Does oil price affect the value of firms? Evidence from Tunisian listed firms

Abstract

A new debate on the potential impact of oil price changes on the value of firms was initiated in this paper. Using a stochastic frontier approach, an attempt was made to derive the optimal value Q* of firms and calculate the Q value observed. Then the shortfall (Q*–Q) which represents the inefficiency term was explained. Starting from 19 industrial Tunisian firms listed on the Tunis Stock Exchange between 2007 and 2011, the fact that variation of oil prices can largely explain distortions in the value of firms was empirically demonstrated.

Keywords

oil price / value of firm / stochastic frontier approach / industrial Tunisian firms

1 Introduction

How do changes in oil prices affect the value of firms? The economics and financial literature focuses on the effect of oil price changes on stock returns, economic growth and some macro-economic phenomenon [1,2]. However, the literature is still silent about the effect of oil price changes on financial variables. Especially, the effect of oil price changes on the value of firms is unexplored.

In fact, previous studies focus on the relationship between the change in oil prices and the macroeconomic variables such as the gross domestic product (GDP), inflation, demand and supply of goods and services, investment, employment and the exchange rate [3,4]. However, the relationship between the change in oil prices and financial variables is less studied. Thus, the effect of oil prices at the micro level and specifically at the firm level is weakly studied.

Prior studies of the effect of changes in oil price can be classified into the market level (macro level) and the firm level (micro level). At the macroeconomics level, the pioneers such as Jones and Kaul [2] studied the effect of oil prices in the stock market and found that oil prices had a negative impact on the return of stock market. They concluded that the reaction of the current Canadian and US equity to the changes of oil price could be fully explained by the shocks on the actual cash flows. In contrast, the authors in Ref. [1] examined the relationship between daily oil future returns and daily US stock returns and found that oil future returns did not have much impact on the broad-based market indexes such as the S&P 500. The author of Ref. [5] studied the impact of oil price shocks on a real aggregate stock returns in the US, which was represented by the difference between the continuously compounded returns of the S&P 500 index and inflation rate. He showed that changes in oil price and oil price volatility have a significant negative impact on stock returns. The authors in Ref. [6] incorporated the expected, unexpected and negative unexpected oil price fluctuations into the model of stock returns. They focused on the ways in which oil price volatility could influence the stock market and found that high fluctuations in oil price had an asymmetric unexpected impact on S&P 500 returns. The authors in Ref. [1] studied the transmission mechanism linking information of oil price with stock prices and found that if the oil futures market and the stock market were efficient, the future price of oil and stock prices would be simultaneously correlated. The reason for this is that each market reacted quickly to information shocks in relation to other markets and therefore, influenced the behavior of investors. Indeed, given the sensitivity of stock prices to changes in oil prices, the stock market becomes more uncertain and riskier, which affected investors’ decisions.

At the micro level, the study of the relationship between changes in oil price and the value of firms was conducted initially for firms producing raw materials. Thus, the impact of the uncertainty of oil prices on the cost of production was studied for firms producing oil. The authors in Ref. [7] showed that this sensitivity was negatively correlated with the debt ratio of the firm and its production costs. They estimated the levels of commodity prices prompting investors to change their perception of future cash flows and, therefore, the value of corporate assets. According to their empirical findings, the oil industry provided an ideal setting to test the effects of the uncertainty of oil price volatility on the prices of options. The implications of these studies were that changes in oil price uncertainty affected the value of firms. The authors in Refs. [8,9] studied the effect of oil price changes and the value of firms and concluded that the fluctuations wild directly affect revenues, profits, investment and cash flow of these firms. In fact, an appreciation of oil prices would be associated with an increase in the production cost which would cause lower profits. As a consequence, it was quite logical that the increased oil price could impact firm stock market value.

The oil price affects the value of firms through their effects on the cost of the firm such as production cost [1,10–12], cost hedging [13,14], cost of capital [15] which in turn, affect revenues, profit investment and cash flow. These studies converge in most of the cases in a common conclusion. The appreciation of oil prices will negatively affect the performance and the corporate strategies and so the value of the firm.

