1
DOMESTIC AND MULTINATIONAL CAPITAL STRUCTURE:
THEORY AND EVIDENCE
J. Edward Graham, Jr.
ABSTRACT
The capital structure of the firm is examined in the domestic environment under successively less restrictive
assumptions. Allowances are then made for agency costs and information asymmetries. The domestic capital
structure theory is extended to the multinational environment and examined empirically. Results broadly support
financial theory. Where the theory is restrictive in its assumptions, it describes multinational capital structure
poorly. Subsequent research is proposed.
2
DOMESTIC AND MULTINATIONAL CAPITAL STRUCTURE:
THEORY AND EVIDENCE
Working Paper
Introduction
What is capital structure and how is capital structure chosen by a corporation? What are the
roles of debt and equity in this capital structure? How are these components chosen in a “perfect market”
without taxes or bankruptcy costs? How do these roles and proportions change as an allowance is made
for taxes and bankruptcy costs? What roles are played by debtholder and equityholder incentives in this
structure? What is the impact of agency costs and asymmetric information on the capital structure? How,
if at all are these factors and their impact on a firm’s capital structure changed when a provision is made
for international variables? Is the capital structure of the multination corporation (MNC) significantly
different from the domestic corporations (DC)?
These questions are addressed.
In Section 1, capital structure is defined and considered under the restrictive assumptions of a
“perfect market.” The implications of a frictionless capital market are examined. An allowance is made
for corporate and personal taxes in Section 2. The following section includes a provision for the impact of
uncertainty, leverage and bankruptcy costs. Agency costs, debtholder incentives, and agency cost of
debt are considered in Section 4. A brief examination of the impact of asymmetric information on capital
structure is presented in Section 5. Selected topics and empirical studies of MNC capital structure are
reviewed in Section 6. The paper closes with a summary and encouragement of subsequent research.
Each section provides the “domestic” theory relevant to the given topic on capital structure and extends
the theory to the multinational setting.
3
Section 1
The financial structure of a firm is the mix of all the items that appear on the right-hand side of the
firm’s balance sheet. The capital structure is the mix of the long-term components of that financial
structure. The domestic and multinational corporate capital structure both consist of various elements of
liabilities and owner’s equity. Similarities and dissimilarities between MCN and DC capital structure are
considered. In the evaluations which follow, the stockholder-owned MNC or DC attempts to select a
capital structure that maximizes firm value: this value is composed of the market value of debtholder and
equity holder financing.
Does capital structure affect the value of the firm? Are investment decisions affected by the
manner in which they are funded? Until the seminal work by Modigliani and Miller (1958), the prevailing
view was that firm value was a concave function of its use of financial leverage; that an optimal mix of
debt and equity existed (a global maximum) which maximized firm value. Modigliani and Miller (M&M)
proposed that firm value was independent of its capital structure, subject to a set of restrictive
assumptions. 1
Central among the provisions of M&M (1958) is an assumption of “perfect” and frictionless capital
and financial markets; there is no allowance for taxes, bankruptcy costs or transaction costs. Coupling
these features of the M&M modeling with their other restrictions provides support for their proposals: that
capital structure is irrelevant as it effects firm value, that investment and financing decisions are
independent and that expected return increases linearly with debt, precluding an increase in firm value
through the use of leverage. Stiglitz (1969) relaxes the risk class, capital market competitiveness and
homogeneous expectations assumptions of M&M (1958) and is able to reach similar conclusions.
However, his modeling is not robust to the introduction of bankruptcy costs.2
1
Adler (1979) is one of many studies, which note that traditional financial theory, of which the work of
M&M (1958) is a watershed, does not extend easily to a multinational setting. Nonetheless, M&M (1958) serves as
a benchmark for an examination of domestic or multinational capital structure.
2
In later sections the relevance of bankruptcy costs to the capital structure of the DC (Kim. 1978) and MNC
(Lee and Kwok, 1988) is considered.
4
He does find the M&M proof holds, however, under much more general conditions than originally
supposed.
An extension of the fairly stringent assumptions of M&M to the multinational setting is difficult.
