Managerial Finance

Agency costs of stakeholders and capital structure: international evidence

Bing Yu

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Bing Yu, (2012),"Agency costs of stakeholders and capital structure: international evidence", Managerial
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Agency costs of stakeholders

and capital structure:
international evidence
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Bing Yu

Agency costs of
stakeholders

303

School of Business, Meredith College, Raleigh, North Carolina, USA

Abstract
Purpose This paper examines the relationship between bargaining powers of creditors as well as
employees and financial leverage across countries. The purpose of this paper is to explore roles of
creditors and employees in capital structure decisions under different legal and political regimes
across countries.
Design/methodology/approach Using country-level creditor rights index and labor rights index
as a proxy for bargaining powers of creditors and employees, respectively, the author addresses the
interaction between creditors as well as employees and shareholders. The paper tests the impact of
employee rights and creditor rights on capital structure across countries.
Findings The author finds a positive relationship between employee rights and firms use of debt
and a negative relationship between creditor rights and firm debt ratio.
Social implications The paper provides a new perspective to interpret international variation in
financial leverage in the world. The results obtained from this paper help us to understand financial
leverage in different countries with various corporate governance mechanisms.
Originality/value This paper takes all stakeholders into account when studying agency problems;
it explores the role of creditors and employees in financing decision making under various corporate
governance patterns and political and legal systems across countries.
Keywords Corporate governance, Capital structure, Creditors, Employees, Agency problems,
Creditor rights, Labor rights
Paper type Research paper

I. Introduction
A growing interest has been given to the impact of non-financial stakeholders such as
creditors and employees on corporate decisions in corporate finance literature. This
paper examines relationship between creditors as well as employees and financial
leverage across countries. The purpose is to explore roles of creditors and employees in
capital structure decisions under different legal and political regimes across countries.
Shareholders, creditors, and employees have heterogeneous utility functions in
corporate context. Tirole (2001, 2006) asserts that corporations select optimal
investment and financing decisions within the constraints of legal and political
environments to which they belong. Within a company, stakeholders bargain with each
other to maximize benefits of themselves. The bargaining between stakeholders is ruled
and regulated by a countrys legal and political regime. While legal and political regimes
differ across countries, the bargaining powers of stakeholders are not identical in
different countries. Interaction between creditors and shareholders is mainly through
the negotiation in debt contracting. The bargaining power of creditors relies largely
JEL classification G30, G32, G38, K3

Managerial Finance
Vol. 38 No. 3, 2012
pp. 303-324
q Emerald Group Publishing Limited
0307-4358
DOI 10.1108/03074351211201433

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304

on creditor rights (CR) provided by a countrys legal system. Employees, on the other
hand, do not have voting right nor bargaining power unless they form unions or get
protection from labor law. Existing literature suggests that shareholders, with the
constraints of legal regime in a country, will seek a mechanism within corporations to
weaken creditors and employees bargaining powers so as to maximize payoffs.
Financial leverage is a tool that shareholders can use to achieve this goal. Dronars and
Deere (1991) develop a model to describe the role of debt in limiting employees
bargaining power when they form unions, while Matsa (2010) finds that debt is
positively correlated with unionization rates at firm level for firms in the USA.
This paper focuses on cross-country comparison. Using country-level creditor right
and labor right indices as proxies for bargaining powers of creditors and employees,
I investigate the impacts of creditor and employee rights on capital structure across
countries. I argue that when employee rights are high, employees will have stronger
bargaining powers and shareholders are more likely to be exploited by employees.
If so, shareholders intend to use more debt obligation to remove free cash flows so as
to reduce amount of revenues employees can extract. When CR are high, creditors have
more negotiation power to obtain good terms in debt contracting. If shareholders
cannot get a favorable debt contract, they are likely to reduce the use of debt capital.
My study extends the literature by exploring country level factors influences and by
taking creditors and employees roles into account when examining capital structure
decisions across countries. This paper is directly related to the capital structure
literature that makes cross-country comparison of financial leverage. Empirical research
on cross-country financial leverage finds a large variation across countries[1]. Basically,
these studies merely document differences in capital structure in different countries or
country groups. They identify how firm-level determinants of capital structure such as
firm size, profitability, market-to-book ratio, retained earnings, and growth
opportunities affect capital structure differently across countries and interpret
generally the empirical results based on agency problems or signaling theories,
without examining specifically the impacts of creditors and employees on financial
leverage across countries. Treating a firm as a nexus through which shareholders and
managers in the productive enterprise contract with each other, law and finance
approach represented by a series of papers by La Porta, Lopez-deoSilanes, Shleifer, and
Vishny (LLSV hereafter) examines the relationship between a countrys legal origin as
well as level of protection for investors and finance. La Porta et al. (1997, 1998) find that
common law countries provide stronger protection for shareholders than civil law
countries do and suggest that stronger investor protection has positive impact of
financial market development. Numerous studies apply this law and finance approach
and link country-level shareholder rights (SR) to corporate finance decisions (Rajan and
Zingales, 1995, Claessens and Laeven, 2003, Hail and Leuz, 2006 and Pinkowitz et al.,
2006). While prior research focuses on SR, this paper extends the literature by exploring
country-level creditors and employees roles in capital structure decisions across
countries.
Around the world, countries with different legal and political systems provide
different extent of supports for various stakeholders. Some countries are in favor of
shareholders or creditors whereas others are in favor of employees (Gourevitch
and Shinn, 2005, Roe, 2004). This variation in legal and political institutions shapes
the characteristics of bargaining powers of various stakeholders (Charny, 1999).

