A country's legal and taxation system, its level of corruption, and the preferences of capital suppliers ... explain a significant portion of the variation in leverage.
Corporate financing choices are determined by a combination of factors that are related to the characteristics of the firm as well as the institutional environment. In An International Comparison of Capital Structure and Debt Maturity Choices (NBER Working paper No. 16445), authors Joseph Fan, Sheridan Titman, and Garry Twite argue that the country in which the firm resides is an even more important determinant of the firm's financing decisions than its industry affiliation. This in turn suggests that differences in country-level institutional factors can have a profound effect on how firms are financed.
Using a large sample of firms from 39 countries, the authors examine how cross-country differences in capital structures can be explained by differences in tax policies, the legal environment, and the importance and regulation of financial institutions. They find that a country's legal and taxation system, its level of corruption, and the preferences of capital suppliers - banks and pension funds - together explain a significant portion of the variation in leverage (the extent to which a firm relies on debt for its financing) and debt-maturity ratios.
In countries with a greater tax gain from leverage, firms tend to use more debt. But the tax effect is not as strong and pervasive as other influences on capital structure. Indeed, the strength of a country's legal system and public governance dramatically affect firm capital structure. Weaker laws and more government corruption are associated with higher corporate debt ratios and shorter debt maturity.
Moreover, in countries with deposit insurance or explicit bankruptcy codes, firms have higher debt ratios and longer debt maturities. In countries with larger banking sectors, the debt maturity structure of corporations tends to be shorter, which reflects the preferences of banks to lend short term. However, the results here suggest that deposit insurance in some way facilitates long-term lending by banks. Finally, the data support the idea that suppliers of capital influence firm financing decisions, even though the evidence of a relation between the size of the insurance sector and capital structure is very weak.
There are some significant differences between the subsamples of developed and developing countries. In particular, common law and the bankruptcy code are significant influences on capital structure in the sample of developed economies, but not in the sample of developing economies. Deposit insurance and the size of the government bond market are important in developing economies, but not in developed economies. Indeed, a larger government bond sector crowds out private debt capital in the developing countries, leading firms in these countries to borrow less and with shorter maturities. Taxes are significant in the sample of developed economies, but not in the sample of developing economies; that may be because the influence of corporate taxes is likely to be weaker in countries where they are easier to evade. Debt maturity increases with the level of economic development. However, corruption is consistently associated with higher debt ratios in all of the subsamples.
-- Claire Brunel