Senbet (1979) questions the extension of the perfectly competitive capital market assumption to the
international setting. Yet, given the assumption and the absence of taxes (or an “international tax
differential”), he finds the international financing mix is irrelevant. M&M (1958) holds.3 He still notes that
existing financial theory “ has to be amply modified if it is to accommodate” MNCs.
Stiglitz (1969) implicitly acknowledges the potential for an optimal capital structure for the
economy as a whole. He merely illustrates irrelevance for the individual firm, given his less-binding
restrictions. Nonetheless, he admits the non-robust nature of his M&M examination to bankruptcy costs
and the “crucial fallacies of the perfectly competitive capital market:” that lending rates different from
borrowing rates, that the nature of a firm’s risky debt changes as its debt ratio changes, and that one
firm’s bonds are different from another’s. These three factors are precluded in the perfectly competitive
capital market.
Errunza and Senbet (1981) note that any international investment by a firm competing with “the
locals” is a departure from “Market perfection.” Given perfectly competitive markets, these locals could
acquire the necessary technologies and capital on their own. Discovering a systematic positive
relationship between “current degree of international involvement and excess market value,” they
illustrate the abbreviation of market perfection in the international arena. 4 They discover that the factors
leading to these financial market imperfections are priced. They provide an indication of the contributions
of international barriers to foreign direct investment. This impacts MNC capital structure.
Many of the arguments against the restrictive assumptions of M&M (1958) apply in both the
domestic and multinational setting. Differential tax, lending and borrowing treatment exist for
3
Corporate and personal taxes are considered in the next sections. An allowance for international tax
differentials is shown to compromise M&M (1958).
4
Imperfections in the international financial markets are also addressed in early work by Black (1974) and in
later examination by Lee and Zechner (1984) and Hodder and Senbet (1990).
5
Corporations with and between nations. The limitations mentioned above are addressed and
successively less restrictive assumptions are provided; a number of insights concerning the capital
structures of the DC and MNC are gleaned. Although capital structure theory is still inadequate, studies
since 1958 have encouraged certain tenets of this theory and discouraged others. 5
Section 2
What is the impact on capital structure if an allowance is made for taxes? Revisiting their earlier
work, M&M (1963) reveal that taxes and leverage (an effective government subsidy of debt) do give the
firm an advantage. The implication is that an optimal cattail structure exists for the firm. Extending this
argument, if the only imperfection in the financial world is corporate taxes, the firm uses all debt
financing.6 Treating the tax shield as perpetuity, they find firm value is maximized through the use of
debt.
Specifying the value of the firm without a provision for personal taxation, M&M (1963) main point
is that required returns are lowered using debt. The value of the firm is an increasing function of debt.
Since firm value is more easily maximized using debt and the firm undertakes investment when the value
of the firm is increased, the probability of investment and magnitude of investment are also increased.
Perhaps some of the liveliest examinations of DC and MNC capital structure have had taxes and
international taxation as their fulcrum. Differential international taxation (a potential barrier to the smooth
operation of international financial markets) has invited extensive study. The differential government
subsidy of business has invited and discouraged the flow of capital across borders. 7
5
See Myers (1984)
Other “imperfections” may lead to an optimal interior mix of debt and equity.
7
International tax differentials are considered by Adler (1979), Black (1974), Errunza and Senbet (1981),
Hodder and Senbet (1990), Lee and Zechner (1984) and Senbet (1979). Many other authors also address this issue.
6
6
Black (1974) addresses capital market equilibrium, given explicit barriers to international
investment, as a function of international tax differentials. Broadly defining “tax” as any kind of barrier to
foreign investment, he posits that where these barriers are effective, a world CAPM does not hold.
8
Financial and capital markets are imperfect and a firm will structure its mix of debt and equity to take
advantage of these imperfections. An optimal multinational capital structure, long in domestic assets and
short in foreign ones, may exist. Where these barriers are ineffective, he seems to imply capital striker
irrelevance as it relates to international capital market imperfections. His work does not specifically model
the impact of personal taxes. His basic premise is that models of international investment assume
“specified or unspecified barriers” to multinational investment and that these barriers cause changes in
the pricing of international securities. Tax-free investors are subsidized by these barriers, to which they
are not subject. Senbet (1979) also notes that international tax differentials affect a firm’s financing mix
and investment.
