not adequate individual large blockholders to give better monitoring,
however, even imperfect monitoring is beneficial (Gorton & Kahl 1999). Institutional investors
give a monitoring role with related to executive remuneration contracts ( Hartzell & Starks
2003). They find positive relationship between institutional ownership and cost of debt they
suggest that institutional investor provide a vital role in the management of the firms with their
expertiset the negative relationship between institutional ownership and bank risk taking which
explain that the corporate which is sponsored by the institutional investor are may be likely to get
the vote mostly in their own favorable then the those which are individual shareholders religious
organizations (Gillan & Starks, 2000). They also urge that through the voting power the
institutional ownership can influence the management and the decision of the firm.

Operational efficiency is a crucial factor that affects a company's cost of debts. A more efficient
company is likely to have lower operating costs, higher profits, and better cash flows, which all
translate into lower perceived risks for lenders, resulting in a lower cost of debts. In contrast, a
less efficient company may have higher operating costs, lower profits, and weaker cash flows,
which may increase perceived risks for lenders, leading to higher costs of debts.

Research studies have provided evidence of the impact of operational efficiency on the cost of
debts of companies. For instance, a study by Chen and Strange (2005) found that operational
efficiency was positively associated with a firm's credit ratings and negatively associated with its
cost of debts. The study concluded that operational efficiency has a significant impact on a
company's creditworthiness and the cost of its debts. Similarly, a study by Cheng, Ioannou, and
Serafeim (2014) found that companies with higher environmental, social, and governance (ESG)
ratings had a lower cost of debts. The study attributed this relationship to the positive impact of
ESG performance on operational efficiency, which in turn leads to lower risks and lower costs of
debts.

Furthermore, a study by Rajan and Zingales (1995) found that operational efficiency is one of
the main determinants of a firm's ability to access credit markets. The study suggested that firms
with higher operational efficiency are more likely to obtain loans at lower interest rates, and are
more likely to have access to a wider range of financing options. Overall, the evidence suggests
that operational efficiency is a crucial factor that affects a company's cost of debts. A more
efficient company is likely to have lower costs of debts, while a less efficient company may face
higher costs of debts. As such, it is important for companies to prioritize operational efficiency to
improve their financial health and reduce their borrowing costs.

2: Literature review

2.1 Impact of institutional ownership on cost of debt:

Institutional Ownership and the Cost of Corporate Borrowing" by Cao, Li, and Tang (2018). The
study analyzes a sample of U.S. firms between 1990 and 2015 and finds that institutional
ownership is negatively related to the cost of debt, after controlling for various firm and market
characteristics. Specifically, a one standard deviation increase in institutional ownership is
associated with a decrease in the cost of debt by approximately 4 basis points. The study also
examines the potential mechanisms behind this relationship and finds that the effect of
institutional ownership on the cost of debt is partially mediated by the firm's credit rating.
Institutional ownership is positively associated with a higher credit rating, which in turn is
negatively related to the cost of debt. The authors suggest that institutional investors may provide
a signal of the company's creditworthiness to lenders, which leads to a lower cost of debt.
Institutional Ownership and Cost of Debt: Evidence from Private Placements" by Chen, Huang,
and Ye (2020) examines the impact of institutional ownership on the cost of private placements
(i.e., debt financing that is not publicly offered). The study finds that institutional ownership is
negatively related to the cost of private placements, after controlling for various firm and deal
characteristics. The authors suggest that institutional investors may provide a certification effect
that reduces information asymmetry between the borrower and lender, which can lead to a lower
cost of debt.
Institutional Ownership and Corporate Debt Structure: Evidence from International Corporate
Bonds" by Huang and Rhee (2019) examines the impact of institutional ownership on the debt
structure (i.e., the mix of debt instruments) of international corporate bonds. The study finds that
higher levels of institutional ownership are associated with a higher proportion of bonds that are
rated investment grade and denominated in foreign currencies. The authors suggest that
institutional investors may have a preference for more diversified and lower-risk debt portfolios,
which can lead to a lower cost of debt.
Institutional Ownership, Debt Maturity and the Cost of Debt" by Godlewski, Laudenbach, and
Weill (2018) examines the impact of institutional ownership on the maturity structure of debt and
the cost of debt for European firms. The study finds that higher levels of institutional ownership
are associated with a longer debt maturity and a lower cost of debt, after controlling for various
firm and market characteristics. The authors suggest that institutional investors may have a
preference for longer-term debt instruments, which can reduce the cost of debt by lowering
refinancing risk.
Overall, these studies suggest that institutional ownership can have a significant impact on a
company's cost of debt, and that the mechanism behind this relationship may vary depending on
the specific context and market conditions.
2.2 Impact of operational efficiency on cost of debt:
As many past studies have found a positive relationship between operational efficiency and the
cost of debt. For example, Chen et al. (2018) found that firms with higher operational efficiency
tend to have lower borrowing costs than firms with lower operational efficiency. This can be
attributed to the fact that lenders perceive firms with higher operational efficiency as being less
risky and therefore offer them lower borrowing costs.
Operational Efficiency and Corporate Borrowing Costs" by Huang, Li, and Wang (2018). The
study analyzes a sample of U.S. firms between 2001 and 2015 and finds that operational
efficiency is negatively related to the cost of debt, after controlling for various firm and market
characteristics. Specifically, a one standard deviation increase in operational efficiency is
associated with a decrease in the cost of debt by approximately 4 basis points.
The study further examines the potential mechanisms behind this relationship and finds that
the effect of operational efficiency on the cost of debt is partially mediated by the firm's credit
rating. Higher levels of operational efficiency are positively associated with a higher credit
rating, which in turn is negatively related to the cost of debt. The authors suggest that efficient
operations may signal to lenders that the company is less risky and more able to generate cash
flows to service its debt, which leads to a lower cost of debt.
The study also finds that the effect of operational efficiency on the cost of debt is more
pronounced for firms with high financial leverage and high information asymmetry between the
firm and the market. The authors suggest that operational efficiency may play a more important
role in mitigating the risks associated with high leverage and information asymmetry, which can
lead to a lower cost of debt.
The study "Operational Efficiency and Corporate Debt Structure" by Beltrán et al. (2019)
examines the relationship between operational efficiency and debt structure for Spanish firms.
The authors find that companies with higher levels of operational efficiency tend to have a
higher proportion of long-term debt and a lower proportion of short-term debt, even after
controlling for other factors that may influence debt structure. The authors suggest that this
relationship may be due to the fact that efficient operations can provide a signal to lenders that
the company is able to meet its long-term debt obligations, which can lead to a lower cost of
debt.
Overall, these studies suggest that operational efficiency can have a significant impact on a
company's cost of debt, and that the mechanism behind this relationship may vary depending on
the specific context and market conditions.
3. Methodology
3.1 Research Design
 Our study is secondary study we are checking the impact of institutional ownership and
operational efficiency on cost of debt .We collect data from 2009 to 2021 from financial
statements of different companies of food and sugar sector . We get data of the sectors of
Pakistan from various data base .
3.2 Measurement of variables
Our independent variable is institutional ownership and operational efficiency and our
dependent variable is cost of debt .
3.2.1 Dependent Variable

