Impact Of Ownership Structure On Debt Equity Ratio

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02 Nov 2017

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Higher Institute of Gabes, Gabes 6002, Tunisia. GSM: (00 216) 93 700 039. E-mail: [email protected]

Abstract:

This study examines the determinants of capital structure as part of the agency theory. French corporate structure with its high corporate concentration provides able us to analyze how ownership variables affect debt policy. Emphasis is placed on the role of ownership structure and ownership concentration in explaining the debt ratio. The empirical study examined a sample of French companies listed on SBF 250 index and observed over the period 1997-2007. Test results show a non linear relationship between managerial ownership and capital structure. Outside shareholdings do not play a disciplinary role to effectively control the behavior of managers in a static framework. However, for high levels of managerial ownership, outside shareholdings does not significantly affect debt ratio. The results remain unchanged in a dynamic framework.

Keywords: ownership structure, management ownership, outside shareholdings, capital structure, retrenchment effect, control effect

1. Introduction

With reference to the literature, a diversity of research have dealt with the determinants of debt borrowing along the way various perspectives, as mentioned in the arguments, postulating and adopting various methodological frameworks.

Before detailing the methodology and results, a summary of the theoretical framework based on the work of Jensen (1986) and Stulz (1990) is an order. Managers in large firms, generally, receive high salaries and take private benefits. Jensen (1986) points to the preference of managers to increase firm size through excessive investment for private benefit, highlighting the disciplinary role of debt which limits the opportunistic behaviour of managers. Based on the argument of Jensen (1986), Stulz (1990) assumes that managers want to invest funds even if the return of liquidity in the form of dividends is better for shareholders. Debt can alleviate the problem of over-investment because the repayment of debt reduces free cash flow. The cost of leverage in their model is that the repayment of debt may reduce funds available for profitable investments and implements the problem of under-investment (assuming free cash flow).

Even if the debt policy is a mechanism of internal control that reduces the problem of over-investment, why do managers in firms characterized by agency problems repaying Free Cash Flow with an increase in debt ratio? The choice of the leverage itself raises an agency problem between shareholders and managers. As suggested by Zwiebel (1996), the assumption of free cash flow requires disciplinary systems that lead managers to use more leverage. On the contrary, if the disciplinary mechanisms directly control the problem of over-investment, leverage and disciplinary systems are likely to serve as alternative mechanisms to attenuate agency conflicts of Free Cash Flows.

In the founding theories of corporate governance, there are several control mechanisms to reduce agency conflicts between shareholders and managers such as the remuneration policy for mangers, characteristics of the Board of Directors, labor market managers and market control of the firm, ownership structure, and concentration of ownership (Agrawal and Knoeber, 1996, Jacelly and Maximilano, 2010; Dimitris and Psillaki, 2010; Julie and Yang 2010).

Moreover, within the founding financial theory (Demsetz, 1983; Shleifer and Vishny, 1986; Agrawal and Mandelker, 1990; Dimitris M. and Psillaki M, 2010; Julie A.E and Jimmy Y, 2010; Alvaro G., Taboada, 2011), the decision of funding depends on firm’s ownership structure. Given these arguments, it appears that the debt is associated with the ownership structure and thus it justifies the purpose of this article. Our paper is organized as follows. In the second section we examine previous empirical and theoretical literature which has developed the potential links between ownership variables and capital structure. Section 3 will be devoted to the analysis of data and methodology. The results are presented in section 4 using two methods of estimation « GMM » method and « Data Panel » method. Dynamic analysis of the relationship between of ownership structure and debt equity ratio is reported in section 5. Sensitivity tests are conducted in section 6. Section 7 will present the concluding remarks.

2. The literature review

The question of the relationship between debt and ownership structure (Shleifer and Vishny, 1986, Boot and Thakor, 1993, Dewatripont and Tirole, 1994, Burkart, Denis and Panunzi, 1997; Myers, 2000) raised a controversy between the main currents of financial literature. Moreover, in the context of the agency theory, the article by Jensen and Meckling (1976) explores the relationship between debt and ownership concentration. The authors highlight that managers follow an opportunistic behaviour and try to dilute the ownership structure by funding investment by equity issuance. Managers take in this case the most important private benefits, while bearing the costs with the new shareholders. Outside investors anticipate this agency problem and offer, therefore, lower prices to acquire the shares of the company, increasing therefore the cost of equity financing. A similar theoretical argument explains the debt financing. Indeed, the agency problem between managers and shareholders stimulate creditors to increase the cost of debt financing. Thus, Jensen and Meckling (1976) support the idea that the optimal debt ratio is the ratio that jointly minimizes the sum of agency costs of debt and equity. So, it appears from this discussion that the decrease in concentration of ownership leads to higher agency costs, and therefore a decrease in the debt ratio.

