POLICY RESEARCH WORKING PAPER 1461 Stock Market Development Are banks and stock markets complements or substsitutes7 and Firm Financing Choices Resu)ts imply that initial improvements in the Asiz Demirgiiq-Kunt functioning of a developing Vojislav Maksimovic stock market produce a higher debt-equity ratio for firms, and thus more business for banks. The World Bank Policy Research Department Finance and Private Sector Development Division May 1995 [Po[ ICY RFSEARCH WORKING PAPER 1461 Summary findings Demirgfic-Kunt and Maksimovic empirically analyze the For developed markets in the sample, further stock issociationl between firm financing choices and the level market development leads to a substitution of equity for ot development of financial markets in 30 countries for debt financing. the period 1980-91. In developing markets, by contrast, large firms become For the whole sample, there is a statistically significant more leveraged as the stock market develops, whereas negative correlation between stock market development, the smallest firms appear not to be significantly affected 1s measured by the ratio of market capitalization to gross by market development. donmestic product, and the ratios of both long-term and short-term debt to firms' total equity. TIiis paper -a product of the Finance and Private Sector Development Division, Policy Research Department -is part of a larger effort in the department to study stock market development. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 678-37). Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-057, extension 38526 (43 pages). May 1995. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the namnes of the authors and should be used and cited accordingly. The findings, interpretations, and conclusions are the authors' own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member countries. Produced by the Policy Research Dissemination Center Stock Market Development and Firm Financing Choices As6 Demirguq-Kunt* Vojislav Maksimovic** *World Bank. ** University of Maryland at College Park. The authors thank Gerard Caprio, Douglas Diamond, Robert Korajczyk, Ross Levine, Sheridan Titman, Dimitri Vittas for useful comments and Qing-Hua Zhao for assistance with the data. 1 Introduction Recent research in corporate finance has identified how asymmetries of information and imnperfections in capital markets affect the firm's ability to raise funds and invest. While empirical evidence suggests that specific imperfections may significantly affect the firm's financial and investment policies, there has been little work on the effect of the level of development of the financial markets on the firnms policies. In this paper we explore this relationship by providing empirical evidence on the association between the financing choices of the firm and the level of development of financial markets in thirty developed and developing economies for the period 1980-1991. The finance literature suggests that stock markets serve important functions even in those economies in which there already exists a well developed banking sector. This is because equity and debt financing are in general not perfect substitutes. Equity financing has a key role in managing the conflicts of interest that may arise between different stakeholders in the firm. Stock markets also provide entrepreneurs with liquidity and for opportunities to diversifv their portfolios. Stock trading transmits information about firms, prospects to potential investors and creditors.' As a result of the different attributes of debt and equity, the development of markets that facilitate the issuance and trading in equity should be reflected in the financing decisions of individual firms. While differences in financial systems have been noted in the literature, there have been few attempts to formally model the effects of financial market development on firms' financing choices or on their investrnent decisions. Notable exceptions are Pagano (1993) model of the effect of opportunities for diversification on entrepreneurs' portfolio choices, Bencivenga et al.'s (1994) analysis of financial 'Allen (1993) contrasts the comparative advantages of stock markets and financial institutions in processing information about investment protects. 3 liquidity on technology choice, and Boyd and Smith's (1995) framework analyzing complementarities of debt and equity financing for capital investments. The empirical work in this area is also sparse. There are empirical studies of firm debt-equity ratios by Titnan and Wessels (1988) for the U.S., R?flan and Zingales (1994) for a sample of developed countries, and Demirguc-Kunt and Maksimovic (1994) for a sample of developing countries. Also, Mayer (1989) and Singh et al. (1992) have looked z corporate financing patters in develored and developing countries. respectively. This is the first paper that empirically explores the effect of financial market developmen;. particularly stock market development on firm financing choices. We compare the relationship between capital structure choice and financial market development in a sample of thirty developed and developing countries. We investigate the extent to which the variation in the aggregate debt-equity ratios within these countries can be explained by (a) the level of development of the country's financial marikets, (b) macroeconomic factors, sucii as the growth rate and the rate of inflation, (c) the differences between the tax treatment of debt and equirt' securities and (d) the firm-specific factors that have been idenified in the corporate finance literature as determining financial st-ucture. We find that in general there is a significant positive relationship between bank development and leverage and a negative but insignifcant relationship between stock market development and leveraae. However, when we break the full sample down into sub-samples and control for the other determinams of firm financing an interesting reLzrionship between leverage and stock market development emer-es. In already developed stock markets, farther development leads to a substitution of equity for debt firumcing. By contrast, in developing stock markets. large firms become more levered as the stock marke: develops, whereas the smallest firms do not appear to be significantly affected by market development. Our results have important implications. In many developing countries with emerging stock markets banks are fearful of stock market development, that stock markets will reduce the volume of their business. Instead, our results imply that initial improvements in the functioning of a developing stock market 4 produce a higher debt equity ratio for firms, and thus more business for banks. These results also suggest that in countries with developing financial systems stock markets and banks play different, yet complementary roles. Thus, policies undertaken to develop stock markets need not affect existing banking systems adversely. Our results are also consistent with the conclusion of Demirguc-Kunt and Levine (1995) that stock market and financial intermediary development proceed simultaneously. The rest of the paper is organized as follows. The predicted relationship between financial market development and debt-equity ratios is discussed in Section 2. The sample of countries is discussed and the data sources are described in Section 3. The statistical model is described in Section 4 and the results are reported in Section 5. The conclusions are stated in Section 6. 2. Framework for Analysis Corporate finance theory suggests that corporations optimally structure financing packages to reduce the economic costs thar result from taxes and from imperfections in the financial markets. As financial markets develop, the comparative significance of different imperfections is likely to change. As a consequence, the issuance of specific securities may become more or less advantageous for certain categories of firms. Thus, there may be a relationship between financial market development and financing choices.2 In this section we consider three classes of imperfections that may result from inadequately developed financial markets. First, insufficient opportunities for diversification of portfolios by investors and entrepreneurs. Second, the inability to enter into financing contracts appropriate for the firm's investment projects. Third, the asymmetries of information between investors and the firm that occur because stock 2 In this section we focus on equity market development, in part because it has been most evident during our period of analysis (for a discussion, see Demirguc-Kunt and Levine (1995)). However. it is important to bear in mind that there are important spillovers between development of the equitv market and development of the banking system. 