Country Governance Structure and Financial Development as Determinants of Firms’ Capital Structure

Abstract

This paper investigates the determinants of capital structure for a sample of 13,070 small medium sized enterprises (SMEs) and 67,449 firm-year observations from Eastern European countries over the period 1994-2004. The use of a sample of SMEs in our analysis rather than large listed firms provide an effective way to test whether country specific factors are important drivers of firm’s capital structure, since SMEs do not have access to international capital markets, being less likely to be influenced by international standards.

We employ usual firm-specific financial variables and country-specific factors that describe the degree of governance structure and financial development of each country. Factor analysis on both the governance structure and financial development indicators adopting the Principal Component Analysis is used to avoid the problems of multicolinearity. Our results indicate that firm ownership concentration and country governance structure are insignificant explanatory variables to the degree of leverage of the firs in our sample. On the other hand, indicators of country financial development are robust determinants of capital structure. However, the marginal explanatory power of country-specific variables is small. We conclude that firm-specific characteristics are decisive in capital structure.

Keywords: Capital Structure, Ownership Structure, Country Governance, Financial Development

JEL Classification: G32, F30, O52