June 7, 2019
Master Thesis
The role of ownership concentration on corporate
leverage decision around the world
Student name: Nan Shen
Student number: S3616983
Supervisor: Dr. A. de Ridder
Second Assessor: Dr. W. Westerman
MSc International Financial Management
AbstractThis study investigates the relationship between ownership concentration and leverage, which might be moderated by country-level shareholder protection and firm-level financial distress. The findings are based on a sample of 11622 firm-year observations from 44 countries over a period from 2011 to 2016 and indicate that the level of ownership concentration is negatively related to firm leverage. Controlling shareholders seem to have preferences for equity financing due to the expropriation effect. The results suggest that the negative effect between ownership concentration and leverage becomes weaker in countries with better shareholder protection, and that financial distress positively moderates the main investigated relationship. However, these moderating effects are not found in a subsample of civil-law countries.
Contents
1. Introduction ... 3
2. Literature review and hypotheses development ... 5
2.1 Theories ... 5 2.2 Ownership concentration ... 7 2.3 Shareholder protection ... 10 2.4 Financial distress ... 12 3. Methodology ... 13 3.1 Data ... 13
3.2 Dependent and independent variables ... 14
1. Introduction
Excessive leverage was considered to be one of the root causes of the Global Financial Crisis in 2008. Overleveraging occurs when a corporation takes on too much debt and has insufficient cash flows to pay the interest on its debt and other relevant expenses. As a consequence, the corporation might face a higher risk of bankruptcy or default. This study is motivated by prior literatures documenting a significant influence of ownership structure on corporate leverage decision, particularly ownership concentration (Antoniou et al., 2008; De Miguel and Pindado, 2001; Rajan and Zingales, 1995; Liu et al., 2011). The agency theory advanced by Jensen and Meckling (1976) investigates the nature of agency costs associated with the existence of debt and equity. They state that managers have the propensity to pursue their own interests that are different from those of shareholders, which may lead to agency conflicts between the two parties and thus agency costs.
In addition to the aforementioned conflict between managers and shareholders, misalignment of interests between controlling and minority shareholders often occurs and leads to the principal-principal problem (Santiago and Brown, 2007). The majority shareholders have motives to expropriate rewards out of the firm at the expense of minority shareholders so as to satisfy their private benefits, which is called tunneling. It is expected that this expropriation by controlling shareholders may affect firm value and also firm capital structure. However, according to La Porta et al. (1999), the tunneling activity occurs less frequently in countries in which minority shareholders are strongly protected by local legal system. The degree of shareholder protection can be used to measure how strongly a country’s law system protects minority shareholders against dominant shareholders (La Porta et al., 1998). Therefore, it is important to investigate the role of shareholder protection as it can reduce controlling shareholders’ tunneling activities and thus affect firm value and also leverage.
As such, my overall research question is: whether and how ownership concentration impacts leverage and how does shareholder protection and financial distress moderate this relationship?
Berle and Mean (1932) are the pioneers who investigate ownership structure in a sample of American firms, but the validity of this study is diminishing, since other studies have shown that ownership concentration is far more prevalent in other parts of the world. La Porta et al. (1999) find that concentrated ownership structure is very common in the investigated 27 wealthy economies. Claessens et al. (2000) who examine 2980 companies over nine East Asian countries suggest that more than two-thirds of these corporations are controlled by one large shareholder. Therefore, this study is going to explore the role of ownership concentration on a worldwide basis, adding country-level shareholder protection and firm-level financial distress as moderators. The findings are based on 11622 firm-year observations from the year 2011-2016 over 44 countries. According to La Porta et al. (1998), common-law countries are more protective of minority shareholders and thus have higher levels of shareholder protection than civil-law countries, but it still remains unclear that whether the role of ownership concentration and the moderating effect of shareholder protection and financial distress differ among different samples. Thus, this study also splits the initial sample into two subsamples of common- and civil-law countries in order to investigate the role of legal origin.
The remainder of this study is organized as follows. Section 2 discusses relevant literatures and provides hypotheses development. Section 3 presents methodology, including data, variables and research method. Section 4 reports descriptive statistics, correlation analysis, regression results and robustness check. Finally, section 5 summarizes and concludes this study.
The existing theories and empirical studies on capital structure stem from the work of Miller and Modigliani (1958), who state that given certain assumptions, the value of a firm is not affected by the way the firm is financed. They assume a perfect market without taxes, bankruptcy costs, agency costs, transaction costs and asymmetric information. However, these assumptions do not hold in the real word, making capital structure a relevant and crucial factor in determining firm value. Since then, in order to find the optimal level of debt financing, researchers have developed diversified theories regarding capital structure, namely the trade-off theory, the agency theory and the pecking order theory (Myers, 1984; Jensen and Meckling, 1976; Myers and Majluf, 1984).
The trade-off theory suggests that the optimal level of leverage is mainly determined by the trade-off between the benefits and costs of using debt. According to Kraus and Litzenberger (1973), firms earn their debt obligations and receive tax savings of interest payments, which are known as the advantages of debt financing. However, the use of debt incurs financial distress costs, which come from bankruptcy costs, indirect costs, and conflicts of interests (Higgins, 2012). One of the conflicts is the conflicting self-interests between managers and shareholders, which lead to agency costs that will be discussed later. The firm’s goal is to balance the value of tax shields against the costs associated with financial distress, and then to optimize its overall value (Myers, 1984). In other words, a value-maximizing firm will pursue an optimal leverage target by evaluating various benefits and costs of borrowing.
