Tourism Management 70 (2019) 124–133

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Tourism Management
journal homepage: www.elsevier.com/locate/tourman

Capital structure in the hospitality industry: The role of the asset-light and T
fee-oriented strategy
Yuan Lia,∗, Manisha Singalb
a
Department of Hospitality & Tourism Management, Pamplin College of Business, Virginia Tech, 342 Wallace Hall, 295 West Campus Drive, Blacksburg, VA 24061-0429,
United States
b
Department of Hospitality & Tourism Management, Pamplin College of Business, Virginia Tech, 363B Wallace Hall, 295 West Campus Drive, Blacksburg, VA 24061-
0429, United States

A R T I C LE I N FO A B S T R A C T

Keywords: An asset-light and fee-oriented strategy (ALFO), which reduces risk and facilitates firm growth with minimum
Asset tangibility capital investment, has increasingly gained attention from industry practitioners and academic scholars alike,
Capital intensity especially in the service sector like the hospitality industry. We empirically examine how ALFO is employed and
Fee-income ratio how it is related to the capital structure, i.e. the proportion of debt and equity financing, in hospitality firms.
Degree of franchising
Using a sample of 982 firm-year observations over the period 2002–2016, we find that ALFO is widely used by
Capital structure
Hospitality industry
the hospitality industry, and as expected, the fee-income ratio and the degree of franchising have increased,
while asset tangibility and capital intensity have decreased. Interestingly, although ALFO is positively related to
long-term debt ratios of hospitality firms, our sub-sector analyses indicate that the relationship is only significant
in the restaurant sector and not in the hotel sector. Our study contributes to the literature by identifying an
important industry-specific variable that affects the capital structure of hospitality firms.

1. Introduction
The trend that began a few years ago of hospitality firms shifting to
a more fee-driven business model, referred to as an asset-light and fee-
oriented strategy (ALFO), has now clearly emerged as a dominant
strategy. Similar to the asset-light strategy employed by other industries
(e.g., the telephone communications industry and the semiconductor
industry) that enable firms to give up plants and facilities to focus on
developing intangible assets that are more profitable (Lin & Huang,
2011; Liou, 2011), an ALFO strategy enables hospitality firms to own
fewer (or no) hotel or restaurant properties and invest more in tech-
nology and loyalty-based assets using franchising and management
contracts. That is, what differentiates ALFO from other types of asset-
light strategies is that it allows hospitality firms to generate sizable
income from franchising and management fees collected from estab-
lishments that are not owned by the company. As an example of the
prevalence of ALFO, Marriott and Hilton, two of the major hotel com-
panies in the world, have clearly stated in their latest annual reports
that they follow an asset-light strategy (Marriott International Inc.,
2018) and rely on the fee-based business for continued expansion
(Hilton Worldwide Holdings Inc., 2018).
In a franchise agreement, the franchisor receives an initial fee and
ongoing royalties from the franchisee by providing the franchisee the
right to use its brand name and operating process (Combs, Ketchen, &
Short, 2011b). While not all hospitality firms choose to franchise, firms
that do franchise sometimes operate up to 100% of their total units
through franchisees (e.g., Dunkin’ Brands Group, Inc.). In a manage-
ment contract agreement, a hotel chain sells a property but signs a long-
term contract with the buyer to continue to operate the property for the
buyer in exchange for management fees. Following a strategy shift from
“asset-recycling” to “asset-light,” Hyatt Hotels announced a plan in
2017 to sell $1.5 billion in hotel real estate over the next 3 years (Ting,
2017).
Despite its prevalence, only a few studies have examined the im-
plications of ALFO in the hospitality industry (Sohn, Tang, & Jang,
2013; Sohn, Tang, & Jang, 2014). Overall, these studies indicate that
ALFO reduces risk and allows firms to expand without large capital
investments. Specifically, Sohn et al. (2013) argue that ALFO reduces
operational risk (i.e., operating leverage and earnings volatility) be-
cause asset-light translates into a lower fixed-asset ratio that decreases
operating leverage (i.e., the ratio of fixed to variable costs) and fee-
orientation translates into a higher fee-income ratio (i.e., the proportion
of income generated by fees) that lowers earnings volatility. In the same
vein, Sohn et al. (2014) argue that ALFO reduces systematic risk

∗
Corresponding author.
E-mail addresses: yuanli@vt.edu (Y. Li), msingal@vt.edu (M. Singal).

