Macroeconomic and strategic determinants of corporate capital structure. The moderating effect of institutional factors, banking system characteristics and a firm’s ownership structure

Resumen

In this abstract, we present our subject of study, capital structure determinants, and a review of previous related literature, as well as the motivations that lead us to extent and improve on prior research. First of all, we present the main arguments to explore external and internal determinants of firm leverage. Regarding external determinants of corporate capital structure, we conduct an in-depth analysis of how macroeconomic and institutional characteristics, at the country-level, shape capital structure. Specifically, On the one hand, we present empirical evidence about the effects of the expected performance of the economy and country institutional characteristics related with the lending process on corporate debt decisions. On the other hand, we advance previous research about the influence of monetary policy measures and features of the banking system on corporate leverage. With regard to capital structure determinants at the firm-level, we present previous literature regarding how firm strategy affects capital structure. Specifically, we focus on the diversification decision and how it can affect corporate leverage, depending on corporate governance characteristics of the company. Finally, we present the main objectives that we aim to achieve in the following chapters and formulate the thesis to be defended in the present dissertation. 1. Economic forecast and institutional environment Despite the great attention attracted by firm indebtedness decisions, recent empirical evidence shows that many questions on how capital structure is formed remain to be answered (Graham et al., 2015). Some determinants of firm debt decisions, such as macroeconomic and institutional factors, have been underestimated in previous literature given the high attention that firm-level characteristics have traditionally received. It is generally accepted that macroeconomic expectations affect corporate leverage positively (Frank & Goyal, 2009) due to the pro-cyclical value of firm collateral. However, it is not clear how the risks that emerge at each stage of the lending process moderate the relation between the expected performance of the economy and a firm’s capital structure. In this regard, it is important to note that any financing process involves two parties (i.e., the lender and the borrower) and, as a consequence, asymmetric information problems need to be considered (Myers, 1984; Flannery, 1986; Narayanan, 1988). These asymmetries hinder the access to external financing and lead to higher costs of debt (Myers, 1984; Myers & Majluf, 1984; Healy & Palepu, 2001; Hughes et al., 2007; Cassar et al., 2015). However, the severity of such problems varies over the different stages of the financing process, with better ex-ante and ex-post conditions facilitating firms’ access to external sources of funds. It is possible to differentiate three stages in the lending process, each one associated with exposure to different risks. The first stage, which we call the lending decision stage, takes place before the creditor provides funds to the company and is characterized by the adverse selection risk. The second stage, the indebtedness stage, begins when the borrower (i.e., the company) receives the funds from the creditor and finishes just before the debt is classified as a nonperforming loan. During this stage, moral hazard is the main risk. The last stage, called the default stage, starts when the firm is unable to honor its commitments and the loans received previously are considered nonperforming. As the name of the stage implies, the main risk is the default risk. With regard to the lending decision stage, empirical studies reveal that eliminating informational opacity on the financial situation of borrowers leads to an increase in the amount of credit available (Strahan & Weston, 1998; Detragiache et al., 2000; Rauch & Hendrickson, 2004; Hyytinen & Väänänen, 2006; Hernandez-Canovas & Martinez-Solano, 2007). Specifically, when lenders have more information about borrowers, they provide more credit (Padilla & Pagano, 1997; 2000; Baas & Schrooten, 2006; Djankov et al., 2007; Brown et al., 2009; Houston et al., 2010) because they are less concerned about the risk of financing unprofitable projects (Jaffee & Russell, 1976; Stiglitz & Weiss, 1981). Therefore, higher transparency on the financial situation of potential borrowers helps to reduce information asymmetries and transaction costs, thus reducing credit rationing problems (Rauch & Hendrickson, 2004). The indebtedness stage is affected by distress costs (i.e., moral hazard). However, it is necessary to separate these costs into ex-ante and ex-post costs of distress. On the one hand, regarding the first type of distress costs, previous literature shows that the likelihood that creditors are expropriated by shareholders is lower in contexts where creditors are well protected (Gungoraydinoglu & Öztekin, 2011), leading to an increase in private credit volume over GDP (Fauceglia, 2015). In addition, Huang & Shen (2015) find that firms adjust faster their leverage ratios to the target in countries with stronger legal protection. Meanwhile, Demirgüç-Kunt & Maksimovic (1999), Giannetti (2003), and González & González (2008; 2014) point out that protecting creditor rights facilitates the access to long-term debt. On the other hand, regarding ex-post distress costs, Gungoraydinoglu & Öztekin (2011) point out that more efficient bankruptcy regulation reduces ex-post financial distress costs, which would have a positive effect on the access to corporate leverage. This is consistent with evidence that reveals how insolvency costs negatively affect long-term debt (Pindado et al., 2006). With respect to the last stage of the lending process, the risk of default has a negative impact on credit. When lenders face large unexpected losses, such as those caused by nonperforming loans, firms have to deal with a contraction in bank credit. This situation occurs because lenders reduce their credit portfolio with the aim of complying with capital requirements (Brummermeier, 2009). Given this scenario, our objective is to investigate whether the institutional framework, by either mitigating or exacerbating the risks inherent in the lending process, could indirectly influence capital structure by shaping the relation between economic forecasts and firm leverage. 2. Monetary policy measures and banking system characteristics Although most literature supports a positive effect of the monetary policy on debt (Berger & Udell, 1998; Gertler & Gilchrist, 1993; Gertler & Gilchrist, 1994), Cooley & Quadrini (2006) suggest the possibility of a non-linear relation between increases in money supply and corporate debt. Due to the different theoretical perspectives on the consequences of an expansionary monetary policy, there is still no consensus among economists about the effects of an increase in the amount of money. On the one hand, the Federal Reserve and the Bank of England follow the orthodox approach and consider that inflation is determined by the Phillips Curve as a function of current output against its potential level (Lothian, 2014). From this perspective, the amount of money in the economy is irrelevant for inflation since this should not increase if output is below its potential level and under the assumption that inflation expectations remain constant. On the other hand, there is another school of thought led by the European Central Bank which considers that an increase in the amount of money entails the risk of a sharp increase in inflation, unless this policy is reversed by subsequent contractionary measures (Lothian, 2014). This approach is supported by previous studies that state that in the long run high rates of money growth result in high inflation rates, because in the long term the Phillips Curve is vertical or positive sloping instead of downward sloping (Fischer & Sahay, 2002; Haug & Dewald, 2012; Lothian, 1985; Lothian & McCarthy, 2009). Concerning the role of banking system characteristics, Tan, Yao, & Wei (2015) highlight that in bank-based systems firms are more vulnerable to liquidity shocks compared to companies that operate in market-based systems. In this regard, Massa & Zhang (2013) find that debt inflexibility facilitates the transmission of monetary policy measures, because when companies face difficulties to access the bond market, firms’ dependence on banks increases. In this line of reasoning, Kwapil & Scharler (2013) find that the monetary policy is becoming more predictable and credible, because the role that banks play to transmit monetary expansions to the real economy has recently become more important. However, although the banking system is essential in the transmission of monetary policy measures and in the influence of such measures on corporate leverage, we need to consider banks’ liquidity and the allocation of banks’ loan portfolios separately. First, we focus on banks’ liquidity. Bassett et al. (2014) argue that banks with higher liquidity can better absorb monetary shocks and therefore they do not need to tighten their lending standards or, if they need to tighten the conditions, at least they can do it gradually during periods of financial turmoil. This is consistent with the idea that a high ratio of liquid assets is among the factors related with banks’ financial structure that are likely to reduce the efficiency of monetary policy measures (Ramos-Tallada, 2015). Second, we focus on the allocation of banks’ portfolios. Graham et al. (2015) find a negative relation between corporate leverage and government leverage. Their evidence reveals that, when governments reduce their debt issues, companies increase their use of debt relative to equity, resulting in an increase in corporate leverage. Becker & Ivashina (2014) find that contractionary monetary policy measures often lead firms to explore new financing alternatives for raising funds. A common alternati