On the other hand, the authors in Ref. [1] found that oil price could have a significant impact on the stock return of a firm and that the market value of a firm was affected by systematic movements in expected cash flow and discount rates. According to Ref. [15], the changes in oil price could affect the discount rates because the expected discount rate was composed of the expected inflation rate and the expected real interest rate. For this, the changes in oil price may track the inflation rate, leading to an increase in the expected discount rate which could probably lead to an increase in the cost of the capital for a firm. This will have a negative impact on the value of a firm. In this same context, the authors in Ref. [16] argued that there was a relationship between the consumption of oil by oil-related firms and the value of firms. Indeed, they studied the impact of energy conservation efforts on the value of firms, using the trading system of carbon rights in China (CERT) as an exogenous shock and the results documented that CERT and the energy saving efforts increased the market value of firms related to energy and influence investor reaction. Consequently, saving energy and oil consumption decreased the costs of firms and improved the market values of firms.

The changes in oil prices was a key factor in the production process which affected the financial performance or cash flows of firms which, in turn, influenced the dividend payments, the retained earnings, and thereafter, the stock prices of these firms [17]. So, the rise in oil price, in the absence of effects of complete substitution between factors of production, increased the operating costs of a firm, which could, then, lead to a change in the costs and the value of a firm [1].

Thus, the increase in oil price reduced the financial profits or economic performance of firms for which oil was a direct or indirect production cost factors [10]. Indeed, the authors in Ref. [10] found that changes in oil price positively and significantly impacted the accounting returns (as represented by the return on equity (ROE)) of oil and gas firms in North America. They showed that the recent financial crisis of 2007 and 2008, negatively affected the oil price and the accounting performance of these firms, and the commodity prices drove the financial performance of commodity-based industries.

Besides, by using derivative instruments to protect against adverse movements in oil price, the cost of hedging could affect negatively the value of the firm [13,18]. In fact, the coverage of volatile commodity prices led to a reduction in the risk premium of the firm against a cost that must be paid using financial products and affected the firm financing decisions because hedging influenced the financing of the firm [14]. Even if a firm was not involved in the oil industry, the rise in oil price represented an increase in the cost of doing business without a corresponding increase in income, leading to a reduction in the benefits of the firm [11].

Consequently, the share prices of these firms will be affected since the operating costs hinder the cash flow and reduce the share prices. Indeed, operating costs and the costs of hedging commodity price volatility, resulting from higher oil price and their impact on accounting returns and the financial performance of firms, will normally affect the reaction of investors who become more cautious to buy their shares.

The effect of changes in oil price on the value of firms varies by sector of activity. Refs. [1] and [15] indicated that an increase in oil price could have a positive or negative effect on the value of a firm as the firm used oil as an input (consumer firm) or output (producer firm). That is to say, the effect of oil shocks on a specific industry could be positive or negative depending on whether the industry is a net producer or net consumer of oil. Indeed, the oil and gas prices had a significant positive effect on the value of the firm of oil and gas producers [19].

However, other studies found that the oil price can have a significant negative effect [15,17,20–23] on the value of firms. The authors in Ref. [15] found that effects of oil price were significantly negative for US tourism and leisure sector, who were considered to be the net consumers of oil, during 1983 to 2011 period. They explained this effect by the cost pressures arising from higher energy prices.

The study conducted by the authors in Ref. [24] was considered to be the first to undertake a detailed analysis of the impact of oil price on the yields of firms in all sectors. They found that oil price affected the performance of firms in different ways depending on their sector location. So, based on this latter observation, there must be interest in studies that focus on the most affected sectors.

The most affected sectors by the changes in oil price are industry, automotive and transportation [17,20,21,25]. Indeed, the authors in Ref. [20] determined the relationship between oil price and the stock prices of the automobile industry. They found that there was an inverse relationship between rising oil price and an accompanying reduction in auto manufacturer stock price. Ref. [21] analyzed the phenomena among transport firms by showing that their performance was negatively influenced by the changes in oil price.

Reference [17] affirmed that the fluctuation of oil price was a systematic risk of the asset prices in the American industrial sector. For the same sector, the authors in Ref. [13] studied the sensitivity of equity returns of the Australian industry in oil prices. They reported that the price of energy, in general, and oil prices, in particular, was likely to have a significant impact on the costs of many businesses.

Reference [22] investigated whether a high oil price event that worsened the quality of the balance sheet in turn of a firm could provide an additional transmission channel to the stock market, which then affected stock returns.

Reference [23] analyzed the effects of oil price uncertainty on the manufacturing production of South Africa and found that oil price volatility affected manufacturing production negatively given that decisions to invest in general and production decisions in particular were often influenced by potential returns.