https://doi.org/10.1016/j.tourman.2018.08.004
Received 2 August 2018; Accepted 7 August 2018
0261-5177/ © 2018 Elsevier Ltd. All rights reserved.
Y. Li, M. Singal
because firms that invest less in fixed and illiquid assets are less vul-
nerable to economic ups and downs and are more flexible to adjust
themselves to economic conditions. To the best of our knowledge, no
study has explicitly examined the implication of ALFO for the financial
risk of a firm, which is part of the overall risk encountered by hospi-
tality firms and a significant concern for many investors and other
stakeholders.
Unlike many industries that are not geographically distributed, the
hospitality industry is traditionally confronted with a higher need for
financial capital to invest in fixed assets such as land, building, and
equipment, and since debt is relatively cheaper than equity, it has been
widely used as a source of capital to fund investments. Using a sample
of S&P 1500 firms over 21 years, Singal (2015) finds that the mean
leverage was 22.8% and the difference between hospitality and non-
hospitality firms was a hefty 9.8%. Although debt can lower the cost of
capital and potentially increase firm profitability, research shows heavy
debt financing has also led to bankruptcy of a number of hospitality
firms (Gu, 2002; Kwansa & Cho, 1995).
Due to the importance of debt, many scholars have examined the
manner in which a firm uses debt and equity to finance its overall
operation and growth, i.e., the capital structure of the firm. Capital
structure decisions are vital to firms because they affect the profitability
and survival of firms. While debt increases firm value through the in-
terest tax shield (Modigliani & Miller, 1963), it also reduces firm value
by incurring bankruptcy costs (Andrade & Kaplan, 1998) and agency
costs (Jensen & Meckling, 1976; Myers, 1977). Compared with equity
financing, debt financing lowers the cost of capital. Given the costs and
benefits of debt financing, whether an optimal capital structure exists
has thus received plenty of scholarly attention.
In the hospitality field, researchers have also examined capital
structure decisions. In particular, Sheel (1994) shows that traditional
leverage determinants have varying effects on the short- and long-term
debt behavior of hotel and manufacturing firms, whereas Tang and
Jang (2007) report that some determinants, such as earnings volatility
and firm size, affect long-term debt usage only in software firms but not
in lodging firms (Tang & Jang, 2007). Both studies conclude that there
are industry-specific variables affecting the capital structure decisions
that are not included in the specifications, which in part explains the
low explanatory power of the regression models.
In this study, we attempt to answer the call by Sheel (1994) and
Tang and Jang (2007) by linking ALFO, arguably the primary dis-
tinctive characteristic of the hospitality industry, to capital structure
decisions of hospitality firms. By definition, both franchising and
management contracts allow companies to expand their business with
little capital investment and therefore lead firms to reduce capital ex-
penditure on fixed assets. Since fixed assets can be used as collateral for
borrowing, leverage of hospitality firms is expected to decrease over
time. However, increases in fee-based income from franchising and
management contracts are also shown to reduce earnings volatility,
which leads to savings in financial distress costs. All else being equal,
firms with lower costs of financial distress can afford more debt, thus a
higher leverage ratio.
Due to the mixed influence of the asset-light and the fee-oriented
components of ALFO on capital structure, especially predicted by
competing capital structure theories discussed later, a systematic ana-
lysis of the potential impact of ALFO on capital structure decisions is
warranted. To do so, we first examine how ALFO is adopted in the
hospitality industry over 15 years by using univariate analyses. We then
examine how ALFO is related to the capital structure of firms by using
panel regressions with firm- and year-fixed effects as well as robust
standard errors. Our expanded measures of ALFO – fixed-asset ratio,
fee-income ratio, degree of franchising, and capital intensity – com-
plement prior studies that only use two measures – fixed-asset ratio and
fee-income ratio – by providing a more comprehensive and fine-grained
view of ALFO and its implications. While prior research only focuses on
the impact individual ALFO measures have on profitability, risk, or firm
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Tourism Management 70 (2019) 124–133
value, our study emphasizes the relationship between an overall ALFO
measure obtained from principal component analysis and capital
structure.
To that end, our study contributes to the literature by identifying an
industry-specific variable in explaining leverage behavior of hospitality
firms. Using panel data analysis, we provide additional time-series
evidence for the effect of traditional capital structure determinants in
the hospitality industry when the existing evidence is predominantly
cross sectional. From a practical standpoint, knowing the determinants
of capital structure is especially important for the hospitality industry
because of the high failure rates associated with high debt levels. The
findings may benefit practitioners, investors, and bankers alike in
making decisions regarding ALFO adoption/adjustment, investment
portfolios evaluation, and lending and borrowing.
2. Literature review
2.1. Capital structure determinants and theories
Existing finance literature has identified several major determinants
of capital structure including impact of taxes, costs of financial distress,
and the agency costs and benefits of debt and equity. Scholars have also
proposed two major theories in explaining capital structure decisions,
i.e., the trade-off theory and the pecking order theory. Using a natural
experimental design, Faccio and Xu (2015) find that both corporate and
personal taxes affect capital structure choices. Since interest expenses
are tax deductible, firms use more debt when firm-specific marginal tax
rates are higher (Graham, 1996). However, heavy debt financing also
incurs direct and indirect costs of financial distress, estimated as
10%–20% of firm value (Andrade & Kaplan, 1998). To balance the
corporate tax benefits and costs of financial distress associated with
debt, the trade-off theory postulates that firms will borrow up to the
point where the marginal benefit of tax on additional debt is equal to
the possible costs of financial distress. In other words, there exists an
optimal capital structure that maximizes firm value.
In a broad sense, the trade-off theory also includes agency costs and
benefits. From an agency perspective, owner-managers have the in-
centive to exchange low-risk investments for high-risk investments that
benefit shareholders at the expense of bondholders (i.e., asset sub-
stitution; Jensen & Meckling, 1976). The presence of debt may also lead
to underinvestment when a debt burden is so large that a firm cannot
borrow more money to finance profitable projects (i.e., debt overhang;
Myers, 1977). Despite the costs, debt has benefits that lower the agency
cost of outside equity (Jensen & Meckling, 1976) and partially solve the
agency problem of free cash flow (Jensen, 1986).
A competing theory to the trade-off theory is the pecking order
theory, which states that due to information asymmetry between
managers and shareholders, equity is more expensive than debt. As a
result, firms should finance their new investments first with internal
funds, then with risk-free debt, followed by risky debt, and lastly with
equity (Myers & Majluf, 1984). A salient implication of this theory is
that an optimal capital structure does not exist.
A number of studies have examined the determinants of capital
structure in the hospitality industry. Dalbor and Upneja (2002) examine
the factors affecting the long-term debt (LTD) decisions of U.S. publicly-
traded restaurant firms. Dalbor and Upneja (2004) investigate the re-
lationship between growth opportunities and LTD in the U.S. lodging
industry, whereas Upneja and Dalbor (2009) test major capital struc-
