Corporate capital structure and equity market development in Latin America

This research investigates existing corporate financing patterns and equity market development in a sample of publicly traded companies in six emerging Latin American economies during the period 1990–1995. Building on previous research regarding the debt-equity choices of firms in this region, this paper documents the pattern of corporate finance in a sample of approximately three-hundred firms. The results indicate that firms in this region are more likely to retain earnings than issue dividends and are more likely to finance new growth with equity issues. This finding in contrast to the traditional “pecking order” hypothesis documented in developed countries, but is not a rejection of the theory. Because the sample includes firms with low profitability and high net asset growth rates, managers are forced to enter external markets for sources of additional financing. To the extent that firms enter capital markets, they prefer equity to debt as a result of government policies that encourage equity financing instruments.; As equity markets develop in this region, firms will change their financing patterns. The evidence indicates that large firms will rely more heavily on debt instruments for new finance as equity markets develop, while small firms will increase equity issues relative to debt. Large firms would utilize more debt finance if they were previously credit constrained, if the development of equity markets allowed for more information and risk sharing, if equity markets were believed to be too volatile or if increased competition among investment banks encouraged firms to increase bond issues relative to equity issues. In addition, this evidence suggests that debt and equity are complementary financing instruments for large firms, and that tax policy has little effect on financing behavior. The policy implications of this study are that emerging market governments should not necessarily neglect the development of one component of the financial sector and that equity markets can play an important role in economies in which the banking sector is already well developed.