European Financial Management, Vol. 11, No.

1, 2005, 51–69

The Capital Structure of Swiss

Companies: an Empirical Analysis
Using Dynamic Panel Data

Philippe Gaud, Elion Jani, Martin Hoesli and André Bender

University of Geneva (HEC), 40 boulevard du Pont-d’Arve, CH-1211 Geneva 4, Switzerland
and (MH)University of Aberdeen (Business School), Edward Wright Building, Dunbar Street,
Aberdeen AB24 3QY, UK
email: philippe.gaud@hec.unige.ch; elion.jani@hec.unige.ch; martin.hoesli@hec.unige.ch; andre.
bender@hec.unige.ch

Abstract
In this paper, we analyse the determinants of the capital structure for a panel of
104 Swiss companies listed in the Swiss stock exchange. Dynamic tests are
performed for the period 1991–2000. It is found that the size of companies and
the importance of tangible assets are positively related to leverage, while growth
and profitability are negatively associated with leverage. The sign of these rela-
tions suggest that both the pecking order and trade-off theories are at work in
explaining the capital structure of Swiss companies, although more evidence
exists to validate the latter theory. Our analysis also shows that Swiss firms
adjust toward a target debt ratio, but the adjustment process is much slower than
in most other countries. It is argued that reasons for this can be found in the
institutional context.

Keywords: capital structure; dynamic panel data; trade-off theory; pecking order theory.
JEL classification: G32

1. Introduction

Since the seminal Modigliani and Miller (1958) paper showing that subject to some
conditions the impact of financing on the value of the firm is irrelevant, the
literature on capital structure has been expanded by many theoretical and empirical
contributions. Much emphasis has been placed on releasing the assumptions made

We thank an anonymous referee, Jaya Krishnakumar, Andi Kabili and Dušan Isakov for very
helpful suggestions, as well as participants at the Sixth Conference of the Swiss Society for
Financial Market Research in Zurich and at the University of Geneva (HEC) finance research
seminars. The usual disclaimer applies. Address correspondence to: Martin Hoesli, University of
Geneva, HEC, 40 boulevard du Pont-d’Arve, CH-1211 Geneva 4, Switzerland, e-mail:
martin.hoesli@hec.unige.ch

# Blackwell Publishing Ltd. 2005, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
52 P. Gaud, E. Jani, M. Hoesli and A. Bender

by Modigliani and Miller, in particular by taking into account corporate taxes

(Modigliani and Miller, 1963), personal taxes (Miller, 1977), bankruptcy costs
(Stiglitz, 1972; Titman, 1984), agency costs (Jensen and Meckling, 1976; Myers,
1977), and information asymmetries (Myers and Majluf, 1984; Myers, 1984). Two
main theories currently dominate the capital structure debate:1 the trade-off theory
(TOT) and the pecking order theory (POT).
The TOT posits that firms maximise their value when the benefits that stem from
debt (the tax shield, the disciplinary role of debt, and the fact that debt suffers
less from informational costs than outside equity) equal the marginal cost of debt
(bankruptcy costs, and agency costs between shareholders and bondholders). The
POT, developed by Myers and Majluf (1984) and Myers (1984), is a consequence of
information asymmetries existing between insiders of the firm and outsiders (i.e. the
capital market). The model leads managers to adapt their financing policy to minimise
the associated costs. More specifically, they will prefer internal financing to external
financing, and risky debt to equity.
The analysis of how companies choose their financing mix has been primarily an
empirical question, and such studies have been plentiful in the last decade. However,
empirical studies dealing with capital structure are not recent (Taggart, 1977; Marsh,
1982; Jalilvand and Harris, 1984; Titman and Wessels, 1988). The latter authors made
a significant contribution in formulating and testing the determinants of the capital
structure as identified by theory. These authors caution on the difficulty of finding
suitable proxies for the determinants of capital structure.
Most initial studies examined the case of US companies. Rajan and Zingales (1995)
test for the G7 countries the theoretical and empirical lessons learnt from the US
studies. These authors find similar levels of leverage across countries, thus refuting the
idea that firms in bank-oriented countries are more leveraged than those in market-
oriented countries. However, they recognise that this distinction is useful in analysing
the various sources of financing. Rajan and Zingales (1995) find that the determinants
of capital structure that have been reported for the USA (size, growth, profitability,
and importance of tangible assets) are important in other countries as well. They show
that a good understanding of the relevant institutional context (bankruptcy law, fiscal
treatment, ownership concentration, and accounting standards) is required when
identifying the fundamental determinants of capital structure. The analysis by
Booth et al. (2001) suggests that the same determinants of capital structure prevail
in ten developing countries. These studies, however, do not shed any light on the
adjustment process of the capital structure.
Other studies, which have addressed the dynamic nature of capital structure
decisions, suffer from some limitations also. For example, the results of Taggart
(1977), Marsh (1982), and Jalilvand and Harris (1984) may be biased as they use
future information about leverage as a proxy for the optimal debt ratio. Moreover,
the tests of the target adjustment model lack power as they are unable to reject the
target adjustment hypothesis even when financing is generated according to POT only
(Shyam-Sunder and Myers, 1999). With respect to the empirical validation of pecking
order theory, Chirinko and Singha (2000) show that the tests by Shyam-Sunder and
Myers (1999) may be misleading. In addition, Frank and Goyal (2003) reject the fact
that the debt level is determined fundamentally by the financing deficit, and find