ture theories in the U.S. casino industry. These studies indicate that the
effect of some debt determinants like growth opportunities may vary
among different sectors within the hospitality industry.
2.2. ALFO and its implications
Traditionally, hospitality firms have heavy fixed costs arising from
capital investment in land and building and from depreciation and
Y. Li, M. Singal
maintenance of fixed assets. Due to the inflexibility of fixed costs, firms
with a higher fixed-asset ratio are subjected to higher earnings volati-
lity, especially during periods of economic uncertainty. To help miti-
gate the risk faced by the firm, firms can reduce holdings of fixed assets
and increase fee-based income from management contracts and fran-
chising.
Generally, a management contract has two components: a base
management fee, which is a fraction of the revenues of the property,
and an incentive management fee, which depends on the profits of the
property. As long as the property generates positive revenue, the op-
erator receives the base management fee, regardless of the profits of the
property, which are subject to both revenue and expenses. When the
performance of the managed property exceeds a predetermined target,
the operators also receive the incentive management fee on top of the
base management fee. Similarly, a franchising contract also consists of
two components: an upfront initial fee, which is due at the time of the
franchise application, and continuing fees, which are, to a large extent,
based on sales revenues. Although not completely immune to economic
conditions, both management contracts and franchising provide more
stable earnings in periods of economic softness and disproportionately
higher earnings in periods of economic expansions (Sohn et al., 2014).
Consistent with these arguments, studies (Sohn et al., 2013, 2014)
find that ALFO shields firms from unexpected negative shocks during
economic recessions, increases firms' sensitivity to economic recovery
during expansion periods, and boosts overall firm value by increasing
profitability and decreasing operational and systematic risks. The dis-
advantage of ALFO is the agency cost of “free-riding” incurred by a
franchisor shifting control to franchisees (Combs, Ketchen, Shook, &
Short, 2011a). The “free-riding” problem, which increases as the degree
of franchising (DOF) increases, has a detrimental effect on the value of
the franchisor's brand, which is an important intangible asset held by
the franchisor. Despite the drawback associated with ALFO, prior re-
search (Sohn et al., 2013) finds that ALFO has a positive effect on firm
value, implying that the benefits outweigh the costs.
Although existing studies have examined ALFO in relation to op-
erational and systematic risks, one type of risk that is widespread in the
hospitality industry and that has not been systematically and explicitly
examined is the financial risk arising from debt. In the following sec-
tion, we discuss in detail the potential relationship between ALFO and
capital structure.
2.3. Relationship between ALFO and capital structure
2.3.1. Dimensions of ALFO
To achieve an asset-light state, firms can either sell properties to
reduce the amount of fixed assets they have, or spend less to acquire
new property, plant and equipment (PPE). This component can be
captured by the capital intensity ratio, which measures capital ex-
penditures as a percentage of total assets, and the fixed-asset ratio (or
asset tangibility), which is a ratio of the firm's PPE to assets. While
capital intensity reflects a firm's spending on fixed assets in a given
year, fixed-asset ratio shows the cumulative effect of the practice of
asset-light on the stock of tangible assets. The second component of
ALFO is fee-orientation, which is captured by the fee-income ratio
(Sohn et al., 2013). An increasing fee-income ratio implies that firms
are generating more income from franchising and management con-
tracts than from operating their own properties. A measure closely re-
lated to fee-income ratio is DOF, which is the proportion of a firm's total
units operated under franchising/management contracts. Overall, we
consider firms having an ALFO strategy to increase their fee-income
ratio and DOF and simultaneously decrease their asset tangibility and
capital intensity.
Prior research indicates that ALFO is a rapid spreading strategy in
the hospitality industry as the industry-wide fee-income ratio has in-
creased more than 75%, from 7.5% in 2002 to 13.3% in 2010 (Sohn
et al., 2013). Consistent with this finding, a recent article indicates that
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the hospitality industry is the largest business line in the franchise
sector of the U.S. economy since 2014 and is forecasted to continue
being the largest in 2018 (IHS Markit Economics, 2018). From 2016 to
2017, the number of franchise establishments grew 1% to 27,998 for
lodging, 1.8% to 190,649 for quick service restaurants, and 1.7% to
31,408 for full service restaurants (IHS Markit Economics, 2018). All
this evidence seems to suggest that the ALFO strategy has become in-
creasingly popular in the hospitality industry. Therefore, we expect
asset tangibility and capital intensity to decrease and the fee-income
ratio and DOF to increase over time.
2.3.2. Asset tangibility and leverage
Intuitively, the asset-light strategy can affect capital structure
through lending and borrowing. Given that tangible assets can be used
as collateral for borrowing and are less costly to monitor, they are often
preferred by lenders. Even in the case of bankruptcy, tangible assets
such as commercial real estate can emerge from the bankruptcy process
largely unscathed (Sohn et al., 2013). As a result, firms with more
tangible assets have less financial distress costs (Pulvino, 1998) and
lower costs of debt financing (Norton, 1995) and therefore can borrow
more than firms with less tangible assets. The positive relationship
between asset tangibility and leverage has been supported by previous
studies (e.g., Rajan & Zingales, 1995; Sheel, 1994; Tang & Jang, 2007).
Therefore, we expect asset tangibility to be positively related to
leverage.
2.3.3. Capital intensity and leverage
Capital intensity, which is a proxy for investment, represents out-
flows for acquisition or maintenance of fixed assets. Shyam-Sunder and
Myers (1999) show that capital intensity directly increases a firm's fi-
nancing deficit, indicating that firms with more investments have more
financing needs. The pecking order theory predicts that holding prof-
itability constant, firms with more investments will have higher
leverage ratios (Fama & French, 2002), which suggests a positve re-
lationship between capital intensity and leverage. Conversely, the
trade-off theory postulates that greater investment opportunities should
lower leverage for firms with similar profitability (Fama & French,
2002), suggesting a negative relationship between capital intensity and
leverge. This is because while debt helps control the agency problem of
free cash flow, having more investments will reduce the availability of
free cash flow and consequently the need to use debt as a means of
control, especially when more debt also increases the possibility of
other agency problems such as asset substitution and debt overhang
(Jensen & Meckling, 1976; Jensen, 1986; Myers, 1977). Given the
ambiguous effect of capital intensity on leverage, it is an empirical
question as to how the two are related.
2.3.4. Fee-income ratio and leverage
The fee-oriented strategy affects capital structure through its impact
on profitability and earnings volatility. One benefit of fee income is that
it stabilizes earnings. Considering the fact that the hospitality industry
is extremely sensitive to economic downturns, fee income guarantees
cash flows to the franchisor/operator in both good times and bad times.
Fee income is also found to be positively related to firm profitability
(Sohn et al., 2013). Drawing from the trade-off theory, higher profit-
ability and stable earnings reduce the possibility of financial distress,
lower the cost of capital, and result in higher leverage (Fama & French,
2002). However, higher profitability also generates more cash, which
can be used to finance new investments. According to the pecking order