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Therefore, shareholders efforts to interact with creditors and employees are constrained
by a countrys institutional conditions. Since creditor and employees rights granted by
law and regulatory regime are exogenous, shareholders will seek reduction of
bargaining powers of creditors and employees within a corporation. Basically, when
shareholders use debt obligation to reduce free cash flows, employees are less likely to
obtain explicit or implicit benefits ( Jensen, 1986; Dronars and Deere, 1991). In regard to
creditors, since stronger CR are in favor of creditors at expense of shareholders in debt
contracting, shareholders will choose to use less debt capital so as to mitigate the
bargaining power of creditors.
My paper is also related in general to several studies that test the stakeholder theory
of capital structure at firm level. Klasa et al. (2009) and Matsa (2010) analyze the
strategic use of debt financing by firms in highly unionized industry areas in the USA
and find that those firms use more debt to remove free cash so as to gain bargaining
advantages over employees and protect firms from exploit of unions. Myers and
Saretto (2009) find that firms increase leverage in response to the possibility of union
strikes when bargaining power of unions is strong. Both Acharya et al. (2011) and Vig
(2011) find that in countries with stronger CR firms have lower financial leverage. They
assert that firms are reluctant to use debt when CR are strong because financial
distress costs are too high under such a situation.
In line with the above studies, I argue that across countries, firms in countries with
stronger employee rights will use more debt while firms in countries with stronger CR
are likely to use less financial leverage. Shareholders will use financing strategy
differently to mitigate bargaining powers of creditors and employees, restricted by
extents of creditor and employee rights provided by a countrys legal regime. When a
firm has less free cash flows, employees are less likely to obtain extra benefits from the
firm even the labor law and regulatory regime provide high employee right in that
country. When shareholders intend to use financial leverage to break employees and
managers preference for overexpansion and excessive risk reduction, another
stakeholder, creditors, will get involved. Unlike employees whose human capital is tied
up in the firm and not well diversified, creditors can diversify their investment well.
Thus, within legal framework, creditors can protect themselves through debt
contracting. Depending on the creditor right provided by a countrys legal regime,
creditors can negotiate with shareholders in such terms as cost of borrowing, limitation
on dividends payment in some circumstances, and restriction on excess borrowing in
the presence of high debt ratio.
This study addresses the following research questions:
RQ1. What is the relationship between country-level employee rights and
corporations financial leverage across countries?
RQ2. What is the relationship between CR and corporations financial leverage
across countries?
While exploring the role of creditors and employees in financing decision making under
various corporate governance patterns and political and legal systems across countries,
this paper provides a new perspective to interpret international variation in financial
leverage in the world. The results obtained from this paper help us to understand
financial leverage in different countries with various corporate governance mechanisms
and fill significant gaps in the literature on capital structure.

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The rest of the paper is organized as follows. A conceptual framework is discussed

and testable hypotheses are developed in Section I. Section II describes data and
research methodologies. Section III discusses empirical results. Section IV concludes
the study.
II. Conceptual framework
While shareholders can reduce their investment risk via diversification, employees tie
their human capital to a corporation. This asymmetric risk reduction between
shareholders and employees induces different risk aversion levels of shareholders and
employees. The contradictory preferences and pursuits between shareholders and
employees induce employees to seek for protection for their interests and job security
through any available channels. The most direct way employees use to protect their
benefits is labor contracting. However, contracting involves negotiation and bargain.
Unlike shareholders, employees have a lower bargaining power in contracting process
unless they form union to get collective bargaining power. A union can extract no more
than the present value of future net cash flows. Dronars and Deere (1991) state that
firms can use debt to limit the effect that a union has on shareholder wealth because
debt obligation requires firms to repay a portion of future revenues to creditors, and
hence limit the amount of cash that employees can extract through a unions strong
bargaining power, without driving the firm into bankruptcy.
Roe (2003) asserts that governments provide protection for employees through their
law regulation in such areas as union formation, the costs of firing employees, and the
difficulties of firing employees. When employees obtain more benefits resulting from
stronger employee protection provided by a countrys labor law and regulation,
shareholders suffer from the increased revenues extracted by employees due to stronger
employee right. Therefore, shareholders have incentives to use more debt to divert
future cash flows to themselves rather than to employees.
With stronger bargaining powers either through formation of labor unions or from a
countrys legal regime, employees and creditors will bargain with shareholders to
pursue their best payoff. Since employee and CR are granted by a countrys legal regime,
shareholders will choose to lessen employees and creditors bargaining powers through
firm-level decisions. Using financial leverage is an effective way at firm level to mitigate
bargaining powers of creditors and employees.
Based on the above discussion, financial leverage is regarded as a tool to limit
bargaining powers of creditors and employees. The extent of bargaining powers
depends on the level of employee protection, SR, and CR provided by a countrys legal
and regulatory regime. Thus, I explore the association between country-level employee
and CR and financing via testing hypotheses. Using country-level labor right as a
proxy for employee protection (Botero et al., 2004) and creditor right as proxy for
creditor protection (LLSV, 2006), I hypothesize:
H1. The stronger the labor right, the more debt the company will use.
A legal and political system that provides strong employee protection will emphasize
employees and managers natural agenda and demeans shareholders nature agenda.
Strong employee protection makes it hard and costly to lay off employees. Therefore,
under such a system, the pressure on the firm for low risk, unprofitable expansion
is high, and the pressure to avoid risky organizational change is substantial.

However, shareholders would prefer to go slow in expanding the firm, because

expansion is harder to reverse later than it would be in a political environment that
provides weak employee protection. To avoid unprofitable expansion and to eliminate
the possibility of raising employees salaries and benefits, shareholders want to remove
free cash flows from the firm via using more interest-bearing debts. When a countrys
legal regime is in favor of employees, in order to weaken bargaining power of employees,
corporations will choose to use more debt:
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H2. The stronger the creditor right, the less the debt the company will use.
Creditor can influence a firms financing decision through debt contracting. The stronger
the creditor right, the more negotiating power creditors have during contracting process.
High creditor right allows creditors more likely to obtain favorable contracting.
To reduce bargaining power of creditor, shareholders are likely to use less debt capital.
III. Data and methodologies
3.1 Data sources and sample selection
The primary data source for the paper is Compustat Global Vantage. All firm-level
financial accounting variable data are obtained from Global Industrial file. Market
price data are collected from Compustat Global Issue file. Country currency exchange
rate data are from Compustat Global Currency File. Country-level data are collected
from various resources. Country-level variables are obtained from previous research in
each aspect, respectively. I obtained SR, CR, and (LR) data from Djankov et al. (2008),
Djankov and Shleifer (2007) and Botero et al. (2004), respectively. I collected macro
economic data including stock market capitalization, bond market capitalization,
banking segment, GDP growth rate, inflation rate from IMF and World Bank annual
statistics. Government quality data are from Kaufmann et al. (2007). Table I lists data
and variable information.
The sample period is 1990-2008. I begin sample construction by matching
Compustat Global Industrial with Global Issue and Global Currency files.
Rajan and Zingales (1995) point out that in any studies that compare corporations
financial data across countries, the differences in accounting practices cause samples
bias. They notice that not every country requires firms to report consolidated balance
sheets, and corporations with unconsolidated balance sheets appear to have
underestimated financial leverage data than those with consolidated financial
statements. To avoid this sample selection bias, I select firms with fully consolidated
accounting statements only (consol F in Global Industrial file). Since firms involved in
major mergers (cstat AB in Global Industrial file) have special capital structure
(Aivazian et al., 2001), such firms are dropped. Following literature on capital structure
(Rajan and Zingales, 1995; Aivazian et al., 2001), I exclude financial firms (6999 . SIC
code . 6000), and utility firms (4999 . SIC code . 4900). I also drop firms with
negative equity, negative sales revenue, missing value of total assets, and negative cash
flows.
I match firm-level data from Global Vantage with country-level data from various
resources and require main three country-level explanatory variables, SR, CR, and labor
rights (LR) indices, be available to each country included in our sample. To comply with
the requirements of time-series cross-sectional regression, I drop the following countries
with less than 30 firm-year observations, Ghana, Croatia, Jordan, Kenya, and Romania.

