Country‐level governance quality, ownership concentration, and debt maturity: A comparative study of Brazil and Chile

• Published date: 01 July 2017
• Date: 01 July 2017
• DOI: http://doi.org/10.1111/corg.12192
• Author: Paulo Renato Soares Terra,Eduardo Schiehll,Henrique Castro Martins

ORIGINAL ARTICLE

Country‐level governance quality, ownership concentration,

and debt maturity: A comparative study of Brazil and Chile

Henrique Castro Martins

1

|Eduardo Schiehll

2

|Paulo Renato Soares Terra

3

1

Universidade do Vale do Rio dos Sinos (Brazil)

2

HEC Montréal (Canada) and Aalto University

School of Business (Finland)

3

Fundação Getulio Vargas, Escola de

Administração de Empresas de São Paulo

(Brazil)

Correspondence

Eduardo Schiehll, HEC Montréal, 3000 Chemin

de la Côte‐Sainte‐Catherine, Bureau 5369,

Montréal, QC H3T 2A7, Canada

Email: eduardo.schiehll@hec.ca

Abstract

Manuscript type Empirical

Research Question/Issue This study investigates the interplay between country‐level

governance quality and the capital structure choice at the firm level in Brazil and Chile. We

examine the association between a firm's ownership concentration and its debt maturity

structure and whether country‐level governance quality influences this association.

Research Findings/Insights Using a large firm‐level dataset from Brazil and Chile for the

period 2008–2013, we find a positive association between low ownership concentration and

debt maturity. However, this association becomes negative when the largest shareholder has high

ownership concentration. This result suggests that long‐term debt and ownership concentration

act as substitute monitoring mechanisms. Moreover, debt maturity is inversely related to our

aggregated index of country‐level governance quality, suggesting that in countries with gover-

nance systems that effectively protect debt holders, firms with high benefits of control (high own-

ership concentration) will use debt with shorter repayment periods in order to benefit from

frequent monitoring by debt holders. Overall, our results support the view that financial markets

tend to pressure firms with high benefits of control or greater agency conflict to make a tradeoff

between the benefits of control and the cost and maturity structure of debt financing.

Theoretical/Academic Implications Thisstudy contributes to the research on comparative

corporate governance and capital structure. We also respond to recent calls to bridge the gap

between under‐and over‐socialized views of corporate governance by examining the interplay

between firm‐and country‐level governance variables. Our findings suggest a substitution effect

between monitoring by equity holders and by debt holders, and that country‐level governance

quality exerts a disciplinary influence over a firm's choice of debt maturity structure.

Practitioner/Policy Implications Investors seeking to enter emerging markets such as

Brazil and Chile can benefit from considering national governance factors that enhance debt

holders’external monitoring effectiveness. Because our findings show the importance of

considering and improving the quality of country‐level governance, they are also useful for policy

makers aiming to reform corporate governance practices in emerging markets.

KEYWORDS

CorporateGovernance, Brazil, Chile, Country‐level GovernanceQuality, Debt Maturity, Ownership

Concentration

1|INTRODUCTION

Corporate ownership and debt financing structures are influential

factors in explaining firms’governance mechanisms and economic

growth (Aslan & Kumar, 2012). For instance, large shareholder

ownership and short‐term debt financing are considered governance

mechanisms because they decrease managerial discretion (Shyu &

Lee, 2009). However, firms’ownership structures and access to financ-

ing vary widely according to country‐level governance mechanisms,

particularly those related to legal origin, financial system development,

Received: 16 July 2014 Revised: 8 December 2016 Accepted: 10 December 2016

DOI: 10.1111/corg.12192

236 © 2016 John Wiley & Sons Ltd Corp Govern Int Rev. 2017;25:236–254.wileyonlinelibrary.com/journal/corg

and investor protection (e.g., La Porta, Lopez‐de‐Silanes, Shleifer, &

Vishny, 1998, 2000). Therefore, in order to assess firm‐level gover-

nance outcomes, it is important to understand the interplay between

the quality of country‐level governance and firm‐level capital structure

(Aslan & Kumar, 2014; Brown, Beekes, & Verhoeven, 2011). This pro-

vides the main motivation for the present study. We investigate the

association between a firm's ownership concentration and its debt

financing maturity structure, and whether country‐level governance

quality influences this association.

The choice between equity and debt, or between short‐and long‐

term debt, has traditionally been regarded as one of the most critical

financial decisions. Since the seminal work of Modigliani and Miller

(1958) and Stiglitz (1974), who suggest that in a perfect market, lever-

age and debt maturity have no effect on firm value, several authors

have addressed this issue, mainly by attempting to explain firm‐level

leverage and debt maturity choices by identified market imperfections

(e.g., Flannery, 1986; Kane, Marcus, & McDonald, 1985; Modigliani &

Miller, 1963; Ross, 1977). From a governance perspective, these

firm‐level choices are assumed to affect the degree of managerial dis-

cretion, and thereby to mitigate or exacerbate agency costs (Florackis,

2008). For instance, debt financing is assumed to decrease information

asymmetry between managers and shareholders (Stulz, 1990) and to

constrain managerial discretion by decreasing a firm's free cash flow

(Jensen, 1986), opportunities for managerial empire building (Hart,

1995), underinvestment (Myers, 1977), and the risk‐shifting problem

(Barnea, Haugen & Senbet, 1980). Ownership concentration is also

considered to be a governance mechanism that minimizes manager–

shareholder agency problems in countries other than the US and the

UK (Kumar & Zattoni, 2014; La Porta, Lopez‐de‐Silanes, & Shleifer,

1999), a perspective corroborated, among others, by Sánchez‐Ballesta

and García‐Meca (2011) in Spain, Shuto and Kitagawa (2011) in Japan,

La Bruslerie and Latrous (2012) in France, Alcock et al. (2012) in

Australia, and Céspedes, González, and Molina (2010) in Latin America.