theory, firms prefer internal funds to debt as a means of financing. Since
profitability and leverage move in opposite directions, there should be a
negative relationship between fee-income ratio and leverage. Due to the
competing views of the trade-off theory and the pecking order theory,
the direction of the relationship between fee-income ratio and leverage
is again an empirically question.
Y. Li, M. Singal
2.3.5. DOF and leverage
Similar to fee-income ratio, DOF also helps mitigate earnings vola-
tility caused by changing economic conditions (Koh, Rhou, Lee, &
Singal, 2018). Franchisors can smooth earnings through retaining the
more profitable sites as company-owned and operating the sites with
less predictable sales through franchising (Martin, 1988; Roh, 2002).
Using similar reasoning, lower earnings volatility is associated with
lower probability of bankruptcy, which suggests a positive relationship
between DOF and leverage. Yet, since franchising and management
contracts can help franchisors/operators to expand their business
without heavy investment on fixed assets, franchisors/operators may
have fewer financing needs and less collateral for borrowing, which
suggests a negative relationship between DOF and leverage. Based on
the above, the effect of DOF on capital structure is undecided.
Our discussion so far has indicated that other than asset tangibility,
the effect of capital intensity, fee-income ratio, and DOF on leverage is
ambiguous as predicted by competing capital structure theories.
Although it is important that we understand how each measure is re-
lated to capital structure, each measure itself is not sufficient to re-
present the whole strategy. To address this issue, we obtain an overall
measure of ALFO that encompasses the variance of the four individual
measures and examine its relationship to capital structure. Assuming
that an overall ALFO strategy requires firms to increase DOF and fee-
income ratio and concurrently decrease capital intensity and fixed-asset
ratio, we expect a negative relationship between ALFO and capital
structure given that the purpose of ALFO is to reduce risk and expand
with minimal costs. Taken together, the research questions of this study
are summarized as follows:
Research Question 1: How is ALFO employed in the hospitality
industry?
Research Question 2: How is ALFO related to capital structure in
the hospitality industry?
3. Methodology
3.1. Data
The sample of this study includes U.S. publicly-traded hotel and
restaurant firms for the period 2002–2016. Before 2002, few companies
reported franchise- or management-based fee income separate from
other income sources (Sohn et al., 2013). As a result, year 2002 is
chosen as the beginning year of the sample period. We retrieve ac-
counting data from Compustat database based on 4-digit SIC codes
7011 and 5812 and hand-collect the number of franchised/managed
and total units as well as fee-income data from company annual reports
(10Ks). Excluding observations with missing values, the final sample
consists of 982 firm-year observations for 133 unique firms.
3.2. Main variables
The dependent variable of this study is leverage (LTD), calculated as
a ratio of long-term debt to total assets. Prior research suggests that
long-term and short-term debt decisions in hospitality firms may be
influenced by different factors (Upneja & Dalbor, 2001). While LTD is
often used to finance fixed assets such as real estate, short-term debt is
generally used by franchisors to provide financial aid to franchisees to
open new outlets or to purchase underperforming ones (Grünhagen &
Dorsch, 2003; Kaufmann & Stanworth, 1995). Since our purpose is to
study the impact of asset-light on capital structure, LTD is chosen over
short-term debt/total debt ratio as the dependent variable.
The independent variable of this study is ALFO, for which we use
four measures: fixed-asset ratio (FA), capital intensity (CapInt), fee-in-
come ratio (Fee), and degree of franchising (DOF). FA, or asset tangi-
bility, is a ratio of fixed assets to total assets. CapInt is a ratio of capital
expenditures to total assets. Fee is a ratio of the sum of management
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Tourism Management 70 (2019) 124–133
fees and franchise fees to total revenue. DOF is a ratio of the number of
franchised/managed units to the number of total units. For hospitality
firms that do not franchise or provide management services, Fee and
DOF are equal to zero.
3.3. Control variables
The standard determinants of leverage typically used in the capital
structure literature are included as control variables. Return on assets
(ROA) is calculated as a ratio of net income to total assets, market-to-
book (MTB) as a ratio of total assets minus book equity plus market
equity to total assets, size as the natural logarithm of book assets, non-
debt tax shields (NDTS) as a ratio of depreciation expenses to revenue,
and volatility as 3-year standard deviation in ROA. We do not specify
the relationship between ROA and LTD because while the pecking order
theory predicts a negative relationship between profitability and debt,
the trade-off theory predicts a positive relationship. Similarly, we do
not specify the relationship between MTB and LTD because while the
pecking order theory postulates a positive relationship between in-
vestment opportunities and debt, the trade-off theory postulates a ne-
gative relationship. Since prior research suggests that larger firms are
less likely to bankrupt and thus are more likely to use more debt (Fama
& French, 2002), we expect the relationship between size and LTD to be
positive. Similarly, we expect a negative relationship between volatility
and LTD because firms with less variable earnings have lower bank-
ruptcy costs and therefore can borrow more. According to DeAngelo
and Masulis (1980), NDTS, such as depreciation and depletion ex-
penses, are substitutes for tax shields associated with debt. Hence, we
include NDTS in the analyses to control for the tax benefits of debt
(Sheel, 1994). Based on the trade-off theory, we expect a positive re-
lationship between NDTS and LTD.
3.4. Data analysis
We use univariate analysis to examine ALFO, and panel data esti-
mation to analyze the effect of ALFO on LTD. All data are windsorized
at 1% and 99% to alleviate the effect of outliers on estimated coeffi-
cients. The regression analysis consists of five models, each including
year dummies, firm fixed effects, and White robust standard errors. The
first four models show how the four ALFO measures individually affect
LTD, while the last model shows how the overall ALFO strategy affects
LTD.
As shown by Pearson's correlation in Table 3, the four ALFO mea-
sures are either modestly or highly correlated, with the correlation
coefficients ranging from −0.352 to 0.731, which can cause multi-
collinearity if simultaneously included in a regression model. Following
prior studies in the finance literature (e.g., Djankov, La Porta, Lopez-de-
Silanes, & Shleifer, 2008; Harford, 2005), we use the principal com-
ponents analysis (PCA) approach to address the multicollinearity con-
cern. Specifically, we extract the first principal component, denoted as
ALFO, from the four ALFO measures and include it as an overall mea-
sure of the ALFO strategy in the fifth model.
PCA is a data reduction technique that reduces the number of
variables to a smaller set of independent components that extract most
of the variance in the variables. The first component is designed to
extract the maximum variance possible, which accounts for more than
60% of the variation in FA, CapInt, DOF, and Fee in our sample. The
PCA results suggest that higher ALFO scores are associated with lower
FA and CapInt and higher Fee and DOF, consistent with our expectation
that firms that implement ALFO will reduce fixed assets and invest-
ments in fixed assets and increase DOF and fee income.
Since prior research suggests that there are sector differences in
terms of capital structure determinants within the hospitality industry,
we perform both overall and sub-sector analyses for hotel and restau-
rant firms. The following regression model is used to examine the re-
lationship between ALFO and capital structure:
Y. Li, M. Singal Tourism Management 70 (2019) 124–133