The pecking order theory stems from Myers and and Majluf (1984), who state that asymmetric information increases the cost of financing, and thus affects a firm’s prioritization of financing sources. The costs of financing for new projects are least for internal financing, low for debt financing, and highest for equity financing. Thus, a firm follows a pecking order in which internal is used before external sources of financing, and debt is favored over equity if external financing is required. According to Myers and Majluf (1984), equity is less preferable because the issue of new equity makes investors feel that the current share price of the firm is overvalued, and that managers can benefit from the overvaluation. In other words, the equity issuance reflects the board’s lack of confidence and is considered as a lower value by investors.
2.2 Ownership Concentration
Considering the effect of concentrated ownership structure on corporate leverage, the existing literature provides two contrary views due to different actions of controlling shareholders. One view suggests that ownership concentration has a positive effect on firm debt financing. The argument is that, for large shareholders, a main disadvantage of using equity is the dilution of ownership and control (Antoniou et al., 2008). In such a situation, in order to prevent the dilution of shares, the major shareholders may raise more debt as opposed to equity. Antoniou et al. (2008) provide another point that it is very likely to some extent the large owners are banks in some bank-based economies, making it much easier for the firm to obtain debt. A high level of bank ownership in the firm could substantially reduce the costs of financial distress, making the firm very likely to be rescued by the owning bank in a financial crisis (Antoniou et al., 2008).
There are empirical studies that document the positive relationship between ownership concentration and leverage ratio (Lundstrum, 2009; Agrawal and Nagarajan, 1990; Rajan and Zingales, 1995). Lundstrum (2009) finds that major shareholders favor debt financing as it can help protect and maintain their positions in the firm. Agrawal and Nagarajan (1990) agree that the use of debt could effectively monitor and control the actions of managers. Rajan and Zingales (1995) use a sample of 2583 firms in G-7 countries on the 1987-1991 period and explain that if some of the largest shareholders are banks that force the firm into borrowing from them, ownership concentration may lead to more debt instead of equity financing. The structure of a country’s economy can be considered to be one factor that influences corporate leverage and will be added as a control variable in this study.
between managers and shareholders. Their argument is that, managers have incentives to use free cash flow in order to invest in projects with negative net present value. They are not willing to return these funds to shareholders. While in the case of highly concentrated ownership structure, shareholders are more likely to monitor and control misbehaviors of managers and thus to prevent them from financing projects with negative net present value. In this process, debt can be used. But since a concentrated ownership has already mitigated the agency problem to some degree, a highly concentrated firm tends to have fewer free cash flow problems and thus issues less debt (De Miguel and Pindado, 2001), which indicates a negative relationship between ownership concentration and leverage ratio. Moreover, when large shareholders effectively exercise control over the firm, agency problems occur mainly between large shareholders and minority shareholders. The largest shareholders may pursue their own interests at the expense of minority shareholders. Thus, in firms with concentrated ownership, it becomes easier for large shareholders to assign benefits to themselves rather than the firm, which is called tunneling (Shleifer and Vishny, 1997). According to Liu et al. (2011), in order to obtain private benefits, the major shareholders prefer equity instead of debt financing.
In general, although the literature is inconclusive and there is ambiguity of the direction regarding the influence of ownership concentration on firm leverage, this study assumes that controlling shareholders’ tunneling is prevalent in firm activities. Since those major shareholders have preferences for equity financing so as to obtain private benefits due to the expropriation effect (Liu et al., 2011), a higher level of ownership concentration is expected to lead to lower leverage. The first hypothesis is formulated as follows.
Hypothesis 1: there is a negative relationship between ownership concentration and leverage.
2.3 Shareholder Protection
There is no doubt that the decision-making regarding corporate capital structure is influenced by the environment in which the company is located, because the company has to comply with the local laws in the country. La Porta et al. (1999) suggest that firms located in countries with limited shareholder protection are more prone to a wider divergence of ownership. Because leverage is associated with ownership concentration and ownership concentration in turn, is related to the level of shareholder protection, shareholder protection is therefore considered a country-level moderator affecting the main investigated relationship between ownership concentration and leverage.
supply of equity financing and thus use more equity than debt. Furthermore, according to Cheng and Shiu (2007), when shareholder protection is poor, firms are likely to experience a divergence of ownership, which then results in agency conflicts and thus agency costs. This could be mitigated by using debt financing, which suggests that shareholder protection negatively impacts firm leverage. On the other hand, Antoniou et al. (2008) explain that shareholder rights can be positively related to the debt ratio, since there is less information asymmetry between managers and shareholders in countries with good shareholder protection. As a consequence, firms’ leverage capability increases and thus they may use more debt financing. Furthermore, Venanzi et al. (2014) argue that the principal-agent problem is less pronounced in countries with more-effective shareholder protection, and that firms might use relatively more debt to exploit tax shield value. With the above arguments, there is likely to be a positive relation between shareholder protection and leverage.
As mentioned before, the dominant shareholders prefer equity financing, since they are able to obtain benefits from minority shareholders, which is then called the expropriation effect (Liu et al., 2011). These controlling shareholders in countries with stronger shareholder protection are less likely to be able to place their benefits ahead of the interests of minority shareholders. Fewer tunneling activities suggest less equity financing and thus higher leverage. Therefore, this study expects that the degree to which minority shareholders are protected should weaken the negative relationship between ownership concentration and leverage ratio.