5 markets do not efficiently aggregate information. For each of these imperfections we identify the effect of financial market development on the fimns' financing choices. Diversification by entrepreneurs and stock market liquidity In an economy in which equity markets are imperfec, entrepreneurs face costs of diversifying their portfolios. Outside investors may require a premiun to acquire the stock of firm that is traded on an illiquid market. Moreover, as Pagano (1993) has emphasized, the benefits to the entrepreneur of exchanging the ownership of a stake of his or her firm for a portfolio of financial assets may be limited if the financial market on which these assets are traded does not provide opportunities for diversification. The costs of diversification may induce the entrepreneur to avoid the use of financial markets and, instead, to alter the firm's investment and product decisions so as to optimally balance his or her personal portfolio.3 There are several ways in which the firm's investment policies may be affected by the owners' inability to diversify optimally in financial markets. First, the firm may diversify into areas in which it does not have a compararive advantage. Second. the firm may invest less than it would if its shares were widely held. Third, it may choose less capital intensive production technologies that are subject to less long-term risk. Optimal contracting andfinancial markets There exist conflicts of interest between the firm and its customers and suppliers and between different classes of investors in the firm. These conflicts mav induce the firm's owners. or managers who represent them, to harm the interests of the other parries. Because such opportunistic behavior can be anticipated, it may make it more difficult for the firm to obtain financing. However, by optimal structuring of the This argument parallels the more familiar argument in finance that the firm's financial policies are chosen so as to take advantage of tax shields which the owners' cannot exploit on their personal accounts. Here, the argument is that the firm's investment policy may be chosen to achieve a risk-return trade-off that owners' cannot obtain by altering their portfolio investments. 6 contracts between the fim and outside investors, the owners' incentives to engage in opportunistic behavior can be mitigated.4 The corporate finance literature has identified several cases in which reliance on outside debt financing increases the incentives of the firm's owners to act opporrunistically or to otherwise harm the creditors, customers and suppliers. Jensen and Meckling (1976) argue that highly levered firms may have an incentive to take on projects that have negative expected net present values and are risky, thereby harming creditors. Myers (1977) shows that firms with significant risky growth opportunities may forgo profitable projects if the resulting increases in value are captured by the firms creditors. Titnan (1984) argues that as high leverage increases the probability of financial distress sufficiently, the firm will enter into contracts that it may be unable to execute. Maksimovic (1988) and Maksimovic and Titmian (1991) argue that leverage increases the firm's incentive to renege on value enhancing implicit contracts with rival firms or with customers. Because debt financing creates incentives to act opportunistically, a highly levered firm may not be able to obtain credit or to exploit fully opportunities for mutually beneficial contracting with customers, rivals or suppliers. In these cases, issuance of equity would mitigate the incentive problems created by debt financing. Equity markets and information aggregation In addition to their primary role of supplying capital to the economy, equity markets have an important informational role. Equity markets aggregate information about the prospects of the firms whose shares are traded (Grossman (1976)). This aggregated information becomes publicly observable by the firm's There is a large literature on conflicts of interest between different classes of investors. The important references are Jensen and Meckling (1976), Myers (1977) and Myers and Majluf (1984). For an overview see Bamea, Haugen and Senbet (1985) and Harris and Raviv (1991). 7 creditors and investors. Markets thereby facilitate the monitoring of the firm bv making it more profitable for them to contribute capital to the firM.5 In addition to aggregating information, financial markets provide incentives for information acquisition by investors. As markets for publicly traded equity increase in size, it becomes profitable for analysts to invest in acquiring information about firmns.6 The resulting increase in the quality of information further facilitates monitoring by creditors. The effect of developing an equity market To fix ideas, consider an entrepreneurial firm operating in an environment without a functioning equity market. The firm is financed by inside equirvy trade credit and bank borrowing. Because we are assuming that there does not exist an effective equity market, the firmns initial debt-equity ratio will not be an economic optimum. Hence, once the market is opened we would expect the firm's owners to move away from the initial debt-equity ratio. The initially limited access to equity markets suggests that such a firm is likely to have a sub-optimally high debt-equity ratio for its scale of operations. A possible secondary implication of limited access is that the firm may be suboptimally small: it may pass up growth opportunities which would be exploited if there existed a functioning equity market. This mav occur for the reasons identified above. First, because expansion can only be financed using the entrepreneur's own capital or debt, investment in risky growth opportunities may increase the risks borne by the undiversified entrepreneur enough to make it unattractive. Second, certain projects are optimally financed with equity capital. Such projects mav not be profitable if financed by debt. Third, in the absence of a public market aggregating information, informational asymmetries may make it too costly to raise capital from outside investors. This role of financial markets is sufficiently important that many investment funds and mutual funds are prohibited from investing in companies whose stock does not trade on a rccognized exchange. 6 For a formal model, see Grossman and Stiglitz (1980). 8 Now allow an equity market to begin functioning. There will be three direct effects of the firm's debt- equity ratio: first, a substitution effect as outside equitv is substituted for outside debt by firms that had previously been constrained to issue only outside debt. This effect will decrease the firm s debt-equity ratio. Second, outside equity will be substituted for inside equity. This will not affect the firnms debt-equity ratio. Third, the entrepreneur's ability to diversify risks may make expansion more attractive. The effect of such expansion on the firm's debt-equity ratio is ambiguous and will depend on the optimal financial structure of the firm. The development of an equity market may also have an indirect effect on the firm's leverage. Equity markets aggregate information investors possess about firms. This makes it less costly for inrvestors and financial intermediaries to monitor firms. Thus, exLernal equity and debt should become less risky. We would therefore expect to see an increase in external financing. It is, however, unclear whether extemal equity or debt would benefit more. To the extent that debt is provided by the product mark:: and by banks, who are probably already well informed, we would expect to see a decrease in leverage as fnancial markets reduce the costs of monitoring to investors. AUl of the above arguments are conditioned on the hypothesis that equity markets develop relative to the market for debt. If the debt market develops faster. then the effects may be reversed. The net effect of above considerations is that the effect of equity market development on the debt-equity ratio is ambiguous. The question is investigated empirically below. 9 3. Description of Sample and Financial Market Indicators Our sample consists of thirty developed and developing economies for the period 1980-91.7 These economies were selected because they have a developed or emerging stock marker and because data on individual firms' financial suuctures is available for a sufficiently large number of firms.8 Table I lists all the countries in the sample, together with several indicators of economic development of each country. As an inspection of the table reveals, the sarnple represents a wide range of economic development: the GDP per czpita for 1991 ranges from $27,492 for Switzerland to S359 for Pakistan. With the exception of South Africa and Jordan, all the economies have experienced growth in per capita income during the sample period. Some economies, especially Brazil, Mexico and Turkev, have experienced high rates of inflation in this peiod. Insert Table 1 here In the absence of a theory of financial market development, we use empirical indicators to measure the level of development of the equity market and financial intermediaries in each country for each vear of the sample. Our first three stock market indicators are the ratio of stock market capitalization to GDP (MCAP/GDP), the ratio of tocal volume of shares traded to GDP (TVT/GDP) and the ratio of the total value of shares traded to market capitalization (TOR). In our sample MCAP, TVT. TOR are drawn from IFC's emerging market data ;-ase. Our indicators of stock market development have been used in previous studies, (e.g., Pagano (1993), 'Tle economies in the sample =e Austria, Australia, Belgium, Brazil, Canada, Finland, France, Germany, Hong Kong, India, Italy, Japan. Jordan, Korea, Malaysia, Mexico. Netherlands, New Zealand. Norway, Pakistn, Singaporc, South Africa, Spf=, Sweden, Switzerland, Thailand, Turkey, United Kingdom, United States, Zimbabwe. To the best of our knowledge. te sample incorporates all the firm level financial data for developing countries currently available to researcuers. 