In the aftermath of the Global Financial Crisis, there were heightened concerns that a reduced availability of long-term finance and the resulting rollover risks would adversely affect the performance of small and medium-sized firms and hamper large fixed investments. Policy makers argued that, as a result, developing countries’ ability to sustain rates of economic growth sufficiently high to reduce poverty and ensure shared prosperity would be diminished. Recently, as corporates of emerging markets have benefited from favorable global liquidity conditions to issue long-term bonds, policy discussions focused on the stability risks of high leverage that could materialize when monetary conditions normalize.
What does the evidence on capital structures tell us? In a new paper prepared for the Global Financial Development Report 2015/2016 on Long-Term Finance, Asli Demirguc-Kunt, Maria-Soledad Martinez-Peria and I study how the Global Financial Crisis impacted the capital structure of firms, focusing in particular on privately held firms and on small and medium sized enterprises (SMEs). We rely on a large dataset of about 277,000 firms from 79 countries, covering the period 2004-2011. The data are collected from Bureau Van Dijk in the ORBIS database.
According to theory, leverage and debt maturity are expected to decline during a crisis because firms and providers of finance adjust to higher uncertainty, higher risks, and lower returns by stepping up risk and term premia (in some cases, suppliers of finance simply cut access to term finance) and because banks restore or protect their soundness partly by tightening lending standards. The resulting decline in the use of long-term finance may not be optimal though, because reduced use of long-term finance can result in a decline in profitable fixed investments and can lower productivity growth.
The authors find that the impact of the Global Financial Crisis on firms’ capital structures was felt in many countries. Firm leverage and the use of long-term debt declined not only in high income countries, where the crisis started, but also in developing countries, including in countries that did not experience a systemic banking crisis. These effects on leverage and debt maturity are economically significant among privately held firms, including among SMEs, even after accounting for the standard empirical determinants of capital structures – such as the share of fixed assets in total assets, the return on assets, the sales turnover (e.g. the ratio of sales to total assets), and the size of the firm – and after accounting for firm time invariant characteristics. The empirical estimates imply that, among privately held firms that used long-term debt before the crisis, the ratio of long-term debt to total assets declined by 1.4 percentage points on average in high income countries and by 2.7 percentage points on average in developing countries. In contrast, the evolution of leverage and of debt maturity seems to have been more complex among publicly traded firms.
The impact of the crisis on capital structures is likely to depend on the characteristics of financial systems and on the institutional environment. In countries with banking systems are less developed (e.g. where monitoring costs are high), or in countries with inefficient legal systems (e.g. where bankruptcy procedures are lengthy and costly and contracts are difficult to enforce), the deleveraging and shortening of maturities are likely to be more severe than elsewhere because conflicts of interest between borrowers and suppliers of finance become more important constraints to lending and borrowing decisions. For example, lenders are likely more reluctant, in time of crisis, to extend long-term credit in a country with inefficient bankruptcy and collateral laws because of the intensified risk of not recouping assets in case of default. On the other hand, the presence of developed capital markets may help mitigate the impact of a credit crunch caused by a banking crisis, especially for large and publicly traded companies.
The evidence suggests that institutional factors and financial development indeed played an important role in shaping the response of capital structures during and in the aftermath of the global financial crisis, irrespective of whether the country experienced a systemic banking crisis.
When focusing on privately owned firms, the authors find that the declines in leverage, debt maturity, and use of long-term debt were significantly larger among SMEs located in countries with less efficient bankruptcy procedures, with less coverage, scope and accessibility of credit information sharing mechanisms (i.e., credit registries and credit bureaus), in countries with less developed banking systems, and in countries with more stringent restrictions on bank entry.
Asli Demirguc-Kunt, Maria Soledad Martinez Peria and Thierry Tressel, 2015, “The Impact of the Global Financial Crisis on Firms’ Capital Structures”, World Bank Policy Research Paper 7522.