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Abbr.

Panel A: firm-level variables

Variable
Debt
Debt ratio
Long-term debt/total assets
MTB
Market-to-book ratio (BV of total assets-BV of
equity MV of equity)/total assets
Profit
Profitability
EBITDA/total assets
Cash
Cash
Cash balance/total assets
Size
Size
Log of total assets in US dollars
Tang
Tangibility
Tangible assets/total assets
Panel B: country-level variables
Proxy for
SR
Shareholder rights Anti-self-dealing index
CR
Creditor rights
Creditor rights index
LR
Stock Market

Table I.
Data definitions,
measurements and
sources

Measurement

Labor rights
Stock market
development
GOV_QUAL
Government quality
OWNER_CON Ownership structure
BDGDP
Bond market
development
GDPG
Economic
development
Inflation
Inflation
BKGDP
Banking
development
COM
Legal origin

Labor union power index

Stock market capitalization/GDP

Source

Global Industrial
Global Industrial
Global Issue
Global Industrial
Global Industrial
Global Industrial
Global Industrial

file
and
file
file
file
file

Djankov et al. (2008)

Djankov and Shleifer
(2007)
Botero et al. (2004)
World Bank report

Government quality index

Ownership concentration index
Private bond market capitalization/
GDP
Annual GDP growth rate

Kaufmann et al. (2007)

LLSV (1998)
World Bank report

Annual inflation rate

Domestic bank deposits/GDP

World Bank report

IMF Statistic report

World Bank report

LLSV (1998)
Dummy variable equals one for
common law origin countries and zero
otherwise

After applying these filters, our sample contains 182,182 firm-year observations from
21,663 unique firms over 52 countries during the period of 1990-2008.
I use two country-level variables, CR and LR indices as proxies for the bargaining
powers of creditors and employees, respectively. The SR is used as a control variable.
LLSV (1998) develop a SR index. This SR index is widely used in literature (LLSV,
2000; Pinkowitz et al., 2006). Djankov et al. (2008) update La Porta et al. (1997) SR index
to make it more accurate. I use the updated anti-self-dealing index from Djankov et al.
(2008) as a proxy for SR.
Similar to SR index, Djankov and Shleifer (2007) use CR index to measure for
country-level protection for creditors. The CR index is an accumulation of four dummy
variables that check:
.
whether a country imposes restrictions, such as creditors consent or minimum
dividends to file for reorganization;
.
whether secured creditors are able to gain possession of their security once the
reorganization petition has been approved (no automatic stay);
.
secured creditors are ranked first in the distribution of the proceeds that result
from the disposition of the assets of a bankrupt firm; and

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whether the debtor does not retain the administration of its property pending the
resolution of the reorganization.

Roe (2004) asserts that a marginal increase in benefits of employees would be a

marginal decrease in shareholders value and that strong LR provided by legal and
political systems in fact hurt a firm value. Therefore, I use measures for LR as a proxy
for bargaining power of employees.
There is an extensive literature on the relationship between LR and law and
regulation of labor (Besley and Burgess, 2003; Heckman and Pages-Serra, 2000; Lazear,
1990). Those studies check the law and regulatory provisions on such aspects as the
difficulty of firing employees, the costs of firing employees, and the easiness of hiring
employees and explore how employees benefits are affected due to the differences in
those provisions. With regard to employees power to pursue maximum benefits,
Botero et al. (2004) use the labor union power index as a proxy for LR. The labor union
power is an average of seven dummy variables which equal one:
(1) if employees have the rights to unionize;
(2) if employees have the rights to collective bargaining;
(3) if employees have the legal duty to bargain with unions;
(4) if collective contracts are extend to third parties bylaw;
(5) if the law allows closed shops;
(6) if workers or unions, or both, have a right to appoint members to the Boards of
Directors; and
(7) if workers councils are mandated by law.
3.2 Methodology and research design
Studies on financial leverage based on the trade-off theory and the pecking order
theory use the partial adjustment model to explore the optimal debt ratio (Harris and
Raviv, 1990; Myers, 2001) whereas studies addressing agency problems use debt ratio
to regress on firm-level determinants (Myers and Majluf, 1984). Studies on
international capital structure test the different impact of firm-level factors and add
country-level variables as explanatory variables. Following Rajan and Zingales (1995)
and Aivazian et al., I use the following model to examine the impact of creditor and
employee rights on financing decisions across countries:
Debtt a1 a2 MTBt a3 Profit t a4 CASH t a5 Sizet a6 Tang t a7 SR
a8 CR a9 LR 1t

Debtt the long-term debt ratio, computed by long-term debt divided by

total assets for firm i at year t (firm subscription is suppressed in
equation (1)).
MTBt the market-to-book ratio, computed by the book value of total assets
minus the book value of equity plus the market value of equity all divided
by the book value of total assets for firm i at year t (firm subscription is
suppressed in equation (1)).

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Profit computed by earnings before interest, taxes, depreciation, and

amortization (EBITDA) divided by total assets for firm i at year t (firm
subscription is suppressed in equation (1)).
Sizet

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310

the log of total assets in US dollars for firm i at year t (firm subscription is
suppressed in equation (1)).

Tangt the tangibility computed by tangible assets divided by total assets for
firm i at year t (firm subscription is suppressed in equation (1)).
SR

the SR index at country level.

CR

the CR index at country level.

LR

the LR index at country level.