1
For an in-depth review of literature on capital structure, see Harris and Raviv (1991).

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 The Capital Structure of Swiss Companies 53

evidence of mean reversion of leverage, the adjustment process being influenced by the
variables used by Rajan and Zingales (1995).
Recent work has benefited from the advances in econometrics. Kremp et al. (1999),
Miguel and Pindado (2001), and Ozkan (2001) focus on the dynamics of the capital
structure decisions, offering better insight on the adjustment process toward the target
debt-to-equity ratio. Kremp et al. (1999) analyse a large panel of French and German
firms and confirm the existence of a dynamic adjustment process. They provide
further evidence that the institutional framework is important when analysing the
determinants of the capital structure. They stress the role of the Hausbank system in
Germany, and the impact of tax policy and the end of the so-called ‘indebtedness
economy’ in France. Miguel and Pindado (2001) show for Spain that firms have a
target leverage ratio, and that they adjust to the target ratio relatively fast. The
institutional context again is important. They argue that adjustment costs are lower
in Spain than in the USA for instance, because of the major role of bank financing.
The aim of this paper is to analyse the determinants of the capital structure in
Switzerland. We add to the relatively limited literature on the dynamics of the capital
structure decision by examining the dynamics of the relationship between leverage and
a set of explanatory variables. The analysis is conducted using panel data pertaining
to 104 Swiss companies for the period 1991–2000. A total of 946 observations are
available for analysis. Our results show that both the pecking order theory and the
trade-off theory are at work, although more evidence exists to validate the latter
theory. Also, we find that the speed of adjustment is quite slow in Switzerland as
compared to other countries. We argue that the complexity and specificity of the
Swiss institutional framework help explain why Swiss firms do not suffer too much
from being away from their target ratios.
The paper is organised as follows. In Section 2, we provide an overview of the
literature on the determinants of the capital structure. The method and data are
presented in Section 3, while our results are discussed in Section 4. Finally, Section 5
contains some concluding remarks.

2. The Determinants of Capital Structure

In this section, we provide a review of the main variables that have been used in
previous studies examining the determinants of capital structure.

2.1. Growth opportunities

For companies with growth opportunities, the use of debt is limited as in the case of
bankruptcy, the value of growth opportunities will be close to zero. Jung et al. (1996)
show that firms should use equity to finance their growth because such financing
reduces agency costs between shareholders and managers, whereas firms with less
growth prospects should use debt because it has a disciplinary role (Jensen, 1986;
Stulz, 1990).
Myers (1977) shows that firms with growth opportunities may invest sub-optimally,
and therefore creditors will be more reluctant to lend for long horizons. This problem
can be solved by short-term financing (Titman and Wessels, 1988) or by convertible
bonds (Jensen and Meckling, 1976; Smith and Warner, 1979). From a pecking order
theory perspective, growth firms with strong financing needs will issue securities less
subject to information asymmetries, i.e. short-term debt. If these firms have very close
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54 P. Gaud, E. Jani, M. Hoesli and A. Bender

relationships with banks, there will be less information asymmetry problems, and they
will be able to have access to long term debt financing as well.
A common proxy for growth opportunities is the market value to book value of
total assets. Firms with growth opportunities should exhibit a greater market-to-book
than firms with less growth opportunities, but Harris and Raviv (1991) suggest that
this is not necessarily the case. This will typically occur when assets whose values have
increased over time have been fully depreciated, as well as when assets with high value
are not accounted for in the balance sheet (e.g. the brand name Nestlé).
Rajan and Zingales (1995) find a negative relationship between growth opportun-
ities and leverage. They suggest that this may be due to firms issuing equity when
stock prices are high. As mentioned by Hovakimian et al. (2001), large stock price
increases are usually associated with improved growth opportunities, leading to a
lower debt ratio.

2.2. Size

Large size companies tend to be more diversified, and hence their cash flows are less
volatile. According to Titman and Wessels (1988, p. 6), ‘relatively large firms tend to
be (. . .) less prone to bankruptcy’. Ferri and Jones (1979) suggest that large firms have
easier access to the markets and can borrow at better conditions. For small firms, the
conflicts between creditors and shareholders are more severe because the managers of
such firms tend to be large shareholders and are better able to switch from one
investment project to another (Grinblatt and Titman, 1998). However, this problem
may be mitigated with the use of short term debt, convertible bonds, as well as long
term bank financing. Most empirical studies report indeed a positive sign for the
relationship between size and leverage (Rajan and Zingales, 1995; Frank and Goyal,
2003; Booth et al., 2001). Less conclusive results are reported by other authors
(Kremp et al., 1999; Ozkan, 2001). For Germany, however, Rajan and Zingales
(1995) find that a negative relationship exists. Kremp et al. (1999) confirm the finding
of Rajan and Zingales (1995) for Germany and argue that the negative relationship is
not due to asymmetric information, but rather to the characteristics of the German
bankruptcy law and the Hausbank system, which offer better protection to creditors
than is the case in other countries.

2.3. Profitability

One of the main theoretical controversies concerns the relationship between leverage
and profitability of the firm. According to the pecking order theory, firms prefer using
internal sources of financing first, then debt and finally external equity obtained by
stock issues. All things being equal, the more profitable the firms are, the more
internal financing they will have, and therefore we should expect a negative relation-
ship between leverage and profitability. This relationship is one of the most systematic
findings in the empirical literature (Harris and Raviv, 1991; Rajan and Zingales, 1995;
Booth et al., 2001).
In a trade-off theory framework, an opposite conclusion is expected. When firms
are profitable, they should prefer debt to benefit from the tax shield. In addition,
if past profitability is a good proxy for future profitability, profitable firms can
borrow more as the likelihood of paying back the loans is greater.
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 The Capital Structure of Swiss Companies 55

Dynamic capital structure models (Fischer et al., 1989; Leland, 1998) take into
consideration the costs of adjusting toward the target debt-to-equity ratio. Empiric-
ally, this behaviour suggests that firms may follow a pecking order in the short term
even though a long term target policy exists.