However, most of the research on the determinants of debt maturity

has been conducted in Anglo‐Saxon countries.

Insofar as various corporate governance practices are prescribed

from within and outside firms, they collectively make up the gover-

nance climate that either enables or constrains managerial and large

shareholder discretion. Building on Aoki and Jackson (2008), we exam-

ine firm‐level ownership concentration in relation to the quality of the

national governance system in order to improve our understanding of

firm‐level capital structure decisions and governance mechanisms.

We propose that long‐term debt and ownership concentration may

act as substitute monitoring mechanisms, and that this relationship

may depend on the quality of the national governance system

(García‐Castro, Aguilera & Ariño, 2013; Ward, Brown, & Rodriguez,

2009). With a few exceptions (Fan, Titman, & Twite, 2012; Kirch &

Terra, 2012; Qian & Strahan, 2007),

1

previous studies of debt maturity

have been conducted within a single national governance system, and

have therefore neglected interactions between debt financing, owner-

ship concentration, and country‐level governance quality.

We conduct a comparative study on a sample of publicly traded

firms operating in two Latin American countries: Brazil and Chile.

Despite certain similarities such as ownership concentration, legal ori-

gin, majority religion, and Latin American culture (Aguilera, Kabbach de

Castro, Lee, & You, 2012a), these countries differ substantially in terms

of country‐level governance factors. As shown inTable A1 in Appendix

A, the mean values for all six governance indicators (Voice and

Accountability, Political Stability and Absence of Violence, Govern-

ment Effectiveness, Regulatory Quality, Rule of Law, and Control of

Corruption) compiled by Kaufmann, Kraay, and Mastruzzi (2011) are

far superior in Chile compared to Brazil. For example, the mean index

score for Rule of Law in Brazil is −.14, whereas in Chile it is positive

at 1.32. Similarly, for Government Effectiveness, Brazil shows a mean

score of −.09 compared to a positive mean score of 1.24 for Chile.

Brazil is therefore classified as a poor governance country, with posi-

tive indexes for Voice and Accountability and Regulatory Quality only.

In contrast, the Chilean governance environment is far superior to that

of Brazil, and quite similar to that of the UK and the US (see Appendix

A for further details). These two countries therefore provide a unique

natural setting for examining the association between ownership

concentration and debt maturity structure. Although a two‐country

comparative study may have limited generalization potential, the more

concentrated focus has the advantage of better data control, “while

holding constant other factors that might be difficult to disentangle in

[large] cross‐country studies”(Fan, Wei, & Xu, 2011: 207).

Our results indicate a nonmonotonic relationship between a firm's

ownership concentration and its debt structure. The association

between ownership concentration and debt maturity is positive for

lower concentrations, but becomes negative when large shareholders

own larger stakes in the firm, suggesting a substitution effect between

monitoring by debt holders and by large shareholders. In addition, we

find a significant effect of country‐level governance quality on a firm's

debt maturity structure, such that firms in countries with better gover-

nance systems –in our study, Chile compared to Brazil –use more

short‐term debt. Our results indicate that dominant large shareholders

make a tradeoff between the private benefits of control and the

agency cost of debt (Aslan & Kumar, 2014), and that country‐level gov-

ernance factors exert a disciplinary influence over large shareholders’

choice of debt maturity structure. However, we find only weak support

for the hypothesis that country‐level governance quality strengthens

the association between a firm's ownership and its debt maturity.

This study advances the research on cross‐country corporate gov-

ernance and capital structure in several ways. First, we respond to

recent calls to bridge the gap between under‐and over‐socialized

approaches to corporate governance research (Aguilera & Jackson,

2003; Kumar & Zattoni, 2013). We consider interactions between

firm‐and country‐level governance variables and provide relevant

insights into the relationship between ownership concentration and

debt maturity structure. Furthermore, although listed UK and US firms

are overrepresented in the empirical governance literature (Kumar &

Zattoni, 2014), little is known about debt financing structure and own-

ership concentration choices in emerging markets such as Brazil and

Chile. Second, we contribute to the recent research stream that

addresses the impact of country‐level governance environments on

firm‐level capital structure decisions (Aslan & Kumar, 2012; Lin, Ma,

Malatesta, & Xuan, 2011; Shyu & Lee, 2009). Our findings suggest that

an examination of country‐level differences in terms of governance

quality in relation to ownership concentration would provide a deeper

understanding of debt maturity structure, which may explain the

MARTINS ET AL.237