Rajan and Zingales (1995) point out that to examine the agency problems associated
with debt, it is necessary to remove liabilities like accounts payable that is used for
transactions purpose rather than for financing purpose. Therefore, long-term debt ratio
is a more reliable measure used to address agency problems. Following this logic, I use
long-term debt only as the dependent variable. Frank and Goyal (2005) argue that
theoretically, the book value of debt is a better measure of creditors liability in case of
bankruptcy than market value of debt and that market value of debt has measurement
problems due to the volatility of market price. Thus, the dependent variable, Debt, is
computed by book value of long-term debt divided by book value of total assets for
each firm i at year t.
As discussed in Section I, this is a research that focuses on the impact of
country-specific characteristics on financing policy, I use two groups of independent
variables in empirical tests: firm-level variables and country-level variables. Two
country-level variables, the CR and LR indices are major explanatory variables to
address research objectives. Firm-level variables are used as control variables. The
firm-level variables are selected based on capital structure theories, following up the
literature on capital structure.
Based on the capital structure theories, empirical research tests the impacts of
various variables on financial leverage and interprets test results using one or another
model. Chen and Zhao (2006) find that market-to-book ratio and profit are two key
firm-level determinants of capital structure in various scenarios. Frank and Goyal (2005)
examine 39 factors relating to financial leverage and divide those factors into two tiers
based on their reliability of relationships with leverage. The top-tier factors include firm
size, average leverage in an industry, risk, and market-to-book ratio. To study capital
structure in the international context, considering availability of data for cross-national
comparison, Rajan and Zingales (1995) limit their firm-level control variables to four
factors: tangibility of assets, the market-to-book ratio, firm size, and profitability.
They argue that those are factors most consistently correlated with leverage in the
literature.
Consistent with Rajan and Zingales (1995) and Frank and Goyal (2005), I choose to
use the follow firm-level variables as control variables: market-to-book ratio, profit,
size, and tangibility. The market-to-book ratio (MTB) is widely used in literature
(Rajan and Zingales, 1995; Aivazian et al., 2001; Chen and Zhao, 2006) to measure for
growth opportunities. I use the book value of total assets minus the book value

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of equity plus the market value of equity all divided by the book value of total assets to
calculate the market-to-book ratio. Market value of equity is computed by stock price
multiplying number of shares outstanding. Stock price information is collected from
Global Issue file. All stock prices are currency exchange rate-adjusted. Profit is defined
as the ratio of EBITDA to total assets. Profit is a proxy for internal finance capacity as
the pecking order model suggests. Size is the log of total assets in US dollars.
Tangibility, Tang, is computed by tangible assets divided by total assets. Both size
and tangibility represent for corporations operating performance. Size is also used as a
proxy for growth.
IV. Empirical results
4.1 Summary statistics
I provide sample description and summary statistics in Tables II and III, respectively.
The sample mean of debt ratio is 12.5 percent and median is 12 percent. Norway has
the highest average debt ratio, 23.13 percent, whereas Morocco has the lowest debt
ratio, 5.31 percent over the sample period. As presented in the following section, the
regression analysis on firm determinants of debt shows that those firm-level variables
affect debt ratios across countries in a similar way, implying that it is country-specific
characteristics that cause variations in financial leverage across countries.
Table IV presents variables that describe country characteristics. I divide sample
into two groups: common law and civil countries. Consistent with literature, common
law countries have better shareholder protection than civil law countries because SR
mean for common law and civil law countries is 0.736 and 0.377, respectively. The LR
mean for common law and civil law countries is 0.261 and 0.340, respectively,
indicating that higher employee rights in civil countries.
4.2 Firm-level determinants of financial leverage
I start analysis by running regression using firm-level variables only. To address the
outliers issue, I winsorize all firm-level variables at 5 percent level[2]. I run the
fixed-effect regression using panel data as follows (firm subscription suppressed):
Debt t a1 a2 MTBt a3 Profit t a4 CASH t a5 Sizet a6 Tang t 1t

The variables are defined the same as in Section II. To test firm determinants of debt
ratio, one needs to adjust to industry effect either by subtracting industry mean
(Chui et al., 2002) or by using industry dummy variables. Here, instead, I run the
regressions using industry segment data and pooled sample. I run regression using
sub-samples, dividing sample groups based on industry segments first (Frank and
Goyal, 2005). Then I run the pooled sample using industry fix effect model. The
significance of coefficients remains consistent, showing that the correlation between
debt ratio and firm-level factors is not driven by industry difference. Table V presents
the regression results.
As predicted by the agency costs model and the pecking order model, the empirical
results are consistent with the literature on international capital structure comparison
(Rajan and Zingales, 1995; Aivazian et al., 2001). There are conflicting theoretical
predictions and mixed empirical findings on the effect of size on leverage. Rajan and
Zingales (1995) point out that firm size is usually regarded as a proxy both for
information asymmetry and for the probability of bankruptcy. These two proxies

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Table II.
Sample description

Country
Argentina
Australia
Austria
Belgium
Brazil
Canada
Switzerland
Chile
China
Colombia
Czech Republic
Germany
Denmark
Egypt
Spain
Finland
France
UK
Greece
Hong Kong
Hungary
Indonesia
India
Ireland
Israel
Italy
Japan
Korea
Sri Lanka
Morocco
Mexico
Malaysia
The Netherlands
Norway
New Zealand
Pakistan
Panama
Peru
Philippines
Poland
Portugal
Russian Federation
Singapore
Slovak Republic
Sweden
Thailand
Turkey
Taiwan
USA

No. of obs
No. of obs
No. of obs
No. of obs No. of obs
Primary Manufacturing Advanced manufacturing Services
Total
5
3,108
95
110
37
1,924
36
43
241
0
12
176
77
0
186
39
324
1,583
95
57
6
145
5
118
6
141
2,332
91
0
0
91
825
119
191
26
20
0
60
212
45
61
28
258
13
174
165
11
185
2,719

99
1,068
219
305
433
1,170
437
293
1,679
44
24
1,182
389
16
387
308
1,352
2,855
199
272
60
810
394
168
100
509
6,054
509
9
8
229
1,834
497
237
168
159
2
30
247
84
143
40
564
19
408
1,034
89
967
8,915

74
1,061
269
270
426
1,059
938
155
2,387
39
16
2,281
396
22
327
470
1,783
3,347
182
367
45
459
337
104
93
754
11,238
762
0
19
151
2,005
529
347
75
85
13
41
152
92
86
21
1,293
7
824
754
155
3,499
15,265

37
3,239
201
313
257
3,297
634
271
1,790
33
40
2,367
514
10
424
379
2,766
9,078
278
800
56
580
242
300
130
568
14,899
452
31
5
316
2,259
941
621
481
29
18
28
381
67
148
50
1,890
0
1,067
1,087
79
907
17,451

215
8,476
784
998
1,153
7,450
2,045
762
6,097
116
92
6,006
1,376
48
1,324
1,196
6,225
16,863
754
1,496
167
1,994
978
690
329
1,972
34,523
1,814
40
32
787
6,923
2,086
1,396
750
293
33
159
992
288
438
139
4,005
39
2,473
3,040
334
5,558
44,350
(continued)

Country

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Venezuela
South Africa
Zimbabwe
Total

No. of obs
No. of obs
No. of obs
No. of obs No. of obs
Primary Manufacturing Advanced manufacturing Services
Total
0
332
7
16,534