10 Demirguc-Kunt and Levine (1995)) and provide intuitive summary statistics for the level of activity of the stock market and the significance of that activity for each of the economies in the sample. MCAP!GDP is measure of both the stock market's ability to allocate capital to investmnent projects and to provide significant opportunities for risk diversification for investors. TVT/GDP and TOR are indicators of market liquidity. The former measures the ability to trade economically significant positions on the stock market, whereas the latter is indicator of liquidity of assets traded on the market, not adjusted for the size of the market relative to the economy. We also combine the three indicators in an equally weighted index of market development (INDEXI). Table 2 lists the 1980-91 averages for the stock market development indicators for each economy.9 In ten of the economies the financial markets are classified as "emerging" by the Intemational Finance Corporation.10 These are Brazil. India, Jordan. Korea, Malaysia, Mexico, Pakistan, Thailand, Turkey and Zimbabwe. Interestineg-. several emerging markets, such as Malaysia, Korea and Thailand have higher MCAP/GDP ratios than some developed economies, such as Canada, Germany and France. The correlation between MCAP/GDP and the GDP per capital is only 0.23. Similarly, the TVT/GDP and TOR ratios are only weakly correlated with GDP (correlation coefficients of 0.23 and 0.34, respectively). Insert Table 2 here The principal indicators we use are measures of activity, rather than measures of the institutional determinants of conditions under which securities are traded. This is in part aue to the difficulty in quantifying differences in, say, the regulatory environment that may affect irms' decisions to issue equity or debt in the United States and Great Britain. However, differences in the institutions among the ten 9 The indicators in columns headed by INST and INDEX2 are discussed below. ' IFC Factbook. 11 emerging markets are large enough to be quantified. Several imnportant institutional indicators in the emerging markets. drawn from various editions of IFC's Factbook, are detailed in Table 3. Insert Table 3 here As shown in the table, bv the end of our sample period the institutions in Brazil, Mexico. Malaysia and Korea were more developed than those of, for example, Zimbabwe. The principal differences resulted from lower restrictions on dividend and capital repatriation and in higher quality of firm disclosures in the former group. An arithmetic average of the ini onal indicators for emerging markets is listed in the INST column of Table 2. For the same emerging markets we also report INDEXI augmented by Korajczyk's indicator of securities mispricing (Korajczyk (1994)). This indicator measures the extent of mispricing of securities relative to a domestic CAPM for each countrv and is an indicator of extent of market efficiency." The augmented index is reported as INDEX2 in Table 2. We use three empirical indicators to measure the siznificance of the banking sector in each of the economies in our sample. Each indicator quantifies different components of banks' provision of funds to the private sector in each of the economies. M3/GDP measures the ratio of banks' liquid liabilities (M3) to GDP. It is an indicator of the size of the banking sector to the economy as a whole and has been used in several studies of the effect of the financial sector on the growth in the economy.'2 Our second indicator is the ratio of domestic credit to the private sector to the GDP. PRIV!GDP. This ratio measures the role of banks on the provision of longer term financing to privare corporations. A third indicator is the ratio of " The indicator is similar to the indicator estimated in Korajczyk and Viallet (1989) and is described in that paper and Korajczyk (1995). We also used mispricing indicarors obtained from international CAPM and AFr models, however these are not reported since the results are not significantly different 12 Studies that have used this indicator include King and Levine. (1993), Levine and Renelt (1992) and Levine and Zervos (1994). 12 deposit bank domestic assets to GDP, BANK/GDP. M3/GDP and PRIV/GDP are averaged to yield FINDEXI. The data on M3, PRIV, BANK and GDP are drawn from Intemational Financial Statistics, published by the International Monetary Fund. Whereas in many developing countries banks are the onlv significant financial intermediaries, in developed economies there also exist significant insurance companies, pension funds and other intermediaries. To gauge the importance of financial intermediaries in general on provision of credit we also take the rario of assets held by deposit banks, non-bank private fmancial assets and assets of private insurance and pension companies to GDP (FINDEX 2). Insert Table 4 here Data on individual firms in Korea, India, Mexico, Jordan. BraziL Turkey, Pakistan and Zimbabwe come from the EFC's corporate finance database. It consists of financial data on the hundred largest firms rading on the stock exchanges of these countries. For some markets the data is only available for a sub-period, as noted in Table 1 in the Appendix. Data on firms in the remaining countries in Table I comes from Global Vantage database. The number of firms available for the Global Vantage sample is also noted in Table 1 in the Appendix. Insert Table 5 here Research in the United States shows that financial policies are in part determined bv firm size. There are economies of scale in issuing securities (Ritter (1987)). Larger firms may have more access to financial markets and be followed by a larger number of analvsts. To aid in the interpretation of the results, Table 5 provides information on the size distribution oi firms in each market. In each market, firms were ranked 13 according to the average size, measured by total assets. over the sample period. The average of each quartile of firm size is reported in the mable. As revealed by inspection of Table 5, firm sizes differ materially across economies. The average asset value of the largest quartile of Italian firms is approximately $4.5 billion, whereas it is approximately $65m in Thailand and Zimbabwe. The differences are equally marked in the smallest quartile: the average fim in the lowest quartile in Sweden is seventy seven times larger than the average fim in the same quartile in the Thailand. Equally significant, there are major differences in firm size within each country. In fourteer of the markets, the average firm in the smallest quartile has assets under $1 Om. In some countries the diffemences in size between the largest and smallest firms are very large. Thus, in Belgium the average firm in the largest quartile is approximately three hundred times larger than the average firm in the smallest quartile. The large differences in firm sizes in the sample suggest that the development of markets may have different effects on large and small firms in the same market 4. Determinants of Financial Structure In order to isolate the contribution of financial market development on the firm's choice of inancial structure we control for other variables that may affect the firm's financing choices. We conrol for three categories of variables: individual firm characteristics. the tax levels in each of the economies in our sample and macroeconomic-factors. As discussed above, the firn's optimal financing mix will depend on the owners' ability to engage in opportunistic behavior at the expense of creditors and other parties. This, in turn will in par: depend on the composition of the firm's assets. We control for asset composition by measuring the firm's net fixed assets 14 to total assets (NFATA) and net sales to net fixed assets (NSNFA). Firms with high NFATA and low NSNFA are predicted to have high long-term and short-term leverage respectively.'3 We use two variables as proxies the finns requirement for debt financing: the ratio of earnings to total assets (PROFIT) and the ratio of dividends to total assets (DIVTA). PROFIT is included because several studies have found an inverse relationship between profitability and leverage. The DIVTA variable is included because cash-constrained firms are unlikely to pay out large dividends. Our last two firm characteristics measure the firms non-debt tax shields (NDTS) and its size relative to the economy (TA/GDP). All other factors being equaL a firm with significant non-debt tax shields is less able to exploit tax shields obtained from debt financing than a finm with smaller insignificant non-debt tax shields. TA/GDP is included as a measure of the firmrs access to the financial markets. The sample means for each of these variable for each country is reported in Table 6. Insert Table 6 here The firm's choice of debt level will depend on part on the tax-treatment of interest income relative to income derived from dividends and capital gains. For each economy and each year we have calculated the relative tax advantage of debt and equity using darm drawn from the annual editions of Coopers & Lybrand, International Tax Summaries during our sample perioL This data is reported in Table 2 of the Appendix. Finally, we also control for two macro-economic variables: the inflation rate (INFL) and the growth rate of the GDP (GROWTH). Because debt contracts are typically written in nominal dollars, the rate of inflation may affect the riskiness, in real terms, of debt financing. Growth is included as a measure of the growth opportunities available to firms in the economv. Finance theory suggests that growth options should not be 13 For a more comprehensive discussion of the relationship between leverage and firm specific characteristics see Demirguc-Kunt and Maksimovic (1994). 15 financed by debt. Thus, we would expect debt financing to be inversely related to GROWTH. Our control model for financial strucmure is y;,_EP0,,\-E y_-+ SElf where y is a measure of leverage, x are the firm specific characteristics (NFATA, PROFIT, NSNFA, NDTS, DIVTA,TA/GDP), m are the macro-economic factors (GROWTH. INFL), t are die tax variables and d are the time and country dummies. Below, this equation is augmented by financial institution and stock market indicators. 