Academic journal article Management International Review

International Differences in Capital Structure Norms: An Empirical Study of Large European Companies

Academic journal article Management International Review

International Differences in Capital Structure Norms: An Empirical Study of Large European Companies

Article excerpt

Introduction

The main purpose of this paper is to assess the validity of some of the possible determinants of capital structure among large European industrials. A secondary purpose is to test the hypothesis that there exist international differences in capital structure norms among the large companies in various European countries.

These questions are of both theoretical and practical interest. For example, international differences in capital structure norms can be of great importance as determinants of the capital structure of the foreign affiliates of multinational companies. In addition, results of such research would also be useful in comparative analyses of financial markets and systems in different countries. Thus, the results of such research would be useful not only to students of international financial markets but also of the MNC.

The first part of this paper is a brief survey of the literature regarding published studies of international differences in capital structure and of the determinants of capital structure. In the second part, new data and findings are presented. The paper concludes with a summary of the findings and suggestions for further research.

Determinants of Capital Structure

Interest in the capital structure of a firm increased greatly as a result of the debate started by Modigliani and Miller [13]. Specifically, they argued that in a world of perfect capital markets and no taxes a firm's financial structure does not influence its cost of capital and, consequently, there is no optimal capital structure. In the presence of taxes and bankruptcy costs, this position has been modified to include an optimal capital structure which is less than 100 % debt [12, 21]. This latter conclusion (for different reasons) is quite similar to the more traditional views [5, 9, 11]. In all of these studies business risk is considered as an important factor related to a firm's cost of capital and capital structure.

Empirical evidence has been presented by Gupta [10], Scott [16], Scott and Martin [17], Schwartz and Aronson [15], and Archer and Faerber [4], amongst others, to show that industry class influences financial structure. On the other hand, dissenting evidence has been presented by Remmers, Stonehill, Wright and Beekhuisen [14] who argue that industry is not a determinant of capital structure and that earlier studies were deficient in many ways. However, since the financial markets set interest rates and maximum debt limits based on the volatility of a firm's income stream, this volatility should be related to a firm's business or industrial classification and, therefore, industrial classification should influence capital structure. Consequently, Ferri and Jones [7] using data on U.S. companies reexamined this relationship and conclude that there is a definite but "less pronounced" than previously determined relationship between capital structure and industry classification. Gonodes [8] has questioned the use of industry classification as a proxy for business risk and, therefore, we cannot extend these empirical results to include the conceptually neat relationship between capital structure and business risk.

The effect of two other variables, i. e., size and growth rate, have also been extensively researched as to their effects on the capital structure of a firm. Scott and Martin [17], Gupta [10], Archer and Faerber [4], and others present empirical evidence that size is a major determinant of capital structure. However, Remmers, et al. [14] present evidence that size of a firm is not one of the determinants of capital structure.

Stonehill, et al. [19] and Toy, et al. [20] have presented evidence to support the view that growth rate is a determinant of capital structure. However, the exclusion of size and industry from their analysis may have resulted in a serious bias in their results. In this study, they also found that profitability is a minor determinant of capital structure. …

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