31
241
7
37,297

32
228
0
55,334

20
1,168
18
73,017

83
1,969
32
182,182

Notes: Primary industry: SIC: 0000-1999; manufacturing industry: SIC: 2000-2999; advanced
manufacturing industry: SIC: 3000-3999 services industry: SIC: 4000-9999

imply two inverse effects on leverage. However, coefficients of size are positively
significant. The coefficients of market-to-book ratios are negatively significant at
1 percent level in services industry segment and pooled sample. While the results in
table show that the firm-level determinants of capital structure across countries are
consistent, given the variations in capital structure around the world (Aggarwal, 1990;
Aivazian et al., 2001; Gaud et al., 2007), it is necessary to explore the impact of country
characteristics on capital structure across countries.
4.3 The impact of creditor and employee rights on financing policy
Based on the conceptual framework and hypotheses developed in Section I, I turn to
explore the relationship between creditor and employee rights and corporations
financing policy across countries. The analysis is implemented by running the pooled
sample ordinary least square (OLS) regression with year and industry fixed effects.
Robust clustering standard errors are estimated to control for interdependence
across firms. Based on Campbell (1996) and LLSV (2000), I introduce seven industry
group dummies in cross-national regression to control for the industry effects[3]. The
reference group is the agriculture industry group.
The H1 in Section I predicts the positive sign for LR and the negative sign for CR.
Table VI presents the regression results.
The pooled sample fixed effects regression generates positive LR coefficients,
statistically significant at 1 percent level, and negative CR coefficients at 1 percent
significant level. Model (1) tests the impacts of CR and LR on debt ratio only whereas
model (2) adds SR as an additional independent variable. The results are significant
after controlling for firm-level factors, firm clustering effects, and the compounded
impacts of SR, CR, and employee rights[4].
To address the possible presence of heteroscedasticity and autocorrelation, I also
estimate the regression model with the Newey-West standard error. The results stay
statistically significant.
To address the multicollinearity issue in OLS regression, I use variance inflation
factor (VIF) and tolerance to diagnose multicollinearity problem. Wooldridge (2002)
defines the VIFs and tolerance as the following:
VIF bi 1=1 2 R2i ; and
Tolerance bi 1=VIF 1 2 R2i
where bi is the coefficients of model and R2i is the unadjusted R 2.

Agency costs of
stakeholders

313
Table II.

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314

Table III.
Firm-level variables for
analyses

Country

MTB

Profit

Size

Tang

Argentina
Australia
Austria
Belgium
Brazil
Canada
Switzerland
Chile
China
Colombia
Czech Republic
Germany
Denmark
Egypt
Spain
Finland
France
UK
Greece
Hong Kong
Hungary
Indonesia
India
Ireland
Israel
Italy
Japan
Korea
Sri Lanka
Morocco
Mexico
Malaysia
The Netherlands
Norway
New Zealand
Pakistan
Panama
Peru
Philippines
Poland
Portugal
Russia
Singapore
Slovak
Sweden
Thailand
Turkey
Taiwan
USA
Venezuela

5.869
1.725
1.225
1.415
1.128
1.696
1.362
1.257
1.420
0.921
1.101
1.417
1.399
1.948
1.438
1.339
1.404
1.687
1.747
1.229
1.266
1.291
1.891
1.720
2.059
1.194
1.215
1.068
1.043
2.256
1.110
1.420
1.587
1.517
1.538
1.371
1.761
0.853
1.107
1.447
1.207
1.167
1.348
1.010
1.498
1.245
1.896
1.557
1.899
0.831

0.116
0.013
0.098
0.118
0.125
0.079
0.110
0.112
0.073
0.067
0.137
0.105
0.104
0.184
0.109
0.119
0.111
0.092
0.133
0.063
0.120
0.128
0.147
0.083
0.095
0.087
0.060
0.099
0.101
0.243
0.126
0.085
0.131
0.092
0.125
0.170
0.108
0.168
0.072
0.130
0.102
0.180
0.078
0.151
0.078
0.110
0.180
0.092
0.096
0.110

6.817
4.249
5.689
6.126
6.919
5.552
6.405
5.983
5.619
6.694
6.695
5.731
5.567
6.168
6.453
6.081
6.005
4.909
5.669
5.808
5.538
4.634
5.516
5.117
5.801
6.588
6.201
7.456
4.634
6.599
7.103
4.712
5.917
5.455
4.993
4.621
8.769
5.654
4.914
5.405
6.021
8.320
4.849
6.332
5.726
4.396
6.285
5.929
5.849
6.081

0.495
0.375
0.323
0.293
0.458
0.465
0.337
0.506
0.391
0.398
0.568
0.256
0.327
0.489
0.370
0.321
0.200
0.320
0.363
0.335
0.454
0.415
0.337
0.348
0.240
0.265
0.301
0.408
0.447
0.344
0.529
0.374
0.292
0.359
0.440
0.420
0.553
0.467
0.407
0.419
0.409
0.567
0.334
0.550
0.269
0.429
0.335
0.348
0.285
0.505

Debt
0.1279
0.1117
0.1172
0.1465
0.1288
0.1690
0.1551
0.1293
0.0680
0.0769
0.0794
0.0956
0.1544
0.1993
0.1224
0.1939
0.1294
0.0984
0.1127
0.0855
0.0869
0.1570
0.1895
0.1518
0.1159
0.1182
0.1244
0.1838
0.0883
0.0531
0.1709
0.0799
0.1237
0.2313
0.2021
0.0949
0.2031
0.0992
0.1183
0.0609
0.1780
0.0968
0.0916
0.0899
0.1426
0.1213
0.0716
0.1156
0.1641
0.1261
(continued)

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Country

MTB

Profit

Size

Tang

Debt

South Africa
Zimbabwe
Sample mean
Sample median

1.516
2.210
1.664
1.416

0.146
0.244
0.115
0.110

5.701
5.069
5.872
5.804

0.376
0.334
0.387
0.375

0.0653
0.1080
0.125
0.120

Notes: Sample period is 1990-2008; the dependent variable Debt is the long-term debt ratio computed
by long-term debt divided by total assets; MTB is the market-to-book ratio computed by the book
value of total assets minus the book value of equity plus the market value of equity all divided by the
book value of total assets; Profit is computed by EBITDA divided by total assets; Size is the log of total
assets in US dollars; Tang is the tangibility computed by tangible assets divided by total assets

