Academic journal article Multinational Business Review

A Comparison of Capital Structure Determinants: The United States and the Republic of Korea

Academic journal article Multinational Business Review

A Comparison of Capital Structure Determinants: The United States and the Republic of Korea

Article excerpt

Abstract:

This paper investigates the determinants of the capital structure of large corporations headquartered in the United States and Korea. We consider five explanatory variables: profit, company size, non-debt tax shields, growth, and business-risk, along with several industry indicator variables as independent variables and examine, for each country the relationship to market value based leverage ratio. With our rigid criteria for inclusion in the study, we study the top thirteen companies (by size) in each of seven industries. The majority of our findings indicate that we can generalize to Korea what has been found for Japanese companies/industries relative to the U.S.

INTRODUCTION

This paper investigates an empirical issue that has received limited attention in the literature: the determinants of the capital structure of large corporations headquartered in the United States (as a developed country) and Korea (as a less developed country). Harris and Raviv (1991) noted that ". . . It is perhaps unfortunate that there seem to be no significant empirical anomalies to guide further theoretical work. . . . Note, however, that many of the theoretical implications have not yet been tested (for the possible determinants of capital structure)." Indeed, high and increasing debt ratios for Korean firms with their high growth in the 1980s and 1990s might have resulted in weak fundamentals and caused these firms to be vulnerable to the financial crisis suffered in 1997 (Fattouh et al. 2005). There are still few comparisons between developed and less developed countries concerning the issue of capital structure. The results of such a comparison may be beneficial for many firms in the U.S. and Korea during the period of the internationalization of current Korean capital markets. We consider the five-year period of 1987-1991, a period chosen specifically due to the relative stability of the Korean market during this period relative to adjacent time periods. Multinational corporations operating foreign businesses in either the United States or Korea, or in other developed and less developed countries, may take into account these results when establishing their own long run capital structure. Moreover, in order to implement financial or economic policies more effectively, government policy makers in both developed and developing markets may benefit from the results of this study.

Our research used more strict criteria than those in most of the previous literature in order to obtain more reliable and representative sample firms. The dependent variable measured at market value, the arcsine transformed average market value based debt ratios, y' = 2 arcsine[(y)^sup 1/2^], was used, rather than a book value based measure as in most previous studies.

The paper is organized as follows: The next section is a review of previous theoretical and empirical literature regarding the possible determinants of corporate capital structure. Then we provide a description of the data collection and methodologies employed in our study. Next is our analysis and interpretation of the empirical findings in the context of inter-country comparisons of the U.S. and Korea. Finally, a summary and concluding remarks are presented.

PREVIOUS RESEARCH

Since the seminal article by Modigliani-Miller (M&M) showed that there would be no optimal capital structure for any firms in the same risk class under the restrictive assumptions of perfect capital markets with no taxes (Modigliani and Miller, 1958), many studies have sought to find determinants which may affect and maximize a firm's value under the imperfect conditions of the real world.

The study by Remmers et al. (1974) indicated that industry was not a determinant of corporate leverage ratios in the manufacturing sectors in the U.S. They also found that there were no industry differences for The Netherlands and Norway, but that there were differences for France and Japan. …

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