2.4. Collaterals
Tangible assets are likely to have an impact on the borrowing decisions of a firm
because they are less subject to information asymmetries and usually they have a
greater value than intangible assets in case of bankruptcy. Additionally, the moral
hazard risks are reduced when the firm offers tangible assets as collateral, because this
constitutes a positive signal to the creditors who can request the selling of these assets
in the case of default. As such, tangible assets constitute a good collateral for loans.
According to Scott (1977), a firm can increase the value of equity by issuing collater-
alised debt when the current creditors do not have such guarantee. Hence, firms have
an incentive to do so, and one would expect a positive relation between the import-
ance of tangible assets and the degree of leverage.
Based on the agency problems between managers and shareholders, Harris and
Raviv (1990) suggest that firms with more tangible assets should take more debt. This
is due to the behaviour of managers who refuse to liquidate the firm even when the
liquidation value is higher than the value of the firm as a going concern. Indeed, by
increasing the leverage, the probability of default will increase which is to the benefit
of the shareholders. In an agency theory framework, debt can have another disciplin-
ary role: by increasing the debt level, the free cash flow will decrease (Grossman and
Hart, 1982; Jensen, 1986; Stulz, 1990). As opposed to the former, this disciplinary role
of debt should mainly occur in firms with few tangible assets, because in such a case it
is very difficult to monitor the excessive expenses of managers.
From a pecking order theory perspective, firms with few tangible assets are more
sensitive to information asymmetries. These firms will thus issue debt rather than
equity when they need external financing (Harris and Raviv, 1991), leading to an
expected negative relation between the importance of intangible assets and leverage.
Most empirical studies conclude to a positive relation between collaterals and the
level of debt (Rajan and Zingales, 1995; Kremp et al., 1999; Frank and Goyal, 2003).
Inconclusive results are reported for instance by Titman and Wessels (1988).

2.5. Risk and financial distress

Many authors have included a measure of risk as an explanatory variable of the debt
level (Titman and Wessels, 1988; MacKie-Mason, 1990; Kremp et al., 1999; Booth
et al., 2001). Leverage increases the volatility of the net profit. Firms that have high
operating risk can lower the volatility of the net profit by reducing the level of debt.
By so doing, bankruptcy risk will decrease, and the probability of fully benefiting
from the tax shield will increase. A negative relation between operating risk and
leverage is also expected from a pecking order theory perspective: firms with high
volatility of results try to accumulate cash during good years, to avoid under invest-
ment issues in the future. A measure of operating risk, however, is only an incomplete
measure of financial distress. Miguel and Pindado (2001) add to such a measure the
financial loss due to bankruptcy by using a measure of asset specificity.
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56 P. Gaud, E. Jani, M. Hoesli and A. Bender

2.6. Taxes

Companies have an incentive to take debt because they can benefit from the tax shield
due to interest deductibility. Nevertheless, as suggested by Miller (1977), the financial
structure decisions are irrelevant given that bankruptcy costs can be neglected in
equilibrium. DeAngelo and Masulis (1980) show that if non-debt tax shields exist,
then firms are likely not to use fully debt tax shields. In other words, firms with large
non-debt tax shields have a lower incentive to use debt from a tax shield point of view,
and thus may use less debt. Empirically, this substitution effect is difficult to measure
as finding an accurate proxy for the tax reduction that excludes the effect of economic
depreciation and expenses is tedious (Titman and Wessels, 1988). MacKie-Mason
(1990) finds evidence of substantial tax effects on financing decisions. He stresses the
importance of different types of tax shield and of their impact on marginal tax rates.
According to Graham (2000), the tax shield accounts on average to 4.3% of the firm
value when both corporate and personal taxes are considered.

3. Method and Data

3.1. Method
We use explanatory variables to proxy for the determinants of capital structure as presented
in Section 2. However, we do not take into account the tax effect for two reasons. First, this
would reduce substantially the size of our sample due to the lack of data regarding taxes.
Moreover, choosing the appropriate marginal tax rate of firms is crucial in determining the
tax shield and such choice is not straightforward (Graham, 2000). Following Miguel and
Pindado (2001), we substitute the operating risk variable by a financial distress cost
variable. We thus posit that leverage can be explained by the following variables:
Leverage ¼ f(growth, size, profitability, tangibles, financial distress costs)
We use two proxies to measure the leverage. The first proxy refers to book values
only and is defined as the ratio of total debt over total assets. The other proxy is based
on the market capitalisation of equity. Two measures of leverage are used to control
for possible spurious correlations that may result from a discrepancy between one of
our proxies for leverage and the debt-to-equity ratio computed by the managers
(Titman and Wessels, 1988). It is important to obtain the same sign from the various
explanatory variables whether we use market capitalisation or book value.
Growth opportunities are proxied by the market-to-book value of assets (MTB).
Other proxies also have been used in the literature, such as R&D and marketing
expenses, or capital expenditures (Titman and Wessels, 1988), but such items are
difficult to measure from published financial statements, and hence are not considered
in this study. We use the natural logarithm of sales as proxy for size (SIZE). This
measure is the most common proxy for size (Titman and Wessels, 1988; Rajan and
Zingales, 1995; Ozkan, 2001). An alternative proxy could be the natural logarithm of
total assets, but it is subject to more accounting problems. Various proxies can be
used to measure profitability (PROF). We choose the ratio of EBITDA to total assets
(Ozkan, 2001; Miguel and Pindado, 20012). We use the ratio of the sum of tangible
assets and inventories to total asset as a proxy for collaterals (TANG). Adding

2
These authors, however, use the replacement value of capital instead of total assets.

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 The Capital Structure of Swiss Companies 57

inventories to the tangible assets is motivated by the fact that debts are used partly to
finance inventories, and in most cases inventories maintain some value when the firm
is liquidated (Kremp et al., 1999).
Proxying for the financial distress costs (FDC) is a difficult task because one should
select a measure that relies on expectations concerning a firm’s profitability as compared
to that of the market and that also takes into account the specific nature of the firm’s
assets. Many authors use the volatility of operating profits of each company as a proxy
(Titman and Wessels, 1988; Booth et al., 2001). Kremp et al. (1999) measure the operat-
ing risk as the squared difference between the firm’s profitability and the cross section
mean (i.e. across firms) of profitability for each year. To measure both components of
financial distress costs, we follow Miguel and Pindado (2001). The probability of
occurrence of bankruptcy is measured by the difference between the standard deviation
and the expected value of EBIT, while the financial losses due to the bankruptcy are
measured by the importance of intangibles.
Legal differences across Swiss cantons (the equivalent of states in the USA), varying
degrees of exports by companies, the nature of the business and the risk profile of share-
holders and managers suggest that the Swiss firms are very different from each other.
Furthermore it is likely that macroeconomic shocks and changes in the institutional
context have occurred in recent years. For these purposes, we prefer panel data analysis,
as it is possible to include time effects as well as to control for the heterogeneity of firms.
Capital structure decisions are dynamic by nature and should be modelled as such.
If there is a target leverage ratio, then firms should take the appropriate steps to reach
this objective. Claiming that the adjustment process is without cost is unrealistic.
Taking transaction costs into account, the model can be written as follows:


