Abstract

The aim of this paper is to analyse for a multi-country large emerging market sample the choice between debt and equity simultaneously with the decision between short- and long-term debts. In order to investigate the joint decision among leverage and maturity, we examine an unique sample of 986 firms and 13,490 firm-year observations from Latin America and 686 firms and 7919 firm-year observations from Eastern Europe for the period 1990-2003. We employ dynamic panel data analysis using Generalized Method of moments. The empirical results support three main findings. First, the cross-effects between leverage and maturity behave exactly the opposite between Latin America and Eastern Europe sub-samples. Capital structure and debt maturity are policy complements in Latin America and substitutes in Eastern Europe. Second, there is a significant dynamic effects component in the determination of leverage and maturity. Finally, adjustment to the target, maturity is by no means costless and instantaneous with firm’s facing moderate adjustment costs.

Keywords

Capital Structure; Debt Maturity; Dynamic Panel Data Analysis; Latin America; Eastern Europe

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1. Introduction

Most of the empirical research on capital structure has focused on a single decision at a time, that is, each financial decision is taken as independent of the other decisions. It may be the case that most of these decisions are not independent but actually complements or substitutes among each other. If that is the case, a further investigation should be undertaken whether there is interdependence among them or not.

In this paper, we investigate the choice between debt and equity simultaneously with the decision between short-and long-term debt for a large sample of emerging markets from Latin America and Eastern Europe. In order to investigate the joint decision among leverage and maturity, we examine an unique sample of 986 firms and 13,490 firm-year observations from Latin America and 686 firms and 7919 firm-year observations from Eastern Europe for the period 1990-2003. These two regions are ideal for our purposes because they contain a larger number of countries that have gone through extensive privatization during the time period analysed but still in different stages in the transition to capitalism systems and markets development. In fact, Latin America has experienced hyperinflation and economic instability over the 1980s and profound economic reforms in the 1990s, and Eastern Europe has made the transition from centralized to market economies during the 1990s as well.

This paper has several objectives: First, we examine whether in an emerging countries context, the theory of joint capital structure and debt maturity determination, attempts to understand country and regions specific differences. Second, we test whether there is a substantial dynamic component in the determination of the endogenous variables. Third, we analyse whether there are differences in the adjustment costs towards optimal capital structure and debt maturity.

The paper proceeds as follows: Section 2 is dedicated to the literature review. Section 3 presents the data sources and discusses sample selection, macro and firm-level financial information. In Section 4, the model and specification tests are presented. Results are presented in Section 5; Section 6 concludes.

2. Background on Capital Structure and Debt Maturity

Theories in capital structure and debt maturity as well as subsequent empirical work mainly focused in a single decision at a time. The main theories of capital structure can be classified into three groups: tax based, agency cost and asymmetric information theories. Trade-off theory argues that firms establish a debt target and strive to reach it through time. In the theoretical framework firms pursue an optimal capital structure determined by a tradeoff between the tax benefits of increasing debt financing (interest tax shield) and bankruptcy costs that arise from higher debt levels. As imperfections such taxes (corporate and personal), a variable interest rate, credit constraints, and bankruptcy costs are introduced in the model, the trade-off results (i.e. [1-3]).

A second group of the literature encompasses all those explanations that are based on imperfect information assumptions. In his seminal paper [4], argues that the value of the firm depends on its assets in place (whose value do not depend on future investment) as well as growth opportunities (whose value depends on future investment strategy). The implication is that this real option characteristic of the firm induces a transfer of wealth between shareholders and bondholders that may prevent the firm to undertake positive NPV projects (the debt overhandor underinvestment problem). [5] realizes that managers have privileged information regarding both tangible (assets in place) and intangible (growth opportunities) assets and investors are aware of this fact. In light of such imperfect information there may be wealth transfers between old and new shareholders when the firm decides to issue new securities. This information asymmetry affects the firm’s financing-investment decision in a way that causes managers to pass up valuable investment opportunities in order to preserve (old) shareholders’ interests: the underinvestment problem. Other stream of literature suggests the agency theory framework to study the optimal leverage ratio [6,7]. In their perspective, too little debt can lead to an overinvestment problem, as managers seek to sustain growth at the expense of profitability.