5 Results In this section we present our analysis of the effects of financial market development on firms' financing choices. First, we discuss the correlations between firms' capital structures and indicators of financial market development. Second, we characterize the relationship between financial structures and financial market indicators in developing and developed financial markets when determinants of firms' capital structres identified in the corporate finance literature are taken into account. Simple correlations Our primary focus is on the effect of financial market development on the use of equity and debt financing in each of the economies under consideration. To this end, we use the average ratio of debt to equity in each economy in each year as the dependent variable.14 Specifically, for each economy, .or each year, "By using aggregated data we avoid problems posed for empirical testing by the observed heterogeneity of capital structures adopted by seemingly identical firms (Myers (1984)). Such heterogeneity is predicted aut theories that focus on macro-economic (Miller (1977)) or industry-level (Maksimovic and Zechner (1991)) determinants of financial structure. 16 we calculate the average ratio of short-term debt to total equity for the fums in our sample (STDTE), long- term to total equitv (LTDTE) end total debt to total equity (TDTE). The simple correlations of LTDTE, STDTE and TDTE for each country and each year with each other and with indicators of stock market and financial institution development are shown in Table 7. As revealed in the table, the use of short-term and long-term debt by finns in an economy is positively correlated. LTDTE is negatively correlated with the size of the stock market (MCAP/GDP), positively correlated with the size of the banking sector (BANK/GDP) and positively correlated with the real per capita income (GDP/CAP). The results for STDTE are similar. Thus, a large stock market is associated with reductions in both long-term and short-term debt financing. Interestingly, the level of activity of the stock market (as measured bv TOR or TVT/GDP) is not correlated with LTDTE or STDTE. This suggests that an active secondary market for stocks is not a first order determinant of flrms financing choices. Similarly, the M3/GDP, which has been used as a measure of the size of the banking sector is not correlated with financing choices of firms. Inserr Table 7 here Financial market developmem as a determinant offirm capital structure While the simple correlations between debt and the level of the stock market and the banking sector suggest that equity is a substinue for both short-term and long-term debt financing, they do not take into account other determinants of firms' financing choices identified in the previous section. Thus, for example, the observed correlarions may be the result of differences in industry composition, in tax regimes and growth rates and macro-factors. To investigate these issues further we perform an OLS regression of the firms' financing variable cn firm characteristics (NFATA, PROFIT, NSNFA, NIDTS, DIVTA, TA/GDP), macro-economic factors (GROWTH, INFL), tax variables, time and country dummies as well as financial intermediary and srock market indicators. By controlling for the determinants identified in the 17 literature, this regression is a more conservative test of the relationship between financing choices and market development indic=tors than the simple correlations reported above. Furthermore, it is likely that some of the time and country dummies may be picking up unmeasured differences in financial markets between countries and over time. Table 8 reports R of each regression and the significance levels of the F-tests testing the joint hvpothesis that coefficients of specific groups of determinants firms financing choices are zero. Insert Tabke 8 here As reported in table, this specification explains approximately eighty percent of the variation in STDTE, LTDTE and TDTE. Among the newly added control variables, firm characteristics and country dummies have highly significant explanatory power. This is consistnt with the results of firm level regressions in Demirguc-Kunt and Maksimovic (1994), where these variables are discussed in detail. Consistent with corporate finance theory, mx variables are significant in the LTDTE regression. Macro variables, growth and inflation, jointly have a negative and significant effect on short-term debt and total debt but not on long term debt. Growth variab.e itself has a negative and significant sign in all thre equations, indicating that debt financing is indeed inversely related to growth as predicted by theory. Turning to the variables of primary interest, as before, BANK/GDP is positiveil related to firms' debt levels. As shown in the table, this relationship is significant at the 5% level in the case of long term debt and 10% in the case of short term debt. A stronger association with long-term debt is expected because financial intermediaries are likely to have a comparative advantage in making long-term loans, whereas short term financing may ie available through trade credit. The stock market indicator INDEX I is negative but is not significant in these regressions. This indicates that the a simple variable measuring the development of the market does not help explain firms' choices 18 of financial structure once the development of the banking sector and the other control variables are taken into account. We have explored this finding in unreported regressions. It is robust for alternative specifications of stock market and financial intermediary indicators. Thus, alternative stock indicators, such as MCAP/GDP, TVT/GDP and TOR, in conjunction with each of the fmancial intermediary indicators M3/GDP, FINDEX I and FINDEX2 consistently yield negative, but insignificant coefficients for the stock market indicator in equations explaining STD/TE, LTD/TE and TD/TE. This pattern suggests that there does exist a relationship between firm financing choices but that this pattern may not be captured with the simple linear specification. We next explore this finding further, and attempt to characterize more fully the interactions between stock market development and financing choices. Stock market development andfirm capital structure: developed vs. developing markets Pagano (1993) and others argue that stock markets may play different roles in financing enterprises in economies where they are small and in economies where they are well developed. To investigate the possibility that stock markets may have different effects on firms' financing choices as the level of market development varies. we split the sample into sub-samples and estimate the effect of stock market development separately in each. We use INDEX1 scores to split the sample into those markets which are "developed" markets and those which are "developing" markets. Top 15 markets in Table 2 are classified as "developed," and the remaining markets are classified as "developing." Consistent with the findings of Demirguc-Kunt and Levine (1995), in this split well-developed stock markets of developing countries such as Korea, Malaysia and Thailand belong to the developed group, whereas the relatively underdeveloped markets in some European countries, such as in Austria, Italy and Finland fall into the "developing" category. This grouping is superior to a split based on developed vs. developing countries, since it takes into account the fact that some markets classified as emerging may 19 already have a significant role in the financing of their national private corporate sector as the established markets in developed countries. The average MCkP.'GDP in the two sub-samples over the sample period is shown in Figure 1. The difference among the two zroups is evident and appears to be constant through time. We examine the effect of stock market development on firm financing in the developing and developed market sub-samples separately. Table 9 shows the coefficients of the stock market development indicator in our equation explaining firms' choice of STDTE, LTDTE and TDTE in the two sub-samples. As financial variables, the basic equation was estimated separately on each sub-sample with one indicator for stock market development (MCAP/GDP, TVT/GDP, TOR, INDEX1 and INDEX2) and one indicator for the development of the financial intermediary sector (M3/GDP, BANK/GDP, FINDEXI and FINDEX2). Insert Tabke 9 here Inspection of Table 9 shows an interesting conutast between the "developed" market and "developing" market sub-samples. The coefficients of the stock market indicator in the developed market subsample are uniformly negative, whereas the coefficients in the developing market subsample are all positve with one exception. 15 These patterns suggest that in economies with more developed stock markets, further development of the market leads to a substitution of equity financing for debt financing. This is seen most clearly in the case of long-term debt, where the coefficients are predominantly statistically significant By contrast, in those economies in which the stock market is developing, further development of the market leads to opportunities for risk sharing and for aggegation of information that allow firms to increase their borrowing. 'M The probabilities of these patterns occurring bv chance are Q.512 and 9x0.512 respectively. That is the probability that all the coefficients of the LTD, STl) and TD equations for all the four stock market indicators for which we have data indeveloping and developed markets take the value they do if there is no relationship and the regression is constructed from independent draws from a data distnbution. Because for each stock market indicator and each equation we have estimated four relationships using different financial institutions indicators, we only cournt the sign once per specification. 