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E-MailThe following post comes to us from Joseph Fan, Professor of Finance at the Chinese University of Hong Kong; Garry Twite, Professor of Finance at the Australian National University; and Sheridan Titman, Professor of Finance at the University of Texas at Austin.
In the paper, An International Comparison of Capital Structure and Debt Maturity Choices, forthcoming in the Journal of Financial and Quantitative Analysis, my co-authors (Joseph Fan and Garry Twite) and I examine the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries.
The country in which a firm resides has a greater influence on its capital structure than its industry affiliation. Specifically, a regression of firm leverage, measured as the book value of debt over the market value of the firm, on firm-specific variables, industry fixed effects and country fixed effects, has an adjusted R-square of 0.19. When the regression is estimated with industry but not country fixed effects, the adjusted R-square is reduced to 0.15. However, in a regression that includes country dummies but not industry dummies the adjusted R-square is reduced by only half as much, to 0.17. A similar regression with debt maturity, measured as the book value of long-term debt to the book value of total debt, as the dependent variable, has an R-square of 0.25, when all variables are included. When country fixed effects are excluded from the regression the R-square is substantially reduced to 0.09, but when the country fixed effect are included, but the industry fixed effects are excluded, the R-square is only slightly reduced to 0.23.
These regressions suggest that differences in country level institutional factors are an important determinant of how the firm is financed. To examine this possibility in more detail, we estimate a panel regression on a sample of firms from 39 countries that examines the extent to which cross-country differences in capital structure and debt maturity choices can be explained by differences in tax policies; legal environment; and the importance and regulation of financial institutions.
We find that a country’s legal and tax system, the level of corruption and the preferences of capital suppliers explain a significant portion of the variation in leverage and debt maturity ratios. Our evidence indicate that firms in countries that are viewed as more corrupt tend to use less equity and more debt, especially short-term debt, while firms operating within legal systems that provide better protection for financial claimants tend to have capital structures with more equity, and relatively more long-term debt. In addition, the existence of an explicit bankruptcy code and/or deposit insurance is associated with higher leverage and more long-term debt. We also find that firms tend to use more debt in countries where there is a greater tax gain from leverage, while firms in countries with larger government bond markets have lower leverage, suggesting that government bonds tend to crowd out corporate debt. Countries with more extensive defined benefit pension funds have higher debt ratios and longer debt maturities, whereas those with more extensive defined contribution fund activities have lower debt ratios. In addition, debt ratios are lower in countries that limit the bond holdings of pension funds. Finally, we do not find a significant association between financing choices and the size of the insurance industry.
The full paper is available for download here.