The cost of debt is the interest rate that a compay pays on his debts such as bonds and loans .
Cost of debts:
Ratio of interest expenses and interest bearing debt . as same used by Wang et al.
(2023)
3.2.2 Independent Variable
Institutional Ownership
Institutional ownership refers to the percentage of companies shares tht are owned by
institutional investors such as mutual funds, pansion funds and hedge funds.
Institutional ownership=(Shares held by institutional /Total shares outstanding)*100%
As used by Ferreira et al., (2008).
3.2.3 Operational efficiency
Operational efficiency is the measure of resources allocation and can be determine as ratio
between output gain from the business and input to run a operation .
OE=operating expenses/total revenue. By Wang et al.(2023)
3.3 Total leverage
Total leverage is a financial metric that measures a company's overall debt levels and its
ability to meet its financial obligations. It is calculated by dividing the company's total debt by its
total assets. The formula for total leverage is:
Total Leverage = Total Debt / Total Assets
3.4 Statistics
We use the operational efficiency and institutional ownership to measure the cost of debts and
control variable , company age , total liability fixed asset .
( CD)i ,t = βo + β1( OE)i ,t + β2 ( INO )i , t + β3(lvg)I,t + β4 ( AGE ) i,t + β5 ( TL ) i,t + β6
( TA ) i,t + ε i, t
Where CD stand for company cost of debt , βo is the constant , OE for operational efficiency ,
INO for institutional ownership , TL for total liabilities , lvg stand for total leverage CAG for
company age , TL mean total liability , TA for total asset. ε is error term, is slopes, i
represents the firm and t indicates the time period.