yit  yit1 ¼
yit  yit1 ð1Þ
with 0 <
< 1
where yit is the target leverage ratio estimated from the following equation:
yit ¼ 0 xit þ uit ð2Þ
with i ¼ 1, . . . ,N and t ¼ 1, . . . ,T
and

yit : target leverage of firm i in year t

xit : K  1 vector of explanatory variables
 : K  1 vector of constants
uit : error term

The coefficient
is between 0 and 1 and is inversely related to adjustment costs.

When
¼ 0, then yit ¼ yit1, which means that there is no move toward the target debt
ratio because the adjustment costs are too high. When
¼ 1, then yit ¼ yit , so the
adjustment occurs without frictions.
Once developed, equation (1) becomes:
yit ¼ ð1 
Þyit1 þ
 0 xit þ i þ t þ it ð3Þ
with:
 i : firm effect assumed constant for firm i over t
t : time effect assumed constant for given t over i
 it : error term

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58 P. Gaud, E. Jani, M. Hoesli and A. Bender

Panel data analysis allows us to study the dynamic nature of the capital structure
decisions at the firm level. However, the fixed or random effects models may give biased
and inconsistent estimators because the error term may be correlated with the lagged
variable. To deal with variables that may be correlated with the error term, we use
instrumental variables. Using instrumental variables has the additional advantage of
solving problems encountered in static models, mainly the simultaneity bias between
the leverage measure and the explanatory variables, and measurement error issue.
For panels with a limited number of years and a substantial number of observa-
tions, Arellano and Bond (1991) suggest estimating equation (3) in first differences3
and using all lags of the level of variables from the second lag as instruments.
We use the Arellano and Bond (1991) two-step GMM estimator for our dynamic model,
which allows for heteroskedasticity across firms. The GMM estimator is consistent if there is
no second order serial correlation between error terms of the first-differenced equation. A
m2 statistic which follows a N(0,1) distribution under the null hypothesis E[D"it, D"it2] ¼ 0
is used to test for lack of second order serial correlation. Concerning the instruments, we
report the Sargan statistic, which tests the over-identifying restrictions. Note that the Sargan
test rejects too often in presence of heteroskedasticity. In addition, we report two Wald
statistics. Wald 1 is a test of the joint significance of the time dummy variables, while Wald 2
is a test of the joint significance of the capital structure determinants. Both tests are
asymptotically distributed as 2 under the null hypothesis of no relationship.

3.2. Data

Our data consist of Swiss firms listed on the Swiss stock exchange SWX for the period
1991–2000. We use annual data extracted from Worldscope1. Banks, insurance com-
panies, utility companies, and some other companies whose business is highly regulated,
such as railway companies, are excluded from the sample. This is motivated by the fact
that such companies have to comply with very stringent legal requirements pertaining to
their financing. Our sample thus contains primarily industrial, commercial and service
companies, for which managers have considerable leeway concerning financial decisions.
We deflate our data using 1992 as base year. Financial statements of companies and
the Swiss Stock Guide4 (1991–2001) are used to fill any gaps in the data, and to
crosscheck the data. We exclude observations (i.e. a given company in a given year)
for which we have negative figures on the balance sheet, except for ‘retained earnings’
and ‘other assets’.5 Our sample is trimmed applying a methodology similar to that of
Kremp et al. (1999). We exclude observations for which profitability, collaterals and
growth opportunities are outside the interval defined by plus/minus five times the
inter-quartile range. Concerning the measure of leverage, we only exclude observa-
tions for which the leverage is higher than the third quartile plus five times the inter-
quartile range. We choose the period 1991–2000 because a new business law required
Swiss firms to comply with new accounting rules since 1991. Before 1991, there would

3
Using first differences eliminates the specific firm effect, thus avoiding any correlation problem
between unobservable firm specific characteristics and explanatory variables.
4
The Swiss Stock Guide is compiled and edited by Verlag Finanz und Wirtschaft AG, with the
co-operation of the Credit Suisse Group and the UBS.
5
When firms adopted the new accounting rules at the beginning of the 1990s, a badwill might
have appeared, and hence negative ‘other assets’ may exist.

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 The Capital Structure of Swiss Companies 59

be too many missing observations. To run the dynamic panel regressions, we include
companies for which we have at least six consecutive years of data. This leaves us with
a sample of 104 firms and a total of 946 observations. As the model is estimated in
first differences and one or more lagged variables are used as explanatory variables,
our sample is reduced to 738 observations.
Table 1 contains summary statistics for selected years (1991, 1994, 1997, and 2000)
of the time period, as well as for the total period 1991–2000. Leverage diminishes over
the period, with a sharper decrease when market values of equity are considered than
when book values are used. Whereas both measures of leverage are roughly equal in
1991 (approximately 57%), the leverage ratio amounts to 40.2% in 2000 when market
values are used and to 54.2% when book values are used. Over the period, companies
on average have grown in size, and have increased the relative importance of intan-
gible assets in their balance sheet.6 The market-to-book ratio has increased from 1.10
in 1991 to 1.87 in 2000, but remains low, which confirms the fact that the Swiss
market is a ‘value’ market rather than a ‘growth’ market. The profitability of Swiss
companies has increased over the period.
The correlation coefficients between variables are reported in Table 2. Correlations
are generally low, except the correlation between profitability, growth and our market

