Legal Systems, Capital Structure, and Debt Maturity in Developing Countries

Abstract

Manuscript typeEmpiricalResearch Question/IssueThis paper analyzes the importance of two aspects of the legal system in shaping firm leverage and debt maturity structure across developing countries.Research Findings/InsightsUsing a larger number of developing countries compared to prior research, four main findings are obtained. First, whereas corruption increases firm debt financing, its effect is moderated when considering the impact of stronger laws. Second, the common versus civil law distinction does matter for firm financing in developing countries, but in the opposite direction documented for developed countries. Third, less corruption combined with stronger laws increases reliance on long‐term debt. Finally, by listing on a developed exchange abroad, firms in developing countries are able to raise equity and extend the maturity of their debt.Theoretical/Academic ImplicationsThe findings on the relative importance of the legal system for firm financing decisions in developing countries do not necessarily agree with prior findings for developed countries. Future research focusing exclusively on developing countries may be warranted to better understand the drivers of private sector‐led growth in these economies.Practitioner/Policy ImplicationsThis study reinforces the importance of strengthening public governance and laws as well as deepening capital markets in developing countries to improve financing conditions.

Debt financing puzzle and internationalization

“…Similarly, Deesomsak et al (2009) use a sample of markets in the Asia Pacific region (Thailand, Malaysia, Singapore and Australia) to show that firms’ capital structure decision is influenced by the environment in which they operate because different markets have different legal, financial and institutional environments. Turk Ariss (2016) finds that the relative effect of legal system on firms’ financing decisions in the developing markets does not necessarily agree with those findings reported for developed markets. Given the differences, researchers extend their focus to assess corporate financing decision from the emerging markets’ perspective.…”

Earnings Quality and Market Performance in LATAM Corporations: A Combined Agency and Cognitive Approach to Investors’ Perceptions of Managerial Information

“…As suggested by the capital structure literature, debt can be efficiently used to undertake profitable investment projects that the market interprets as positive growth opportunities by pushing up the market valuation [33]. Similarly, the size of the company (SIZE) is also positively related to its performance.…”

Export Diversification and Financial Openness

“…On the other hand, the opening-up of capital account can allow firms to have access to a wide variety of financial instruments, which provides opportunities for better risk diversification (e.g., Acemoglu and Zilibotti, 1997;Greenwood and Jovanovic, 1990;Obstfeld, 1994;Saint-Paul, 1992). It also provides for access to more liquidity; to funding at lower capital costs, and at longer maturities compared to funding from domestic markets (e.g., Ball et al, 2018;Chouinard and D'Souza, 2004;Schmukler and Vesperoni, 2006;Stulz, 1999;Turk Ariss, 2016). The risk-sharing opportunities (i.e., the greater protection against idiosyncratic risks) provided by greater financial openness can allow countries to enhance production specialization (through production differentiation) in order to fully exploit economies of scale or technological competitive advantages.…”

“…These include the access to a bigger investor base (e.g., Reese and Weisbach, 2002), to a wide variety of financial instruments (and hence to the possibility of better diversifying risk) (e.g., Obstfeld, 1994), and access to more liquidity. Access to international financial markets also allows firms to obtain funding at lower capital costs, and at longer maturities compared to funding from domestic markets (e.g., Ball et al, 2018;Chouinard and D'Souza, 2004;Schmukler and Vesperoni, 2006;Stulz, 1999;Turk Ariss, 2016). It improves corporate governance and enhances investments (e.g., Benos and Weisbach, 2004), firms' visibility and prestige (e.g., Baker et al, 2002;Bancel and Mittoo, 2001;Herrmann et al 2015), macroeconomic policies discipline (e.g., Agénor, 2003;Prasad and Rajan, 2008;Tytell and Wei, 2004), and ultimately increases economic efficiency (e.g., Bekaert et al 2005).…”