20 Differences between large vs. small firms It is likely that the effect of stock market development may be different for large and small firms. In particular, the information aggregation role of the market is likely to be more significant for large firms that trade often and are followed by many analysts. To test this hypothesis, we formed portfolios consisting of the largest and smallest quartiles of fims in each country based on their asset size. Our basic regression equation was then estimated on four sub-samples: the largest quartile of firms in developed and developing stock markets and the smallest quartile of frms in the developed and developing stock markets. Insert Table 10 here Table 10 reports the results of the splits according to size. The coefficients of the stock market variable for large firms in the developed stock markets sample are uniformly negative and for LTDTE statistically significant at the 5% level when MCAP/GDP is used as an indicator of market development. By contrast, the coefficients of the stock market variable for large firms in the developing stock markets sample are uniformly positive and for the most part statistically significant at the 5% for STDTE, LTDTE and TDTE.6 These findings suggest that for large firms in developed stock markets, further market development acts to enhance opportunities for substitution of equity for debt financing. By contrast, large firms in developing stock markets take advantage of further development to increase their borrowing. The coefficients of the stock market indicator for small firms in developed stock markets are negative. This accords with the results for large firms in the same markets and suggests that small firms are also taking advantage of market development by substituting debt for equity financing. Interestingly, the coefficients 16 The probability of these patterns of signs occurring by chance are 0.5' for the developed markets sample and 0.59 for the developing markets sample. 21 of small firms in developing markets are also predominantly negative, although not statistically significant.'7 To place these results in context, Table 11 presents F-tests of the joint hypothesis that certain categories of coefficients are zero estimating a basic regression on each of the sub-samples. In these regressions the stock market development indicator is INDEXI and the financial intermediary development indicator is BANK/GDP. Panel I shows the split between developed and developing markets. As inspection of the stock market indicator column reveals, stock market development, as measured by INDEX 1, most significantly affects the financing choices of firms in developed markets. Stock market development induces firms in these markets to substitute equity for debt. The corresponding results for developing markets are not significant In Panel II we further analyze the largest and smallest quartiles of firms in each market and see that stock market development significantly affects the financing choices of large firms in developing markets, inducing them to increase their leverage. Inspection of Panel II also reveals that we are better able to explain financial structures of large firms than small firms in all markets. Insert Table 11 here To obtain a visual representation of the interaction between financing choices and stock market development, following Barro (1991) we subtract from the dependent variables of the first two regressions reported in Panel II of Table 11 (LTDTE and STDTE), all the dependent variables multiplied by their estimated coefficients with the exception of the stock market indicator. For the two subsamples of developed and developing markets, Figure 2 shows the unexplained residuals of STDITE and LTDITE plotted against INDEX 1 at the sample means of each variable during the sample period for each economy. '7 The probability of this pattem of signs occurring by chance in the developed markets sample is 0.59. The probability of obtaining seven or more negative coefficients in the nine equations of the developing markets sample in the absence of a relationship is 45xO.59. The probability is obtained using the Binomial formula 0.59x(l+9!18!+9!/(7!2!)). 2_ The visual evidence is striking. It suggests that for economies with developing stock markets debt-equity ratios of large firms increase with the development of the stock market. For large firms in economies with more developed markets, further development is associated with lower debt to equity ratios. Taken together, the results suggest that further development of stock markets may affect firms differently in economies where the markets already play a significant role than in those where thev do not. If stock markets are already significant, further development leads to a substitution of equity financing for debt. However, in economies where stock markets are too small to have a significant role in the economy, as measured by our indicators, development permits large firms to increase their leverage. 6. Conclusion This is the first paper in literature that empiricallv explores the effect of financial market development, particularly stock market development, on firm financing choices. We use aggregated firm level data for a sample of thirty countries for the period 1980-91. We measure stock market development by the ratio of market capitalization to gross domestic product, total value traded to gross domestic product and the annual turnover ratio. Taking all the countries in the sample together, we find that there is a statistically signficant negative correlation between stock market development, as measured by market capitalization to gross domestic product, and the ratios of both long-term and short-term debt to total equity of firms. There is also a statistically significant positive relationship between the size of the banking sector and leverage. Interestingly, there is no correlation between the level of activity of a stock market, as measured bv the turnover ratio or the ratio of total value traded to GDP, and firm leverage. The negative linear relationship between leverage and stock market development loses statistical significance when we control for variables that have been identified in the corporate fmance literature as 23 determining firms' financial structures. However, when we break the full sample down into sub-samples an interesting pattern emerges. In developed markets, further development leads to a substituion of equity for debt financing, especiallv for long term debt. In developing markets, large firms become more levered as the stock market develops, whereas the smallest firms do not appear to be significantly affected by market development These findings suggest tat the development of a stock market initially affects directly the financial policies of only the largest firms. This may be because diversification of ownership and the aggregation of information provided by the development of stock markets initially benefits the larger firms more, due to the need to spread fixed issuance costs and traders' costs of information acquisition. Moreover, these finms increase leverage. Thus, initially at least, an important role of the stock market is to aggregate information and thereby induce lenders to extend credit to firms whose stock is traded. 24 References F. Allen, 1993, Stock markets and resource allocation, in C. Mayer and X. Vives (eds.), Capital Markets and Financial Intermediation, Cambridge Universitv Press, Cambridge. Barnea, A., R. Haugen, and L. Senbet, 1981, Agency problems andfinancial contracting, Prentice-Hall, Englewood Cliffs, N.J. Barro, R.J., 1991, Economic growth in a cross-section of countries, Quarterly Journal of Economics 106, 407-441. Bencivenga, V., B.D. Smith and R M. 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Titman, S. and R Wessels, 1988, The determinants of capital structure choice, Journal of Finance 4, 1-19. 26 Table 1. Economic Development Indicators GDP/CAP Growth 80-91 Inflation 80-91 Life expectancy (US S) (percent) (percent) (years) Switzerand 27,492 1.7 3.8 78 Japan 23,584 3.9 1.5 79 Norway 19,664 1.7 5.2 77 Sweden 19,649 1.6 7.4 78 United States 18,972 1.9 4.2 76 Finland 18,046 1.6 6.6 76 France 17,365 1.8 5.7 77 Austria 17,288 2.2 3.6 76 Netherlands 16,479 2.3 1.8 77 Germany 16,439 1.8 2.8 76 Canada 16,098 2.0 4.3 77 Belgium 16,051 2.2 4.2 76 Italy 14,570 2.5 9.5 77 Australia 13,095 1.6 7.0 77 United Kingdom 12,585 2.3 5.8 75 New Zealand 10,643 1.0 10.3 76 Singaporm 10,294 4.9 1.9 74 Hong Kong 9,820 5.8 7.5 78 Spain 8,752 3.3 8.9 77 Korea 4,259 6.8 5.6 70 Malaysia 2,465 3.6 1.7 71 South Africa 2,198 -1.0 14.4 63 Brazil 2,073 2.1 327.6 66 Mexico 1,801 1.0 66.5 70 Turkey 1,375 3.1 44.7 67 Jordan 1,372 -2.1 1.6 69 Thailand 1,362 7.0 3.7 69 Zimbabwe 630 1.7 12.5 60 India 375 3.3 8.2 60 Pakistan 359 3.9 7.0 59 GDP/CAP is the real GDP per capita in US$ in 199 1. Growth rate is the average annual growth rate in GDP/CAP for the period 1980-9 1. Average annual inflation is given for the period 1980-9 1. Life expectancy at birth is for year 1991. 27 Table 2. Stock Market Development Indicators IMCAP/GDP 1TVT/GDP 'TOR INST INDEX I INDEX 2 Hong Kong 1.261 0.511 0.41 0.731 Japan 0.981 0.531 0.51 0.671 Germany 0.241 0.291 1.23 0.591 United Kingdom 0.86[ 0.351 0.39 0.531 Unired States 0.611 0.361 0.58 0.521 Singapore 0.951 0.311 0.31 0.521 Swirzerland 0.751 0.311 0.39 0.491 South Africa 1.351 0.071 0.05 0.491 Malaysia | 0.881 0.16! 0.161 1.61 0.401 -0.07 Korea 0.221 0.171 0.691 1.49 0.361 -0.21 Thailand 0.211 0.181 0.67 1.351 0.35i -0.22 Netherlands 0.461 0.191 0.391 0;351 Australia 0.491 0.151 0.30! 0.31! Canada 0.46j 0.131 0.291 0.291 Sweden 1 0.431 0.101 0.25 0.261 Mexico | 0.101 0.051 0.691 1.57 0.28! -0.63 Jordan i 0.481 0.071 0.14 1.12 023l -0.24 India 0.07! 0.041 0.59 1.29 0.231 -0.26 Norway 0.181 0.081 0.42 0.231 Austria 1 0.081 0.051 0.51! 0.22! Brazil I 0.111 0.051 0.481 1.48t 0.211 -0.97 France 0.23! 0.081 0.321 0.211 Spain1 0.21! 0.071 0.311 0.201 NewZealand 1 0.381 0.06! 0.16j 0.201 Belgium 0.31! 0.041 0.121 0.151 'Italy 0.151 0.041 0.231 0.141 Finland 0.171 0.041 0.18] 0.1I-i Zinbabwe 0.10i 0.01| 0.081 0.621 0.06i -0.71 Pakistan F 0.041 0.011 0.111 0.861 0.061 -0.20 Turkey 0.05! 