Table 1
Descriptive statistics.
This table presents descriptive statistics for the variables used in our estimations. The data are
from Worldscope1 and the sample contains 104 Swiss firms listed on the Swiss stock exchange
(SWX) for which we have a minimum of six consecutive years of data for the period 1991–2000.
DTAB is the ratio of total debt to total assets where the total assets are measured with book
values. DTAM is the ratio of total debt to total assets where total assets is the sum of the book
value of debt plus the market value of equity at the end of the year. SIZE is the natural
logarithm of sales in real terms (base year ¼ 1992). TANG is the ratio of tangible assets plus
inventories to total assets using book values. MTB is the ratio of market value of assets (book
value of assets plus market value of equity less book value of equity) to book value of assets.
PROF is the ratio EBITDA to total assets. FDC is the sum of the difference between the time
series standard deviation of EBIT and its expected value and the book value of intangible
assets. Summary statistics include the mean and the standard deviation for years 1991, 1994,
1997, and 2000. For the total period (1991–2000), we also report the minimum and maximum.

1991 1994 1997 2000 1991–2000

Year Mean Std Mean Std Mean Std Mean Std Mean Std Min Max

DTAM 0.572 0.180 0.521 0.192 0.467 0.198 0.402 0.191 0.495 0.202 0.001 0.883
DTAB 0.571 0.134 0.578 0.147 0.564 0.152 0.542 0.157 0.565 0.151 0.004 0.892
SIZE 13.326 1.501 13.501 1.554 13.678 1.646 13.895 1.611 13.586 1.588 9.055 18.287
TANG 0.575 0.192 0.575 0.180 0.547 0.192 0.465 0.178 0.548 0.188 0.000 0.987
MTB 1.067 0.308 1.231 0.477 1.461 0.811 1.874 1.645 1.371 0.848 0.590 11.810
PROF 0.118 0.062 0.125 0.060 0.135 0.069 0.139 0.063 0.128 0.066 0.114 0.508
FDC 0.015 0.076 0.001 0.096 0.003 0.108 0.017 0.111 0.007 0.097 0.241 0.684
N 80 97 104 86 946

6
The relative importance of the ratio of intangible assets to total assets has increased from 1.4%
in 1991 to 7.5% in 2000.

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60 P. Gaud, E. Jani, M. Hoesli and A. Bender

Table 2
Pearson correlation coefficients between variables and VIF coefficients.
This table presents the Pearson correlation coefficients for the variables used in our estimations and
VIF (variance inflation factor) tests between dependent variables. The data are from Worldscope1
and the sample contains 104 Swiss firms listed on the Swiss stock exchange (SWX) for which we
have a minimum of six consecutive years of data for the period 1991–2000. DTAB is the ratio of
total debt to total assets where the total assets are measured with book values. DTAM is the ratio
of total debt to total assets where the total assets is the sum of the book value of debt plus the
market value of equity at the end of the year. SIZE is the natural logarithm of sales in real terms
(base year ¼ 1992). TANG is the ratio of tangible assets plus inventories to total assets using book
values. MTB is the ratio of market value of assets (book value of assets plus market value of equity
less book value of equity) to book value of assets. PROF is the ratio EBITDA to total assets. FDC
is the sum of the difference between the time series standard deviation of EBIT and its expected
value and the book value of intangible assets.

DTAM DTAB SIZE TANG MTB PROF VIF

DTAM
DTAB 0.691
SIZE 0.002 0.167 1.15
TANG 0.279 0.044 0.344 1.33
MTB 0.670 0.242 0.069 0.292 1.39
PROF 0.535 0.323 0.026 0.196 0.490 1.53
FDC 0.225 0.306 0.047 0.180 0.083 0.327 1.21

based measure of leverage. To check whether these variables are collinear, we perform
a VIF test. Our VIF tests are substantially lower than 10, so collinearity should not
constitute a problem (Chaterjee and Price, 1977).

4. Results

We test various specifications concerning the endogeneity of the explanatory vari-

ables, but only report the results of the model that posits that all variables are
endogenous. Not surprisingly, the latter model is the best-specified one as all variables
are based upon accounting values and are thus determined simultaneously. We
present the results in Table 3. The Sargan and m2 tests suggest our model specifica-
tion for the sample of Swiss firms is valid.7 The Wald 1 tests of the joint significance of
the time dummy variables are satisfied at the 1% level. These results indicate that
macroeconomic events and changes in the institutional context play a significant role
on the borrowing decision of Swiss firms.
The coefficients on the lagged leverage whether measured with market (DTAMit1)
or accounting (DTABit1) values are positive and significant at the 1% level. These
coefficients are greater than 0.613. SIZE also plays a positive role and the coefficients
are significant at the 1% level for all estimations. For the profitability variable
(PROF), we find a negative relationship with leverage and all the coefficients are

7
To check further the robustness of our results, we also ran the regressions by only considering
long term debt. However, the m2 test points out that we cannot reject the hypothesis of no
autocorrelation of order 2 at the 10% level when leverage is based on market values.

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Table 3
Dynamic results.
In this table we present the results using the Arellano and Bond two-step GMM estimator. The data are from Worldscope1 and the sample contains 104
Swiss firms listed on the Swiss stock exchange (SWX) for which we have a minimum of six consecutive years of data for the period 1991–2000. DTAB is
the ratio of total debt to total assets where the total assets are measured with book values. DTAM is the ratio of total debt to total assets where the total
assets is the sum of the book value of debt plus the market value of equity at the end of the year. SIZE is the natural logarithm of sales in real terms (base
year ¼ 1992). TANG is the ratio of tangible assets plus inventories to total assets using book values. MTB is the ratio of market value of assets (book

The Capital Structure of Swiss Companies

value of assets plus market value of equity less book value of equity) to book value of assets. PROF is the ratio EBITDA to total assets. FDC is the sum
of the difference between the time series standard deviation of EBIT and its expected value and the book value of intangible assets. d1 is a dummy
variable which takes the value of 1 for the lower MTB firms. d2 is a dummy variable which takes the value of 1 for firms that face minor asymmetric
information. Heteroskedasticity consistent asymptotic standard deviations are reported in brackets. *** indicates significance at the 1% level.
** indicates significance at the 5% level. * indicates significance at the 10% level. t1 is a t-statistic for the linear restriction test under the null
hypothesis. Wald 1 is a test of the joint significance of time dummy variables. Wald 2 is a test of the joint significance of the estimated firm specific
coefficients. Wald 1 and 2 are asymptotically distributed as 2 under the null hypothesis of no relationship. The Sargan test of over-identifying
restrictions is asymptotically distributed as 2 under the null of instrument validity. The m2 test is a test for second order autocorrelation of residuals and
is distributed as N(0,1). Degrees of freedom are reported in brackets.