Hypothesis 2: a higher level of shareholder protection negatively moderates the relationship between ownership concentration and firm leverage.
2.4 Financial Distress
costs of using debt. The costs of borrowing, which include bankruptcy costs may rise within times of crisis, whereas the benefits of using debt remain the same. This would imply that firms will adjust their leverage ratio towards a lower position during a financial crisis.
However, financial distress as a moderator for the relationship between ownership concentration and firm leverage is often overlooked. As mentioned before, Friedman et al. (2003) indicate that entrepreneurs may choose either tunneling or propping regarding the degree of a negative shock. According to Friedman et al. (2003), in case of a moderate adverse shock, controlling shareholders prop the firm to make sure the firm stays in business, and thus they can continue to enjoy the private benefits. On the other hand, when a firm experiences a severe financial crisis, the same controlling shareholders are more likely to tunnel the resources and loot the firm to benefit themselves. As this study proposes a negative relationship between ownership concentration and leverage above, and much argument is based on the tunneling action by controlling shareholders. These dominant shareholders prefer equity than debt financing, since they are able to obtain benefits from minority shareholders due to the expropriation effect (Liu et al., 2011). Given a financial distress, the same controlling shareholders tend to expropriate more rewards out of the firm so as to satisfy their own benefits, as they are facing high uncertainty and risk. More tunneling actions then implies more equity than debt financing and therefore lower leverage. My third hypothesis regarding the role of financial distress between ownership concentration and debt financing is as follows.
Hypothesis 3: financial distress positively moderates the relationship between ownership concentration and corporate leverage.
The essence of this study is to examine how ownership concentration influences leverage on the basis of a worldwide dataset, so it is necessary to decide the number of countries at first. This study contains three country-level variables. Firstly, for the moderator of the main relationship, shareholder protection, the measurement will be done by using the index of La Porta et al. (1998). They include 49 countries in their research, which to some extent restricts the number of countries in this study. Secondly, regarding the country-level control variable,
bank-based or market-based country, the value will be derived the paper from Demirgüç-Kunt
and Levine (1999). They classify 57 countries as bank or market-based economies. Thirdly, the value of creditor rights is taken from Djankov et al. (2007), who include 129 countries. In order to make sure all the countries are available in these three indices, this study contains 46 countries. Finally, after excluding countries with incomplete information of firm-level variables, this study includes 41 countries.
This study contains 11622 observations of 1937 firms from 44 countries for a period from 2011 till 2016. All firm-level data is obtained from Orbis database, as it includes the specific information of ownership concentration, which is the shareholding percentages of the largest shareholders. The sample only includes active publicly-listed firms because they are more likely to have complete information relative to other firms. Firms that operates in industries regarding financials and utilities are excluded to avoid regulation influences. Furthermore, in order to do a decent research, this study eliminates firms that have missing values over the investigated period, as many firms do not disclose complete information in particular the shareholding percentage. This restriction to some extent greatly reduces the number of observations. All firm-level data has been winsorized by 1% to eliminate errors and extreme outliers.
The dependent variable is leverage, which is generally the ratio showing whether a firm relies more on debt or equity financing. Among the prior studies, there are several definitions of corporate leverage. Rajan and Zingales (1995) argue that the most appropriate and relevant measurement of leverage should be related to the objective of the analysis. According to Rajan and Zingales (1995), the influence of past financing decisions in the firm are largely related to firm value including equity and debt, which can be proxied by the ratio of total debt relative to capital. Following Modigliani and Miller (1958), in this study, the ratio of total debt to capital would be used, where capital equals debt plus equity.
3.2.2 Ownership Concentration
The main independent variable is ownership concentration, which is measured by the shareholding percentage of the largest shareholder (TOP 1). The influence of the largest shareholder is impotant, as the largest shares enable them to have strong power in decision-making of corporate policies. Therefore, TOP 1 signifies the role of ownership concentration, and is used in this study to represent the top largest shareholder’s shareholding proportion. Although the Herfindahl index is useful to capture the total power of several top largest shareholders and is often adopted to measure ownership concentration in past studies, this study does not consider it as there are not enough firms with complete information of shareholdings for the three largest shareholders from 2011 to 2016.
3.2.3 Shareholder Protection
shareholders to defend against directors, (5) the country permits the shareholders to have preemptive rights, and (6) the minimum needed shares to demand for an extraordinary meeting are fewer than or equal to 10 percent (La Porta et al., 1998). In theory, the value ranges from 0 (weakest shareholder protection) to 6 (strongest shareholder protection), but actually the maximum score is 5 for Canada and the United Kingdom, for example. As a robustness check, this study will also consider a revised Anti-director index from Djankov et al. (2008), which leads to corrections for 33 of the 46 countries.