0.011 0.081 0.96 0.05 -0.31 _ _ _ _I I__ __ _ 1 _ _ 1 ._ __ __ ._ _ I _ _ _ I. I I i_ __ _ MCAP/GDP is the ratio of stock market capitalization to GDP. TVT/GDP is the total value of traded shares divided by GDP. TOR is the turnover given by total value traded divided by market capitalization. INST is the aggregate institutional indicator given by the average of insfttional factors in Table 3. Index I is the average of MCAP/GDP, TVT/GDP, and TOR. Index 2 averages the indicators in index I and a pricing indicator estimated using a domestic CAPM model for developing countries. Values are 1980-91 averages. 28 Table 3. Institutional Indicators - 1992 Figures 2 3 4 5 _ 6 7 Regular Accounting Quality of Securities Restrictions on Average publication standards investor exchange Dividend Capital Entry Institutional of p/e yield protection commission repat. repat. Indicator Brazil I 2 2 1 2 2 2 1.71 Mexico I 2 2 1 2 2 2 1.71 Malaysia _ 2 2 1 _ 2 2 2 1.71 Korea 1 2 2 1 2 2 2 1.71 Thailand I I I 1 2 2 2 1.43 Turkey I I I 1 2 2 ___2 1.43 Pakistani 0 1 1 2 2 2 1.29 India 1 2 2 1 1 1 1 1.29 Jordan 0 1 1 1 2 2 2 1.29 Zimbabwe 0 1 1 1 0 0 1 0.57 xo Columii (2) O=publishied, I =comprehensive and publishied internatiolially_ _ __________ Columns (3) and (4), O=poor, I =adequate, 2=good, of internationally acceptable quality Column (5) I-functioning securities exchange commission or similar government agency, O=no agency Column (6) O=restricted, I=some restrictions, 2=free _ ____ Column (7) average of columns (2)-(6)._ A I 9. ,All data are as of end- 1992. The table is based on the infor mation provided in tile IFC's Facitbook . Table 4. Financial Intermediary Development Indicators I IM3/GDP PRIV/GDP !BANK/GDP FINDEX I FINDEX 2 Hong Kong 3.64 l Switzerland 1 2.82 3.011 3.12 2.911 3.12 Japan 3.41 2.131 2.45. 2.771 1.42 Singapore 2.14 1.671 1.88 1.911 0.95 Jordan 2.001 1.131 1.34 1.561 1.34 Malaysia I 1.87 1-241 1.54 1.561 0.67 Netherlands l 1.63 1.47! 1.89 1.551 1.89 France 1 1.40 1.67T 1.91. 1.531 0.77 Germany i 1.30 1.721 2.07 1.51 1.19 Austria 1.661 1.34T 2.26 1.50| 2.26 United Kingdom 1.311 1.622! 1.62 1.471 0.92 United States 1.32 1.41 0.96 1.37! 0.67 Spain 1.371 1.27! 1.80. 1.321 0.70 Finland 1.02 1.421 1.41 1.22[ 0.77 Norway 1 1.201 1.161 1.50 1.181 1.50 Thailand 1 1.261 0.961 1.19! 1.111 0.54 Italy 1 1.481 0.671 1.05: 1.071 0.68 Canada i 1.261 0.871 0.95 1.07 0.56 Australia j 1.10 0.891 1.01 0.99 0.80 Sweden 0.971 0.921 137 0.94 0.93 South Africa 1.061 0.72' 0.76' 0.89 0.76 New Zealand 0.971 0.71 ! 0.88' 0.841 0.88 Korea 0.77] 0.88! 0.92 0.831 0.45 Belgium 0.9,2 0.58! 1.14 0.751 1.14 Pakistan 0.791 0.52 1 0.66 0.661 0.24 India | 0.81l 0.481 0.63! 0.651 0.32 Turkey 1 0.571 0.361 0.49! 0.461 0-25 Zimbabwe I 0.771 0.14; 0.33 0.467 0.22 Mexico | 0.42 0.231 0.41 0.321 0.16 Brazil 1 0.31 0.27! 0.45 0.29 0.12 M3/GDP is the ratio of liquid liabilities (M3) to GDP. PRIV/GDP is the ratio of domestic credit to private sector to GDP. BANK/'GDP is the ratio of deposit money bank domestic assets to GDP. FINDEX I averages M3/GDP and PRIV/GDP. FINDEX 2 averages BANK GDP, private non-bank assets to GDP, and assets of private insurance and pension companies to GDP. The last two terms are omirted when not available. Values are 1980-91 avera2es. 30 Table 5. Avcrage Firin Size (in millions of' US$) SMALL MEDIUM LARGE VERY LARGE Sweden 192,704.24 518,652.29 1,178,085.02 3,094,530.22 Japan 116,233.63 256,922.34 556,993.49 4,160,906.34 hlily 85,289.56 215,579.12 697,712.97 4,476,866.60 Korea 63,000.00 121,000.00 178,000.00 527,000.00 Finlanid 69,528.45 257,052.99 682,229.69 1,848,150.08 Spain 38,505.10 107,061.40 234,045.83 965,832.66 India 28,300.00 57,200.00 89,800.00 286,000.00 Norway 19,787.63 65,376.93 202,275.11 946,660.13 France 19,730.74 74,938.50 284,118.03 2,502,374.75 Switzerland 18,731.98 76,265.54 214,584.49 2,146,238.60 New Zealand 17,932.45 55,886.32 126,670.89 648,211.76 Germany 16,899.23 77,578.54 266,325.13 2,779,747.45 Netherluaids 14,595.95 69,811.69 216,311.03 1,958,972.95 I loing Koiig 13,549.41 39,890.70 83,067.67 607,074,62 United States 13,483.58 50,750.71 137,437.22 1,220,275.64 Austria 11,883.93 40,866.86 149,432.11 1,039,346.90 Brazil 9,900.00 17,800.00 30,800.00 93,900.00 United Kingdomi 9,548.49 35,739.16 110,966.45 1,180,701.29 rurkey 7,800.00 17,600.00 29,200.00 81,400.00 Singapore 7,541.20 26,065.43 68,452.41 206,160.13 South Africa 6,530.17 40,299.70 140,792.68 827,443.38 Mexico 5,900.00 18,000.00 44,300.00 210,600.00 Zimbabwe 5,900.00 11,600.00 21,000.00 64,400.00 Pakistan 5,700.00 11,800.00 17,600.00 76,500.00 Cal,,alal 5,519.0)6 32,984.18 106,908.67 629,525.98 Malaysia 4,886.31 14,091.94 29,770.33 148,555.45 Jordan 4,100.00 9,600.00 17,300.00 177,800.00 Belgium 4,092.03 31,236.36 144,011.40 1,242,864.60 Australia 2,961.29 18,058.71 59,656.91 509,707.27 Thailand 2,532.44 7,744.35 16,840.92 65,729.57 The values are average total assets, for each quartile of firns classified by total assets, over the country's sample period. Table 6. Firm Characteristics by Country LTDTE STDTE 'InlE NFATA DEPTA DIVTA PROFIT NSNFA NDTS TA/GDP Australia 0.563 0.653 1.248 0.385 0.033 0.025 0.064 4.509 -0.008 0.0024 Austria 1.201 1.495 2.69, 0.293 0.051 0._17 0.0._ 3.477 0.012 o0 .0i46 Belgiumn 0.764 1.259 2.023 0.22 1 0.039 0.022 0.092 6.153 0.030 0.0087 Brazil 0.139 0.421 0.560 0.640 0.002 0.057 1.166 0.017 0.0033 Canada 0.990 0.539 1.600 0.479 0.045 0.014 0.064 3.674 -0.031 0.0018 Swikzerland 0 878 0.872 1.750 0.304 0.043 0.016 0.073 5.463 -0.081 0.0090 Gmermay 1.47'). 1.188 2.7,32 0321 0.070 0.013 0.087 7.209' 0.0.07 0.0018 .Spalii _ _ 1.08_. 1.6319 2.7416 0.446 0.04) 0.016 0.095 3.613 0.017 0.0070 Finland 3.094 1.856 4.920 0.341 0.042 0.007 0.077 3.977 0.010 0.0154 France 1.417 2.108 3.613 0.234 0.043 0.014 0.094 7.727 0.010 0.0019 United Kingdom 0.387 1.065 1.480 0.336 0.032 0.025 0.108 6.447 0.009 0.0010 I long Kong 0.309 0.967 1.322 0.344 0.017 0.057 0.121 6.676 0.020 0.0094 India 0.763 1.937 2.700 0.405 0.038 0.019 0.132 5.614 0.027 0.0006 I a 1y_ _ _ . _ _ 1.114 3,954 _ 3.068 0.327 0.041 0,014 0.080 3.287 0.0000 0.0049 Jordanil 0.266 0.915 I .181 0.459 _ ___0.033 0.073 2.979 _ _ 0.0089 Japa_ (0.9.1 2.726 3.688 0_245 0.026 O i0.007 0.067 8.373 -0.016 0,1N08 r Korea 1,057 2.390 3.662 0.371 0.053 0.008 0.100 4.340 0.002 0.0023 Mexico 0.375 0.442 0.817 0.579 0.076 1.445 0.013 0.0021 Malaysia 0.284 0.639 0.935 0.405 0.021 0.026 0.087 3.264 0.010 0.0032 Nctherlands 0.710 1.297 2.156 0.334 0.043 0.020 0.094 7.500 0.018 0.0(89 Norway 3.495 1.880 5.375 0.433 0.049 0.009 0.092 2.703 -0.005 0.0143 NewZealand 0.752 0.776 1.527 0.401 0.030 0.025 0.106 5.067 0.022 0-0224 Pakistan 0.595 2.358 2.953 0.384 0.038 0.028 0.115 11.155 0.055 0.0012 Singapore 0.491 0.718 1.232 0.363 0.022 0.018 0.077 5.152 -0.004 0.0104 Sweden 2.879 2.321 5.552 0.342 0.036 0.01i 0.100 4.398 0.021 0.0146 Thailiand1 _ . _0_ __ _1).51R8 _ _ 1.7(i'9 2.215 .31(1 __ _O.(.1i3 0.(29 0.129 5.710 ()(07 0(H)07 Turkey 0.485 1.511 1.996 0.414 0.068 0.239 4.240 0.01i 0.0011 United Slates I.054 0.679 1.791 0.370 0.045 0.016 0.091 6.943 -0.015 0.0003 South Africa 0.597 0.518 _1.115 0.535 0.013 0.062 0.206 4.036 0.066 0.0120 Zimbabwe 0.187 0.615 0.801 0.033 0.028 0.1311 0.033 0.0063 LTDITE is the book value of long term debt divided by book value of equity. STD/TE and TD/T are the book value of short tern and total debt divided by book value of equity. NAFTA is thc net fixed assets divided by total as!;cts. DEPTA is depreciation divided by total assets. DIVrA is the dividends divided by total assets. PROFIT is the Income before Interest and taxes divided by total assets. NSNFA is the ne sales divided by net fixed assets. NDTS is the non-debt tax shield which is earnings before taxes minus the ratio of corporatc taxes paid to corporate tax rate, deflated by total assets. TA/GDP is total assets divided by the GDP of the country. The value of each item is calculated as the average of all firms for each country's sample period. Table 7. Correlations of Leverage and Financial Indicators STDTrE TDTE MCAP/CJDP TVT/CuDP TOR INDFX I M3/GDP BIANKIGDP FINDEX I H NDEX 2 GDP/CAP LTDTE- 0.531 0.890 -0.191 -0.094 0.054 -0.120 -0.106 0.194 0.066 0.162 0.471 0.000 0.000 0.002 0.141 0.398 0.060 0.088 0.002 0.294 0.0)0 0.000 STDTI3 ___ 0.846 -0.261 -0.007 0.076 -0.106 0.008 0.130 0.066 -0.036 0.087 0.000 0.000 0.910 0.231 0.097 0.902 0 038 0.295 0.571 0.153 TDlE ____ ~~~~~~ ~ ~~~~~-0.246 -0 051 0.079 _ -0.117 -0.065 0.191 0.074 0.083 0.3'14 0.000 0.421 0.215 0.066 0.293 0.002 0.239 0.188 0.000 MCAP/GDP 0.664 0.05 1 0.782 0.555 0.365 0000.268 0.228 0.000 0.277 0.000 0.000 0._000 0.000 a.000 0.000 'rVT/GD)P ______0.523 0.894 0.592 0.470 0.594 0.311I 0.334 0.000 0.000 0.000 0.000 0.000 0.000 0.000 lOllk 0.648 0.178 0,249 0.270 029 0-19 8 0.000 0.000 0.000) 0.000 0.000 0.000 INDIEX, ______ _____ ____________ ___________0.-530 -0.46'2 -0.5 2 9 - 0.-3 15 0.29-2 0.000 0.000 0.000 0a000 0.000 M3/GDp______ _______ ___ _____ 0.816 0.951 0.707 0.451 _________ ________ ______ _____ ____ __________ ~~~~~~~~~~~0.000 0.000 0.000 0.000 l1ANKJGIW____ P__ 0.905 0.868 0.645 _______ ____________ _______ ~~~~~~~~~~~~~~~~~~~~0.000 0.000 0.000 FINDEX 1 _____ _________ ____ 0.742 0.631 _____ ~~~~~~ ~~~~~~~~~~~~~~~~~~~~~~0.000 0 000 I:IDEX 2 __ _ _ __ _ _ _ _ _0.578 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 0.0 00.0 0 P-values are given in italics. Variable definitionis arc as given in Tables 1, 2, 4, and 7.__________________ Table 8. Dctermiiiants of Capital Structure Firti Financial Stock Macro Tax | Time Country Adjusted | Number of Characteristics Variable Market Factors Variables Dummnies Dummies R2 Observations Indicator All countries ~Sld/tc 33.19*** 3.43 .22 2.39* . 