Debt plays a similar role to reduce risk as suggested by Fama (1980). In line with the work of Alchian and Demsetz (1972) and Jensen and Meckling (1976), Fama (1980) defines the firm as a knot of contracts between factors of production. Indeed, the different partners of the firm (managers, shareholders) behave in their own interests. In addition, managers who are investing heavily their human capital in the firm try to ensure its survival and sustainability of the firm. In this regard, Fama (1980) argues that the separation between ownership and control can be explained as an effective form of economic organization within the firm. Thus, to ensure the economic survival of the firm, Fama (1980) emphasizes that managers try to minimize the risk of bankruptcy by reducing the firm’s debt ratio. This result is in favour of a negative relationship between debt and managerial ownership.

In the light of the theoretical work of Jensen and Meckling (1976) who assume that the issue of external debt leads to agency costs arising from conflicts of interest between existing shareholders and creditors and the managerial ownership reduces the agency costs. Kim and Sorensen (1986) examine empirically the relationship between debt and agency costs. thus, following the methodology suggested by Leland and Pyle (1977), Downes and Heinkel (1982) and Rozeff (1982), Boquist and Moore (1984), Bowen, Daley and Huber (1982), Ferri and Jones (1979), Flath and Knoeber (1980), Jensen (1983) and Scott and Martin (1975), Kim and Sorensen (1986) divide a sample of 168 U.S. firms into two groups: one group containing 84 firms with high managerial ownership, and a second group containing 84 firms with low managerial ownership. Managerial ownership in the first group equals to 43%, whereas in the second group it equals to 2%. The empirical results show that firms with high managerial equity have higher debt ratios then those with low managerial shareholdings. This can be explained by the existence of agency costs. However, these nonparametric tests have drawbacks, including not taking into account the effects of other factors on leverage ratios. Kim and Sorensen (1986) resolve this problem by testing a system of equations and conclude that these models explain only 20% of the variation of debt and that managerial ownership positively and significantly affects the capital structure.

Stulz (1988) examines the impact of managerial ownership on the value of the firm and financial decisions. The author develops a model in which conflicts of interest between managers and outside shareholdings occur only when a potential takeover affects differently the utility of the various partners of the firm. The author concludes that the premium paid is an increasing function of managerial ownership. On the other hand, Stulz (1988) reports that the debt increases the share of capital held by management, reducing therefore the probability of takeover, and increasing the premium paid. Harris and Raviv (1988) develop a theoretical model similar to Stulz (1988) and conclude a positive relationship between debt and managerial ownership.

Following Larner (1971), McEachern (1975), Herman (1981) and Sorensen (1974), the work of Chaganti and Damanpour (1991) revolves around two related issues: what are the relationships between outside institutional shareholdings, on the one hand, and the capital structure and performance, on the other? Does managerial ownership explain this relationship? The empirical results obtained on a sample of 40 industrial firms over a period of three years from 1983 to 1985, show that the size of the share capital of the outside institutional shareholdings has a significant effect on the capital structure of firms. Chagnat and Damanpour (1991) also find that institutional shareholders and family executives attenuate the relationship between outside institutional shareholdings and capital structure. Likewise, managerial ownership improves the relationship between outside institutional shareholdings and performance of firms. These results suggest that internal and external coalitions interact with each other to influence the firm’s conduct.

In line with the work of Peterson and Benesh (1983), Dhrymes and Kurz (1967), McCabe (1979), Jalilvand and Harris (1984), Jensen and Solberg (1992) examine the determinants of cross-sectional differences in insider ownership, debt and dividends policies. These financial decisions are interrelated not only directly, but also indirectly through their influence on the operating characteristics of firms. Using a sample of 565 firms for 1982 and 632 firms for 1987 in an "American" context and using the method of triples least squares, Jensen and Solberg (1992) conclude that the financial decisions and level of insider ownership are interdependent. Specifically, the insider ownership affects negatively levels of debt and dividends of the firm. In addition, the results strongly support the theory of "Pecking Order", which suggests that agency costs and bankruptcy costs also affect the financial decisions of the firm