Theoretical arguments for the choice of corporate debt maturity can be divided in trade-off considerations and, asymmetric information problems as well. Arguments based on trade-off considerations rely on the proposition that the optimal maturity of debt is determined by the trade-off between the costs of rollover short-term debt vis-à-vis the usually higher interest rate bore by longterm debt. In many senses the arguments rely on explicit transaction costs of different kinds of debt such as flotation and rollover costs as well as tax-shield benefits and implicit bankruptcy costs. The tax-based explanation suggested by [8,9] are perhaps the best known examples. Other hypothesis derives from asymmetric information. In this case, the maturity structure is yet another instrument that firms can use in order to solve the agency problems faced by the various stakeholders of the firm. These agency approaches suggest that firms choose the optimal debt maturity in order to solve information asymmetry that gives rise to the underinvestment and/or overinvestment problems.

Most of the existing literature on capital structure comes from single country analysis. These studies use primarily large listed firms as in [10], for the United States, [11-13] for the United Kingdom, [14] for Spain and [15] for Portugal. A few studies focus on international samples ([16- 20]) and more recently [21-23]. However, all of these studies focus on large listed firms. In [16] the sample was from large listed firms for the G7 countries. They found that the determinants of capital structure in the United States are the same for the other countries. They also find that debt levels do not differ among bank-oriented countries and market-oriented ones. [17] finds for a sample of G5 countries that the mean leverage among countries appears to be similar. However, he highlights that some of the differences can occur because of the differences in tax policies, agency problems, and information asymmetries and shareholder/creditors conflicts. [18] finds for 10 developing countries that capital structure choices are affected by the same variables as in developed countries. [19], using the same sample as [16] but with more recent data found that the overall leverage in 2001 is lower than in 1991 and the determinants of capital structure is the United States lose some of the explanatory power overseas. [20] using a sample of listed firms provided evidence that neither the trade-off nor pecking order model offer a suitable description of the capital structure policies in Europe. They also document that the notional environment do matter for capital structure decisions. [21] uses a large sample of listed firms for 42 countries equally divided between developed and developing countries covering the years from 1997 to 2001. They stated that country-specific factors do matter in determining and affecting the leverage choice around the countries analysed. [22] analyses how firms operating in capital market-oriented economies (United States and United Kingdom) and bank-oriented economies (France, Germany and Japan) determine their capital structure. They find that leverage is affected by the market conditions in which the firm operates and overall the capital structure of a firm is heavily influenced by corporate governance, tax systems and the level of investor protection. Finally [23], using a sample of 39 developed and developing countries for the period 1991 to 2006 suggest that a firm’s capital structure is determined more by the country in which it is located than by its industry affiliation. They find as well that country’s legal and tax systems, level of corruption explain a significant portion of the variation in leverage.

Regarding debt maturity, most empirical studies have concentrated on the United States. [24,25] pioneer studies have taken different empirical approaches to the problem. While [25] investigates the maturity structure of firm’s total indebtedness, [24] focuses on the maturity of single bond issues. These are the two most common empirical approaches in the literature. The first approach is followed by [26-32]. The second approach is preferred by [33-35] who also investigate bond issues finding evidence of market timing of bond issues. Few studies investigate debt maturity in an international setting. [36] investigates the maturity structure of 604 and 750 nonfinancial firms from the United Kingdom and Italy, respectively. They find support for the hypothesis that firm chooses the maturity of their liabilities to match those in their assets. Their results are in line with those of [37,38] and find that debt maturity depends on both firm-specific and country-specific factors, opening the question of the degree of influence of each group of factors on the maturity structure. Larger sets of countries are studied by [39] who explored the hypothesis that the financial development of a country determines the maturity of its firms’ debt. They find support for the hypothesis that legal and institutional differences among countries explain a large part of the leverage and debt maturity choices of firms. [23] also studies the subject for 11 industries in 39 countries and their results largely support [39] findings.

In a joint determination of capital structure and debt maturity perspective [40] build the argument that a firm chooses leverage and debt maturity to maximize its value given a set of exogenous firm characteristics. Their empirical results suggest that capital structure and debt maturity are substitutes in addressing financial problems.

3. Data, Variables and Methodology

3.1. Macro Financial Data

This study focus in emerging markets countries that have gone through substantial changes in the past couple of decades. Two geographic distinguish groups are studied: Latin America, which has experienced hyperinflation and economic instability over the 1980s and profound economic reforms in the 1990s and, Eastern Europe that have made the transition from centralized to market economies about the same period of time. Both groups of countries have gone through extensive privatization as documented in [41,42] in the case of Latin America and [43,44] for Eastern Europe.