3.2.4 Financial Distress
Previous literatures (Ward and Foster, 1997; Zhi, 2009; Campello et al., 2010) present contradicting ways to identify the existence of financial distress. Legal bankruptcy has been frequently used, but Ward and Foster (1997) argue that this measurement may produce inconsistent results with economic reality since a bankruptcy can be recognized even though the firm is economically solvent, as it is more like a legal event. Zhi (2009) emphasizes the significance of cash flow analysis in predicting financial distress, because cash flow information is able to show the corporation’s available cash for business activities and to assess the corporation’s financial flexibility. In reality, firms such as airplane corporations may experience negative cash flows occasionally due to a mismatch of expenditure and income, but these negative cash flows do not actually mean such firms are in financial distress. Dividend payout ratio is also adopted as a response variable for the identification of financial crisis. Campello et al. (2010) posit that financially distressed firms tend to reduce cash dividends in order to make sure sufficient cash flows support firms’ operating activities. The propensity to pay dividends is a reflection of the current business situation of the firm.
pay share divided by earnings per share. This study will proxy a firm as being in or close to a financial distress when dividend payout ratio is less than 20 percent. That is, financial distress is measured by a dummy variable that equals one if the reported dividend payout ratio that is below 20 percent in a fiscal year, and zero otherwise.
3.3 Control Variables
This section turns to factors that are supposed to have influences on corporation leverage decisions. However, empirical literatures are not consistent in selecting the variables, this study will use the most common and relevant determinants in explaining firm capital structure. In line with the research of Rajan and Zingales (1995), at firm-level, firm size, profitability, asset tangibility and growth opportunities are considered as control variables. At country-level, two important variables are considered, namely, bank or market-based countries and creditor rights.
3.3.1 Firm Size
Firm size is measured in terms of the natural logarithm of total sales. There are conflicting theories about the relationship between firm size and the level of leverage. On the one hand, firm size may positively impact leverage. As firm size is adopted as an inverse proxy for the probability of bankruptcy (Rajan and Zingales, 1995), larger firms tend to be more diversified and experienced in the market, which means that they can borrow more money and have higher debt ratios. On the other hand, firm size may be negatively associated with leverage. According to Rajan and Zingales (1995), firm size can also a proxy for the information that outsiders have, which results in a higher preference for equity compared to debt financing.
3.3.2 Profitability
advanced by Myers (1984) expects that profitability is positively related to leverage. That is because more profitable firms have lower possibilities of facing financial distress, and thus more inclined to take on debt to profit from tax shields. On the contrary, the pecking order theory from Myers and Majluf (1984) predicts a negative correlation between profitability and leverage, since firms with higher profits prefer internal to external financing.
3.3.3 Asset Tangibility
The third determinant to be considered is asset tangibility that is defined the ratio of tangible assets divided by total assets. The relation between asset tangibility and firm leverage is expected to be positive. Tangible assets can act as good collateral for lenders and are able to reduce information asymmetry issues as tangible assets’ payoffs are more observable (Almeida and Campello, 2007). Moreover, tangible assets have a tendency to lower financial distress costs, as they can hold their value in case of a financial crisis. Therefore, from the perspective of lenders, they are more willing to supply loans to firms with more tangible assets.
3.3.4 Growth Opportunities
The variable, growth opportunities, is measured by the market-to-book ratio, which equals the book value of assets less the book value of equity plus the market value of equity all divided by the book value of assets. Firms with more growth opportunities are expected to have less leverage. In order to gain benefits from the investments, managers tend to overinvest in volatile future growth options even for risky negative net present value projects, which increase the value of equity but decrease the value of debt (Myers, 1977). Another explanation is that firms are likely to exercise future growth options to minimize conflicts between stockholders and bondholders (Billett et al., 2007). The apparent way is to issue equity rather than debt, which implies a negative relationship between growth opportunities and leverage.
In order to examine the influence of a country’s financial structure on firm leverage, this study will use the index from Demirgüç-Kunt and Levine (1999) to classify the countries as bank-based or market-bank-based. In their index of financial structures, a high value of the structure reflects high degree of stock market development. Thus, countries with values above the mean are identified as market-based and countries with values below the mean as bank-based. Considering different degrees within one structure, this study uses the index value of corresponding countries rather than a dummy variable that indicates whether a country is bank or market-based.
The index value is supposed to negatively related to the leverage, implying that firms in bank-based countries tend to have higher levels of leverage compared to firms in market-bank-based countries. According to Demirgüç-Kunt and Levine (1999), there exists a long-term relationship between borrowers (firms) and lenders (banks) in bank-based countries where banks are actively engaged in providing debts to firms. Therefore, firms may rely on these robust debt markets and increase their leverage. In contrary, in market-based countries, firms are likely to raise funds in equity markets, suggesting lower costs of equity. A more developed market-based financial system facilitates equity financing, which means a lower leverage ratio.
3.3.6 Creditor Rights
induces lenders to provide borrowers with more debt financing (La porta et al., 1997). On the other hand, the opposing view regarding demand-side in capital markets, suggests that higher levels of creditor protection result in less debt demand, as managers tend to avoid debt due to the fear of losing control in case of bankruptcy (Cho et al., 2014).