Working in the line with the approaches of Huddart (1993) and Admati, Pfeiderer and Zechner (1994) which examine the role of the controlling shareholder in solving problems of managerial moral hazard, and the work of Harris and Raviv (1991) which explores the capital structure in the presence of agency conflicts and / or asymmetry information, Zhang (1998) examines the effect of capital structure on investment decisions of a firm controlled by a large risk-averse shareholder. The author concludes that the controlling shareholder is more likely to accept the project if the firm has higher debt ratio. In short, the work of Zhang (1998) implies a positive relationship between debt and ownership concentration. The larger the share capital held by the controlling shareholder, the more the firm employs debt. In addition, for a given level of concentration of ownership, the debt ratio is higher for firms with a large risk-averse shareholder. Usually, individual shareholders are more risk averse than institutional shareholders. This conclusion was motivated by several empirical studies. Mehran (1992) shows that the debt ratio is positively related with the share capital hold by the largest shareholder. Moreover, this relationship is statistically significant when the shareholder is an individual investor, but not statistically significant when the shareholder is an institution. Friend and Lang (1988) show that firms with controlling shareholders have higher debt ratio than firms without controlling shareholders.

Based on the theoretical and empirical works of Demsetz and Lehn (1985), Crutchley and Hansen (1989), Galai and Masulis (1976), Amihud and Lev (1981) and May (1995) that highlight the causal relationship between managerial ownership and risk of the firm, the work of Jensen, Solberg and Zorn (1992) that examines the interdependence of managerial ownership, debt and dividends, the work of Ravid (1988), Friend and Lang (1988) that emphasize the relationship between debt and managerial ownership, Chen and Steiner (1999 ) uses a nonlinear simultaneous equation methodology to examine how managerial ownership relates to risk taking, debt policy and dividend policy. Using a Least Square method, the results indicate that low levels of risk may positively affect managerial ownership, which is consistent with the effect of aligning the interests of shareholders and managers. At high levels of risk, the authors find managerial risk aversion to be a significant effect. The results also indicate that managerial ownership affects positively the risk of the firm, which is consistent with the contention that managerial ownership serves to exacerbate the conflict between shareholders and bondholders. Finally, Chen and Steiner (1999) document a substitution monitoring effect between insider ownership and debt policy and between insider ownership and dividend policy.

John and Minkler (2001) incorporate the theoretical arguments put forward by Jensen and Meckling (1976) and develop a dynamic model that examines the relationship between debt and ownership concentration. John and Minkler (2001) conclude that the debt and ownership concentration are inversely related.

Rishard and Fosberg (2004) propose to test the theory of Friend and Hasbrouck (1988) using a sample of 350 U.S. firms for a period of seven years from 1990 to 1996. Having replicated descriptive statistics, Rishard and Fosberg (2004) conclude that the debt of the firm decreases with an increase in the share of capital held by management. A direct relationship was found between outside shareholdings and debt ratio of the firm. This result suggests that outside investors effectively control agency problems related to sub-optimal debt policy. In addition, for a given level of outside shareholdings, the greater the number of external shareholders is, the less effective the disciplinary role of outside shareholdings.

following the work of Demsetz and Lehn (1985) and Himmelberg, Charles P., Hubbard, R. Glenn, Palia and Darius (1999), Demsetz and Villalonga (2001) who argue that the ownership structure and performance are often affected by the same financial characteristics of the firm, Michael and Santor (2008) examine how the family ownership affects the performance and capital structure for a sample of 613 "Canadian" firms for a period of 8 years from 1998 to 2005. The authors distinguish the effect of family ownership from the use of control enhancing mechanisms. Following the empirical methodology developed by Himmelberg, Charles P., Hubbard, R. Glenn, Palia and Darius (1999), Claessens, Stijn, Djankov, Simeon, Fan, J.P.H., Lang, Larry H.P (2002), Michael and Santor (2008) points to the positive and statistically significant effect of control of individual shareholders on firm’s debt ratio consistent with the theoretical proposals of Stulz (1988). Similarly, ownership family and institutional ownership affect positively and significantly the debt ratio. The authors also conclude that firms with ownership family of one class of shares have more debt in their capital structure, with a financial leverage that is 2.2% higher on average than the other firms. Indeed, family single firms may issue more debt to grow assets without diluting ownership, while family dual firms can issue non-voting equity without diluting their control stakes.

