Characteristics of Subsidiary Financing Choices: The Role of Institutional Distance from Home Country

Abstract

We examine how the institutional distance between home and host countries affects the characteristics of foreign subsidiary debt, including leverage and debt maturity choices, as well as cash holdings. We utilize the multidimensionality of institutional distances to examine ten different distance dimensions. We use a sample of 3,139 foreign subsidiaries operating in France and being headquartered in 44 different countries. We find that while subsidiaries’ financing choices are partially explained by standard determinants, they are also significantly impacted by different forms of institutional distance. Regarding the heterogeneity of institutional distances, results show the dominance of financial and cultural distances for leverage levels; knowledge and political distances for debt maturities; and a dominance of demographic, geographic, and political distances for cash holdings levels. Especially interesting, we find that leverage levels of subsidiaries are more, not less, levered when the parent has greater cultural distance from France. We interpret this result as consistent with parents, out of agency concerns, being less forthcoming with equity to more culturally distance subsidiaries. Culturally distant subsidiaries must contend with enhanced agency concerns of parent MNCs as well as liability of foreignness with local debt markets.

Keywords: Capital structure, Debt maturity, Institutional distance, Liability of foreignness, Subsidiaries financing

JEL Classification: G15, G30, G32