Table 1
Variable Definitions and Sources
Variables Definitions Sources
Leverage The ratio of total debt relative to capital, where capital equals debt plus equity
Orbis
Ownership concentration-TOP 1
The shareholding proportion held by the top largest shareholder
Orbis
Shareholder protection Country level scores of Anti-director rights La Porta et al., 1998 Financial distress Equals 1 if dividend payout ratio (dividend per share/
earnings per share) is less than 20%, and 0 otherwise
Orbis Firm size Natural logarithm of total sales Orbis Profitability Represented by EBITDA divided by total assets Orbis Asset tangibility The ratio of tangible assets divided by total assets Orbis Growth opportunities The book value of assets less the book value of equity
plus the market value of equity all divided by the book value of assets
Orbis
Bank or market-based countries
Index value of financial structures to distinguish countries as bank or market-based
Demirgüç-Kunt and Levine (1999) Creditor rights Index of creditor protection in each country Djankov et al., 2007 Country dummies Each country dummy variables equals one if the firm
operates in corresponding country
Orbis
Industry dummies Each industry dummy variables equals one if the firm operates in corresponding industry
Orbis
This table provides definitions of all used variables.
3.4 Research method
Leveragei,t = 𝛽0 + 𝛽1TOP 1i,t + 𝛽2Shareholder protectionc + 𝛽3Financial distressi,t +
𝛽4TOP 1i,t*Shareholder protectionc + 𝛽5TOP 1i,t* Financial distressi,t + 𝛽6Firm sizei,t +
𝛽7Profitabilityi,t + 𝛽8 Asset tangibilityi,t + 𝛽9Growth opportunityi,t + 𝛽10Bank or
market-based countries + 𝛽11Creditor rightsc + 𝜀𝑖.𝑡
where i, c and t denote firm, country and year respectively. β0 is the intercept and ε refers to the
error term. Other variables have been explained in the previous section. For Hypothesis 1, a general relationship between ownership concentration and leverage is estimated by running with and without fixed effects. For Hypothesis 2, this study runs the regression with only the individual effect of shareholder protection on firm leverage before analyzing the interaction effect between ownership concentration and shareholder protection. Similarly, for Hypothesis 3, both regressions with and without the interaction variable TOP 1*financial distress are included in the results.
4. Empirical Results 4.1 Descriptive Statistics
is represented by EBITDA divided by total assets and the negative minimum value of -0.007 suggests that the firm is facing some difficulties. For asset tangibility, it has an average value of 0.281, and varies between 0.006 and 0.898. The mean value of growth opportunities is 0.497, measured by the book value of assets less the book value of equity plus the market value of equity all divided by the book value of assets.
The country-level moderator, shareholder protection is taken from La Porta et al. (1998). It ranges from 0 to 5, indicating the level of shareholder rights. The median value of shareholder protection is 3, which suggests that the sample contains almost equal number of countries with relatively high and low degree of shareholder protection. The value of the control variable, bank or market-based countries is found to vary between -0.82 and 2.93. A high value of the corresponding country reflects a higher degree of stock market development. With regard to creditor rights, the average value is 1.869 with a standard deviation of 0.878.
Table 2
Summary statistics
Number Mean Median Standard deviation Minimum Maximum Firm-level variables Leverage 11622 0.228 0.187 0.208 0.006 0.866 TOP 1 11622 0.312 0.267 0.217 0.009 0.908 Financial distress 11622 0.198 0 0.399 0 1 Firm size 11622 13.296 13.209 2.011 9.061 18.199 Profitability 11622 0.119 0.107 0.071 -0.007 0.405 Asset tangibility 11622 0.281 0.240 0.219 0.006 0.898 Growth opportunities 11622 0.497 0.507 0.189 0.076 0.947 Country-level variables Shareholder protection 44 3.114 3 1.183 0 5 Bank or market-based 44 0.295 -0.060 0.679 -0.820 2.930 Creditor rights 44 1.869 2 0.878 0 4
4.2 Correlation Analysis
Table 3
Correlations
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Panel A: correlations matrix
Leverage (1) 1 TOP 1 (2) -0.032*** 1 Shareholder protection (3) 0.107*** -0.056*** 1 Financial distress (4) -0.031*** 0.003* 0.024*** 1 Firm size (5) 0.305*** -0.070*** -0.010* -0.052*** 1 Profitability (6) -0.115*** 0.033*** -0.083*** -0.008* 0.071*** 1 Asset tangibility (7) 0.214*** -0.026*** -0.041*** 0.004 0.045*** 0.074*** 1 Growth opportunities (8) 0.691*** -0.001* -0.038*** 0.015* 0.381*** -0.120*** 0.056*** 1
Bank or market-based countries (9) 0.104*** -0.059*** -0.198*** -0.050*** 0.077*** 0.155*** 0.047*** -0.012 1
Creditor rights (10) -0.017*** 0.026*** 0.139*** 0.080*** 0.052*** 0.012 0.061*** 0.003* 0.0142* 1
Panel B: VIF values
Leverage - 1.02 1.08 1.01 1.21 1.07 1.02 1.21 1.08 1.04
4.3 Regression Results
This section provides the results of regression models. Model (1) reports the main relationship between ownership concentration and leverage. Model (2) and (3) investigate the moderating effects of shareholder protection and financial distress on the main investigated relationship. All models use panel data of 1937 firms from 2011 to 2016. Besides, in order to explore the role of legal origin, this study separates the sample into common- and civil-law countries to see if there are substantial differences of the results between the initial sample and subsamples.
4.3.1 Leverage and Ownership Concentration
Table 4 presents empirical evidence for the effect of ownership concentration on firm leverage by using different samples. The results show a significant negative relationship between ownership concentration and leverage in all relevant regressions, which supports the first hypothesis. Model (1b) applies both country and industry fixed effects, and it could be observed that the R-Square of 0.6406 in the fixed effects model (1b) is much higher than that of 0.4550 in model (1a) that does not use fixed effects. This means that by using fixed effects, model (1b) has more explanatory power. Since data often fall into some categories, it is important to control for characteristics of these categories that may affect the dependent variable leverage. Therefore, this study will focus on the results of fixed effects model (1b), as it can capture systematic differences across both countries and industries.