Based on the methodology developed by Leibenstein (1966), Dimitris and Psillaki (2010) investigates the relationship between capital structure, ownership structure and firm performance. Using an estimate of the firm’s productivity efficiency, Dimitris and Psillaki (2010) examines the impact of debt on agency costs. Specifically, the authors test the impact of debt on firm performance (Jensen and Meckling, 1976). In addition, the econometric task is to test the effect of efficiency on the firm's capital structure and whether this effect varies with industries. Similarly, Dimitris and Psillaki (2010) explicitly consider the role of ownership structure in capital structure and performance of the firm. Using the method of least squares, the empirical results show that debt significantly affects firm efficiency (McConnell and Servaes, 1995; Jensen, 1986; Stulz, 1990, Booth and Maksimovic, 2001). Similarly, the concentration of ownership significantly affects the performance of the firm within the chemical industry. Concerning the second model, the empirical results show a positive and significant effect of the firm efficiency on debt ratio. Throughout this analysis, the authors conclude that the ownership concentration does not affect significantly the firm’s debt ratio for all industries sectors except for the sectors of information technology and research and development.

by referring to the work of Bradley et al. (1984), Titman and Wessels (1988), Kale et al (1992), Rajan and Zingales (1995), Booth et Jarell et Kim (2001), Flannery and Rangan (2006) and Hovakimian (2006) made in the context of Latin America, Jacelly and Maximiliano (2010) evaluates the capital structure determinants using a sample of 806 non-financial firms for a 10-year period from 1996 to 2005, covering seven countries, "Argentina", "Brasile", "Chile", "Colombia", "Mexico", "Peru" and "Venezuela." Firms in these countries have debt levels similar to U.S. firms, which is puzzling given that these countries experience relatively lower tax benefits and higher bankruptcy costs. Having replicated descriptive statistics, the authors show a statistically significant negative relationship between debt and ownership concentration. In addition, the coefficient on the variable "Herf-ind2" is positive and statistically significant. These results highlight the existence of a nonlinear relationship between debt and ownership concentration. Firms of larger size, which have more tangible assets and growth opportunities, and are less profitable, have higher leverage than others. This last result confirms the theory of "Pecking Order".

3. Data and Methodology

3.1. Sample selection

Our sample consists of 246 non-financial French firms listed on the index "SBF250" for a period of 11 years from 1997 to 2007 which belonging to several sectors ( oil sector: 17 firms (6.90%), industrial sector: 115 firms (46.74%), transportation sector: 20 firms (8.13%), trade sector: 42 firms (17.07%), service sector: 52 firms (21.14%)). This allowed us to form a cylinder of stacked data panel of 2706 observations. The study of the effect of ownership variables on capital structure requires the use of different sources of information. The databases' MERGENTONLINE "," DATASTREAM "," and "FMI" are our primary sources of information. Occasionally, we use the database "MERGENTONLINE" to collect accounting and financial data from company financial statements. The market capitalization of firms is obtained by consulting the database "DATASTREAM" .With regard to the macroeconomic factors used to calculate the market value of debt (interest rate long-term interest rates in the short term, price index for consumption), they are obtained from the database "FMI". Regarding the data on the ownership structure of firms, they are obtained from the annual reports available on the "MERGENTONLINE" database.

3.2. The models

The models are conducted on Book and Market measure of Leverage ( DE1 and DE2). Regarding the first step, and as our subsequent theoretical developments may indicate: it is to test the relationship of non-linearity between management ownership and capital structure in a static framework;

DE1 = f (MSO, MSO2, SIZE, PER, IND, TRA, COM, SER, VOLTY, GROWTH, PROF, FCF, INTA, NDT, DIV) (1)

Then, we test the relationship between outside shareholdings and capital structure;

DE1 =f (EBO, SIZE, PER, IND, TRA, COM, SER, VOLTY, GROWTH, PROF, FCF, INTA, NDT, DIV) (2)

The third test is the study of the relationship between outside shareholdings and capital structure at different levels of management ownership referring to the founding theories of the firm, namely the agency theory and portfolio theory.