Miller (1977) extends the theoretical consideration of capital structure to personal taxes.
Proposing that bankruptcy costs and agency costs are insufficient to offset the tax advantage of debt, he
posits that the value of the firm, in equilibrium, is independent of capital structure. He acknowledges (as
did Stiglitz (1969)) an aggregate macroeconomics capital structure, but denies an optimal structure for the
individual firm. 9 He proposes that, in equilibrium, the marginal tax rate for a buyer of corporate debt
equals the marginal tax rate for the issuing corporation; implying a macro-level capital structure optimum
but a micro-level irrelevance.
This “tax” can “represent various kinds of barriers to foreign investment, such as the possibility of
expropriation of foreign holdings, direct controls on the import or export of capital, reserve requirements on bank
deposits and other assets held by foreigners, and restrictions on the fraction of a business that can be foreign owned.
It is even intended to represent the barriers created by the unfamiliarity that residents of one country have with other
countries.”
9
This is countered in DeAngelo and Masulis (1980). The presence of non-debt tax shields such as
depreciation and depletion and investment tax credits (foreign countries have similar provisions in their tax coeds)
imply a market equilibrium in which each firm has a unique interior optimal leverage decision. They argue that
these shields and optima are supported in preliminary empirical findings. Bankruptcy costs, in their analysis,
become significant and mitigate Miller’s “horse and rabbit stew” argument concerning bankruptcy costs.
8
7
Lee And Zechner (1984) extend the Miller (1977) hypothesis to the international setting and find
that the “Miller equilibria do not hold” in the presence of different tax subsidies between countries. They
analyze capital structure in a two country setting and find, on a theoretical basis, that firms tend to be all
equity or all debt depending on location. They likewise identify “differential tax subsidies of debt if
inflation rates differ across countries.” Differential rates of inflation and national corporate tax rates can
change the equilibrium structure of international capital markets. In the presence of barriers to
international investment (capital markets are not perfectly integrated), the Miller irrelevance theorem
holds; in the sense that “leverage is indeterminate for the individual firm while it is determinate for the
aggregate economy.” Given integrated international capital markets, high-tax country firms tend to be all
debt-financed and low-tax, all equity. 10
Hodder and Senbet (1990) also generalize the Miller analysis to an international setting. Given
differential international taxation, they note implications for national differences in capital structure, the
international Fisher effect and yield differentials. They propose that corporate tax arbitrage plays a key
role in generating an international capital structure equilibrium. Contrary to Lee and Zechner (1984) they
show that, “ if corporations engage in international tax arbitrage on an equal footing, no optimal capital
structure exists for the individual firms.” Miller (1977) holds. Thus, differences in international tax rates
alone are not sufficient to dictate a firm’s capital structure. Assuming otherwise “perfect” capital markets,
their international analogy of Miller is robust to different tax rates.
11
Apparent international differences in
capital structure are not due solely to differences in personal and corporate tax rates. The international
Fisher effect holds despite differences in taxes and inflation. Additionally, there exists no “induced
preference for corporate borrowing in a particular currency.” Much of the difference in the findings
between Lee and Zechner (1984) and Hodder and Senbet (1990) can be attributed to their adopted
10
With barriers to international investment, Lee and Zechner (1984) show that the Fisher hypothesis of
equality in real returns is violated at the international level.
11
They assume no government restriction on individual or corporate response to differences in international
tax rates.
8
Restrictions. Nonetheless, the contrasts of those two studies are noteworthy.
Section 3
What are the implications for the firm’s cattail structure when an allowance is made for
uncertainty and bankruptcy costs? Kim’s (1978) modeling provides support for the traditional view; that a
firm’s value is a concave function of its debt financing and that an interior optimum exists where the slope
of these function equals zero. He proposes that the value of the levered firm is equal to the value of the
unlevered firm plus the present value of the tax-shield provided by debt less tax credits lost and costs
incurred in bankruptcy. This traditional argument flows from the M&M (1958 and 1963) argument by
allowing for taxes and bankruptcy costs. He shows an optimal level of debt financing (optimal capital
structure) at less than the firm’s debt capacity.