Table 1 upward trend in fee-income ratio and DOF.

Descriptive statistics. To examine the effect of ALFO on capital structure, we first compare
Variable Overall Restaurant Hotel asset tangibility, capital intensity, and LTD between fee firms (fee-in-
come ratio > 0) and non-fee firms (fee-income ratio = 0). We do not
Mean SD Mean SD Mean SD compare DOF and fee-income ratio between fee- and non-fee firms
because, by construction, these ratios are zero for non-fee firms. As
LTD 0.30 0.30 0.27 0.30 0.42 0.28
ROA 0.02 0.12 0.02 0.13 0.03 0.09 shown in Table 2, fee firms have significantly lower asset tangibility
MTB 2.05 1.32 2.07 1.23 1.99 1.58 than non-fee firms for both hotels and restaurants. Similarly, fee firms
Size 6.09 1.76 5.72 1.66 7.49 1.38 have lower capital intensity than non-fee firms, although the difference
NDTS 0.06 0.03 0.05 0.02 0.08 0.05 is insignificant for hotel firms. In general, fee firms account for 76.58%
Volatility 0.04 0.06 0.05 0.07 0.03 0.02
of restaurant firms and 83.90% of hotel firms, indicating that fee-
Asset Tangibility 0.57 0.23 0.58 0.22 0.52 0.26
Capital Intensity 0.09 0.07 0.11 0.07 0.05 0.05 business is a common practice among hospitality firms. As for LTD, the
DOF (%) 40.74 35.29 35.47 32.45 60.69 38.44 difference between non-fee and fee firms are negative and significant
Fee-income Ratio (%) 10.77 18.83 6.65 12.05 26.40 29.02 for the overall sample, suggesting that fee firms have a higher LTD than
non-fee firms. However, this result is mainly driven by the restaurant
subsample, which constitutes the majority of the overall sample. Con-
LTDit = β0 + β1FAit/CapIntit/Feeit/DOFit/ALFOit + β2ROAit + trary to restaurant firms, hotel firms with fee income have lower LTD
β3MTBit + β4Sizeit + β5NDTSit + β6Volatilityit + αi + λt + εit than hotel firms without fee income. The univariate evidence presented
in Table 2 offers some preliminary evidence that ALFO affects capital
where α represents firm fixed-effects; λ represents year fixed-effects; ε structure. Since our objective is to identify whether and to what extent
represents an error term; and the subscripts i and t represent individual ALFO affects capital structure, firms with no fee income are excluded
firm and year, respectively. All other variables are as previously de- from the sample in subsequent analyses.
fined. Table 3 shows the Pearson's correlation of variables for the overall
sample. Asset tangibility and capital intensity are negatively correlated
4. Results with LTD, while DOF and fee-income ratio are positively correlated
with LTD. Between the four ALFO measures, assets tangibility is posi-
4.1. Descriptive statistics tively correlated with capital intensity and negatively correlated with
DOF and fee-income ratio. Similarly, DOF is positively correlated with
Table 1 lists the summary statistics of the variables in this study. The fee-income ratio and negatively correlated with asset tangibility and
average LTD is 0.30 for the overall sample, 0.27 for restaurant firms, capital intensity.
and 0.42 for hotel firms. On average, fixed assets account for 58% of Table 4 reports the results of the five models for the overall sample.
restaurant firms' total assets and 52% of hotel firms' total assets. Capital As shown in Models 1–4, while asset tangibility and fee-income ratio
expenditures account for 11% of total assets for restaurant firms and are significantly related to LTD, DOF and capital intensity are not.
only 5% for hotel firms. On average, 35.47% of restaurant units are While asset tangibility/capital intensity and fee-income ratio/DOF have
franchised or managed, while 60.69% of hotel units are franchised or opposite effects on LTD, the negative relationship between asset tan-
managed. Fee-income makes up 26.40% of total revenue for hotel firms gibility and LTD is intriguing. Overall, there is a positive relationship
and only 6.65% for restaurant firms. between ALFO and LTD (Model 5). As for the control variables, ROA is
negatively related to LTD, supporting the pecking order theory. MTB is
4.2. Empirical findings positively related to LTD, consistent with prior research (Dalbor &
Upneja, 2004; Tang & Jang, 2007). Size is positively related to LTD,
Fig. 1 show the industry grand average of ALFO measures for the affirming the argument that large firms can afford more debt. NDTS has
sample period. Take asset tangibility for example, the industry grand a positive effect on LTD, supporting the tax benefits of debt. Interest-
average is a ratio of the sum of fixed assets of all sample firms to the ingly, earnings volatility is not related to LTD after controlling for other
sum of total assets of the same firms for a given year. As shown in Fig. 1, determinants of debt.
hospitality firms reduced asset tangibility from around 0.65 in 2002 to In Table 5, we estimate the five models separately for hotel and
around 0.36 in 2016, consistent with the asset-light strategy. Specifi- restaurant firms. The results for the restaurant sample are qualitatively
cally, restaurant firms have higher assets tangibility than hotel firms. A similar to the results in Table 4. That is, there is a positive relationship
close look at the data indicates that the sudden drop of asset tangibility between ALFO and LTD. However, the relationship is not significant for
of hotel firms in 2005 is due to the privatization of several hotel the hotel sample. Specifically, contrary to restaurant firms, hotel firms
companies. For example, both La Quinta Corporation and Wyndham that are capital intensive have higher LTD, whereas hotel firms with
International Inc., which have an asset tangibility of 0.88 and 0.73 in more franchised/managed units have lower LTD.
2004, respectively, were acquired by private-equity firm Blackstone
Group and dropped out of the sample in 2005. Capital intensity peaked 4.3. Additional analyses
in 2007, right before the financial crisis in 2008, and plummeted in
2009. It subsequently came back in 2012, before it went down again to In this section, we conduct several analyses to determine whether
0.04 in 2016, which is lower than 0.065 in 2002. The fluctuation of our results hold for different model specifications, samples, and mea-
capital intensity could result from the variation of risk factors and the sures. We first repeat the same analyses for restaurant firms excluding
availability of investment opportunities market-wide and industry- McDonald's, which is considered a potential outlier because they gen-
wide. During the sample period, fee-income ratio has increased by erally own the land and buildings and lease them back to franchisees. In
around 50% for both hotel and restaurant firms, with hotel firms' fee- other words, McDonald's can simultaneously have high asset tangibi-
income ratio being three times that of restaurant firms. Overall, DOF lity, capital intensity, and DOF. The results excluding McDonald's are
has increased from almost 70% in 2002 to around 84% in 2016 and has qualitatively similar to those reported in Table 5, suggesting that
stayed above 90% for hotel firms since 2004. Taken together, the evi- McDonald's did not drive the results in the restaurant sample.
dence suggests that ALFO is a widely practiced strategy in the hospi- Second, we replace the dependent variable LTD with total debt ratio
tality industry, especially among hotel firms. As expected, there is a (i.e., short-term debt plus long-term debt scaled by book assets) and re-
general downward trend in asset tangibility and capital intensity and an estimate all models in Tables 4 and 5. Although prior research suggests