1.1 I 1 5.9 8 * .8( 2 1i ltd/te 3.25*** 4.18** 2.40 1.84 2.62$ 1.25 11.42** .79 211 td/te 3.07*** 8.09*** .99 2.73* 2.67* .99 13.19*** .80 211 F-test are reported testinig lhe joint hypotliesis that specilied variable coefficients are equal to zero. Coefficients are obtainied by regressinig STD/'T'E, LTD/TE, and TD/TE on firm characteristics (NIFATA, PROFIT, NSNFA, NDTS, DIVTA, TA/GDP), macro factors (GROWTII, INFL), tax variables, stock market development indicator (index 1), financial intermediary variable (bank/gdp), time and countr-y dummy variables. *, +, and indicate significance levels of 10, 5, and I percent respectively. lable 9. Capital Structure aMiil Stock Miarkel Development- D)cveloped and Developing Stock Markes I ncap/gdp tvtIgdp lor Index I index 2 Countries will) developed stock market m3/gdp -.23 -.36 -.04 -.27 -.14 sid/tc bank/gdp -.07 -.48 -.06 -.24 -.16 findexl -.04 -.47 -.07 -.23 -.16 findcx 2 -.06 -.48 -.07 -.23 -.17 m3/gdp -.43 -.62' -.34' -.78" -.43 lidhe bank/gdp -.50' -.81" -.37* -.90*0* -.53' findex I -.54' -.82" -.37' -.94*" -.52' findex 2 -.49' -.80"0 -.37' -.90** -.530 m3/gdp -.49 -.93' -.35 -.95' -.52 id/lc bank/gdp -.47 -1.18'" -.38 -1.040' -.60 findex I -.42 -1.21" -.40 -1.07"# -.62 lilidex 2 -.44 -1.15" _ -.38 -1.02* -.61 Countries with developing slock markcts m3/gdp .10 .97 .06 .20 .74"' sid/te bank/gdp .16 .84 .05 .17 .69" ' lijidex I .15 .93 .07 .22 .74"' _ findex 2 29 1.21 .08 .31 .76"' m3/gdp 1.06 2.26 .03 .50 .99"' ltd/te bank/gdp 1.04 1.94 -.01 .39 .90" limlex I 1L, 2.1t0 .02 .47 .972*' findex 2 1.27 2.52 .04 .59 .9'* m3/gdp 1.4.0 3.61 .16 .93 1.80"' td/te bank/gdp 139 3.09 .09 .76 1.65"' rindex I 139 3.39 .16 .90 1.7"' findex 2 1.79 4.06 .18 1.11 1.81"' Coefficient values are frto,, regressions of STrD/ E, LIl DrrE, and TD(TltI on liren characteristics (NFATA, PROFIT, NSNFA, NDTS, DIVTA, T1A/GDP), macso factors (GROWlTl, INIS), tax variables, stock imiket variables, financial iiterimiediary variables, timie and country dummy variables. lThe split between developed nid developing stock markets Is determilned based on index I. Index 2 includes CAPM mis-pricing in(licator when available. rach regression includes only die indicated stock market and financial iiternediary variables.', ", and "' indicate significancc levels of 10, 5, and I percent respectively. lFllMe 111. Capitil Structure stikd Stock lj hIe l)t vlDv liopment - D)eveloped anid Developiug Stock Markets, Latrge vs. Small nlrmns Small flirmis Large Fimis _ncap/gdp i idexl iidex 2 . mcap/gdp lidexl h[idex 2 Couluriiies wili developed stock nmarkets m3/gdp -.32 -.64 -.41 -.39 -.59 -.44 std/te bank/gdp -.43 -.75 -.51 -.14 -.28 -.27 findex i -.47 -.74 -.53 -.25 -.39 -.31 findex 2 -.44 -.79' -.56 -.17 -.26 -.26 m3/gdp -.68 -1.28 -.84 -.39" -.29 -.03 lid/ic hank/gdp -.85 -1.72 -1.19 -.39"' -.28 -.03 finidex I -1.22 -1.92' -1.25 -.45" -.31 -.04 flitlex 2 -.85 -1.67 -1.15 -.39" *.28 -.03 m3/gdp -.71 -2.17 -1.29 -.68 -.83 -.48 td/te bank/gdp -1.03 -2.67' -1.71 -.62 -.66 -.35 findex I -1.44 -2.99" -1.85 -.71 -.76 -.41 Iindex 2 -1.1)2 -2.63' -1.71 -.65 -.63 -.34 Counlries with developing stock markets . m3/gdp |1.11 -1.02 -.22 .47 1.64" | 1.23'* sid/te bank/gdp -1.07 -1.05 -.24 .02 1.49" 1.00"' findex I -1.13 -1.06 -.24 .26 1.58"| 1.18"' rfindex 2 -1-17 -1.05 -.21 .74 1.77" !1.19"' mn3/gdp -.34 -.26 .23 2.85| 3.060' 2.17"*' lid/te banklgdp --34 -.30 .19 1.80 2.70* 1.72" findex I -.39 -.30 .21 2.27 2.88' 2.05"** findex2 -.43 -.28 .25 3.10"| 3.23"| 2.16"' m3/gdp -1.50 -1.26 .00 3.98' 4.92" | 3.57"' d/te bank/gdp -1.38 -1.31 -.06 12.13 430" 2.77"' (index I -1.52 -1.32 -.04 13.10 4.65"* 3.38"' findex 2 1-1.57 -1.28 .05 .4.48" 5240" 3.54"*' Cocieficient values are from regressions of STDMrE, I.TD/;E, and TD/TE on firm characteristics (NFATA, PROFIT, NSNFA, NDTS, DIVTA, TA/GDP), macro factors (GROWTII, INFI.), tax variables, stock niarket variables, flnancial lntcmiedlairy varlables, time and counlry dummy variables. 1 he spIlt between developed and developing slock markets Is delermined based on index I. Indcx2 includes CAPM mis-pricing indicator when available. Small and large flrms are the firms that fall into the smallest and largest quartiles classified by total assets over each country's sample period. Each regression includes only the indicated stock markel and rinancial intermediary variables.', ", and ** indicate significanec levels of 10, 5, and I percent respectively. I'able I 1. I)etermitanants of Capitial Structure, Developed anrd Developinig Stock Markets, Large vs. Small Firms Finn Financial Stock Mnrket Macro Factors Tax Variables Time Dummies Country Adjusted Number of Characterislics Variabile Ind icaor Dummiles R' Obscrvations 1. Couitries wilh developcd stock markets std/te 5.47"' 1.01 .63 .44 3.42" .77 16.81 .85 114 ltd/te 2.56" .06 6.59" 1.55 .64 1.69* 4.01*"* .70 114 td/te 3.21"' 1.95 3.80' 1.64 1.46 1.37 8.20"* .82 114 Countries with dvcelopiiig stock markets std/te 1.22 4.91'' .10 3.53" 2.24' .37 7.05"' .72 97 tlJd/te ~ 3.46"' 5.030* .21 6.40"' 1.14 1.12 19.50"'' .85 97 Id/te 2.57"* 6.52'"' .37 7.10''' 2.03 .74 15.88''' .81 97 11. Large Firms - Countries with developed stock markets std/te 6.58"' 2.71' .43 1.67 2.51' 2.10" 7 61"' .84 114 lidlte 1.69 .66 1.20 3.31" .37 2.41" 4.66"* .74 I!4 Id/tc 3.774" 4.55*" 1.32 3.17"1 1.84 2.22" 7.26** .82 114 latge IFinny - Countirles wilh developing stock nan kels std/te 4.06"'| 11.35"' | 3.92" 6.80*" .34 1.97** 7.63"' .77 97 ltd/te 5.95*"' 10.05"' | 3.45' 6.22"' .90 3.11** 12.09"' .75 97 Id/ic 3.99"' 1565"'' 4.35"* 7.43''' .51 2.90"' 10.28"' .73 97 Small Firms - Countries with developed stock markets std/te 14.82"' 11.34 2.60' 2.95' 7.98"' .42 9.22"' .75 114 ltd/te 12.17'' |.11 12.55' .32 2.23' 1.40 1.71' .40 114 td/te |12.28' .87 3.27' .26 2.82' 1.19 2.130" SI 114 Small Firms - Countries with developing stock mnaikets std/te 2.35'' .11 J 1.96 .35 .14 1.24 3.68"' 71 93 ltd/te 1.58 1.16 1.04 54 .13 .54 5.22"' .57 93 Id/Ie .64 1.20 1.52 .61 .01 .75 5.48"' .64 93 IAtN are reported lestinig the joitii ltypotltcsis that specilled variaible coemieletis arc ciltial to zero. Coefliclinis sic obtainied by regressing STFDf1'r, LTlIYIF, and lIri'rF on firm characicristics (NFATA, PROFIT, NSNIA, NDTIS, D)lViA, TA/GI)I'), micro faclors ((ROWTII, INFL), tax variables, stock niarket development liidicitlor (index 1), financial literimiediary variable (bank/gill)). itime and country dummny variables. 'Ihe split between developed and developing stock niarkets is determined based on lidexl. Siaiill anm large firns are Ihe tinis thal fall Iito tile smallest amnd largest quartiles classified by total assets over each country's sample period. ' " and '" indicate significance levels of 10, 5, and I percent respectively. Figure 1 Developing Markets vs. Developed Markets: Average MCAPIGDP 90% 80% 70% 60% - r _ countries with 60% developed stock markets / - * countries with 40% Z developing stock markets 30% . 20% , .Z, 20% L ' -- - --. " " l l I 10% 0% I . I I I A 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Figure 2 Leverage and Stock Market Development STDTE, Developing Stock Markets STDTE, Developed Stock Markets 08 0 i-_ 0 0.7 0.2 0.4 0.6 0 8 0 6 -0.05 0.5 0.4 -0.1I 0.3 ~~~~~~~~~~~~~~~~~~~~-0.15 0.2 0.1 -0.2 0 0.05 0.1 0.15 0.2 0.25 Index I Index I LTDTE, Developing Stock Markets 1 LTDTE, Developed Stock Markets 0.8 .0 l i 07 0.2 0.4 0.6 08 0.6 -0.05 0.5 0.4 -0. 1 0.3 0.2 -0.15 0.1 0 +- I- 02 0 0.05 0.1 0.15 0.2 0.25 Index I Index I Appendix Table 1. Number of Firms and Sample Period Countrv No.of Firms Time Period Australia 401 1983-93 Austria 44 1983-93 Belgium 89 1983-94 Brazil 100 1985-91 Canada 494 1983-93 Switzerland 150 1983-93 Germany 359 1983-93 Spain 116 1983-93 Finland 55 1983-93 France 544 1983-93 United Kingdom 1275 1983-93 Hong Kong 173 1983-93 India 100 1980-90 Italy 81 1983-93 Jordan 38 1980-90 Japan 1104 1983-93 Korea 100 1980-90 Mexico 100 1984-91 Malaysia 143 1983-93 Netherlands 165 1983-93 Norway 52 1983-93 New Zealand 41 1983-93 Palistan 100 1980-88 Singapore 213 1983-93 Sweden 68 1983-93 Thailand 137 1983-93 Turkey 45 1982-90 United States 3247 1983-93 South Africa 67 1983-93 Zimbabwe 48 1980-88 40 AppendixTinble 2. Tsix Advantatge of_lDebt ivitim_Rlespcct to_Di)vidend a,ndalCapilaI nioiii COUJNTR'Y -- BRAZIL ___ INDIA KOIREA MALAYSIA MEXICO YEAR 1980 1990 1980 1990 1980 1990 1980 - 990 -~1980 __ 990 corporate tax rate 0.400 0.400 0.591 0.525 0.420 0.375 0.500 0.390 0.420 0.360 local-taxes: 0.000 0.050 0.000 0.000 0.032 0.028 0.000 0.000 0.000 0.000 corporate tax rate on distributed profits 0.400 0.400 0.59 1 0.525 0.420 0.375 0.500 0.390 0.420 0.360 high personal tax rate ____ 0.550 0.400 0.720 0.525 0.744 0.600 0.550 0.400 0.550 0.350 local taxes: 0.000 0.050 0.000 0.000 0.056 0.045 0.000 0.000 0.000 0.000 personal capital gains tax 0.000 0.250 0.720 0.525 0.744 0.600 0.000 0.000 0.000, 0.000 rate oni interest income ____ 0.550 0.250 0.720 0.525 0.744 0.600 0.550 0.400 0.550 0.2 10 rate on dividend income 0.550 0.080 0.720 0.525 0.744 0.600 0.400 0.350 0.550 0.350 rebate on dividends 0.000 0.000 0.000 0.000 0.150 0.120 0.400 0.350 0.000 0.000 net interest income per $1 0.450 0.750 01.280 0.475 0.256 0.400 0.450 0.600 0.450 0.790 net capital gain per $1 0.600 __0.450 0.114 0.226 0.148 0.250 ___0.500 0.610 0.580 __ 0.640 niet dividends per $1 ___ 0.270 0.552 0.114 0.226 0.235 0.325 0.500 0.610 0.261 0.4 16 tax disadvanitage: dividenids 0.400 0.264 0.591 0.525 0.080 0.188 -0.111 -0.017 0.420 0.473 tax disadvantage: capital gainis _-0.333 040 0.591 0.525 0.420 0.375 -0.111 -0.0 17 -0.289 0.190 COUN'I'RY ____ AKISTIAN___ TIIAILANI) TruRKEY ____ ZIMBJAIIWE___ AUSTR'IALIA __ YEAR 1981 1990 1980 1990 1982 1990 - 1980 1990 1980 1990 corporate tax rate ____ 0.578 0.550 0.300 0.300 0.400 0.492 0.495 0.500 0.460 0.390 local taxes: 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 _ 0.000 corporate tax rate on distributed profits 0.578 0.550 0.300 0.300 0.400 0.492 0.495 0.500 0.460 0.390 high personal tax rate 0.660 0.495 0.650 0.550 0.650 0.500 0.495 0.600 0.611 0.470 local taxes: 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 personal capital gains tax ____ 0.000 0.495 0.000 0.000 0.650 0.000 0.000 0.300 0.000 0.470 rate on interest income 0.660 0.495 0.650 0.150 0.650 0.500 _ 0.495 0.600 0.611 0.470 anlem oi (livi(lcflcI incomec 0.660 0.495 0.650 0.150 0,650 0.500 0.200 0.20(1 0.611 0.470 irebate on dividenids 0.W(1 (1.000 0.