It could be said that these costs and the uncertainty and volatility of oil price could affect investment of an industrial firm. In fact, the variation of oil price as a risk could lead to an increase in costs for non-producing oil firms and the subsequent reduction of profits and dividends, which were the main drivers of stock prices [26].

Therefore, uncertainty and volatility regarding the price of an important input like oil price may affect strategic investment decisions and hence reduce manufacturing production.

As it was presented in all of the previous studies, the risk of uncertainty about the oil price affects the costs of the firm which in turn affects stock price, profit, investment, cash flows of the firm and consequently the value of the firm.

This paper continues and completes these studies. Based on all of these studies, it aims to study the effect of oil price on the Tunisian industrial firms. In other terms, it tries to answer the following question: To what extent does oil price affect the value of the firm, which has not been well investigated in previous studies.

2 Hypothesis development

According to Ref. [27], the value of a firm is the economic value of its operating assets. It reflects the present value of all the cash flow generated by the firm in the future, and the assets financed by the various donors who are shareholders and lenders. It is determined using the accounting data. According to Ref. [28], the value of a firm is the present value of the cash flow generated by its assets. According to Ref. [29], the value of a firm is defined as the ratio between the market value of the firm and the book value of the total assets. The market value of the firm is measured by the sum of the market value of equity and the book value of the total liabilities.

An examination of the previous literature indicated that the majority of studies that examined the effect of changes in oil prices at the firm level were limited only to the effect on their stock prices [11,17,20,21], on their costs, on their profit, on their performance [10,26,30] and on their returns [13,24]. Thus, at the micro level, the changes in oil price is a key factor in the production process which affects the costs [1,10,15,16] and the financial performance or cash flow of firms which, in turn, influences the dividend payments, the retained earnings, and thereafter, the stock prices of these firms [26]. Starting from these studies, it can be concluded that changes in oil price affects the value of the firm through its influence on the costs, profits, returns and share price of the firm.

The effects of oil may be well observed on the industrial firm level. This effect was predicted to be negative [10,15,20–23,31].

H₁: Changes in oil price affects negatively the value of firms.

In the studies in Ref. [11], the empirical results showed that the increase in the size of the firm or in oil prices affected the stock price returns. The author in Ref. [11] studied the relationship between oil price and stock prices when the size of the firm varied. He found that the relationship between the changes in oil price, and in stock prices varied depending on the size of firms, and the relationship was stronger for midsized firms. According to Ref. [32], although small firms were particularly sensitive to shocks, empirical work on the management of corporate risk rather focused on large firms. Small firms were generally considered to face more severe than large firm financial constraints. In this paper, the logarithm of total assets is used as an indicator of the size of the firm [21,33]. Table 1 lists the details of the effect of oil price on the value of firms.

H₂: Effect of changes in oil price on value of firms is more pronounced for small firms.

Examinations of the effect of the board of directors show its importance in affecting the value of firms. Reference [37] stated that there was an inverse relationship between the size of the board and the value of the firm in Singapore and Malaysia and that the negative relationship between the size of the board and the value of firms exceeded the different systems of corporate governance. Thus, firms with a greater board were associated with a lower valuation. The reason for this was that firms with a greater board size were associated with a less efficient use of assets and a low profitability.

Reference [38] found a significant negative correlation between the size of the board and profitability in a sample of small and medium-sized Finnish firms. Reference [39] examined the relationship between the value of the firm and the structure of the board. It was found that complex firms, which had greater requirements, had boards of larger size with more outside directors. The restrictions on the size of the board and management representation on the board necessarily enhanced the value of the firm.

In attempting to explain the importance of the effect of board of directors on the value of the firm besides the effect of changes in oil price, the size of the board was introduced as an explanatory variable in this paper. The size of the board is the number of directors voted in this board [28,40–42].

H₃: Negative effect of changes in oil price on the value of firms increase with the size of board of directors.

In this paper, the stochastic frontier model was used for a theoretical measurement of optimal Tobin’s Q. The stochastic frontier approach is an econometric technique used in Ref. [43] to estimate the technology underlying production and technical inefficiency for individual producers. According to Ref. [44], the unique feature of this model is that the error term is the sum of a unilateral term technical inefficiency and a noise term for both sides. In other words, the integration of the random effect of error decomposition into an inefficiency component and a random error component combining the measurement error and the exogenous shocks which are not under the control of the firm [45].