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Y. Li, M. Singal Tourism Management 70 (2019) 124–133

Fig. 1. ALFO from 2002 to 2016.

Table 2
Comparison between fee and non-fee firms.
Variable Overall Restaurant Hotel

Non-Fee Fee Diff. Non-Fee Fee Diff. Non-Fee Fee Diff.

LTD 0.23 0.33 −0.10*** 0.17 0.30 −0.14*** 0.54 0.40 0.14*
Asset Tangibility 0.69 0.53 0.16*** 0.67 0.55 0.12*** 0.79 0.46 0.33***
Capital Intensity 0.11 0.09 0.02*** 0.12 0.10 0.02** 0.07 0.05 0.02

Non-Fee Fee Total Non-Fee Fee Total Non-Fee Fee Total

N 215 767 982 182 595 777 33 172 205

Percentage 21.89 78.11 100 23.42 76.58 100 16.10 83.90 100

*p < 0.05, **p < 0.01, ***p < 0.001.

Table 3
Pearson's correlation.
Variables 1 2 3 4 5 6 7 8 9

1 LTD –
2 ROA 0.119*** –
3 MTB 0.315*** 0.495*** –
4 Size 0.173*** 0.349*** 0.158*** –
5 NDTS −0.006 −0.221*** −0.290*** 0.174***
6 Volatility −0.036 −0.458*** −0.084* −0.342*** −0.054
7 Asset Tangibility −0.261*** −0.037 −0.312*** −0.104** 0.284*** −0.152***
8 Capital Intensity −0.299*** 0.025 0.130*** −0.304*** −0.079* −0.022 0.412***
9 DOF 0.293*** 0.251*** 0.319*** 0.345*** −0.082* −0.044 −0.575*** −0.385***
10 Fee-income ratio 0.215*** 0.210*** 0.241*** 0.420*** −0.115** −0.087* −0.513*** −0.352*** 0.731***

*p < 0.05, **p < 0.01, ***p < 0.001.

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Y. Li, M. Singal Tourism Management 70 (2019) 124–133

Table 4
The effect of ALFO on LTD in all sample firms.
Explanatory variables Dependent Variable: LTD

β/SE β/SE β/SE β/SE β/SE

Model 1 Model 2 Model 3 Model 4 Model 5

ROA −0.512*** −0.546*** −0.500*** −0.473*** −0.508***

(0.180) (0.171) (0.175) (0.180) (0.175)
MTB 0.028** 0.024* 0.027** 0.029** 0.030**
(0.013) (0.013) (0.013) (0.014) (0.014)
Size 0.02 0.053** 0.026 0.023 0.039*
(0.023) (0.022) (0.024) (0.023) (0.022)
NDTS 2.641** 2.095** 1.877* 1.926* 2.250**
(1.125) (0.944) (1.046) (1.035) (1.033)
Volatility −0.007 0.024 0.05 0.012 −0.019
(0.269) (0.263) (0.276) (0.266) (0.258)
Asset Tangibility −0.204**
(0.096)
Fee-income Ratio 0.006***
(0.002)
DOF 0.001
(0.001)
Capital Intensity −0.225
(0.164)
ALFO 0.046***
(0.018)
Constant −0.032 −0.316*** −0.191 −0.138 −0.18
(0.126) (0.114) (0.125) (0.116) (0.111)

Adj. R2 0.766 0.77 0.764 0.764 0.767

N 630 630 630 630 630

*p < 0.10. **p < 0.05. ***p < 0.01. ****p < 0.001.

