Using a sample of non-financial listed firms located in the Euro area, I investigate the determinants of capital structure choices. In line with the traditional theoretical approach, I use a market-value measure of leverage, estimated with the Black-Scholes-Merton model. In the cross-section regressions for firm leverage I find that some variables have similar effects across countries, while others may play a different role; risk, measured as the volatility of the market enterprise value, is the best predictor of observed leverage ratios. Risk, and asymmetric information about risk, make debt less attractive, because of higher expected bankruptcy costs, lower expected debt tax shield and higher agency costs. National environments are an important determinant of observed ratios; sector of activity is a relevant factor as well. The integration of Euro-area financial markets varies significantly depending on the market segment considered: money and inter-bank markets are highly integrated, corporate bond and equity markets show a clear path of increasing integration, retail banking markets are much less integrated. Fiscal and bankruptcy rules differ across the twelve countries; the economic background varies as well.
Table of Contents
Introduction
1 Review of the literature
1.1 The theoretical literature
1.1.1 The irrelevance proposition
1.1.2 The role of corporate and personal taxes
1.1.3 Bankruptcy costs and the trade-off theory
1.1.4 Agency costs and firms financing
1.2 The empirical literature
1.2.1 The tax advantage of debt
1.2.2 Costs of financial distress
1.2.3 Empirical evidence on capital structure
2 Empirical findings
2.1 The dataset
2.1.1 Data sources
2.1.2 The relevant variables
2.2 Econometric analysis
2.2.1 The methodology
2.2.2 The results
2.2.3 Results with market-value debt ratios.
2.2.4 Results with book-value debt ratios.
2.3 Sectoral versus country regressions
2.4 Relationships with the existing literature and conclusions
3 National environments and the role of risk
3.1 Financial markets integration in the Euro area
3.2 The conditions of local financial markets
3.3 The economic background
3.4 Bankruptcy laws and the quality of governance
3.5 The effects of asset value volatility on financing costs
Conclusions
Research Objectives and Key Topics
This work aims to identify the determinants of capital structure choices for non-financial listed firms within the twelve countries of the Euro area for the financial year 2003, using both market-value and book-value measures of debt to test theoretical frameworks such as the trade-off theory and the pecking order theory.
- Determinants of capital structure in the Euro area
- Impact of asset value volatility on leverage
- Comparison of market-value versus book-value debt ratios
- Role of national legal and institutional environments
- Sector-specific versus country-specific drivers of financing decisions
Book Excerpt
1.1.1 The irrelevance proposition
In their seminal paper of 1958, Modigliani and Miller derived the well-known irrelevance proposition: under perfect capital markets, the market value of any firm is independent of its capital structure and is given by capitalizing its expected return at the rate ρ appropriate to its class; in other words, the average cost of capital to any firm is totally independent of its capital structure, and it is equal to the rate of return required for an all-equity financed stream of cash flows of the same risk class.
This result is derived under a set of hypothesis which can often be considered unrealistic: frictionless capital markets, possibility of borrowing and lending at the same risk-free rate, costless bankruptcy, tax neutrality, absence of informational asymmetries. All these assumptions assure that the operating cash flows are independent of the firms’ capital structure: as a consequence, financing choices only affect the way cash flows are partitioned, but not their total value.
As later works have shown, relaxing some of these assumptions can be critical: the irrelevance proposition would not hold anymore, and capital structure choices can affect the value of the firm. Moreover, investment and financing decisions might become interconnected so that the two aspects cannot be analyzed separately since they are jointly determined.
The derivation of the irrelevance proposition is based on an arbitrage argument, for if it did not hold, then investors could buy and sell stocks and bonds in order to transfer one income stream for another stream, totally identical other than the price. This exchange would clearly give favorable opportunities of trade to investors independently of their risk attitude. Obviously, such opportunities cannot exist in equilibrium, since investors would take advantage of them in order to make risk-less profits. Thus, overvalued securities would fall and underpriced securities would rise until the equilibrium is achieved, that is, until the law of one price is restored: being the streams of income identical, in equilibrium they must sell at the same price.
Summary of Chapters
1 Review of the literature: Provides a comprehensive overview of the theoretical foundations of capital structure, including the irrelevance proposition, tax benefits, bankruptcy costs, and agency theory, followed by a synthesis of existing empirical studies.
2 Empirical findings: Details the dataset construction and the econometric methodology (Tobit model) used to analyze the determinants of capital structure, comparing market-value and book-value debt ratios and presenting regression results.
3 National environments and the role of risk: Examines how institutional factors, such as financial market integration, bankruptcy laws, and macroeconomic conditions across Euro-area countries, influence firms' financing behaviors and the importance of risk.
Keywords
Capital structure, Euro area, Black-Scholes-Merton model, Leverage, Asset volatility, Trade-off theory, Pecking order theory, Corporate finance, Financial distress, Bankruptcy costs, Agency costs, Marginal tax rate, Market integration, Corporate governance, Debt capacity
Frequently Asked Questions
What is the primary objective of this research?
The research investigates the determinants of capital structure for non-financial listed firms in twelve Euro-area countries during 2003, specifically testing how variables like risk and national environments influence financing choices.
Which theoretical models are central to this study?
The study primarily utilizes the trade-off theory and the pecking order theory to analyze corporate financing decisions.
How is debt measured in this analysis?
The author uses both market-value measures of debt (estimated via the Black-Scholes-Merton model) and traditional book-value measures to evaluate leverage.
What is the role of asset volatility in the findings?
Asset volatility is identified as the most significant predictor of observed leverage ratios, demonstrating that risk is a primary determinant of corporate financing structures.
How does the national environment affect capital structure?
The study finds that national legal frameworks, tax laws, and levels of financial market integration continue to play a distinct role in determining firm-level financing, despite the common currency.
What sectors are analyzed?
The research incorporates firms across twelve sectors defined by the Global Industry Classification Standard (GICS) to identify sectoral influences on financing patterns.
Why are financial firms excluded from the study?
Financial firms are excluded because their capital structures are heavily regulated and influenced by systemic stability requirements, which would distort the analysis of standard financing determinants.
What is the conclusion regarding the Pecking Order Theory?
The author finds mixed evidence for the pecking order theory, noting that it has limited explanatory power in the Euro-area context compared to the trade-off theory, particularly when accounting for firm risk.
- Citar trabajo
- PhD Marco Botta (Autor), 2007, Capital structure and assets risk, Múnich, GRIN Verlag, https://www.grin.com/document/273880