DE1 =f (MSO, MSO2, EBO,, SIZE, PER, IND, TRA, COM, SER, VOLTY, GROWTH, PROF, FCF, INTA, NDT, DIV) (3)

Finally, we operationalise our approach to a dynamic analysis of the relationship between debt and ownership structure using a partial adjustment model that underlies the "trade off" theory revisited following the methodology advocated by Flannery and Rangan (2006). This theory assumes the existence of a target debt ratio (Shyam-Sunder and Myers, 1999; Hovakimian, Opler, and Titman, 2001; Ivo Welch, 2004). Thus, in a dynamic framework we estimate the following models

(4) (5)

(6)

(7)

(8) (9)

3.3. Choice of variables and hypothesis to be tested

The dependant variables

Following Rajan and Zingales (1995), we use two main measures of long-term debt ratio are used; the first is the Book Leverage (BL) (Friend andLang, 1988 ; Titman and Wessels, 1988; Harvey, Lins and Roper, 2004; Kee Hong, Kang and Wang, 2011) which measures the level of debt as the ratio of the book value of long term debt to market value of equity [DE1 = BVLTD/MVE]; the second measure is the Market Leverage [1] (Bowman, 1980; Brian and Zhang, 2011; Prasit U, Seksak J, Pornsit J; 2011) by substituting the book value of long term debt by market value of long term debt [DE2 = MVLTD/MVE]

The explanatory variables

Management ownership is defined as the percentage of shares held by all executive directors and non-administrative. Managerial ownership is a great incentive to manage the business in accordance with the interests of shareholders (Jensen and Meckling, 1976, Grossman and Hart,1982 ; Claessens, Djankov, Fan and Lang, 2002; Anderson and Al, 2003; Kouki M and Ben Said H, 2011). We assume that for low levels, the managerial ownership is positively related with the debt ratio (hypothesis of alignment of interest 1). In addition, Jensen and Meckling (1976) Grossman and Hart, 1980), Chen and Steiner (1999), Hermalin and Weisbach (1991) argue that for levels of managerial ownership above 20%, debt and managerial ownership are inversely related. Due to the effect of retrenchment, we assume that for high levels of managerial ownership is negatively related with debt ratio (retrenchment effect hypothesis 2). For sensitivity analysis, we use as approximation of management ownership, the share of capital held by the largest shareholder, two largest shareholders, three largest shareholders, four largest shareholders and five largest shareholders.

External Block Ownership is defined as the percentage of shares held by the five largest shareholders. Friend and Lang (1988), Mehran (1992) and Shleifer and Vishny (1986) suggest that External Block Ownership is encouraged to monitor and influence managers to protect their significant investments (Friend and Lang, 1988; Mehran, 1992). Due to the effect of control (Shleifer and Vishny, 1986), we assume that the External Block Ownership is positively related with the debt ratio (effect control hypothesis 3). However, previous studies have considered only the effect of outside shareholdings on capital structure (Friend et Lang, 1988; Jensen and Solberg, 1992; Kim and Sorensen, 1986; Mehran, 1992). In our paper, we will test the effect of the interaction of External Block Ownership with managerial ownership on capital structure. For low levels of managerial ownership (Dummy variable less then 20%), external shareholders have a significant role in controlling the behaviour of managers, leading to a lower managerial opportunism (effect of control) and a higher debt ratio (hypothesis 4). However, for high levels of managerial ownership (Dummy variable above 20%), the effect of control of external shareholders is rewarded by a retrenchment effect. Thus, the relationship between outside shareholdings and debt for high levels of managerial ownership is weakened (hypothesis 5). Similarly, for sensitivity analysis, we use the share of capital held by the largest shareholder, two largest shareholders, three largest shareholders and four largest shareholders.

SIZE, is measured by the natural logarithm of total assets. This variable is inversely related to risk of bankruptcy. Then "size" positively affects debt ratio of the firm (Scott and Martin, 1975, Ferri and Jones, 1979, Friend and Lang, 1988, Agrawal and Nagarajan, 1990). In addition, the "Free Cash Flow" theory of Jensen (1986) suggests that large firms, with significant cash flow, are expected to issue more debt to discipline managers and ensure tax savings. On the other hand, information asymmetry is likely less severe for larger firms than smaller firm. Thus, larger firms can issue equity to fund investment, allowing larger firms to have lower leverage. We suppose a positive relation between size and leverage (hypothesis 6).

Activity sectors, Boquist J.A and W.T Moore (1994), Flat. D and Knoeber C.R (1980), Kai L, Heng Y and L. Zhao (2009) call for integrating the impact of industries on the debt ratios. Using the Standard Industrial Classification "SIC" digit Codes. In particular, we will also integrate the following sectors: Oil (PER), Industrial (IND), Tranport (TRA), Trade (COM) and Service (SER).we compute this variable as a binary variable (1 or 0).

