"We found that restaurants with a potential for growth used less long-term debt than those without growth potential," says Dr. Arun Upneja, associate professor of hotel, restaurant and recreation management, Penn State. "This is identical to other market sectors, but differs from the lodging industry."
Upneja and Michael C. Dalbor, assistant professor, University of Nevada-Las Vegas, looked at restaurant firms traded on the stock market as listed in Standard & Poors COMPUSTAT database. In the November issue of the Journal of Hospitality & Tourism Research, they report that "restaurant firms with significant growth opportunities tend to use less long-term debt." They also note that "larger firms can afford the higher fixed costs associated with long-term debt placement."
Short-term debt is usually used to cover day-to-day expenses like payroll or materials costs and while short-term debt is usually expensive, it is also short term. In this case, the researchers define long-term debt as debt held for three years or more. Long-term debt may be used for capital projects, expansion or acquisitions, but it is not the only way to finance these growth options. In most industries previously studied, companies with growth potential use these other options rather than incur long-term debt.
"Business schools look at total stock market results and various sectors, but we realized that no one was looking specifically at the hospitality sector," says Upneja. "When we initially looked at the lodging industry, we found that those companies with good growth potential do use long-term debt. Unlike our hotel study, the study of the restaurant firms was in line with the majority of companies."
Growth opportunities for companies include opening new restaurants, increasing income in existing restaurants, increasing the menu prices, opening new types of restaurants, increasing table turnover or acquiring another chain or company. Successful companies strive to obtain financing for growth projects from reinvestment of earning or their stockholders, rather than from lending institutions.
Growth opportunities in the lodging industry generally mean building new hotels, renovating or expanding existing properties and acquiring other chains, all approaches that include large capital expense. Upneja speculates that hotels have very fixed assets and need a lot of money for buildings. Acquiring debt for building is relatively easy and so to hedge against loses, the lodging industry builds more and more buildings, considering there is safety in numbers and perhaps diversity of location. This leads to the direct relationship between growth in the lodging industry and long-term debt.
Other industries, including the restaurant industry, choose to avoid long-term debt when expanding to please Wall Street.
"The short-term focus of Wall Street does not allow thinking in the long term," says Upneja. "As soon as the stock market believes that a company has very few possibilities for growth, the stock will fall. If a company has no growth potential, a change of management may soon follow."