Haugen and Senbet (1978) counter that the expectations of bankruptcy costs and other costs of
financial distress do not impact capital structure. They also find Kim’s one-period model deficient. They
propose that the choice of liquidation and/or reorganization exists as an effective alternative to
bankruptcy. They argue that the costs of bankruptcy are bounded by the costs of informal reorganization.
They posit, given rationality and large financial markets, that the costs of bankruptcy “must be small” and
that the liquidation decision is made independently of capital structure. They note that all claimants have
“ an incentive to avoid bankruptcy.” Given the widespread use of bankruptcy in firm reorganization, their
arguments seem to lack intuitive appeal.
Titman (1984) notes that traditional approaches to the consideration of capital structure have not
considered all claimants. He introduces a third claimant – workers, customers, community, and suppliers.
Noting the shallow nature of the claims of Haugen and Senbet (1978) that these third parties should join
in reorganization coalitions to protect their interests, he proposes the use of preferred stock to protect
these third parties. His arguments do not extend easily into the multinational arena.
9
Bradley, Jarrel, and Kim (1984) (BJK) acknowledge that the general view (though not a
consensus) is that optimal capital structure involves “balancing the tax advantage of debt against the
present value of expected bankruptcy costs.” The “upshot” of extensions of Miller’s (1977) modeling is
the recognition that the existence of an optimal capital structure is essentially an empirical issue as to
whether or not various leverage-related costs are significant enough to influence the costs of corporate
borrowing.12 Their examinations reveal that firm leverage ratios are negatively related to the volatility of
earnings (given non-trivial costs of financial distress) and that “permanent ratios” are related to the firm
industrial classification. They generate strong findings of intra-industry similarities in capital structure and
a persistence of inter-industry differences.
These theoretical and empirical considerations of capital structure, leverage, and bankruptcy
costs have been extended to the international setting. Shaked (1986) examines the failure probabilities of
a sample of MNCs. His findings suggest that the probability of bankruptcy is greater for DCs than MNCs.
He observes that MNCs are significantly more capitalized with lover returns volatility than DCs. His study
seems to lack an adequate explanation for these findings, however. MNCs might be expected to have
higher debt ratios, given their less volatile and internationally diversified operations, than their domestic
counterparts. Given also the hedging of local political risk with higher debt ratios by foreign affiliates and
the reduction of bankruptcy probability (expected bankruptcy costs) through international diversification,
this seems counter-intuitive.
Lee Kwok (1988) address the deficiency noted above. Commenting on the intuition of Myers
(1977) and Jennies and Mocking (1976) Lee and Kwok (1986) not that international environmental factors
lead to higher agency costs of debt.
13
These factors, in turn, offer one explanation for the lower debt
ratios of MNCs. Lee and Kwok also find that MNCs “do not have lower bankruptcy costs” than DCs.
12
These leverage-related costs can include bankruptcy costs, costs of reorganization, agency costs, and loss of
non-debt tax shields (see DeAngelo and Masulis, 1980).
10
Whereas contemporary capital structure theory as it relates to bankruptcy might imply the greater us of
leverage by the MNC, this does not appear to be the case. MNCs have lower means of bankruptcy costs
“not because of their international involvement but simply because of their large sizes.
14
Rajan (1993) examines the capital structure and term structures of debt of corporations in the G-7
countries. Given differential tax structures and cultural norms of those nations, one might expect
significant differences. His findings are surprising. Capital structures and maturity structures of debt –
after correcting for differences in accounting, reporting, and asset valuation – are similar across the G-7
countries. They also seem to be driven by similar factors. Leverage is broadly similar, through some
differences are noted. 15
Many international systems have been lauded for encouraging efficiency (i.e. Japan) or damned
for denying it (often the U.S.). However, Rajan (1993) notes that “there is little evidence on
competitiveness.” He closes noting that either the “theoretical underpinnings” of these factors or prior
studies on the “efficiency of different institutional settings are effective. “ His findings would seem to
complicate the comparison of the capital structure of MNCs and DCs, if one assumes broad differences.