Table 5
The effect of ALFO on LTD in restaurant and hotel firms.
Dependent Variable: LTD

Restaurant Hotel

β/SE β/SE β/SE β/SE β/SE β/SE β/SE β/SE β/SE β/SE

Model 1 Model 2 Model 3 Model 4 Model 5 Model 1 Model 2 Model 3 Model 4 Model 5

ROA −0.392** −0.441** −0.389** −0.334* −0.401** −0.712* −0.789* −0.741* −0.836** −0.740*
(0.191) (0.172) (0.186) (0.191) (0.184) (0.396) (0.398) (0.395) (0.411) (0.408)
MTB 0.032** 0.026* 0.026 0.033** 0.032** 0.035 0.034 0.025 0.039 0.036
(0.016) (0.015) (0.016) (0.016) (0.016) (0.035) (0.033) (0.034) (0.035) (0.035)
Size 0.008 0.044* 0.031 0.015 0.041 0.061 0.07 0.039 0.075 0.058
(0.029) (0.026) (0.032) (0.028) (0.026) (0.054) (0.055) (0.051) (0.052) (0.052)
NDTS 6.138**** 4.203*** 4.908**** 4.980**** 5.029**** −1.535 −1.43 −1.879* −2.176* −2.364**
(1.463) (1.473) (1.392) (1.354) (1.343) (1.203) (1.350) (1.017) (1.117) (1.190)
Volatility 0.063 0.124 0.149 0.073 0.065 −1.333** −1.213* −0.993 −0.874 −0.956
(0.289) (0.289) (0.301) (0.289) (0.276) (0.662) (0.627) (0.626) (0.638) (0.649)
Asset Tangibility −0.289** −0.12
(0.117) (0.167)
Fee-income Ratio 0.007 0.002
(0.004) (0.003)
DOF 0.002* −0.002*
(0.001) (0.001)
Capital Intensity −0.370** 0.768*
(0.168) (0.400)
ALFO 0.058*** −0.034
(0.020) (0.033)
Constant −0.115 −0.405*** −0.418*** −0.265** −0.349*** −0.012 −0.237 0.416 −0.162 0.052
(0.152) (0.128) (0.150) (0.134) (0.127) (0.568) (0.625) (0.563) (0.549) (0.556)

Adj. R2 0.786 0.785 0.782 0.783 0.787 0.703 0.704 0.708 0.71 0.704
N 492 492 492 492 492 138 138 138 138 138

*p < 0.10. **p < 0.05. ***p < 0.01. ****p < 0.001.