Volatility Various measures are used in the literature to measure earnings volatility. Bradeley Jarell and Kim (1984) used the standard deviation of the annual percentage change in cash flow (earnings before interest, taxes and depreciation). Titman and Wessels (1988) used operating income instead of cash flows in the construction of their measures of volatility. In our paper the volatility is measured as the standard deviation of the annual percentage change in operating income before interest, taxes and depreciation (Bradely, Jarell and Kim, 1984). Given the volatility of the firm’s future earnings as the key factor in determining the ability of the firm to meet its financial charges, it is an indicator of the risk business (Ferri and Jones, 1979). Because creditors are interested in the net income of the firm as a means of protection, an increase in earnings volatility decreases the supply of debt (Bradley, 1984; Mehran, 1992) (hypothesis 7).

Growth opportunities will be approximated by the annual percentage change in total assets. Kim and Sorensen (1986), Titman and Wessels (1988), Jensen et al (1992) and Mehran (1992) suggest that growth opportunities for the firm are a good proxy for agency costs of debt. Given agency relationship between managers and debtholders, a negative sign is expected on growth opportunities. This conclusion is also due to the fact that growth opportunities are not noncollateral assets. On the other hand, Pecking Order theory of Myers and Majluf (1984) predict a positive relationship between growth opportunities and leverage. In other word, a firm must have sufficient internal funds available for investment which generates a positive impact on its leverage. We suppose a negative relationship between growth opportunities and leverage (hypothesis 8).

Free Cash Flow is defined in a way similar to Lehn and Poulsen (1989). It also represents a measure of the "Free Cash Flow" hypothesis of Jensen (1986). As noted by Zwiebel (1996), the argument about the role of "Free Cash Flow" (Jensen, 1986; Dmitris M and Psillaki, 2010; Lopez F and V. Lima, 2010) can be explained as follow. the debt can alleviate the problems of «Free Cash Flow ", but conversely, managers with the "Free Cash Flow» may have little need of debt in the first place. The sign of this variable is ambiguous.

Profitability, to asses the firm’s profitability we use operating income before interest and taxes divided by total assets. As an indicator of the profitability of firms, we can also use the ratios of operating income divided by sales and operating income divided by total assets (Titman and Wessels, 1988, Jensen, Solberg and Zorn, 1992). The trade off theory predicts a positive sign on profitability which imply that the higher the firm’s profitability, the higher tax savings and therefore the higher the firm’s debt ratio (DeAngelo and Masulis, 1980). On the other hand, the theory of Pecking Order (Myers and Majluf, 1984) predicts a negative sign between profitability and leverage (Friend and Lang, 1988; Jensen, Solber and Zorn, 1992) (hypothesis 9). In other words, firms use internal funds to finance his operations.

Intangibility previous studies have used several measures of tangibility assets (Jensen and Meckling, 1976): inventory plus gross plant and equipment to total assets (Titman and Wessels, 1988); and the ratio of tangible assets to total assets (Rajan and Zingales, 1995; Short, Keasey and Duxbury, 2002). In our paper, we will approximate intangibility by the ratio of total intangible assets divided by total assets. Balakrishnan and Fox (1993) argue that asset specificity creates problems of debt financing due to the characteristics of non redeployment of specific assets. In particular, the specificity of assets adversely affects the ability of the company to issue debt. Balakrishnan and Fox (1993) suggest that examples of specific assets of the firm are intangible assets such as brands, research and development expenditure and other investments reputations. The variable "INTA" can also capture the discretionary investment opportunities of the firm. Myers (1977) argues that the agency costs associated with intangible assets are higher than those associated with tangible assets. In addition Scott (1977) highlight that firms with more tangible assets will issue more debt. It will be inferred that intangibility is negatively related to leverage (hypothesis10).

NDTS, DeAngelo and Masulis (1980) suggest that the tax saving can affect debt ratio of the firm. This variable is approximated by the annual depreciation expense divided by total assets. They argue that the higher the tax savings, the lower the benefit of additional debt. Then, consistent with the Pecking Order theory the negative sign of tax savings is a proxy of firm’s profitability (Myers, 1977; Myers and Majluf, 1984). On the other hand, the theory trade off predicts a positive sign (hypothesis 11) (De Angelo and Masulis 1980; Graham, 1996)

Dividends, is measured as the dividends paid each year reported on the total dividends paid during the period (Howard and Brown, 1992). The sign of the relationship between the variable "DIV" and the leverage depends on the relationship between company tax rate, personal tax rates and effective capital gains tax rates. Since these rates may vary between shareholders, it is difficult to predict the sign of this variable.



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