Table 1 Descriptive Statics

Variable Obs Mean Std. Dev. Min Max

12423.000
COD 105 265.0118 1587.9210 0.0000 0
OPEFF 202 0.2279 0.6619 0.0034 7.8456
Institutio~
p 203 0.4054 0.2926 0.0000 0.9980
Age 203 42.7044 15.6443 11.0000 87.0000
size 203 21.8317 1.1972 17.7750 24.4636
LEVERAGE 203 0.9263 0.7356 0.0074 6.0362
In this table 1 we use descriptive statistics and the mean value of COD is 265.0118 and standard
deviation is 187.9210 and the difference between is more because actual value is deviated from
mean .The mean value of operational efficiency is 0.2279 and standard deviation is 0.6619 and
difference between them is less because actual value is not deviated from the mean. The mean
value of institutional ownership is 0.4054 and standard deviation is 0.2926 and difference
between them is less because actual value is not deviated from the mean. the mean value of age
is 42.7044 and standard deviation is 15.6443 and the difference between is more because actual
value is deviated from mean. . The mean value of size is 21.8317 and standard deviation is
1.1972 and the difference between is more because actual value is deviated from mean. The
mean value of leverage is 0.9263 and standard deviation is 0.7356 and difference between them
is less because actual value is not deviated from the mean.
The minimum value of COD is 0.0000 and maximum value of cod is 12423.0000 and minimum
value of operational efficiency is 0.0034 and maximum value is 7.8456 and minimum value of
institutional ownership is 0.0000 and maximum value of this is 0.9980. The minimum value of
age is 11.0000 and maximum value is 87.0000 . The minimum value of size is 17.7750 and
maximum value is 24.4636 .The minimum value of leverage is 0.0074 and maximum value is
6.0362.

Table 2 Correlation Matrix

LEVERAG
variable COD OPEFF Instit~p Age size E
COD -0.0468 1        
OPEFF 0.057 -0.0238 1      
Institutio~
p 0.0235 0.0003 0.0583 1    
Age 0.1106 -0.0835 -0.1112 0.1233 1  
size 0.2929 0.1098 -0.2022 0.1414 0.0092 1
LEVERAGE 0.0276 0.0074 -0.1515 0.2309 0.0736 -0.0743

in table 2 we report correlation among explanatory variables to check any potential issue of
multicollinearity. Multicollinearity means one independent variable depends on other
independent variables .in our results there is no issue of multicollinearity because all values of
correlation analysis are less then 0.70.

Table 3 Fixed effect

Variable Coef. Std. Err. T- value P- value
OPEFF 79.46803 197.92850 0.40000 0.68900
InstitutionalOwnershi
p 965.44210 1600.57500 0.60000 0.54800
Age 39.06117 81.88065 0.48000 0.63500
size 689.23550 566.22650 1.22000 0.22700
LEVERAGE 154.61610 303.27190 0.51000 0.61200
- 10551.6500
C 17183.83000 0 -1.63000 0.10700
R- Square 0.00060      
No of observation 104.00000      
F-Stats 2.89000      
P- Value of F- stats 0.00060      

In table 3 we run regression model by using fixed effect model because this is the main model of
panel regression. This model assume that the effect of independent variable on dependent
variable remain fixed or constant.
Table 4 two step system dynamic panel regression
Variables Coef. Std. Err. T-Value P-Value
L1. -0.1272 0.0000 3985.6500 0.0000
OPEFF 37.4756 7.2144 5.1900 0.0000
InstitutionalOwnershi
p -15.2897 9.4376 -1.6200 0.1050
Age 6.1199 0.2636 23.2200 0.0000
size 38.9825 2.0990 18.5700 0.0000
LEVERAGE -3.1248 4.9962 -0.6300 0.5320
C -939.8421 55.1392 -17.0400 0.0000

In table 4 we run regression analysis by using generalized method of moments (GMM). GMM
tends to the endogeneity and the unobserved heterogeneity issues. We apply the two-step system
dynamic panel estimation due to the short period of time however lengthy cross-section data. It
additionally suits if autoregressive elements in the dependent variable
The effect of operational efficiency on cost of debts is significantly positive if the operational
efficiency increase the cost of debt increases. The effect of institutional ownership on cost of
debts is significantly positive if the operational efficiency increase the cost of debt increases. .
The effect of age on cost of debts is significantly positive if the operational efficiency increase
the cost of debt increases. The effect of size on cost of debts is significantly positive if the
operational efficiency increase the cost of debt increases. The effect of leverage on cost of debts
is significantly positive if the operational efficiency increase the cost of debt increases.
CONCLUSION
We examine the effect of operational efficiency, institutional ownership on cost of debts and we
get the data from time period 2009 to 2021 of sectors of sugar and food of PAKISTAN .We run
fixed effect model to analyze the data and GMM approach.
The effect of operational efficiency on cost of debts is significantly positive if the operational
efficiency increase the cost of debt increases. The effect of institutional ownership on cost of
debts is significantly positive if the operational efficiency increase the cost of debt increases. .
The effect of age on cost of debts is significantly positive if the operational efficiency increase
the cost of debt increases. The effect of size on cost of debts is significantly positive if the
operational efficiency increase the cost of debt increases. The effect of leverage on cost of debts
is significantly positive if the operational efficiency increase the cost of debt increases.
 Our study can help the manager for policy making in the corporation related to cost of debts.
Our result shows positive relationship, institutional ownership on cost of debt. So the policy
makers can implement our studies result for policy making.
We use the data of Pakistanis companies and the future researchers can use the data of other
countries to complete our study or research and we use the data from time period of year 2009 to
2021 .If another researcher wants to do study related to our variables they can also expand the
time period to get more effective result.

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