The approach in Refs. [28,46,47] was followed in this paper to obtain the estimates of efficiency. An attempt was made to explain the sensitivity of the value of firms to changes in oil price. Based on the study in Ref. [28], it is necessary to determine what variable X determines the location of the border, and what variable Z explains the deficits of the border. The choice of the set of the explanatory variables is similar to that in Ref. [46]. The determinants of the value of firms are sales which represent the revenues at the end of period t; the investment in fixed assets; the fixed assets; the investment-to-fixed asset ratio; the ratio of fixed assets to sales; the ratio of operating income before depreciation to revenues; and the ratio of the debt book value to the firm market value (see Table 2).

The stochastic frontier model estimated in this paper has the following form:

Q_{it}={\beta }_{\mathrm{0}}+{\beta }_{\mathrm{1}}{\mathrm{In}\mathrm{sales}}_{it}+{\beta }_{\mathrm{2}}{\left({\mathrm{In}\mathrm{sales}}_{it}\right)}^{\mathrm{2}}+{\beta }_{\mathrm{3}}{\displaystyle \frac{I_{it}}{K_{it-\mathrm{1}}}}

(1)+{\beta }_{\mathrm{4}}{\displaystyle \frac{K_{it-\mathrm{1}}}{{\mathrm{sales}}_{it}}}+{\beta }_{\mathrm{5}}{\mathrm{operMar}}_{it}+{\beta }_{\mathrm{6}}{\mathrm{LEV}}_{it}-v_{it}+{\epsilon }_{it},

where Q_it is the value of the firm, sales is the total income, I_it is the investment in fixed assets, K_it−1 is the fixed asset, operMar_it is the operating margin, and LEV_it is the ratio of the debt book value to the market value of the firm. More details concerning the definitions variables can be referred to in Table 2.

According to Ref. [28], the optimal value of the firm summarized by Q* must have two characteristics: the first is to keep the characteristics of firms constant to better compare the performance of firms, and the second is that it should be taken into account for stochastic errors of the estimate. By examining the changes in oil price and characteristics of the firm, a curve can be drawn that shows the maximum Q observed. In a sample for any combination of all the oil prices and characteristics the firm, the curve X is called the function of the border, and it is of the form Q* = f(X). When Q (the observed value of the firm) of the firm moves over the border, we talk about the short fall (Q*‒Q) which is a measure of the cost of the variation in oil prices.

Based on the study in Refs. [28] and [47], Q is written as

(2)Q_{it}=X_{it}\delta +{\epsilon }_{it},

where {\epsilon }_{it}=v_{it}-u_{it}. In this formulation, X_it is the function of the border. v_it is the two-sided error term which denotes the zero-mean, symmetric, IID error component. It allows for estimation error in locating the frontier itself. While, U_it is the one-sided error term u_it≥0 permits the identification of the frontier (firms are on the frontier (u_it = 0), firms are strictly below the frontier (u_it>0)). Therefore, u corresponds to the shortfall in the actual valuation of a firm (the inefficiency term that represents the shortfall (Q*‒Q) which represents the distortions in the value of the firm, and is given by Eq. (3).

(3)U_{it}={\delta }_{\mathrm{0}}+{\delta }_{\mathrm{1}}{\mathrm{PP}}_t+{\delta }_{\mathrm{2}}{\mathrm{TE}}_{it}+{\delta }_{\mathrm{3}}{\mathrm{TCD}}_{it}+{\epsilon }_{it},

where PP_t is the oil prices for period t, TE_it is the size of firm i for period t, and TCD_it is the board size of firm i for period t.

The optimal value of the company is Q*. This value can be defined as the sum of the observed value of the firm and the distance from the frontier: the shortfall inefficiency term

Q^{*}=Q+u.

3 Data description

The sample consists of 19 industrial firms listed in the Tunis Stock Exchange for the period between 2007 and 2011. The data are obtained via the website of the BVMT and by contacting the head of communication department. The data on oil price from West Texas Intermidiate (WTI) for the same period are also used.

The choice is highly motivated by the fact that the industrial firms are assumed to be more affected by oil price. The reason for this is that these firms use the oil as an input. All Tunisian industrial firms that are publicly traded during a five-year period are selected. A panel data that is composed from 95 annual observations are obtained. The descriptive statistics is summarized in Table 2.