But since a high level of ownership concentration has already sorted out the free cash flow problem, firms can issue less debt, implying a lower leverage ratio.
In order to investigate the role of legal origin, this study also runs regressions in subsamples of common-law and civil-law countries, which are shown in model (1c) and model (1d) respectively. Although the number of observations is lower in the subsample of civil-law countries, the R-Square is slighter higher than that in the subsample of civil-law countries, which means all these factors have more explanatory power upon a subsample in common-law countries. However, the size of the effect of ownership concentration in model (1c) is much smaller than that in model (1d). The coefficient of ownership concentration is -0.0672 in a subsample of civil-law countries, significant at the 1% level. In the sample of common-law countries, the coefficient becomes -0.0055 and the effect remains significant, though the significance level drops to 10%. It could be argued that an increase of ownership concentration has a relatively smaller effect on the adjustment of leverage in common-law countries.
Table 4
Regression results for the impact of ownership concentration on leverage
This table reports OLS-regression results of firm leverage for the entire sample and two subsamples over the period 2011-2016. The dependent variable, leverage, is defined as debt/(debt+equity). The independent variable, ownership concentration, is measured by TOP1, which is the shareholding proportion of the top largest shareholder. Firm size is calculated in terms of the natural logarithm of total sales, profitability is the ratio of EBITDA/the book value of assets, tangibility is defined as the ratio of tangible assets divided by total assets, and growth opportunity equals (the book value of assets-the book value of equity+the market value of equity)/the book value of assets. All firm-level data has been collected from Orbis and winsorized by 1% to eliminate errors and extreme outliers. Creditor rights is taken from the index of Djankov et al. (2007). Bank or market-based countries are defined in Demirgüç-Kunt and Levine (1999). The robust standard errors are reported in parentheses below the estimated coefficients. The symbols ***, **, *denote statistical significance at 1%, 5% and 10% levels, respectively.
4.3.2 Leverage, Ownership Concentration and Shareholder Protection
In addition to the main relationship, this study then examines the moderating effect of shareholder protection. There are four regression models in Table 5 and all of them have applied country and industry fixed effects. Model (2a) only tests the individual effect of shareholder
Model (1) All countries (1a) All countries (1b) Common-law countries (1c) Civil-law countries (1d) Constant -0.2093*** (0.0182) -0.1441*** (0.0358) 1.1726*** (0.1492) -0.1932*** (0.0355) TOP 1 -0.0161* (0.0130) -0.0346*** (0.0066) -0.0055* (0.0100) -0.0672*** (0.0084) Firm size 0.0025* (0.0013) 0.0014* (0.0008) 0.0022* (0.0013) 0.0011 (0.0010) Profitability -0.2002*** (0.0160) -0.2031*** (0.0198) -0.2278*** (0.0290) -0.1865*** (0.0269) Tangibility 0.1264*** (0.0089) 0.1569*** (0.0063) 0.1343*** (0.0089) 0.1849*** (0.0091) Growth opportunities 0.8061*** (0.0085) 0.7630*** (0.0089) 0.8152*** (0.0137) 0.6988*** (0.0116) Bank or market-based countries 0.0352*** (0.0041) -0.0036 (0.0117) 2.0676*** (0.2264) -0.0520* (0.0301) Creditor rights -0.0069** (0.0032) -0.0661*** (0.0144) -0.8339*** (0.0890) 0.0104 (0.0100) Country
fixed effects NO YES YES YES
Industry
fixed effects NO YES YES YES
𝑅2
adjusted 0.4550 0.6406 0.6629 0.6181
protection, while in model (2b), the interaction term between shareholder protection and leverage is employed. Model (2c) and (2d) then show the moderating effect of shareholder protection in two subsamples of common- and civil-law countries. As shown in Table 5, ownership concentration is negatively and significantly related to the level of leverage, which again supports Hypothesis 1. With a value of -0.0801 and -0.0182 in model (2c) and (2d) respectively, it could be noticed that ownership concentration has a stronger effect on leverage in common-law countries.
positive coefficients of the interaction term, which then leads to the same conclusion. Nevertheless, in model (2d), the effect of the interaction term is found to be negative and statistically significant at the 5% level in civil-law countries, which is unexpected. Compared to common-law countries, civil-law countries might have relatively weaker shareholder protection. One implication is that the tunneling actions of controlling shareholders would become more often in civil-law countries, since minority shareholders are not well protected by local law system. As a result, there is low leverage as controlling shareholders use more equity than debt financing so as to exploit advantages out of the firm.
