Financial crises, banking regulations, and corporate financing patterns around the world

• Published date: 01 September 2022
• Author: Ali Gungoraydinoglu,Özde Öztekin
• Date: 01 September 2022
• DOI: http://doi.org/10.1111/irfi.12381

ORIGINAL ARTICLE

Financial crises, banking regulations, and

corporate financing patterns around the world

Ali Gungoraydinoglu | Özde Öztekin

College of Business, Florida International

University, Miami, Florida, USA

Correspondence

Özde Öztekin, College of Business, Florida

International University, 11200 S.W. 8th St.,

Miami, FL 33199-0001, USA.

Email: ooztekin@fiu.edu

Abstract

This study examines financing behavior during financial cri-

ses in an international sample of corporate firms including

85 countries from 1987 to 2017. Measuring “financial

cyclicality”as the difference between financing levels dur-

ing normal times and financial crisis times, we document

counter-cyclicality in leverage and pro-cyclicality in security

issuances and debt maturity. Financial crises discourage

both debt and equity issuances, with a greater decline in

equity, leverage increases, and debt maturity decreases.

Public debt markets partially act as spare tire during crises

when bank loan supply contracts significantly. Leverage

financial counter-cyclicality is more pronounced in countries

with weaker banking regulations.

KEYWORDS

bank regulations, debt maturity, financial crises, leverage, security

issuance

JEL CLASSIFICATION

G15, G20, G32

1|INTRODUCTION

There is a series of financial crises that stretch back into the mists of time and scattered around the globe. Such

extreme financial events in history are likely due to the confluence of many different factors. Both financial and

regulatory factors may play significant roles in triggering financial crises. While the impact of financial factors on cor-

porate firms have been studied extensively, to date, no study has systematically evaluated firm financing behavior

during financial crisis episodes using a broad range of crisis measures, both systemic and non-systemic, in a large and

diverse international sample with a focus on banking regulatory differences across countries.

Received: 10 January 2019 Revised: 11 February 2022 Accepted: 22 March 2022

DOI: 10.1111/irfi.12381

© 2022 International Review of Finance Ltd.

506 International Review of Finance. 2022;22:506–539.

wileyonlinelibrary.com/journal/irfi

Financial crises sparkly differ from economic downturns, as they coincide with significant tightening of credit

and banking runs or failures and large-scale policy intervention to support banks; are associated with much higher

fluctuations in real and financial sector indicators, including severe and prolonged declines in asset prices; and are

followed by deeper recessions and longer recovery periods. Most economic downturns reflect short-term problems

that can be addressed through a mix of fiscal and monetary policies, whereas financial crises are rare events that

likely require structural policy changes and result in permanent or long-lived disturbances. Thus, the consideration of

the bank regulatory environment is crucial for an evaluation of the impact of financial crises on firm financing behav-

ior. Are there systematic shifts in corporate financing behavior—capital structure, security issuances, and debt

maturity—around the world during financial crises? And if so, in which direction? How do the effects of financial cri-

ses on firm financing behavior vary with the bank regulatory environment? To shed light on these issues, we examine

the financing behavior of corporate firms during financial crises in a comprehensive international dataset covering

85 countries in the period from 1987 to 2017.

A growing body of literature employs cross-country comparisons to study financing patterns in different states

of the economy, with a focus on varying macroeconomic and capital market conditions. These studies quantify the

economic states using (a) a set of macroeconomic determinants (Korajczyk & Levy, 2003), (b) business cycles based

on expansions and recessions (Erel et al., 2011; Halling et al., 2016), (c) a principal components decomposition of a

set of key macroeconomic variables that provides a more nuanced characterization of the phases of the business

cycle (Chang et al., 2019), and (d) normal times and systemic banking crisis times (Halling et al., 2016; Öztekin, 2020).

In this article, we study financial cyclicality of leverage, security issuances, and debt maturity, measured as the

differences in their levels during normal times and financial crisis times. In a closely related study, Halling et al. (2016)

document a leverage effect for recessions that coincide with systemic banking crises for the average firm across a

sample of 18 countries. What is not known is whether their results extend to a much larger panel of countries. More

recently, Öztekin (2020) provides evidence on the heterogeneous effects of systemic banking crises on leverage

dynamics with a focus on capital market conditions (i.e., capital supply constraints and supply-side institutions). The

analysis undertaken herein is complementary to theirs, with important differences. First, we focus on all crises, both

systemic and non-systemic. Second, we establish the relationship between financing choices firms make during

global financial crises and banking sector regulations. Third, since the literature has not yet determined the extent to

which changes in leverage over the financial cycle are due to issuance patterns or debt structure, we link security

issuance and debt maturity choices to the cyclicality during financial crises. Finally, we evaluate the relative impor-

tance of demand and supply effects in leverage changes by controlling for the changes in investments and cash poli-

cies as demand-driven forces and by focusing on how the effects of the traditional determinants of leverage change

during financial crises.