It is readily seen that the higher VIF or the lower the tolerance index, the higher the
variance of bi and the greater the chance of finding bi insignificant, which means that
severe multicollinearity effects are present. Thus, these measures can be useful in
identifying multicollinearity. Table VII presents the test result and VIF does not show
serious multicollinearity problem.
The regression results reveal a positive relationship between LR and financial
leverage level and a negative relationship between CR and the usage of debt financing.
As discussed in Section I, when employees get strong protection from high LR, they
more easily obtain benefits from corporations through union negotiation or government
intervention. Such employees benefit gain is at expense of shareholders. Since
protections for employees are exogenous, shareholders will seek a way within the
corporation to protect them from exploiting by employees. Using higher financial
leverage to remove the free cash flow is one option shareholders can choose to achieve
this goal. When I add SR index as an additional control variable, the coefficients of LR
stay positively and increase substantially. They increased from 0.0185 to 0.043, and
from 0.0193 to 0.0506 in two estimations, respectively. The increased positive
coefficients of LR in model (2) imply that in a country where SR are higher, it is more
likely that shareholders will use high financial leverage to mitigate agency costs
of employees if such agency costs are caused by government law and regulatory
regimes.
The negative coefficient of CR suggests that CR affect corporations financing
decisions differently than LR. Unlike employees, creditors involve in debt contracting
directly. In a country where CR are strong, creditors have more power to negotiate with
shareholders and corporations to obtain better terms in debt contract or can easily
apply restrictions to corporations. Such restrictions might include the one that limits
corporation to use excess debt. On the other side, corporations and shareholders will
choose to use less debt since it is harder to get a favorable debt contract if CR are
strong. This result also supports the H2, which says the stronger the CR, the less debt
the firm will use.
4.4 Robust check
Regression analyses that use international sample are likely to generate biased results
due to the sample selection bias and the model misspecification (omitting variable)
bias. In robust tests, I address the first issue by running the two-stage residual

Agency costs of
stakeholders

315
Table III.

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316

Table IV.
SR, CR, and LR indices
and country-level control
variables

Country
Panel B: civil law
Argentina
Austria
Belgium
Brazil
Switzerland
Chile
China
Colombia
Czech Republic
Germany
Denmark
Egypt
Spain
Finland
France
Greece
Hungary
Indonesia
Italy
Japan
Korea
Morocco
Mexico
The Netherlands
Norway
Panama
Peru
Philippines
Poland
Portugal
Russia
Slovak Republic
Sweden
Turkey
Taiwan
Venezuela
Civil law mean
Civil law median
Sample mean
Sample median

SR

CR

countries
0.34 1
0.21 3
0.54 2
0.27 1
0.27 1
0.63 2
0.76 2
0.57 0
0.33 3
0.28 3
0.46 3
0.2
2
0.37 2
0.46 1
0.38 0
0.22 1
0.18 1
0.65 2
0.42 2
0.5
2
0.47 3
0.56 1
0.17 0
0.2
3
0.42 2
0.16 4
0.45 0
0.22 1
0.29 1
0.44 1
0.44 2
0.29 2
0.33 1
0.43 2
0.56 2
0.09 3
0.377 1.722
0.375 2.000
0.487 1.981
0.440 2.000

LR
0.3
0.52
0.6
0.25
0.25
0.12
0.14
0.078
0.3
0.38
0.8
0.27
0.13
0.84
0.09
0.354
0.66
0.012
0.4
0.24
0.138
0.4
0.28
0.8
0.12
0.05
0.12
0.13
0.35
0.63
0.5
0.9
0.12
0.35
0.28
0.340
0.280
0.315
0.270

Stock
GOV_QUL ECO_GLB GDPG Inflation Bank Bond Market
20.74
1.53
1.32
0
1.45
1.41
20.19
0.1
0.95
1.39
1.81
20.44
1.06
1.7
1.06
0.79
1.1
20.26
0.84
1.27
0.7
20.15
0.43
1.65
1.34
0.33
0.11
20.06
0.64
1
20.45
1.08
1.44
0.21
0.94
21.35
0.667
0.890
0.720
0.925

3.24
5.13
5.5
3.44
5.16
4.63
3.16
3.41
4.41
4.35
4.42
3.41
4.81
5.15
4.79
4.65
4.58
3.54
3.64
4.16
3.64
3.14
3.55
5.57
4.64
4.35
3.85
3.17
3.67
4.86
3.07
4.22
5.05
3.75
3.13
4.150
4.220
4.240
4.330

2 0.284
7.83
1.945
1.5
1.945
1.58
0.87
9.33
0.98
0.86
3.779
4.1
8.156
0.37
1.244
9.12
0.742
2.88
1.698
0.82
1.618
2.13
2.74
3.41
2.068
3.81
2.424
1.52
1.728
1.41
1.451
3.45
1.565
8.69
3.853 12.4
1.99
2.48
2.247 21.73
5.763
1.94
1.4
0.87
1.335
9.7
1.726
3.42
2.489
4.86
1.358
0.55
2 0.037
2.36
0.443
5.59
3.18
3.8
2.787
3.7
2 0.063 31.22
1.063
5.55
1.689
1.61
1.429 45.38
5.691 21.11
2 1.5
26.31
1.986
6.159
1.694
3.415
2.176
7.626
1.936
2.945

0.274
1.230
1.172
0.577
1.716
0.546
0.353
0.589
1.346
0.962
0.709
1.172
0.714
1.040
0.738
0.447
0.446
0.870
2.070
0.712
0.528
0.314
1.339
0.716
0.710
0.195
0.429
0.322
1.144
0.220
0.565
0.721
0.289
0.144
0.745
0.710
0.792
0.714

0.047
0.328
0.449
0.087
0.439
0.159
0.063
0.005
0.046
0.461
1.099
0.228
0.284
0.450
0.023
0.020
0.014
0.358
0.439
0.465
0.074
0.416
0.215
0.024
0.003
0.000
0.188
0.000
0.000
0.476
0.002
0.218
0.004
0.215
0.159
0.211
0.150

0.316
0.196
0.570
0.310
1.891
0.865
0.315
0.178
0.233
0.385
0.486
0.300
0.566
0.902
0.606
0.389
0.192
0.223
0.340
0.787
0.477
0.278
0.282
0.946
0.378
0.215
0.240
0.491
0.145
0.312
0.293
0.074
0.895
0.189
1.013
0.091
0.455
0.316
0.605
0.400

regression (Hoeffler, 2002; Chui et al., 2002) and overcome the second bias by including
additional control variables.
The major research objective of this paper is to examine the impacts of country-level
CR and employee rights on financing across countries, using firm-level variables as
control variables. The pooled sample regressions have two limitations. First, running
pooled sample regression cannot totally remove the disturbance of firm-level variables.
Second, including all countries in the sample results in unequal weights in sample.