Table 5
Regression results for the role of shareholder rights
This table reports OLS-regression results of firm leverage for the entire sample and two subsamples over the period 2011-2016. The dependent variable, leverage, is defined as debt/(debt+equity). The independent variable, ownership concentration, is measured by TOP 1, which is the shareholding proportion of the top largest shareholder. The moderator, shareholder rights, is taken from La Porta et al. (1998). Firm size is calculated in terms of the natural logarithm of total sales, profitability is the ratio of EBITDA/the book value of assets, tangibility is defined as the ratio of tangible assets divided by total assets, and growth opportunity equals (the book value of assets-the book value of equity+the market value of equity)/the book value of assets. All firm-level data has been collected from Orbis and winsorized by 1% to eliminate errors and extreme outliers. Creditor rights is taken from the index of Djankov et al. (2007). Bank or market-based countries are defined in Demirgüç-Kunt and Levine (1999). The robust standard errors are reported in parentheses below the estimated coefficients. The symbols ***, **, *denote statistical significance at 1%, 5% and 10% levels, respectively.
4.3.3 Leverage, Ownership Concentration and Financial Distress
Model (2) All countries (2a) All countries (2b) Common-law countries (2c) Civil-law countries (2d) Constant 0.7190*** (0.0837) 0.7347*** (0.0841) -0.3425*** (0.0348) -1.4647*** (0.2001) TOP 1 -0.0346*** (0.0066) -0.0458*** (0.0177) -0.0801*** (0.0252) -0.0182* (0.0263) Shareholder protection 0.1531*** (0.0112) 0.1482*** (0.0112) 0.0791*** (0.0100) 0.3007*** (0.0416) TOP1*Shareholder protection 0.0270*** (0.0052) 0.0231*** (0.0072) -0.0124** (0.0062) Firm size 0.0014* (0.0008) 0.0014* (0.0008) 0.0020 (0.0013) 0.0011 (0.0010) Profitability -0.2031*** (0.0198) -0.2038*** (0.0199) -0.2220*** (0.0290) -0.1878*** (0.0270) Tangibility 0.1569*** (0.0063) 0.1567*** (0.0063) 0.1335*** (0.0089) 0.1840*** (0.0092) Growth opportunities 0.7630*** (0.0089) 0.7634*** (0.0089) 0.8166*** (0.0137) 0.6985*** (0.0116) Bank or market-based countries 0.0657*** (0.0102) 0.0632*** (0.0102) 0.1566*** (0.0202) 0.2201*** (0.0455) Creditor rights -0.2993*** (0.0284) -0.3113*** (0.0286) -0.1185*** (0.0088) 0.1488*** (0.0257) Country
fixed effects YES YES YES YES
Industry
fixed effects YES YES YES YES
𝑅2 adjusted 0.6406 0.6416 0.6635 0.6183
Table 6 illustrates the empirical results of the moderating role of financial distress. Model (3a) shows the regression result that does not include the interaction term between ownership concentration and financial distress. Model (3b), (3c) and (3d) test the moderating effect of financial distress in the full sample and two subsamples respectively. The coefficients of ownership concentration in all models remain negative and significant, which once again supports the first hypothesis.
the results support the third hypothesis that financial distress positively moderates the main investigated relationship, though this conclusion is invalid in a subsample of civil-law countries.
Table 6
Regression results for the role of financial distress
This table reports OLS-regression results of firm leverage for the entire sample and two subsamples over the period 2011-2016. The dependent variable, leverage, is defined as debt/(debt+equity). The independent variable, ownership concentration, is measured by TOP 1, which is the shareholding proportion of the top largest shareholder. The moderator, financial distress is a dummy variable that equals one if dividend per share/earnings per share<20%, and zero otherwise. Firm size is calculated in terms of the natural logarithm of total sales, profitability is the ratio of EBITDA divided by the book value of assets, tangibility is defined as the ratio of tangible assets divided by total assets, and growth opportunity equals (the book value of assets-the book value of equity+the market value of equity)/the book value of assets. All firm-level data has been collected from Orbis and winsorized by 1% to eliminate errors and extreme outliers. Creditor rights is taken from the index of Djankov et al. (2007). Bank or market-based countries are defined in Demirgüç-Kunt and Levine (1999). The robust standard errors are reported in parentheses below the estimated coefficients. The symbols ***, **, *denote statistical significance at 1%, 5% and 10% levels, respectively.
Model (3) All countries (3a) All countries (3b) Common-law countries (3c) Civil-law countries (3d) Constant -0.1424*** (0.0356) -0.1396*** (0.0356) 1.2176*** (0.1707) -0.1849*** (0.0356) TOP 1 -0.0343*** (0.0066) -0.0422*** (0.0073) -0.0230** (0.0114) -0.0641*** (0.0090) Financial distress -0.0063** (0.0031) -0.0185*** (0.0049) -0.0128* (0.0073) -0.0168** (0.0065) TOP1* Financial distress -0.0389*** (0.0127) -0.0771*** (0.0185) -0.0095 (0.0166) Firm size 0.0014* (0.0008) 0.0013* (0.0008) 0.0020 (0.0013) 0.0009 (0.0010) Profitability -0.2026*** (0.0198) -0.2008*** (0.0198) -0.2258*** (0.0289) -0.1856*** (0.0270) Tangibility 0.1567*** (0.0063) 0.1565*** (0.0063) 0.1346*** (0.0089) 0.1848*** (0.0091) Growth opportunities 0.7636*** (0.0089) 0.7643*** (0.0089) 0.8166*** (0.0136) 0.7036*** (0.0117) Bank or market-based countries -0.0041 (0.0118) -0.0039 (0.0117) 2.1297*** (0.2608) -0.0522* (0.0287) Creditor rights -0.0654*** (0.0140) -0.0655*** (0.0142) -0.8584*** (0.1023) 0.0089 (0.0010) Country
fixed effects YES YES YES YES
Industry
fixed effects YES YES YES YES
𝑅2 adjusted 0.6408 0.6410 0.6642 0.6197
4.4 Robustness check
In order to do the robustness test, this study will also consider a revised Anti-director index introduced by Djankov et al. (2008) to measure the level of shareholder protection. The results are shown in the appendix. It could be seen that shareholder protection remains significant, though the sign is ambiguous, and that the interaction term between ownership concentration and leverage is insignificant at all, which implies that shareholder protection does not have a moderating effect. This is in line with the findings of Spamann (2009) that many empirical results based on the original values from La Porta et al. (1998) are found to be invalid with the revised index. More specifically, this revised index fails to support some influential arguments, such that common-law countries have relatively stronger shareholder protection compared to civil-law countries, and that shareholder protection is associated with ownership concentration or dispersion (Spamann, 2009). Therefore, it could be concluded that even though the moderating effect does not show by using the revised index of Djankov et al. (2008), the second hypothesis is still valid based on the original values from La Porta et al. (1998).
