Determinants of Leverage in Slovenian Blue-Chip Firms and Stock Performance Following Substantial Debt Increases

Abstract

Hypotheses concerning capital structures are some of the most frequently tested in the financial literature. Authors usually discuss different incentives for the use of leverage. Their views can be broadly classified in two main groups. The proponents of the first argue that leverage increases the cash flow available to investors. With the use of debt a firm gains because it uses a cheaper component of capital and since it pays less tax thanks to advantageous debt tax shields. On the other hand, the proponents of the second group stress the importance of minimising transaction costs, and information asymmetry. They point to a pecking order of finance sources. In this article, I explain the most frequently stated drivers that provide incentives for the more extensive use of debt with a focus on an emerging market environment and test whether they are relevant to Slovenian blue-chip firms that emerged from the transition of the last decade. The second part introduces the owners' point of view. I test whether raised debt levels in fact improve the long-term return to the stockholders of Slovenian firms. This should be expected because of the institution-led capital structure conservatism that firms practised in the past. Three methods are employed to test the relationship between increased levels of debt and long-term stock return. All of them offer a similar conclusion that the expected long-term performance of firms which significantly increased their leverage is no better than the long-term performance of firms that did not. The results are useful for other emerging capital markets in Europe where firms and investors faced similar circumstances tied to their socialist past and transition process.

Keywords: long-run stock performance, leverage, capital structure, emerg- ing capital markets capital

JEL Classification: G32, G10, G14