Section 4
What are the implications of agency costs, debtholder incentives, and agency costs of debt for
the capital structure of the domestic and multinational corporation? The separation of ownership and
control and the pursuit of conflicting goals by management and shareholder are at the core of agency
13
Agency costs and debtholder incentives and agency costs of debt are examined in the following section.
The findings of BJK (1984), o f shared capital structures among members of an industry is blurred with the
MNCs; the MNCs, as a result of their size and diverse activities, lose their industry distinction. (See also Sekely and
Collins, 1988). These industry differences, however, “played an important part in explaining differences in capital
structure between MNCs and DCs” in Lee and Kwok (1988).
14
11
theory. Jensen and Meckling (1976) are among the first to model capital structure as a function of
agency costs. They develop a theory of capital structure where inside and outside ownership and
leverage are chosen to maximize firm value. There are agency costs (of monitoring, bonding, and
residual losses) suffered in the pursuit of equilibrium. These costs are borne by management and
owners.
A number of claimants have an incentive to minimize agency costs. Management has the motive
to signal low agency costs (through greater management ownership and debt ratios) to maximize equity
value and their value of the job market. Debtholders have the incentive to create covenants to preclude
agency cost. Capital structure is chosen, in the Jensen and Meckling milieu, to minimize agency costs;
an optimal level of debt and “inside” equity are chosen to signal and insure desired management
behavior. Demsetz (1983) proposes that the stock and human capital markets preclude egregious
agency costs. He addresses the premise that the link between private ownership and efficient resource
utilization is presumable broken by a structure of ownership that reduces the incentive of management to
maximize profit. Given the imperfections in the international capital markets outlined earlier, an extension
of his argument to MNCs seems tenuous.
Fama and Jensen (1983) examine the survival of organizations characterized by the separation
of ownership and control. Considering the firm a nexus of contracts, they note the need for well-defined
decision-making processes, specified residual claimants and mechanisms for controlling agency costs.
Extending their proposals to the international setting seems fairly straightforward. The benefits of
specialization and the need for separation may be even more pointed in the MNC than in the DC.
Contracting, legal restraints, and cost functions need to be sensitive to multination requirements. Capital
structure might be impacted as the nature of claims responds to given multinational corporations issues
(i.e., increased/decreased foreign ownership, increased cost of foreign debt, management contracts
tailored to specific foreign requirements, etc.).
Free cash flow is the cash flow in excess of that needed to fund positive NPV projects. Jensen
(1986) considered the implications of free cash flow in the context of agency theory. With substantial
15
The market-oriented economies of the U.S., U.K., and Canada would be expected to have significantly
different ratios of debt and equity than the banking-oriented economies of France, Italy, Germany, and Japan.
12
Free cash flow, conflicts develop. He notes that management, in pursuit of their own agenda, is
motivated to over-in-invest or otherwise misallocate or misappropriate free cash flows. He concludes that
debt serves as an incentive to bond management and reduce agency costs (as does a fixed highdividend-payout policy).
Stulz (1990) gives Jensen objective support. He considers alternative financing policies to
mitigate agency costs in a theoretical framework. Like Jensen, he provides evidence of a favorable
bonding effect of debt and dividend payments. Given unobserved free cash flows, he composes a
comparative static that bounds this overinvestment issue; management is encouraged to commit funds
“properly.” He illustrates the positive impact on firm value of debt for equity swaps and of higher
dividends; he likewise shows the negative effect on firm value of new stock issues.
The extension of Jensen (1986) Jensen, and Meckling (1976) and Stulz (1990) to the
multinational arena can be appreciated with references to Myers (1977) and Lee and Kwok (1988). In
Myers (1977), many corporate assets are viewed as “real” options; growth opportunities are particularly
well-modeled as call options. According to Myers, issuing risky debt reduces the present market value of
the firm by inducing sub-optimal investment policy. Given that value accrues to risky Debtholders with
firms having substantial value in growth opportunities, an agency cost of debt develops. Equityholder
may forego favorable investments in the face of these costs. Lee and Kwok (1988(note that the
underinvestment problem of Myers (1977) is a factor in reduced levels of debt, ceteris paribus, for the
multinational firm.