Two-step Arellano-Bond estimator

1 2 3 4 5 6 7 8
DTAM DTAB DTAM DTAB DTAM DTAB DTAM DTAB

DTAMit1 0.727 0.613 0.860 0.722

(0.058)*** (0.052)*** (0.070)*** (0.060)***
DTABit1 0.815 0.788 0.991 0.813
(0.050)*** (0.053)*** (0.066)*** (0.051)***
SIZE 0.060 0.060 0.062 0.055 0.067 0.073 0.062 0.064
(0.012)*** (0.010)*** (0.011)*** (0.010)*** (0.013)*** (0.011)*** (0.012)*** (0.011)***
TANG 0.122 0.015 0.101 0.036 0.126 0.023 0.146 0.008
(0.045)*** (0.044) (0.042)** (0.045) (0.046)*** (0.043) (0.046)*** (0.048)

61
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62
Table 3
Continued.

Two-step Arellano-Bond estimator

1 2 3 4 5 6 7 8
DTAM DTAB DTAM DTAB DTAM DTAB DTAM DTAB

P. Gaud, E. Jani, M. Hoesli and A. Bender

MTB 0.088 0.003 0.072 0.005 0.095 0.002 0.089 0.003
(0.012)*** (0.005) (0.010)*** (0.005) (0.012)*** (0.005) (0.012)*** (0.005)
d1(MTB) 0.171 0.080
(0.036)*** (0.027)***
PROF 0.552 0.598 0.441 0.639 0.470 0.587 0.481 0.643
(0.079)*** (0.061)*** (0.094)*** (0.055)*** (0.073)*** (0.073)*** (0.084)*** (0.065)***
d2(PROF) 0.186 0.065
(0.053)*** (0.034)*
PROFit1 0.426 0.457
(0.074)*** (0.079)***
FDC 0.057 0.075 0.117 0.027 0.066 0.046 0.035 0.069
(0.057) (0.050) (0.067)* (0.047) (0.054) (0.054) (0.059) (0.050)
t1 82.4 56.8 100.4
Wald1 123.0(7) 21.2(7) 67.9(7) 25.0(7) 129.7(7) 29.1(7) 111.3(7) 21.8(7)
Wald2 815.0(6) 708.7(6) 977.7(7) 768.4(7) 911.8(6) 623.3(6) 912.3(6) 699.9(6)
Sargan 35.5(35) 35.3(35) 34.58 34.39 39.5(35) 29.5(35) 34.8(35) 34.5(35)
m2 0.86 1.43 0.65 1.33 0.84 1.54 0.64 1.41
N 738 738 738 738 738 738 738 738
 The Capital Structure of Swiss Companies 63

again significant at the 1% level. For the other variables, the results vary more across
specifications. The MTB variable negatively impacts on leverage and is significant at
the 1% level only when market values are used. Tangible assets (TANG) have a
positive impact that is significant at the 5% (in some cases 1%) level with market
values only. In summary, the DTAMit1 (DTABit1, respectively), SIZE and TANG
variables have a positive impact on leverage, whereas MTB and PROF have a
negative impact. The coefficient on the FDC variable is not significant, except positive
in one case at the 10% level. When leverage is measured with market values, the
results exhibit greater statistical significance.
For the Swiss market, the size of the coefficient on lagged leverage is in the
0.613–0.860 range when leverage is measured using market values but is higher
when it is measured using book values. Caution has to be exercised when
cross-country comparisons are made, but such comparisons are interesting however.
The adjustment process is slow in Switzerland compared to the results for other
countries as reported in many studies: Miguel and Pindado (2001) find a (1 
) of
0.21 for Spain, Shyam-Sunder and Myers (1999) a value of 0.41 for the USA,
Kremp et al. (1999) a value of 0.47 for Germany, and Ozkan (2001) a value of
0.43 for the UK. For France, the speed of adjustment is comparable to that for
Switzerland as: (1 
) ¼ 0.72 as reported by Kremp et al. (1999).
The adjustment process is a trade-off between the adjustment costs towards a target
ratio and the costs of being in disequilibrium. If the costs of being in disequilibrium are
greater than the adjustment costs, then the estimated coefficient should be close to zero
(Ozkan, 2001). For example, Miguel and Pindado (2001) explain the small coefficient that
they find for the Spanish market by the importance of bank credit. They argue that
Spanish companies have low transaction costs when borrowing funds from banks, and
that such financing leads to lower agency costs between creditors and shareholders. It
could seem appropriate to use the same explanation for the Swiss market because com-
panies in both countries mostly rely on banks for their long term borrowing needs.
According to the World Bank (1999), the public debt ratio is 5.7% for Spain and 7.9%
for Switzerland, as compared e.g. to 27.4% for the USA. However, the reason used to
explain the adjustment process for Spain does not necessarily hold for Switzerland. Unlike
Spain, which was in a boom market during the 1990s, the growth in Switzerland during
that period was smaller, and therefore less capital expenditures were made and internal
financing was sufficient. Whenever the Swiss companies needed external funds to finance
their investments they relied on borrowing more than equity increases. However, it
remains difficult to tell whether these decisions may be considered as a result of a POT
or TOT behaviour since the POT and the dynamic specification of the TOT may both
consider the use of debt in this case. There is also a purely mechanical reason that
can explain the lower level of debt within the framework of a dynamic TOT model.
When stock prices increase due to a market boom without an increase in the size of assets
nor in the value of the growth options, this will lead to a decrease of the leverage.8
Some institutional factors tend to lead to a high level of debt rather than a low level of
debt. Hertig (1998) shows that Swiss firms have benefited from relatively easy credit
during the period under study. This is because loans were often granted based more on
personal relationships, than based upon objective criteria. The large banks were the first
to modify their organisation by splitting credit analysis from credit decisions, and by

