The Impact Of Ownership Structure On Financial Leverage:A Comparison Between Mid-Cap Firms From Developed And Emering Economies

The classical agency theory creates the image of a firm with separation of ownership from management,where clash of interests of two groups(owners and managers)demands control mechanisms to reduce resulting agency costs.The mechanisms that are put in place to oversee the internal and external dealings of corporate organizations fall under the umbrella of corporate governance.At the core of corporate governance is to implement and ensure that such controlling mechanisms create a balance between the interests of stakeholders of a firm and reduce agency costs.Ownership structure also acts as such a mechanism,because owners of a firm have a direct stake in the firm and they directly govern the firm towards optimum profitability for themselves and other stakeholders.A key issue for the owners and managers of every firm is the choice of its capital structure;whereby any misjudgment can result in substantial costs.Acting as the governance mechanisms they have to ensure the effective and efficient utilization of available corporate resources i.e.capital,and they affect the various aspects of the corporate organizations and induce changes directly and indirectly at almost all the levels of an organization.This study is an attempt to find out how ownership structure as a corporate governance variable affects the choices of corporate leverage of firms,and to make a comparison between developed and emerging economies,and thus to come up with broader and more generalizable conclusions applicable to firms in different economies.The impact of managerial ownership and institutional ownership on the choice of leverage is examined in this study.New international alliances are being formulated recently as power is shifting between nations.It is creating more opportunities for the emerging countries to align themselves in the international arena.These shifts in the political landscape are bound to affect the corporate sector worldwide.Especially with the initiatives like OBOR(One Belt One Road)from the Chinese government which connects so many countries together,firms from both the developed and emerging countries might have more growth opportunities and new markets to cater to,thus more opportunities to go global.To get proper benefits from such opportunities in global markets,it is critical for them to understand the potential problems they might face regarding their financing policies and the leverage choices that they might need to make.Research has been conducted in this field before but evidence gathered from different countries separately is inconsistent even contradictory at times.Therefore,a comprehensive and comparative investigation across countries is needed,so that more meaningful conclusions can be drawn in light of the particular conditions of different types of economies.To fill this void,the extensive data from five developed and five emerging economies has been gathered,in order to estimate the data under the same model for more generalizable conclusions.The study emphasizes on mid-cap firms from ten sample countries,five of whom are developed(USA,UK,Japan,France,Australia)and five are emerging countries(China,India,Russia,Indonesia and Brazil).Among the other criteria used for selection of the sample countries(details in section 4.3),one is the availability of data of at least 25 mid-cap firms from the country.Mid-cap firms(on the basis of market capitalization)provide us ease of comparison,otherwise large firms from some countries could be very large in size as compared to the large firms of other countries;and smaller firms often have a greater tendency of missing data on key variables(further explained in section 4.2).Finally,the data comprises of 5536 firm-year observations of mid-cap firms from developed and emerging countries.This study attempts to answer two fundamental questions.First,how does the ownership structure of a firm affect leverage?Second,are there any differences in the potential results between developed and emerging countries,and what are the theoretical underpinnings for such potential differences?By answering these questions this study will attempt to understand the influence of ownership measures in the determination of level of leverage.Two econometric models are formulated for this purpose;the first one to test the non-linear relationship between managerial ownership(MNG)and leverage;and the second one to test the relationship between institutional ownership and leverage.The study uses fixed effects regression for estimation of results.To ensure the robustness of results year fixed effects,industry fixed effects and country fixed effects are also controlled.Heteroscedasticity tests are also conducted and generalized method of moments(GMM)method is also tested on the model to ensure the robustness of results and to solve the potential endogeneity problems.After the rigorous estimation process,we find that managerial ownership has a non-linear inverted U-shaped relationship with leverage,in both the developed and emerging countries.It means that at a lower level of managerial ownership the managers prefer to use more leverage,but at a higher level of managerial ownership,they decrease the level of leverage.At a lower level of the managerial ownership interests of managers and owners are aligned with each other and managers use debt to increase the value of the firm.On the other hand,as managerial ownership crosses the certain limit of low level and the stakes of managers in the firm increase,managers pursue their own interests and decrease the level of debt to avoid not only a controlling mechanism but also to reduce their non-diversified risk.Thus,both the interest alignment and managerial entrenchment hypotheses hold true for the developed and emerging economies.Further,we find out that institutional ownership exhibits a positive relationship with leverage in developed economies but a negative relationship in emerging economies.The positive relationship lends support to the signaling theory,indicating that institutional shareholding is a positive sign for creditors,as it reduces managerial discretion and cost of debt.Additionally,tax advantage of debt makes it more attractive for institutional investors.The negative relationship for emerging economies is supported by the agency theory also,as the institutional investors may themselves assume the disciplinary role of debt.This study is a comparative examination of developed and emerging economies which hasn't been conducted before in recent times for the research questions underlying this study.This study is also unique in the sense that it targets the mid-cap firms from different countries(developed and emerging)which eliminates the size bias between firms from different countries,and it seems to be a more logical way of comparisons in cross-country studies of firms.Non-linearity of the relationship between managerial ownership and leverage has also not been tested so often,especially in comparative studies based on large samples.Therefore,this study is unique in the sense that it is studying this possible non-linearity of the relationship over a large sample,and making comparisons between developed and emerging countries.The study can provide support to managers and academicians in understanding the impact of ownership structure on the choice of level of leverage in the capital structure in developed and emerging economies.It can help the firms operating globally or planning to go global.Better policies can be formulated at all levels after the clear understanding of the phenomenon in question,and financing decisions can be reformed accordingly.