Lee and Kwok also address the substitution problem of Jensen and Meckling (1976); wherein the fear of
wealth transfers from debtholders to equityholders lowers bond value, increases another agency cost of
debt (this is often and overinvestment problem for risky firms or firms near bankruptcy), and motivates
lower debt levels. Lower debt usage is encouraged for the MNC in the face of higher agency costs of
13
debt because of “several international environmental factors.” 16 Lee and Kwok (1988) provide empirical
support for the premise that MNCs tend to have lower debt ratios than DCs.
Section 5
Among the authors who address the implications of asymmetric information for the firm’s choice
of financial structure, Ross (1977) makes several points. Given management’s possession of “insider”
information and an incentive to signal the value represented by this information, a managerial incentive
schedule develops where valid inferences are drawn from the signals in equilibrium. One empirical
implication is that, in a cross-section, the value of the firm will increase with leverage – as leverage
increases the market’s perception of value. M&M (1958, 1963) “assume the market has full information
implicitly”; this is not true given information asymmetries. So the firm signals value with its debt level,
inasmuch as management runs the risk of bankruptcy and reduced compensation if they send a “false”
signal. The difficulty of extending Ross (1977) to the MNC due to agency cost of debt is outlined in
Section 4. The appropriateness of a signal by the management of a MNC using debt levels seems to be
compromised.
Similar to Ross (1977), Myers and Majluf (1984) consider capital structure as a signal to
outsiders. Assuming management acts in interest of “old “ shareholder, positive NPV projects may be
foregone to preclude wealth transfers to new shareholders. Management possesses information
unavailable to outsiders and may attempt to use the capital structure to signal this value. Optimal
resource allocation seems to be thwarted in the Myers and Majluf framework; contracts and institutions
should be structured to mitigate this resource allocation problem. “Stack” (cash on hand) mitigates the
problem but leads to agency costs of free cash flow. A desire to spin off new projects or finance them
separately may develop due to the information asymmetries, agency costs, and agency costs of debt
16
17
See Lee and Kwok (1988).
The Myers and Majluf (1984) study has been criticized for the simultaneity of their modeling equation and
the lack of an illustration of equilibrium in the same equation.
17
14
Section 6
Although the links between the capital structure of the MNC and financial theory are often
tenuous, a few features have come to light. Several related studies of MNC capital structure highlight
these features and the often “fluid” nature of that capital structure.
Given an assumption of exchange rate controls and restricted international flows of capital the
MNC is analogous to a domestic multi-divisional firm. Adler (1979) notes that this segmentation leads to
differing valuation objectives and investment-acceptance criteria. (If the segmentation is “extensive,” this
analogy may not apply.) The MNC capital structure may be unstable of inefficient. 18
Toy, Stonehill, Remmers, Wright, and Beekhuisen (1974) study differences in debt ratios between
countries in the manufacturing sector. They propose a linear model and test whether growth, profitability,
and risk impact debt ratios in the manufacturing sectors of industrialized countries. They examine
international corporate financial policy in the U.S., Japan, Norway, and Europe. Significant relationships
are found in all countries but France. A surprising result is that higher earnings risks are associated with
higher debt levels. Differing debt ratios between countries are attributed to differing cultural perceptions
of debt ratios (i.e. higher debt ratios are tolerated and expected in Japan than in the U.S.)
Stonehill, Beekhuisen, Wright, Remmers, Toy, Pores, Edgan, and Bates (1975) assume differences in the
capital structures of MNCs in their study. In examining whether the capital structures of foreign
subsidiaries differ from their parent, they find financial risk (and not parent structure) is the most important
debt ratio determinant.19 Their survey shows a clear preference of financial executives in France, Japan,
18
Senbet (1979) also addresses foreign exchange risk. Like Adler (1979), he notes that existing financial
theory has to be “amply modified” to accommodate MNCs and that studies of the time were subject to distinct
limitations in scope and links to financial theory.
19
Stonehill, et al. (1975) use surveys data. Survey data is often suspect.
15
The Netherlands, and Norway for capital structures that respond to “local environmental factors”; those
countries have policies, which often mitigate the threat of bankruptcy.
20
(Is social awareness impacting capital structure decisions?) They found international factors such as
government incentives to raise funds locally, hedging operations and repatriation of capital are important
in determining capital structure.
