Legal Systems, Capital Structure, and Debt Maturity in Developing Countries

• Author: Rima Turk Ariss
• DOI: http://doi.org/10.1111/corg.12132
• Published date: 01 March 2016
• Date: 01 March 2016

Legal Systems, Capital Structure, and Debt

Maturity in Developing Countries

Rima Turk Ariss*

†

ABSTRACT

Manuscript type: Empirical

Research Question/Issue: This paper analyzesthe importance of two aspects of the legal system in shaping f‌irm leverage and

debt maturity structure across developing countries.

Research Findings/Insights: Usinga larger numberof developing countries comparedto prior research, four main f‌indingsare

obtained. First, whereas corruption increases f‌irm debt f‌inancing, its effect is moderated when considering the impact of

stronger laws. Second, the common versus civil law distinction does matter for f‌irm f‌inancing in developing countries, but in

the opposite direction documented for developed countries. Third, less corruption combined with stronger laws increases

reliance on long-term debt. Finally, by listing on a developed exchange abroad, f‌irms in developing countries are able to raise

equity and extend the maturity of their debt.

Theoretical/Academic Implications: The f‌indings on the relative importanceof the legal system for f‌irm f‌inancing decisions in

developing countries do not necessarily agree with priorf‌indings for developed countries.Future research focusing exclusively

on developing countries may be warranted to better understand the drivers of private sector-led growth in these economies.

Practitioner/Policy Implications: This study reinforces the importanceof strengthening public governanceand laws as well as

deepening capital markets in developing countries to improve f‌inancing conditions.

Keywords: Corporate Governance, Developing Countries, Corporate Financing, Corruption, Legal Origin

INTRODUCTION

Since the seminal work of La Porta, Lopez-de-Silanes,

Shleifer, and Vishny (LLSV, 1997, 1998, 2002), a growing

body of the law and f‌inance literature has shown that institu-

tions may affect corporate decisions (e.g., Claessens, Djankov,

& Nenova, 2001);Giannetti, 2003). Further, differences in insti-

tutional featuresare found to explain capital structure choices

not just in developed but also developing countries (Booth,

Aivazian, Demirguc-Kunt, and Maksimovic (BADM), 2001).

More recent evidence by Fan, Titman, and Twite (FTT, 2012)

also conf‌irms that f‌irm f‌inancing decisions across both devel-

oped and developing countries are inf‌luenced by corporate

characteristicsas well as the institutional environment. In par-

ticular, FTT (2012) emphasize the role that the legal system

plays in explaining variations in leverage and debt maturity,

reporting that f‌irms in more corrupt countries and with

weaker laws use more debt, especially short term.

Following the tradition of BADM (2001), we focus exclu-

sively on developing countries, considering a much larger

sample of f‌irms from 22 developing countries; BADM (2001)

includes f‌irmsfrom only 10 developing countries). The impor-

tance of the role played by developing countries can be

gauged by the enlargement of the G7 to the G20 to include

11 emerging economies, which are regarded as playing a key

role in restoring global output growth since the 2008 crisis.

Against this background, a better understanding of f‌irm f‌i-

nancing choices in developing economies may help spur pri-

vate sector-led growth.

Among the few studies that recognize the importance of

drawingconclusions separately for developed and developing

countries when analyzing corporate f‌inancing decisions, FTT

(2012) focus on two aspects of the legal system: corruption

and legal origin. These two characteristics capture different

features of the legal system, namely the integrity of the laws

(or public governance) and their strength, and they vary

considerably across developing countries in our sample. To il-

lustrate, Chile –a civil law origin country –scores best on public

governance with a low corruption index of 9.61 on a scale of 100,

whereas Nigeria –a country with common legal tradition –

scores worst at 88.29. More broadly, the mean corruption index

in our sample across common law countries (42.22) is statisti-

cally signif‌icantly lower than the corresponding average for

civil law countries (46.03). In view of these variations across

developing countries, one can only wonder whether the joint

consideration of the integrity of the laws and their strength

matters for corporate f‌inancing choices in these economies.

*Addressfor correspondence: Rima TurkAriss, InternationalMonetary Fund, European

Department,HQ1-212F, 700 H Str.,WashingtonD.C. 20431. E-mail: rturk@imf.org

†

The views expressed in this paper are those of the author(s) and do not necessarily

representthe views of the IMF,its Executive Board, or IMF management.

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12132

130

Corporate Governance: An International Review, 2016, 24(2): 130–144