5. Conclusion
Secondly, the results also provide evidence on the negative moderating effect of shareholder protection on the main investigated relationship. That is, an increase in a firm’s ownership concentration will result in a smaller decrease of leverage in countries with strong shareholder protection compared to those with weak shareholder protection. It is expected that the tunneling activity by controlling shareholders occurs less frequently in countries in which minority shareholders are well protected by local legal system. Since controlling shareholders use more equity than debt due to the expropriation effect, fewer tunneling activities means less equity financing and thus higher leverage in the presence of good shareholder protection. However, this conclusion is not valid in the sample of civil-law countries. One can argue that the tunneling actions of controlling shareholders would become more often in civil-law countries due to the weak legal shareholder protection. As a result, there is low leverage as controlling shareholders use more equity than debt financing so as to exploit advantages out of the firm.
Thirdly, this study shows that financial distress positively moderates the main relationship. Specifically, firms tend to have a more negative relation between concentrated ownership and leverage in times of crisis. Given a financial distress, controlling shareholders tend to expropriate more rewards out of the firm due to the fear of high uncertainty, which then increases the tunneling actions. As argued before, those major shareholders would prefer equity to debt financing so as to obtain their private benefits and therefore decrease the level of leverage. However, the moderating effect does not occur in civil-law countries. One of the possible reasons could be that besides the tunneling action, propping will also occur because the largest shareholders also have incentives to avoid the firm from bankruptcy. Controlling shareholders prefer equity financing in tunneling activities, but since tunneling and propping may occur simultaneously, firms may make similar leverage decisions in times of crisis.
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Appendix
Table A.1
Robustness check for the role of shareholder protection
This table reports OLS-regression results of firm leverage for the entire sample and two subsamples over the period 2011-2016. The dependent variable, leverage, is defined as debt/(debt+equity). The independent variable, ownership concentration, is measured by TOP 1, which is the shareholding proportion of the top largest shareholder. The moderator, shareholder rights, is taken from Djankov et al. (2008). Firm size is calculated in terms of the natural logarithm of total sales, profitability is the ratio of EBITDA/the book value of assets, tangibility is defined as the ratio of tangible assets divided by total assets, and growth opportunity equals (the book value of assets-the book value of equity+the market value of equity)/the book value of assets. All firm-level data has been collected from Orbis and winsorized by 1% to eliminate errors and extreme outliers. Creditor rights is taken from the index of Djankov et al. (2007). Bank or market-based countries are defined in Demirgüç-Kunt and Levine (1999). The robust standard errors are reported in parentheses below the estimated coefficients. The symbols ***, **, *denote statistical significance at 1%, 5% and 10% levels, respectively.
Model (4) Model (4a) Model (4b) Model (4c) Model(4d) Constant -0.2240*** (0.0186) -0.2266*** (0.0209) 0.1213 (0.1407) 0.1504 (0.1407) TOP 1 -0.0138 (0.0136) -0.0048 (0.0360) -0.0346*** (0.0066) -0.1205*** (0.0147) Shareholder protection 0.0115*** (0.0026) 0.0124*** (0.0043) -0.1410*** (0.0512) -0.1495*** (0.0512) TOP1*Shareholder protection -0.0031 (0.0115) 0.0298 (0.0049) Firm size 0.0014 (0.0013) 0.0014 (0.0013) 0.0014* (0.0008) 0.0012 (0.0008) Profitability -0.2046*** (0.0161) -0.2045*** (0.0161) -0.2031*** (0.0198) -0.2016*** (0.0199) Tangibility 0.1238*** (0.0089) 0.1238*** (0.0089) 0.1569*** (0.0063) 0.1557*** (0.0063) Growth opportunities 0.8017*** (0.0085) 0.8016*** (0.0085) 0.7630*** (0.0089) 0.7641*** (0.0089) Bank or market-based countries 0.0221*** (0.0035) 0.0221*** (0.0035) 0.0457*** (0.0104) 0.0464*** (0.0104) Creditor rights -0.0040 (0.0033) -0.0041 (0.0033) 0.1037*** (0.0350) 0.1020*** (0.0350) Country
fixed effects NO NO YES YES
Industry
fixed effects NO NO YES YES
𝑅2 adjusted 0.4550 0.4550 0.6406 0.6416