8
In this case, managers may be inclined to raise equity which would further reduce the debt level.

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64 P. Gaud, E. Jani, M. Hoesli and A. Bender

using criteria based on company expected earnings. In contrast, cantonal banks, in part
due to political reasons, have been more inclined to continue granting loans based on the
old system of credit, thus providing Swiss firms with relatively inexpensive financing
given the risk incurred. It is difficult, however, to measure the effect of the cantonal bank
behaviour on the capital structure policy of listed companies as they predominantly
finance non-listed SMEs. There might be some indirect benefits for listed firms too.
As far as corporate governance is concerned, Hertig (1998) shows that the role of large
banks in Switzerland during the period under review is quite limited. For example, the
stockholdings of large banks giving them more than 10% of the voting rights in industrial
companies is less than 5% of their total assets (BNS, 1992–2001). One of the consequences
of the passive role of bank representatives on the boards of Swiss companies, the high
concentration of ownership (La Porta et al., 1998), and the lack of control in bank credit
proceedings is that agency costs stemming from the conflicts of interest between lenders
and borrowers are mainly borne by lenders. This will lead to an increase in the use of debt.
For the above reasons, we can conclude that being in disequilibrium due to a mechan-
ical effect is not so costly. Two factors appear to explain the slow adjustment process of
the debt level towards the target. On the one hand, there is a purely mechanical reason
due to the bullish stock market that leads companies to find themselves with a lower
leverage than the target. On the other hand, easy credit policy has enabled companies to
borrow to finance new investments. Such firms will often have an above target leverage.
Such behaviour is rational as the risk premium on bank loan interest rates is too low.
Reported insignificant estimations for FDC are another evidence of these low premia.
Moreover, outstanding levels of cash of Swiss firms may reduce financial distress issues.9
The positive and significant impact of size on leverage is consistent with the results
of many empirical studies (Rajan and Zingales, 1995; Booth et al., 2001; Frank and
Goyal, 2003). It leads us to reject the hypothesis that size acts as an inverse proxy for
information asymmetries. To further investigate the link between size and capital
structure, we divided our sample in two sub-samples. First, we construct a vector of
the medians of SIZE for all firms and then take the median of this vector as a cut-off.
As the small companies have relatively more bank credit in their balance sheet than
larger companies, one might expect the adjustment costs to be smaller for these firms
than for large firms. In both sub-samples, coefficients for the SIZE variable are
significant, positive and of the same magnitude. However, the speed of adjustment
increases for the large firms, although it remains slow compared to other countries.
We performed a test of the equality of the two speed of adjustment coefficients. We
can reject the null hypothesis at the 1% level, which confirms the lower speed of
adjustment for small firms.10 One possible explanation is that large companies have
easier access to the bond markets (Ferri and Jones, 1979) and can adjust more quickly
than small firms.
The coefficient of the TANG variable is positive and significant when market based
leverage is used only. This result is similar to those reported in previous research

9
Jani (2003) finds that the median of cash for Swiss firms is twice as large as that of cash in
most other developed countries.
10
(1 
) is 0.518 for the sub-sample of large firms and 0.703 for the sub-sample of small
companies when leverage is measured using market values (the t-test of the equality of these two
coefficients is 3.43). When book values are used to measure leverage, these coefficients are
0.413 and 0.827 (t-test of 9.99).

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 The Capital Structure of Swiss Companies 65

(Rajan and Zingales, 1995; Kremp et al., 1999; Frank and Goyal, 2003) suggesting
that firms use tangible assets as collateral when negotiating borrowing. The observed
sign of the relationship does not confirm the sign that would be expected when using
the pecking order theory framework. In such a framework, firms with less tangible
assets are more subject to asymmetric information problems, and are more likely to
use debt – mostly short term debt – when they need external financing.
The negative sign of the MTB coefficient confirms the hypothesis that firms with
growth opportunities are less levered when market leverage is used. Such a relation-
ship can also be explained by the market timing of firms, which issue equity when
stock prices are high. However, the MTB coefficient is not significant with book
leverage. To analyse further this relationship we divide our sample in two sub-
samples. Again, we construct a vector of the medians of MTB for all firms and take
the median of this vector as a cut-off. The dummy variable d1 takes the value of 1 for
the lower MTB sub-sample. Then we interact this dummy variable with MTB to test if
there is a difference between the two sub-samples. As we can observe in columns 3 and
4 of Table 3, the sign and significance of the coefficients remain the same irrespective
of the leverage measure for the higher MTB sub-sample. Concerning the lower MTB
firms, we observe a negative and significant relationship between MTB and leverage
when market values are used (0.072–0.171 ¼ 0.243), and a positive and significant
relationship when leverage is measured with book values (0.080).
The latter relation can be explained by the fact that in our lower MTB sub-sample,
companies typically belong to either of the following two categories: (1) companies
with cash-cow activities or (2) companies in financial distress. For the former type of
company, current activities generate sufficient cash to renew assets, and even to
support a marginal increase of assets. Any remaining cash will increase cash and
cash equivalents. Retained earnings will increase also, leading to a lower leverage
ratio. Moreover, as highlighted by La Porta et al. (1998), these companies are often
family-owned (such as Loeb, Vetropak, and Bucher), and may have a strong tax
incentive not to distribute any remaining cash. In addition, the repurchase of shares is
too costly for shareholders who are not tax exempt, which is the case of private
shareholders. For companies in financial distress (such as Axantis, and WMH), banks
are reluctant to lend funds as the prospects are not encouraging. In some cases, these
companies have been forced to sell some of their activities, often with a capital gain,
making it possible to reduce the debt-to-equity ratio level. When market values are
used, the above-mentioned financial operations will have a strong negative impact on
the market value of equity.11 Therefore, the debt-to-equity ratio may even increase.
As reported in several other studies, the PROF variable is negative and significant in
all cases (Ozkan, 2001; Miguel and Pindado, 2001; Frank and Goyal, 2003). This finding
provides support for the pecking order theory. However, caution has to be exercised
before the dynamic nature of the relation between leverage and profitability is examined
(Frank and Goyal, 2003; Titman and Wessels, 1988). To examine the impact of
profitability over the dynamics of borrowing, we add the lagged profitability in equation
(3). This is motivated by the fact that we want to test the persistence of a pecking order
financing as found in our results reported in Table 3, columns 1 and 2. These results are
reported in columns 5 and 6 of the same table. Models such as those of Fischer et al.

