Capital Structure with Risky Foreign Investment
Mihir A. Desai
Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)
C. Fritz Foley
Harvard Business School; National Bureau of Economic Research (NBER)
James R. Hines Jr.
University of Michigan; NBER
Political risks increase the volatility of multinational firm operating returns, prompting firms to adjust their capital structures. Politically risky countries feature more volatile returns, and the volatility of a parent company's aggregate foreign returns also increases with the extent of the firm's political risk exposure. Parent companies mitigate the cost of return volatility by adjusting their capital structures: a one standard deviation increase in exposure to political risks reduces domestic leverage by 4.4% of its mean level. Foreign political risks most strongly influence the capital structures of firms in industries that are particularly susceptible to political risks. These results suggest that other business risks may similarly affect capital structures.
Number of Pages in PDF File: 33
Keywords: Capital Structure, Political Risk, Leverage, Expropriation
JEL Classification: G15, G32, F30
Date posted: May 17, 2006