We formulate two broad sets of hypotheses. First, extreme and negative financial market conditions should

adversely affect a firm's overall demand for and access to capital by raising external financing costs as reflected in

higher distress costs, contracting costs, moral hazard problems, agency costs, and information asymmetry costs. If

such costs are raised, we should observe lower levels of external financing during financial crises. During a financial

crisis, both lenders and investors become hesitant to lock-in capital in long-term investments. Thus, total issuances

of both debt and equity would decline. If the decline in equity issuances is more severe, due to their higher sensitiv-

ity to the aforementioned costs, the denominator effect (total assets or debt plus equity) could dominate the numer-

ator effect (debt), leading to an increase in the firm's financial leverage. The negative supply shock to bank debt

during financial crises may also alter the composition of debt by leading to a substitution from bank debt to bonds

for firms with access to public debt markets (De Fiore & Uhlig, 2015; Fernández et al., 2018; Levine et al., 2016). In

addition, financial crises could lead firms to structure securities in ways that lessen their information sensitivity, risk,

and refinancing costs. An increase in investor demand for relatively safe securities could therefore lead firms to issue

securities with shorter maturities (Erel et al., 2011). The conditional probability of obtaining short-term debt is likely

higher relative to long-term debt during financial crises and tightening credit markets as firms turn away from more

information sensitive or more risky debt (Erel et al., 2011). Since long-term securities are more information sensitive

GUNGORAYDINOGLU AND ÖZTEKIN 507

and more risky, financial crises would result in reduced debt maturity. Systematic fluctuation in refinancing risk over

the financial cycle may also play a role in debt maturity decisions. The risk of default and refinancing costs increase

in a crisis, encouraging forward-looking firms to lengthen their debt maturity during normal times to minimize the risk

of refinancing their debt when it is more costly during financial crisis times (Chang et al., 2019; Chen et al., 2021;

Mian & Santos, 2018). Second, the adverse effects of market conditions on firms' financing patterns can be moder-

ated in countries with strong banking regulations that make the banking system more resilient, resulting in a more

attenuated capital supply shock to corporate firms. If so, financial counter-cyclicality in capital raising could be

moderated in countries with stronger banking regulations.

We test these propositions in our comprehensive international sample spanning 85 countries over 31 years. To

assess the impact of financial crises on how firms make decisions on leverage and debt maturity, we employ partial

adjustment models estimated using the system generalized method of moments (SGMM), multilevel mixed effects,

and dynamic panel fractional estimators. Employing logistic regressions, we examine financing behavior outside of

the partial adjustment framework, with complementary evidence from firms' security issuance choices. Our bench-

mark models include an extensive set of controls, including firm, industry, macroeconomic factors, along with firm,

year, and country fixed effects and facilitate ready comparison with a plethora of US and international studies. The

results throughout the article are even stronger when we include various additional country-level time-varying fac-

tors such as debt and stock market conditions along with the usual explanatory variables and firm, country, and year

fixed effects.

We present three types of evidence showing that financial crises significantly affect the financial decisions of a

typical corporation globally. Our first type of evidence takes the form of multivariate regressions explaining leverage.

We estimate partial adjustment models of leverage using the SGMM with financial crisis indicators and an extensive

set of controls, including macroeconomic conditions, firm and industry features, as well as firm, country, and year

fixed effects. Our key finding is that financial crises lead to higher measures of financial leverage. We expose our

main results to a variety of alternative specifications, additional country-level time-varying controls such asdebt and

stock market conditions, and variable definitions without changing our basic conclusion that financial leverage is

counter-cyclical over the financial cycle in the full sample. In other words, leverage decreases during normal times

and increases during times of financial crisis. The influences of financial crises on leverage remain strongly significant

in estimations using book and market definitions of financial leverage, various definitions of crises (systemic and

non-systemic, as well as binary and continuous measures), and estimations employing actual leverage as well as esti-

mated targets as the dependent variables. Our inferences are also robust to alternative empirical specifications,

including multilevel mixed effects models that take into account the hierarchical nature of the data (firms nested

within countries) and dynamic fractional estimators that allow for corner solutions that take into account the

bounded nature of our corporate decision (leverage) variable.

The second type of evidence we present shows that financial crises negatively affect a firm's aggregate security

issuances, which is consistent with increases in financing frictions during such episodes. Logistic regressions indicate

that financial crises tend to discourage both total debt and total equity issuances, albeit with a greater decline in total

issuances of equity. Thus, shareholders also become reluctant to provide capital to firms during financial crises and

this effect was particularly strong during the most recent financial crisis, consistent with large spikes in risk aversion

and risk premiums during such episodes. We also find that bonds did not substitute bank debt during the most

recent global crisis. However, the substitution from bank debt to bonds was significant when all banking crises epi-

sodes are jointly considered. This evidence is consistent with the expectation that public debt market partially acts

as spare tire for firms that are able to tap into bond markets during crisis episodes when bank loan supply contracts

significantly. Thus, financial crisis episodes do not only alter aggregate issuance patterns, but also cause a shift in

composition of credit between loans and bonds.

Our third type of evidence is comprised of the evaluation of the effects of financial crises on debt maturity. Con-

sistent with the supply of capital shifting toward less risky securities during bad economic states, firm preference

shifting toward financing sources with lower sensitivity to information during downturns and lower refinancing risk

508 GUNGORAYDINOGLU AND ÖZTEKIN