11
As mentioned by Goyal et al. (2002), the change of sign may also be a statistical phenomenon
because book leverage and MTB have the same denominator.

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66 P. Gaud, E. Jani, M. Hoesli and A. Bender

(1989) and Leland (1998) postulate the existence of an optimal debt-to-equity ratio, but
allow pecking order behaviour in the short run due to the adjustment costs. Despite the
fact that the current profitability is a determinant of the importance of leverage, the cash
flow generated during the year can be used partly to decrease the level of debt. Lagged
profitability is positive and significant at the 1% level and its impact on leverage is
almost the same in magnitude but with a different sign as expected by a dynamic trade-
off framework and a short-term pecking order behaviour by Swiss firms. One possible
reason could be that Swiss banks have made use of historical data when granting loans;
in such a context, one would expect past profitability to play an important role.
According to pecking order theory, information asymmetries play a central role.
Miguel and Pindado (2001) investigate the reasons that could lead to a preference for
internal financing by including a dummy variable to account for information asym-
metries. Tangible assets account for assets which have been committed. Therefore,
they suffer less from the moral hazard problem underlying the agency conflict
between shareholders and bondholders (Jensen and Meckling, 1976; Myers, 1977).
The reverse holds for intangible assets which are additionally hard to monitor and
have a low residual value. Consequently, the importance of intangible assets indicates
significant problems of asymmetric information, while a high proportion of tangible
assets suggests less such problems. We follow the Miguel and Pindado (2001) two-step
approach to proxy for when asymmetric information exists and when it does not. First,
we derive a score from a factor analysis with principal components on the importance of
tangible and intangible assets relative to total assets.12 Second, we use the sign of the
score to construct a dummy variable (d2) which takes the value 1 for firms that face
minor asymmetric information. We report the results in columns 7 and 8 of Table 3.
PROF and the sum of PROF and our interacted variable, d2(PROF), enter with a
negative sign for the two leverage measures and the coefficient is significant at the 1%
level.13 For a given asset structure, one can hypothesise that asymmetric information
problems decrease with the quality of information and the level of disclosure. This
hypothesis leads us to extend the previous score by adding successively two types
of ratings in the factor analysis: Investor Relations and the Level of Disclosure.14
Both ratings are developed by Finanz und Wirtschaft for the Swiss Stock Guide.
None of the resulting dummies when interacted with the PROF variable alters our
conclusions. There is no evidence to conclude that the preference for internal
financing is related to information asymmetries. Our results rather suggest that

12
The eigenvalue of the first factor is 1.343; the component loadings for this factor being 0.707 and
0.707 for tangible and intangible assets, respectively. Therefore, this score is positive for firms with
relatively high levels of intangible assets and low levels of tangible assets. As a result, firms exhibiting
a positive score should face higher asymmetric information problems.
13
For the lower asymmetric information sub-sample, the coefficient is 0.481 þ (0.186) ¼
0.667 when leverage is based on market values and 0.643 þ 0.065 ¼ 0.578 when leverage
is based on book values. The linear restriction test rejects the null hypothesis at the 1% level.
14
The Investor Relations rating is based on various criteria that cover both structural and
information policy aspects (income-oriented dividend policy, capital market transactions,
capital and voting structure, etc.). The Level of Disclosure is based on aspects such as
consolidated accounts in accordance with internationally recognized standards, breakdown of
sales and profit by divisions, regions and/or subsidiaries, publication of interim reports and
clearly formulated company strategy.

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 The Capital Structure of Swiss Companies 67

there is a negative mechanical impact of internal financing on the debt level, which
is consistent with the dynamic TOT.

5. Concluding Remarks

This paper presents a study of the determinants of the capital structure for Swiss
companies. The analyses are performed using data pertaining to 104 firms for the
period 1991–2000 in a dynamic panel framework. This analysis is conducted using a
combination of the GMM approach and instrumental variables to check for endo-
geneity in variables.
Our results show that the size of companies and the importance of tangible assets
are positively related to leverage, while growth and current profitability are negatively
associated with leverage. The dynamic analysis suggests that there exists a target debt-
to-equity ratio. Lagged profitability has a positive impact on leverage, which confirms
the prediction of a short term pecking order behaviour towards the target ratio.
However, the adjustment process is shown to be very slow. We argue that the most
realistic explanation is that being in disequilibrium is not costly for Swiss companies.
Once data for a longer time period are available, research should focus on the
analysis of the stability of the speed of adjustment of Swiss firms towards the target
debt-to-equity ratio. Also, the results contained in our paper suggest that macroeco-
nomic events and the institutional context play an important role on the capital
structure decisions of Swiss companies. It would seem appropriate that further
research focus on the role played by the institutional framework, such as the impact
of taxation and that of the relative importance of the various sources of credit
(securitised debt vs. bank debt).
From an empirical perspective, emphasis should be placed on constructing dynamic
models that enable to discriminate between the various factors that impact on the
target and those that impact on the speed of adjustment. Finally, focus should be
placed on the ownership structure of Swiss companies to examine how firms make
their financing decisions.

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