130
Y. Li, M. Singal
that hospitality firms use long-term and short-term debt for different
purposes and the determinants of long-term and short-term debt could
vary, it is unclear whether the ALFO strategy will have a different effect
on total debt. Using total debt ratio as the dependent variable, we
continue to find the impact of ALFO on leverage to be statistically po-
sitive for the overall sample and the restaurant sample and statistically
insignificant for the hotel sample.
Next, we replicate the analyses in Tables 4 and 5 using one-year
lagged independent variables to address endogeneity concerns related
to reverse causality, as one may argue that managers' decision to reduce
debt financing increases the use of franchising and management con-
tracts and decreases the need for tangible assets. The results of this
additional test are qualitative similar to results reported in Tables 4 and
5 and thus mitigate the concern for potential endogeneity in our study
design.
5. Discussion
Using a sample of 982 firm-year observations over a period of 15
years, we examine how ALFO is employed in the hospitality industry
and how it is related to capital structure of hospitality firms. Our
findings indicate that ALFO is widely employed by the hospitality in-
dustry. Controlling for other determinants of capital structure and fixed
effects (firm and year), there is a positive relationship between ALFO
and LTD in restaurant firms, although we did not find this to be true of
hotel firms. The findings offer some new research insights into the role
of ALFO as an industry-specific variable that affects capital structure of
hospitality firms. Several practical implications derived from the find-
ings are also discussed.
5.1. Theoretical implications
This study contributes to the literature by comprehensively ex-
amining the use of ALFO in the hospitality industry for the period
2002–2016. Consistent with the recognition that ALFO is becoming
increasingly popular, we find that the vast majority of hotel and res-
taurant firms in our sample receive some amount of fee income as part
of their total revenues. There is a decreasing pattern for asset tangibility
and capital intensity and a corresponding increasing pattern for fee-
income ratio and DOF. The fluctuation of capital intensity reflects the
industry-wide investment activities and does not necessarily contradict
ALFO. It is possible that strategic acquisitions and divestitures plus the
overall market conditions that facilitate these kinds of events together
lead to the fluctuation of capital intensity. For example, although
Marriott acquired significant numbers of owned and leased properties
from Starwood, it planned to sell most of these properties over the next
two years to maintain asset-light (Marriott International Inc., 2018). As
a result, despite fluctuation, we continue to see a downward trend in
capital intensity.
This study also contributes to the literature by explicitly examining
the effect of ALFO on capital structure. Prior research suggests that
traditional capital structure determinants have low explanatory power
for hospitality firms and that industry-specific variables are needed to
better understand the capital structure decisions (Sheel, 1994; Tang &
Jang, 2007). In this study, we have initiated analysis of ALFO as a vi-
able industry-specific variable with strategic implications for capital
structure. We find that ALFO is positively related to LTD for restaurant
firms, but not for hotel firms, implying that capital structure determi-
nants of hospitality firms may differ by sector. While prior studies
predominantly focused on one sector at a time, our study facilitates
comparison of findings by offering a direct contrast between restaurant
and hotel firms using the same study design. Intuitive logic suggests
that when there are less tangible assets for collateral, less investment in
fixed assets, less financing needs due to higher DOF, and higher prof-
itability due to higher fee-income ratio, LTD should be lower. However,
we find a positive relationship between ALFO and LTD in restaurant
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Tourism Management 70 (2019) 124–133
firms. The finding seems to suggest that franchising funds lower the cost
of capital in restaurant firms (Park & Jang, 2017) and allow them to
borrow more. Future research is needed to better understand the drivers
of the sector difference reported here.
In addition, our study presents time-series evidence on the effect of
traditional capital structure determinants studied in prior research. The
positive relationship between MTB and LTD contradicts Dalbor and
Upneja' (2002) finding in restaurant firms, but affirms Dalbor and
Upneja' (2004) and Tang and Jang' (2007) findings in lodging firms.
The inconsistency in findings could be attributed to methodological
differences. While prior research used pooled cross-sectional regression,
we use panel data estimation that accounts for firm heterogeneity. Also,
while prior research concludes that the positive relationship between
MTB and LTD does not match the prediction based on the agency costs
of debt (Tang & Jang, 2007), we argue that the finding is consistent
with pecking order theory's prediction that holding profitability con-
stant, firms with more growth opportunities will have higher leverage
(Fama & French, 2002).
Contrary to our expectation, we find a negative relationship be-
tween asset tangibility and LTD in restaurant firms. One possible ex-
planation is that tangible assets are considered less efficient in restau-
rant firms, whereas intangible assets, such as brand name and licenses,
are considered more efficient in creating firm value (Kim & Kim, 2005).
As a result, firms with lower asset tangibility may have higher debt
capacity than firms with higher asset tangibility and therefore can
borrow more. Another possible explanation is that due to asset speci-
ficity, not all tangible assets in a franchise restaurant chain can be used
as collateral for debt (Norton, 1995). Hence, franchisers with more
tangible assets may have higher costs of debt and lower debt ratios.
6. Practical implications
The current study offers several managerial implications. Managers
of firms can gain practical insights as to how much the industry has
used ALFO and how ALFO is related to the use of debt. CEOs of non-fee
companies can infer from the results of this study the strategies their
peers use and understand changes that ALFO may bring about in their
firms before deciding on whether or not to adopt ALFO. CEOs of fee
companies can fine-tune their ALFO levels based on their financing
needs. Specifically, CEOs of franchise restaurant chains can increase
debt capacity by implementing higher levels of ALFO.
To increase ALFO and DOF to attain a high fee-income ratio, fran-
chisors should be competitively attractive to potential franchisees, who
care foremost about the technical and operational knowhow and as-
sistance provided by the brand, followed by the franchisor's name re-
cognition, the possibility of owning multiple outlets, franchisor support
services, and potential profitability (Guilloux, Gauzente, Kalika, &
Dubost, 2004). In other words, franchisors have to improve their ser-
vice to their franchisees and increase their brand equity through in-
vestments in technology and loyalty to gain franchising and manage-
ment contracts.
Furthermore, an increase in the asset-light structure does not ne-
cessarily mean a sale of all company-owned properties. In our analyses,
very few hospitality firms reach 100% DOF, although many keep their
DOF fairly high. There are two factors that may affect a firm's stock of
tangible assets. The first one is the nature of equity real estate invest-
ments, which can be difficult to sell quickly, especially at desirable
prices. As a result, managers need to be flexible when using ALFO to
adjust capital structure. The second factor is “asset-right” rather than
“asset-light.” Although firms may prefer to keep a lower level of asset
tangibility, they may also make strategic decisions to invest in new
properties or to keep the most profitable units as company-owned or as
prototypes of new products. Hence, managers may need to decide
which properties to put on the market and which ones to keep or ac-
quire.
Lastly, the findings of this study may be useful to investors and
Y. Li, M. Singal
advisors to evaluate U.S. hospitality firms. It is known that high
leverage increases the possibility of bankruptcy and the cost of capital,
which in turn lower the value of the firm. Since restaurant firms have
high bankruptcy rates and ALFO is associated with higher leverage in
restaurant firms, investors and analysts may predict the value of the
firm by closely monitoring the extent to which restaurant firms use
ALFO and decide whether to add or drop a firm from their investment
portfolios accordingly. As for advisors and bankers, high ALFO may
suggest that a franchisor has a strong brand name or valuable intangible
assets, which may be used as a form of collateral for borrowing.
6.1. Limitations and future research
Our research has certain limitations which should be taken into
account while interpreting the results, and which also serve as avenues
for future research. Our sample is U.S. publicly-traded hotel and res-
taurant firms. As a result, our findings may not be generalizable to
private hospitality firms. Similarly, due to country differences that can
affect franchising and loans, our findings may not be generalizable to
hospitality firms outside of the U.S. Future research can replicate our
study using different samples to compare findings for greater general-
izability. Compared with restaurant firms, our sample size for hotel
firms is relatively small. While data availability is a common issue with
hospitality studies involving hotel firms, future studies may test the
robustness of our findings by supplementing the sample with publicly-
traded hotel firms in other countries. Although our study shows that
there are significant differences in terms of capital structure between
fee and non-fee firms, we do not examine the capital structure de-
terminants of non-fee firms. Future research may identify the factors
that affect capital structure decisions similarly and dissimilarly between
fee and non-fee firms.
While the majority of firms in the sample employ ALFO to some
extent, we do not investigate why some firms choose to own all the
properties (e.g., Extended Stay America, Inc. and Bob Evans
Restaurants), whereas others choose not to own any (e.g., Choice Hotels
International, Inc. and Dunkin’ Brands Group, Inc.). We hope future
research will help answer this question by identifying what factors
determine the adoption of ALFO strategy among firms. Finally, we call
for research to identify other industry-specific variables that can ex-
plain the financing behavior of hospitality firms.
Declarations of interest
None.
Author contribution
Yuan Li carried out the study. Manisha Singal supervised the pro-
ject. Both authors contributed to the final version of the manuscript.
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Y. Li, M. Singal
Yuan Li is a Ph.D. student in Hospitality and Tourism
Management in the Pamplin College of Business at Virginia
Polytechnic Institute and State University (USA). Her re-
search interests lie in the areas of corporate finance and
strategic management in the context of the hospitality and
tourism industry. She has published papers in several
journals such as Tourism Management, International
Journal of Hospitality Management, and the Journal of
Hospitality and Tourism Research.
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Tourism Management 70 (2019) 124–133
Manisha Singal is an Associate Professor in Hospitality and
Tourism Management in the Pamplin College of Business at
Virginia Polytechnic Institute and State University (USA).
Her research interests lie in the areas of corporate govern-
ance and corporate social responsibility in the context of
the hospitality and tourism industry. She has published
papers in several journals such as Strategic
Entrepreneurship Journal, Journal of International
Management, International Journal of Hospitality
Management, Cornell Hospitality Quarterly, and the
Journal of Hospitality and Tourism Research.