Primary
MTB
Profit
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Size
Tang
Constant
No. of
obs
No. of
firms
Adj. R 2

20.0001
(0.80)
20.0947 * * *
(13.08)
0.0279 * * *
(26.58)
0.0955 * * *
(17.42)
20.0601 * * *
(10.13)
16,472
2,354
0.0704

Manufacturing
20.0000
(0.44)
20.1774 * * *
(23.84)
0.0418 * * *
(43.64)
0.1009 * * *
(17.75)
20.1241 * * *
(20.38)
37,286

20.0000
(0.24)
20.1599 * * *
(30.59)
0.0279 * * *
(39.35)
0.1458 * * *
(28.79)
20.0685 * * *
(15.40)
55,333

4,593
0.0711

Agency costs of
stakeholders

Debt ratio
Advanced
manufacturing
Services

6,943
0.0602

Pooled

2 0.0001 * * *
(2.64)
2 0.0807 * * *
(16.14)
0.0305 * * *
(51.08)
0.1597 * * *
(39.03)
2 0.0739 * * *
(20.28)
62,090
8,613
0.0709

2 0.0002 * * *
(5.07)
2 0.0588 * * *
(12.14)
0.0230 * * *
(53.11)
0.1557 * * *
(38.16)
2 0.0699 * *
(2.01)

317

171,181
22,503
0.2035

Notes: Significant at: *10, * *5, * * *1 percent; absolute value of t-statistics in parentheses; the tstatistic reported in parentheses controls for firm clustering standard errors; this table presents the
regression results of the following Default (with firm subscripts suppressed):
Debt t a1 a2 MTBt a3 Profit t a4 Casht a5 Sizet a6 Tangt 1t
sample period is 1990-2008; the dependent variable Debt is the long-term debt ratio computed by longterm debt divided by total assets; MTB is the market-to-book ratio computed by the book value of total
assets minus the book value of equity plus the market value of equity all divided by the book value of
total assets; Profit is computed by EBITDA divided by total assets; Size is the log of total assets in US
dollars; Tang is the tangibility computed by tangible assets divided by total assets

Some countries such as the USA, Britain, and Japan have a much larger number of
observations than other countries do. Consequently, the results cannot exclude
the excess impact of those big countries. To overcome such limitations, I use a
two-stage regression model to remove the firm-level factors and to exclude the sample
selection bias.
In the first stage, following Chui et al. (2002), I construct an adjusted dependent
variable by following method. First, debt ratio for firm i at year t in county j is estimated
by the following Default (firm and county subscription suppressed):
Debtt a1 a2 MTBt a3 Profit t a4 Casht a5 Sizet a6 Tang t 1t

The dependent and independent variables are defined the same as in Section II. Then,
I use the residual of this equation as the adjusted debt ratio.
After building the adjusted debt ratio for each firm at each year, in the second stage,
I calculate the mean of adjusted debt ratio for each country at each year and then use
country mean of adjusted debt ratio as dependent variables to run the cross-national
regression model:
MeanAdjDebt t bX 1
X is the vector of country-level variables.

Table V.
Firm and industry factors
and financial leverage

MF
38,3

Debt ratio
(1)
MTB

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2 0.0002 * * *
(5.40)
2 0.0631 * * *
(12.96)
0.0221 * * *
(50.79)
0.1609 * * *
(40.06)
0.0586 * * *
(14.07)
0.0473 * * *
(8.90)
2 0.0228 * * *
(26.25)
2 0.0804 *
(1.94)
171,150
0.2240

(6.28)
20.0620 * * *
(12.78)
0.0212 * * *
(49.36)
0.1632 * * *
(40.55)

Profit

318

(2)

20.0002 * * *

Size
Tang
SR

0.0185 * * *
(3.74)
20.0167 * * *
(24.01)
20.0445
(1.16)
171,150
0.2192

LR
CR
Constant
No. of obs
Adj. R 2

Notes: Significant at: *10, * *5, * * *1 percent; robust t-statistics in parentheses; the t-statistic reported
in parentheses controls for firm clustering standard errors; this table presents the regression results of
the following Default (with firm subscripts suppressed):
Debt t a1 a2 MTBt a3 PROFIT t a4 CASH t a5 SIZE t a6 Tang t a7 SR a8 CR a9 LR 1t

Table VI.
Impacts of CR and LR on
financial leverage

Table VII.
Variance inflation factors

where model (1) tests the impact of CR and LR on debt ratio and model (2) test the compounded impact of
SR, creditor right, and labor right on debt ratio; sample period is 1990-2008; the dependent variable Debt
is the long-term debt ratio computed by long-term debt divided by total assets; MTB is the market-tobook ratio computed by the book value of total assets minus the book value of equity plus the market
value of equity all divided by the book value of total assets; Profit is computed by EBITDA divided by
total assets; Size is the log of total assets in US dollars; Tang is the tangibility computed by tangible
assets divided by total assets; SR and CR are shareholder rights and creditor rights from Djankov et al.
(2008) and Djankov et al. (2007), respectively. LR is the labor rights from Botero et al. (2004)

Variable

VIF

Tolerance

R2

SR
CR
LR
Mean VIF

1.59
1.53
1.28
1.47

0.6306
0.6515
0.7826

0.3694
0.3485
0.2174

The two-stage regression results are presented in Table VIII. After removing firm-level
factors totally and controlling for sample selection bias through two-stage regression,
the tests results stay statistically significant.
To address the omitting variable issue, I run the robust tests by adding additional
country-level controlling variables and re-run the two-stage regression. Following the
prior research, I add both country-level corporate governance quality variables such as
government quality index and ownership concentration index and economic variables

Common law countries

0.0421 * * *

SR

(5.06)
20.0055 * * *
(2.89)
0.0530 * * *
(5.96)

CR
LR
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MeanAdjDebt
Civil law countries

STKGDP
GOV_QUAL
ECO_GLB
Constant
No. of obs
R2

20.0450 * * *
(8.01)
830
0.0987

Full sample

Full sample

0.0224 * * *

0.0306 * * *
(3.57)
2 0.0055 * * *
(2.88)
0.0321 * * *
(2.92)
2 0.0001 *
(1.94)
0.0126 * * *
(2.87)
0.0019
(0.55)
2 0.0455 * * *
(3.65)
814
0.1244

(2.83)
2 0.0038 * *
(2.12)
0.0239 * *
(2.25)
2 0.0000
(0.99)
0.0162 * * *
(3.70)
0.0002
(0.06)
2 0.0293 * *
(2.27)
814
0.1130

0.0324 * * *
(2.92)
20.0001 *
(1.94)
0.0136 * * *
(3.13)
0.0005
(0.14)
20.0474 * * *
(3.77)
814
0.1144