4 Results and discussion

The results obtained highlight that the sales and capital of firms increase the value of firms. However, the leverage is negatively correlated with the value of the firm. These results are in part similar to those in Ref. [28] and those in Refs. [46,47].

The most important finding is that changes in oil price negatively affect the value of firms. In fact, the estimated results in Table 3 show that the (PP) variable is positively correlated with the inefficiency term (Q*–Q), which represents the distortions in the value of the firm, thus, the changes in oil price negatively affect the value of the firm. This result is significant at the 1% level (T–statistic= 5.169).

The changes in oil price have a great effect on the production efficiency of firms. The oil price can inhibit firms to achieve all opportunity growth since the cost of corporate investment will increase. The oil price as an input of the production cycle of firms can so negatively affect corporate investment strategy. Firms will never produce at the efficient frontier, nor will it trade in its optimal value Q*.

The results obtained in this paper can be justified by the fact that a high oil price will be reflected in the prices of goods and services of a firm and so it loose its competitiveness. Over the long-term, the firm will have funding problems. It will be oriented to external financing sources of funding. Such a result will also negatively influence the corporate investment level. According to this second interpretation, the firm will have distortions at its investment strategy that inhibits to reach its optimal value Q*.

Finally, this negative relationship between changes in oil price and the value of the firm can also be justified by the fact that the oil price affects the stocks of the firm and so it can affect the market value of its stocks.

The effect of the characteristics of the board, here the board size, seems to have a positive effect on the inefficiency of the firm. This result is similar to that in Ref. [28], in which it is demonstrated that the corporate governance mechanisms such as the size, the duality and the independence of the board among other ownership variables can affect the value of the firm. The coefficient of the relationship between the size of the board and the inefficiency terms is intense and significant [d₃ = 69.979, T–statistic= 1.723].

A large board of director can reduce the rationality and the optimality of corporate decisions. It can affect the corporate and the financing process, which will negatively affect the value of the firm. A high number of the board can create agency problems and conflicts between its members, a thing that will push firms to act beyond the optimal frontier, which inhibits such firm to trade with its optimal value Q*.

Finally, the size of the firm can reduce the inefficiency terms but this result is not significant. Normally, a firm with a large size can achieve all opportunity growth since it can easily have access to production factors. It generally has internal funding sources and if not, it can use external funding because such firm will be financially unconstrained.

5 Conclusions and recommendations

Although oil price fluctuates frequently and dramatically, it is important for the economy, in particular, in the industry sector where there are the biggest energy consumers. This paper is an original study of the effect of changes in oil prices, whereas the value of the firm is a topic that is largely ignored by the finance literature. This paper examines for the first time the influence of changes in oil price on the value of the firm for 19 industrial firms listed in the Tunis Stock Exchange. The results presented here document some important new discoveries that improve the understanding of the impact of oil price on the micro level of economics. First, the values of the industrial firms are negatively influenced by a higher oil price, and the risks increase more with a higher oil price, which can also be perceived as a source of risk for firms. Industrial firms should take care of the changes to reduce inefficiency and increase their value. Second, the size of the firm and the size of the board are not important to explain much of the shortfall in the value of firms (Q*–Q). Tunisian firms, as they are limited in terms of size and number compared to other industrialized countries, are influenced, too, by the changes in oil price.

Given the economic importance of oil price, these results, which add financial importance, should be of great interest for researchers, business leaders, fund managers, regulators and policy makers. Tunisian firms must consider the oil price for their financial and cost management. Therefore, it is advisable that these firms adopt a system of saving energy, taking China as an example. This solution can allow the firm to control their costs and may also help to protect the environment against the immense use of oil.

The policy of reducing oil consumption and to substitute it by renewable energy and invest more in the fight against pollution costs will not hurt economic growth but rather improve the economy by controlling costs. It could be a feasible policy tool for Tunisia to achieve its sustainable growth in the long-run. For sustainable development, Tunisia has to change its economic structure to a more efficiency-oriented and less resource-depleting one and rely more on renewable-energy sources. Renewable-energy technologies have an enormous potential to solve energy problems in Tunisia. So, now, it is essential that we know how we can best use these resources and at the same time, we must make efforts to encourage industry to adopt technologies that reduce pollution.

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