The Determinants of Capital Structure: Capital Market Oriented Versus Bank Oriented Institutions

Abstract

The paper investigates how firms operating in capital market oriented economies (the United Kingdom and the United States) and bank oriented economies (France, Germany and Japan) determine their capital structure. Using panel data and a two-step system-GMM procedure, the paper finds that the leverage ratio is positively affected by the tangibility of assets and the size of the firm, but declines with an increase in firm profitability, growth opportunities and share price performance in both types of economies. The leverage ratio is also affected by the market conditions in which the firm operates. The degree and effectiveness of these determinants are dependent on the country's legal and financial traditions. The results also confirm that firms have target leverage ratios, with French firms being the quickest in adjusting their capital structure towards their target level, and the Japanese are the slowest. Overall, the capital structure of a firm is heavily influenced by the economic environment and its institutions, corporate governance practices, tax systems, the borrower-lender relationship, exposure to capital markets, and the level of investor protection in the country in which the firm operates.

Keywords: dynamic capital structure, leverage, panel data, GMM

JEL Classification: G20, G32, G15, K20