In Table 1 is provided a country-level summary statistics on key economic indicators and financial indicators for these countries for the period 1990 to 2003¹. The countries sampled are Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela (henceforth called “Latin America 7” or simply “LA-7”) and Bulgaria, Czech Republic, Latvia, Lithuania, Poland, Romania and the Russian Federation (henceforth called “Eastern Europe 7” or simply “EE-7”).

In both groups of countries is observed highly inflationary environments in the period 1990-2003, although the high average annual inflation is influenced by the hyper-inflationary early 1990s in some countries (e.g. Argentina, Bulgaria, Brazil and Mexico). In addition, inflation has been more resilient in Romania and Russian Federation (henceforth simply “Russia”) during the same period. Due to this inflationary environment, countries in the sample display depressing growth, particularly in Eastern Europe. The average annualized growth rates are often negative for the EE-7, and generally below 3 percent in Latin America². The economies in the sample are in general small, with three large outliers: Brazil, Mexico and Russia, which have GDPs above US$300 billion in constant US dollars (2000). In terms of financial structure, Latin American economies showed in general a more developed stage than Eastern European ones. The EE-7 has a larger ratio of liquid liabilities to GDP than the LA-7 that might be reflect of the higher inflation rate, since central bank assets are proportionally bigger in the LA-7. In both groups the credit to the private sector is similar, but EE-7 countries seem to be more bank-based than the LA-7 given the larger bank deposits to GDP and bank concentration. Interestingly, the net interest margin is higher for the LA-7 indicating a less competitive bank market. Private bond markets are equally incipient for both groups of countries, while public bond markets are at least three times larger. This might suggest that the government crowds out private issuers in such markets. Stock markets are greater in Latin America, in both absolute and relative terms, although Eastern European markets are relatively more actively traded. In all other aspects, Latin American stock markets seem more developed: they trade a larger number of companies and those companies have larger market capitalization than their counterparts in the EE-7. This is not a surprise since stock markets in Latin America date from the beginning of the 20^th century while in Eastern Europe such markets have just begun trading about two decades ago.

In summary, these are economies that have a recent history of unstable economies, combining higher inflation with lower growth. These economies are predominantly bank-based, although the LA-7 has comparatively more developed stock markets, and public bond markets are much larger than private ones moving towards market based more quickly than eastern European countries.

3.2. Firm-Level Data and Variables

The primary data sources are from the Economatica Pro

database for the Latin America countries (Economatica 2003) and from the 2004 version of Amadeus (Analyse major Database from European Sources) Database by Bureau Van Dijk for the Eastern European countries. We only considered listed firms, the level of analysis is each firm and observations are yearly during the period 1990- 2002 for Latin America and 1994-2003 to Eastern Europe. The database contains 1242 unique firms for the LA-7 and 693 industrial firms for the EE-7 over the period covered. After excluding financial firms as well as firms with missing data for key variables (discussed later), the sample is reduced to 986 firms and 13,490 firm-year observations from Latin America and 686 firms and 7,919 firm-year observations from Eastern Europe³. Table 2 presents the distribution of firms by country and region.

The dependent variables in our study are proxies for leverage and maturity of debt and measured as long-term debt over book equity (i.e. the debt-equity-to-ratio “Leverage”) and long-tern financial debt over short-term loans plus long-term financial debt (i.e. “Maturity”)⁴.

Table 3 panels (a) and (b) shows the summary statistics of Leverage and Maturityfor the LA-7 and EE-7 countries, respectively. One can highlight that Brazil heavily influences the Latin America sample while the most influential countries in Eastern Europe are Poland, Russia and Bulgaria. On the other hand, Venezuela has little impact on the Latin America sample as well as Latvia in the Eastern Europe group of firms. There is evidence of substantially higher maturity ratios for EE-7 compared with LA-7 (0.59 and 0.48, respectively), being Mexico and Poland the countries with larger values in each sub-sample (0.54 and 0.76, respectively). In terms of Leverage, long term debt corresponds to 105 percent and 19 percent of equity to LA-7 and EE-7 countries, respectively. Brazil has the highest level of leverage for the whole 14 countries (170 percent) while Poland has the lowest level (8 percent).

Conflicts of Interest

The authors declare no conflicts of interest.

References