(Ot) (ODOt 0.330 0.000 0.000 t).OOt) 0.000 0.000 net interest income per $1 0.340 0.505 0.350, 0.850 0.350 0.500 0.505 0.400 0.389 0.530 net capital gain per $1 0.423 0.227 0.700 0.700 0.2 i10 0.508 0.505 0-.350 0.540 0.323 net dividends per $1 ___ ___ 0.144 0.227 0.245 -0.595 0.408Ol 0-. 2 54 0.404 _ _0.40t) 021 .2 tax disadivantage: dividends 0.57-8 0.550 0.300 0.300 -0.166 0.492 0.200 QOOt 0.460 _0. 390Q itax disadvant(age: capital gains -023 0.550 100 016 040 -.1 0.0 0.1251 -0.3871 0.390 Appeindix Table 2 cont(inued. Tax Advanitage of Debt wvith_ Respect to_Dividendi and( Capital Gainis COUNTFRY -~AUSTIRIA BELGIUM CANADA --FINLAND) FRANCE YEAR 1980 1990 1980 1990 1980 __ 1990 1980 1990 1980 1990 corporate tax rate 0.550 0.300 0.480 0.4 10 0.360 0.288 ___0.430 0.250 _ 0.500 0.370 local taxes: ______0.150 0.135 0.000 0.000 0.140 0.155 0.160 __0.1 70 0.000 0.000 corporate tax rate on distribuited profits 0.275 0.300 0.480 0.410 0.360 __0.-288 0--. 172 0.250 -0.500 0.420 hiighi persoialI tax rate_ __ 0.595 0.500 0.763 -0.550 0.430 0.305 -- 0.5.10 0.43-0 0.600 0.568 local taxes: _____0.000 0.000 ___ .60 0.100 _ 0.226 ___0.162 0.160 0.186 0.000 _ 0.000 personiili capital gains (ax -~ 0.000 0.000 0.175 _ 0.165 0.022 ___0.203 0.5 10 0.430 0.600 0.160 r'ate on initerest inicom-e 000 050 0.763 0.550 0.430 0.305 __0.000 0.100 0.600 0.568 rate oi dlividend( inicomie 0.595 0.500 0.763 0.550 0.323 0.330 0.5 10 0.430 0.600 (0.568 rebate oni dividends _____0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.0(1(1__ 0.500 0.500 net_interest income pL'r $1 1.000 ~~0.50(1 (0.237 0.450 0.570() 0.695. I L00(1 0.-900 0.400 0.432 net_capital gain per $1 ___ 0.450 0.700 0.429 0.493 0.626 0.567 0.279 0.428 0.200 ___0.529 niet dividends per $1 ___ 0.294 0.350 0.123 ___0.266 0.434 0.477 0.406 0.428 0.450 0.541 tax disadvantage: dividends __0.706 0.300 ___0.480 0.410 0.239 0.3 14 0.594 0.525 -0.125 - -0.251 tax disadatge aialgis0.550 -0.400 ..0.812f -0.095 -0.099 0.184 0.72 1 0.525 __0.500 -0.225 COUN__R GERMANY IIONG KONG IT'ALY ____JAPIAN __ NEprIERlLANI)S YEAR -~1980~ 1990 1980 1990 1980 1990 1980 1990 - 1980 1990 corporate (ax rate 0.560 0.500 0.170 0.165 0.250 0.360 0,400 0.375 0.480 0.400 local taxes: 0.200 0.250 0.000 ~0.000 0.1J50 ~0. 162 ---.19-1 -0-.187 _0.00-0 _0.00 corporate_tax rate oni distribuited profits 0.360 0.360 ___0.170 0.165 0.250 0.360 0.300 0.375 0.480 0.400 high personal tax rate 0.560 0.530 0.150 0.150 0.720 0.500 0.750 0.500 0.720 0.600 local taxes: 0,050 0.048 0.0(10 0.00(1 0.150 0.162 0.05(1 0.150 0.000 0.000 personal capital gains tax 0.000 0.000 0.000 0.000 _ 0.000 0.000 0.000 0.260 0.200 0.200 rale on initerest_incomie - _ -6 050 0.000 0.000 - 0.720- 0.5(0 - 0.750 0.200 --0.720 - 0.600 rate on dividend incomne ___0.560 0.530 0.000 0.000 0.720 0.500 0.750 0.200 0.720 0.600 rebate on dividends ___0.000 0.000 0.000 0.000 0.333 0.563 0.000 0.000 0.000 0.000 _net interest income per $1 0.440 0.470 1.000 1.000 0.280 0.500 0.250 0.800 0.280 0.400 net capital gain per $1 0.440 0.500 0.830 0.835 0.750 0.640 0.600 0.463 0.416 0.480 net dividends per $1 0.282 0.301 0.830 0.835 0.460 0.680 0.175 0.500 0. 146 0.240 tax disadvantage: dividends_ 0.360 0.3601 0.170 0.165 -0.642 -0.3601 0.300 -0.375 0.480 0.400 ilax disaidvantiage: capilal gains I 0.0001 -0,06_4j 0.,170 066 -1.6791 -0.2801 -1.4001 0.4221 -0.4861 -0.2001 Append(ix Table 2 cointiniedI. Tax Advaintage of Debt withi Respect to Dividend. and Capital Gains _____ COUN -kIII-t NEW ZEALAND NORWAY __ SINGAPORE &9)UTII AFRIICA SPA-IN- YEAR 1980 1990 1980 1990 1980 1990 1980 1990 1980 1990 corporate tax rate ________0.450 0.380 0.278 0.278 0.400 0.3 10 0.473 0.545 0.330 0.350 local taxes: _____ 0.000 0.000 0.230 0.230 0.000 0.000 0.000 0.000 0.000 0.0 15 corporate tax rate oni distributed profits ___0.450 0.380 0.278 0.278 0.400 0.3 10 0.473 0.545 0.330 0.350 hiighi personal tax rate 0.600 0.330 0.480 0.184 0.550 0.330 0.500 0.440 0.655 0.560 local taxes: ___ _____0.000 0.000 0.230 0.250 0.000 0.000 0.000 0.000 0.000 __0.000 personal capital gains tax ______ 0.000 0.000 0.500 _ 0.400 0.000 0.000 _ 0.000 0.000 0.655 0.560 ra(e oni initerest inicomei 0.600 0.330 0.480 0.184 0.550 0.330 _ 0.500 0.440 0.655 0.560 rate oni dividenid inicomie 0.600 0.330 0.480 0.184 0.550 0.330 0.167 _ 0.150 0.655 0.560 rebate oni dividenids _____ 0.000 0.000 0.000 0.000 0.000 0.000 _ 0.000 0.000 0.000 0.100 net interest i-icnicm per $1 0.400 0.670 0.520 0.8 16 0.450 0.670 0.500 0.560 0.345 0.440 net capital gain per $l 0.550 0.620 ___U61 0.433 0.270 0.462 0.528 0.455 0.231 0.286 net_dividends per $1 0.220 0.415 0.375 0.589 0.270 0.462 0.440 0.387 0.231 0.351 tax disadvantlage: dividend(s - -0.450 - 0.380 0.278 0.278 0.400 0.3 10 ___0.121 0.309 _ 0.330 0.202 tax disadvantage: capital gainis -0.375 0.075 0.306 0.469 0.400 0.3 10 -0.055 0.188 0.330 0.350 COUNTRY- - SWEIDEN -- SWITZERLAND.- UNfTIA) KINGDOMI UNITED STATES - .- . YEAR - 1980 1990 -~1980 1990 1980 1990~ 1980 1990 corporatc tax rate __ ____ 0.400 0.300 0.098 0.098 0.520 0.350 - 0.460 0.340 _- local taxes: 0.280 0.000 _ 0.3 14 ___ .000 0.000 0.120 0.120 ____ corporate tax rate oii distribuited profits 0.400 0.300 0.098 0.098 0.520 0.350 0.460 0.340 ___ hiighi per-sonial tax rate 0.580 0.510 0.115 -0.1 IS 600 0.400 0.700 0.330 local taxes: __________ 0.280 0.000 0___(.145 1)000 0.000 0.1201-0.120 ____ personal capital gainis tax 0.580 0.300 0.000 ___0.000 -0.300 0.400 ---0.280 ___0.330 rate ori interest inicome ____ 0.580 0.300 0.1l I 0.115 0.600 0.400 0.700 0.330 rate ond(ivideid income __0.580 0.300 0.115 _ 0.115 0.600 0.400 0.700 ___0.330 __ rebate oni dividenids 0.000 0.000 0.000 0.000 0.429 0.333 0.000 0.000 net inter-est income per $1 0.420 0.700 0.885 0.885 0.400 0.600 0.300 0.670 n-et capit-ai gain per $1 _-- - -- 0.51 040 -__ .0 .0 .3 0.39 0 039 -0.442 - .- . oict dlividlends pcr-$l _ 0.252 0.490 0.798 0.798 0.398 01.607 __0.162 0.442____ tax disadvantage: dividends -- 0.400 0.300 0.098 0.098 0.006 -0.01 I 0.460, 0.340 ___ tax disadlvantage: capital gains ___0.400 0.300 -0.0 19 -0.0 19 0.160 0.350 -0.296[7 0.340 ___ _ Ilihe tax rates usc(d are thie statuitory onces. D)ata atie obtalined f-oin variiouis editionis of Coopers & Lybrand, linterniatioittal'rax Summartinies. Policy Research Working Paper Series Contact Title Author Date for paper WPS1437 Travel Mode Substitution in Sao Joffre Swait March 1995 C. Jones Paulo: Estimates and Implications Gunnar S. Eskeland 37699 for Air Pollution Control WPS1438 Trade Reform, Efficiency, and Growth Ejaz Ghani March 1995 A. Nokhostin Carl Jayarajah 34150 WPS1439 Nontariff Barriers Africa Faces: What Azita Amiadi March 1995 S. Lipscomb Did the Uruguay Round Accomplish, Alexander Yeats 33718 and What Remains to Be Done? WPS1440 Poverty and Social Transfers in Christiaan Grootaert March 1995 N. Sachdeva Poland 82717 WPS1441 The Significance of Credits and Douglas Galbi March 1995 N. Castillo Subsidies in Russian Agricultural 33490 Reform WPS1442 Energy Price Increases in Einar Hope March 1995 C. Jones Developing Countries: Case Studies Balbir Singh 37699 of Colombia, Ghana, Indonesia, Malaysia, Turkey, and Zimbabwe WPS1443 Policy-Based Finance, Financial Dimitri Vittas April 1995 P. Infante Regulation, and Financial Sector Akihiko Kawaura 37642 Development in Japan WPS1444 Roads, Lands, Markets, and Kenneth M. Chomitz April 1995 E. Schaper Deforestation: A Spatial Model David A. Gray 33457 of Land Use in Belize WPS1445 Human Capital and Industry Wage Chris N. Sakellariou April 1995 I. Conachy Structure in Guatemala 33669 WPS1446 Review of Integrated Approaches Donna J. Lee April 1995 C. Spooner to River Basin Planning, Ariel Dinar 32116 Development, and Management WPS1447 Environmental Inspections and Benoit Laplante April 1995 E. Schaper Emissions of the Pulp and Paper Paul Rilstone 33457 Industry: The Case of Quebec WPS1448 Environmental Regulation and Susmita Dasgupta April 1995 E. Schaper Development: A Cross-Country Ashoka Mody 33457 Empirical Analysis Subhendu Roy David Wheeler WPS1449 Worker Displacement during the Peter Orazem April1995 J. Prochnow-Walker Transition: Experience from 37466 Slovenia Policy Research Working Paper Series Contact Title Author Date for paper WPS1450 Social Safety Net and the Poor Fareed M. A. Hassan May 1995 F. Smith during the Transition: The Case of R. Kyle Peters, Jr. 36072 Bulgaria WPS1451 Tunisia's Insurance Sector Dimitri Vittas May 1995 P. Infante 37642 WPS1452 The 1985-94 Global Real Estate Bertrand Renaud May 1995 R. Gamer Cycle: Its Causes and Consequences 37670 WPS1453 Air Pollution and Mortality: Results Bart Ostro May 1995 C. Bemardo from Santiago, Chile Jose Miguel Sanchez 37699 Carlos Aranda Gunnar S. Eskeland WPS1454 Child Labor: A Review Christiaan Grootaert May 1995 M. Youssef Ravi Kanbur 34614 WPS1455 Tentative First Steps: An Assessment Bemard Hoekman May 1995 F. Hatab of the Uruguay Round Agreement 35835 on Services WPS1456 Equity Markets, Transaction Costs, Valerie R. Bencivenga May 1995 P. Sintim-Aboagye and Capital Accumulation: An Bruce D. Smith 38526 Illustration Ross M. Starr WPS1457 Does Decentralization Increase Antonio Estache May 1995 WDR Spending on Public Infrastructure? Sarbajit Sinha 31393 WPS1458 Credit Policies: Lessons from East Dimitri Vittas May 1995 P. Infante Asia Yoon Je Cho 37642 WPS1459 Pension Funds in Central Europe Dimitri Viftas May 1995 P. Infante and Russia: Their Prospects and Roland Michelitsch 37642 Potential Role in Corporate Govemment WPS1460 Efficiency and Equity Considerations Yacov Tsur May 1995 C. Spooner in Pricing and Allocating Irrigation Adel Dinar 32116 Water WPS1461 Stock Market Development and Firm Asli Demirgug-Kunt May 1995 P. Sintim-Aboagye Financing Choices Vojislav Maksimovic 38526 WPS1462 Stock Market Development and Asli Demirgu9-Kunt May 1995 P. Sintim-Aboagye Financial Intermediaries Ross Levine 38526