Agency costs of
stakeholders

319

Notes: Significant at: *10, * *5, * * *1 percent; robust t-statistics in parentheses; the t-statistic reported
in parentheses controls for county clustering standard errors; this table presents the regression results
of the following model:
MeanAdjDebt t bX 1
where X is a vector of country-level variables; STKGDP, the stock market capitalization to GDP, is
from World Bank; GOV_QUAL is the regulation quality of government, obtained from Kaufmann et al.
(2007); ECO_GLB is the economic globalization index from World Bank; the dependent variable,
MeanAdjDebt, is the country mean of residuals of the following model (with firm subscription
suppressed):

Debtt a1 a2 MTBt a3 Profit t a4 Casht a5 Sizet a6 Tang t 1t

where Debt is the long-term debt ratio computed by long-term debt divided by total assets; MTB is the
market-to-book ratio computed by the book value of total assets minus the book value of equity plus
the market value of equity all divided by the book value of total assets; Profit is computed by EBITDA
divided by total assets; Size is the log of total assets in US dollars; Tang is the tangibility computed by
tangible assets divided by total assets; SR and CR are shareholder rights and creditor rights
from Djankov et al. (2008) and Djankov and Shleifer (2007), respectively; LR is the labor rights from
Botero et al. (2004); sample period is 1990-2008

such as GDP growth rate, bond market development measure, and banking section
development measure. The regression results are reported in Table IX.
The above robust tests results show that the coefficients of major target variables:
CR and LR, stay statistically significant. These significant results support the
hypotheses. Specifically, LR have a positive relationship with debt ratio whereas CR
have a negative relationship with debt ratio.
V. Conclusion
This paper explores the relationship between CR as well as employee rights and capital
structure across countries. The results reveal the impacts of bargaining powers of creditors
and employees on capital structure given a countrys legal and political framework.

Table VIII.
Country-level corporate
governance factors and
debt ratio

MF
38,3

MeanAdjDebt
(1)
GDPG

320

Inflation

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STKGDP
Bond
Bank
SR
CR
LR

0.0069 * * *
(3.69)
20.0002
(0.54)
20.0098 * * *
(2.80)
0.0465 * * *
(7.55)
0.0190 * * *
(4.10)
0.0431 * * *
(3.55)
20.0117 * * *
(4.95)
0.0375 * * *
(4.14)

GOV_QUAL
ECO_GLB
Constant
Observations
R2

20.0631 * * *
(8.25)
746
0.2504

(2)
0.0076 * * *
(3.96)
2 0.0088 * *
(2.27)
0.0505 * * *
(6.90)
0.0234 * * *
(5.03)
0.0470 * * *
(3.86)
2 0.0119 * * *
(5.24)
0.0452 * * *
(4.10)
2 0.0063
(1.05)
0.0005
(0.14)
2 0.0714 * * *
(4.77)
746
0.2523

Notes: Significant at: *10, * *5, * * *1 percent; robust t-statistics in parentheses; the t-statistic reported
in parentheses controls for county clustering standard errors; this table presents the regression results
of the following model:
MeanAdjDebt t bX 1
where X is a vector of country-level variables; GDPG is the GDP growth rate; Inflation is the inflation
rate; Bond is the private bond capitalization to GDP; Bank is the domestic bank deposits to GDP;
STKGDP, the stock market capitalization to GDP, is from World Bank; GOV_QUAL is the regulation
quality of government, obtained from Kaufmann et al. (2007); ECO_GLB is the economic globalization
index from World Bank; the dependent variable, MeanAdjDebt, is the country mean of residuals of the
following model (with firm subscription suppressed):

Debtt a1 a2 MTBt a3 Profit t a4 Casht a5 Sizet a6 Tang t 1t

Table IX.
Country-level economic
factors and debt ratio

where Debt is the long-term debt ratio computed by long-term debt divided by total assets; MTB is the
market-to-book ratio computed by the book value of total assets minus the book value of equity plus
the market value of equity all divided by the book value of total assets; Profit is computed by EBITDA
divided by total assets; Size is the log of total assets in US dollars; Tang is the tangibility computed by
tangible assets divided by total assets; SR and CR are shareholder rights and creditor rights from
Djankov et al. (2008) and Djankov and Shleifer (2007), respectively; LR is the labor rights from
Botero et al. (2004); sample period is 1990-2008

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In corporate governance context, stakeholders such as shareholders, creditors, and

employees have heterogeneous utility functions. As a result, a game is played among
those stakeholders within a countrys legal and political framework. As firm residual
claimants, shareholders stand on the one side of the game whereas other stakeholders
stand on the other side. When stakeholders other than shareholders pursue to maximize
their benefits and interests within corporations, their gains are at the expense of
shareholders. This is the essential of interaction between stakeholders.
Using country-level CR index and LR index as a proxy for bargaining powers of
creditors and employees, respectively, I find a positive correlation between employee
rights and firms use of debt and a negative correlation between CR and firm debt ratio.
This is because when employee rights are high, shareholders are more likely to be
exploited by employees. If so, shareholders intend to use more debt obligation to
remove free cash flows to reduce employees opportunities to obtain more benefits from
the firm. When CR are high, creditors have more negotiation power to obtain good
terms in debt contracting, making debt less attractive to shareholders.
The empirical results are robust by controlling for sample selection bias, test model
specification, and a series of country-level control variables. The results obtained from
this paper helps us to understand financial leverage in different countries with various
corporate governance mechanisms and fills significant gaps in the literature on
international financing policy. These results should be of interest to managers,
investors, and policymakers.
Notes
1. Studies on international capital structure include Aggarwal (1990), Rajan and Zingales
(1995), Aivazian et al. (2001) and Gaud et al. (2007), among others.
2. I also used 1 percent winsorized sample and original sample to run all tests. The tests results
do not change qualitatively.
3. LLSV (2000) classify non-financial firms into seven broad industrial groups: (1) agriculture;
(2) mining; (3) construction; (4) light manufacturing; (5) heavy manufacturing; (6)
transportation, communications and utilities; and (7) services.
4. Since debt ratio is censored by zero at lower bound, we also use Tobit model to regress debt
ratio on the same firm-level independent variables, the SR, CR, and LR indices with year and
industry fixed effect. The coefficients of CR and LR stay significant statistically with the
expected sign. Since Tobit model cannot generate robust standard errors, we report our
results based on OLS regression.

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About the author
Dr Bing Yu is an Assistant Professor of Finance at the School of Business, Meredith College,
Raleigh, North Carolina, USA. Bing Yu can be contacted at: yubing@meredith.edu

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