Kester (1986) compare the capital structure of manufacturers in the U. S. and Japan. He
responds to the purported competitive advantage of Japanese business through their greater use of
leverage. However, he finds that when leverage is measured on a market value basis and “adjusted for
liquid assets,” there are no significant overall differences in debt use between the U. S. and Japan. The
composition of Japanese capital and ownership structure is quite different than the U.S.; leverage is
simply not as great a factor as previously thought. 21 Japanese corporate structure and financial
institutions do, however, seem to facilitate the use of debt. The competitive implications of the Japanese
financial system and corporate capital structure are by no means straightforward.
Sekely (1988) examines the significance of international cultural and industry factors in
determining capital structure. Similar to other studies, he fins “significant country and minimal industry
influences.” He provides evidence that “cultural influences” are highly correlated with capital structure
and that MNCs (due to their size and diversity) are losing their industry distinctions. He proposes that
financial theory tends to minimize the significance of cultural influences on capital structure. He finds
that, whatever the link between social, legal and commercial arguments within a given country (he studies
677 firms in 23 countries) there is a significant link. He also discovers distinct groups of countries ranked
by their average debt ratio; this may be due to shared cultural patterns.
Conclusions
20
21
This contrasts with patterns in the U.S., the fifth country in their study.
Higher leverage is found in Japan in “mature concentrated industries.”
16
What is the difference between the capital structure of the domestic and multinational
corporation? Although broad references have been made to differing components of capital structure
In different countries, what are the implications for the firm operating in many countries? Do foreign
subsidiaries adopt the parent’s capital structure? Does the parent adapt its striker to differing
international inputs? It appears there is no industry standard for the capital structures of U.S.-based
MNCs. Each firm adapts to its own circumstances. However, several features of these MNCs’ capital
structures have come to light. These firms must respond to features of risk, culture, and strategy
common only to the multinational.
In the simplest vein, Sekely (1988) notes that “if an optimal capital structure exists, management
need only finance the firm in that fashion and the objective of the maximization of firm value is achieved.”
In the strictest sense, his point is valid. However, given the dynamic nature of exchange rates,
international capital flows, government regulations and economic cycles, capital structure selection is not
a parsimonious as Sekely implies.
Harris and Raviv (1991) identify several categories of determinants of capital structure. These
include:
1. To ameliorate conflicts of interest among certain groups with claims to the firms resources
(agency issue, debtholder incentives).
2. To convey private information to the capital markets or mitigate adverse selection effects
(asymmetric information issue).
3. To influence the nature of products or competition in the product market, and
4. Affect the outcome of corporate control contests.
They also identify properties of debt (bankruptcy provisions, convexity of payoffs, signaling features,
relation to management compensation and ownership) that influence capital structure.
Similar to the findings of Harris and Raviv (1991), this review has discovered empirical evidence
largely consistent with the theory, provided the theory is malleable. Where strict structure has been
17
imposed on the theoretical underpinnings of MNC capital structure, the theory has performed poorly. The
agency models, for example, generate interesting implications.
22
Much of the work considered by Harris and Raviv (1991) has been examined in this study. Many
of their postulates have been easily extended to the international setting, while others have not. Capital
structure theories as a function of information asymmetries did not lend themselves well to this
examination, for example. If investors are misinformed about inside information, securities may be
mispriced in the markets.
Myers (1984) echoes the inadequacies of financial theories on capital structure. Many of his
concerns are borne out in the review. His affinity for a “modified pecking order theory” is likewise
confirmed. The MNC seems to favor equity uniformly over debt.
Stulz (1998) notes that the market for corporate control also impacts capital structures. (See #4
above, this section.) Voting rights – especially those held by management – are at the center of his
study. The impact of this market on the capital structure of MNC should be considered in later studies.
There are a great many potential determinants of capital structure. This examination has considered only
a few of the “key players.” The roles played by asymmetric information and insider ownership, for
example, deserve greater scrutiny. A few general principles have been reviewed. There is a need,
however, to sort out which of these principles and what factors are dominant as the multination
corporation selects its capital structure.
22
See Lee and Kwok (1988).
18
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