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Financial liberalization and firms’ capital structure adjustments evidence from Southeast Asia and South America

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Abstract

This paper investigates the impact of financial liberalization on the adjustment of debt ratios in 12 emerging markets using firm-level data from 1991 to 2004. The results support the central hypothesis of this paper that adjustment costs are important in explaining firms’ adjustment toward their debt ratio targets. Our results show that deviations from targets are halved within 1.09 years in South America and 1.19 years in Southeast Asia, suggesting speed of adjustment is relatively faster in South American countries than Southeast Asian countries. Furthermore, our results show that after full liberalization those countries where rule of law and creditors rights were properly enforced, firms had higher adjustment speed compared to those countries where such enforcement was not present.The estimated adjustment coefficients imply that on average firms’ adjustment speeds have increased in all South American countries over the period of financial liberalization. On the contrary, firms’ adjustment speeds did not increase in Southeast Asian countries, reflecting the uneven effect of liberalization on the firms’ financing behaviour in Asian countries. There was a significant reduction in time (in years) taken to half the gap between actual debt ratios and targets only in Pakistan and South Korea. This finding supports the idea of uncertain impact of financial liberalization programs on the domestic financial markets in those emerging markets which started opening up their market and integrating with the rest of the world latter than others. These findings have significant implications for the sequence of banking sector liberalization in the emerging markets.

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Notes

  1. The rationale for financial repression in emerging markets is explained in Denizer et al. (1988), Stiglitz (1994), and Alm and Buckley (1998).

  2. Blejer and Sagari (1988) argue that the impact of sequencing of internal and external liberalization on firms’ financing also varies according to the competitive structure of the banking sector in a country.

  3. Henry (2000) ignores the impact of other reforms such as domestic banking sector liberalization. The liberalization of the banking sector has been one key component of financial reforms in most of the emerging markets (Laeven 2003).

  4. Most of the studies have used event study methodology to examine the influence of various liberalizations on the cost of equity capital (Henry 2000; Bekaert and Harvey 2000; Errunza and Miller 2000).

  5. The time to completion of the liberalization reform is far shorter in South America than in Asia.

  6. Zhang (2003) argues that the difference in liberalization timings in East Asian emerging markets such as South Korea and Thailand might be attributed to fundamental differences in the organizational structures of the private sector, the bureaucracy, and the party system, which shaped the economic interests and political behavior of social groups and state agencies in the policy-making.

  7. Creane et al. (2003) used six themes, each of which reflects a different facet of financial sector development: (1) development of the monetary sector and monetary policy; (2) banking sector size, structure, and efficiency (including the role of the government in the sector); (3) quality of banking regulations and supervision; (4) development of the non-bank financial sector; (5) openness of the financial sector; and (6) institutional environment.

  8. These five dimensions are the existence of credit controls, controls on interest rates, entry barriers to the banking industry, government regulation of the banking sector and the importance of government-owned banks.

  9. For example, Miguel and Pindado (2001) and Gaud et al. (2005) have used at least six consecutive years of data for the estimation of partial adjustment model.

  10. For instance, in Indonesia, prior to liberalization, the government required banks to allocate at least 30% of their loan portfolios to export-related activities and 20% to small-scale enterprises. Consequently, the debt ratio was 1.61 for export firms compared to 0.61 for non-export firms, which implies that some firms might have a higher and faster speed of adjustment than others.

  11. Shareholders might decide to under invest to avoid passing the proceeds of future projects to creditors.

  12. Several attempts were made to identify estimates of a 1 and a 2 but the model produces a singular matrix due to presence of fixed effects, as such these are not estimated in Miguel and Pindado (2001), and Gaud et al. (2005).

  13. Booth et al. (2001, p.90) have reported debt ratios of more than 50% for India, South Korea, Pakistan over the period of 1980–1990.

  14. All of our sample countries were studied by Mitton (2008) over the longer period of 1980–2004.

  15. de Jong et al. (2008) have reported that high long-term debt ratios of over 15% for Korea, and lower debt ratio for Malaysia and Taiwan. For other emerging markets, India, Pakistan, Taiwan and Philippines, debt ratios have reduced consistently.

  16. Foreign banks held nearly two-third of corporate debt by in Indonesia and nearly half in Thailand. In Malaysia, domestic banks held about 90% of corporate debt (Iskander et al. 1999, p.44). The debt contracts with floating rates increased the level of long-term debt during the Asian financial crisis, while firms found it difficult to roll over short-term debt (Schmukler and Vesperoni 2000).

  17. It has been suggested that least square tend to overestimate the coefficients and therefore there might be weakness in the way the data is statistically used. Time invariant firm fixed effects may be correlated with the explanatory variables which might be endogenous. This problem is solved by using GMM which uses first-difference to transform all variables and use lagged levels of explanatory variables are used as instruments. By transformation, fixed effects are removed. This makes the endogenous regressors pre-determined and not correlated with error term. We thank an anonymous referee for this comment.

  18. We compute the half-life, the time required to for a deviation from target to be halved, as ln0.5/ln(1-δ) (see Huang and Ritter 2009).

  19. These findings are same as Rajan and Zingales (1995), and Booth et al. (2001).

  20. The estimated adjustment speed coefficient using GMM approach is somewhat similar to using FE in Asia. The estimates imply that deviation from target is halved within 1.09 years in South American pool and 1.19 years in Asian pool, suggesting speed of adjustment is relatively faster in South American countries than Asian countries.

  21. This estimation routine requires no significant serial correlations in lag 1 and lag 2 of residuals and Sargan test of over-identification restrictions (see Flannery and Rangan 2006, p.504).

  22. After liberalization deviations from targets took more than 2 years to be halved in South American countries.

  23. In spirit of Schmukler and Vesperoni (2000), if we use the classification of countries into bank-based (Argentina, Indonesia, India, Pakistan) and market-based countries (Brazil, Mexico, Malaysia, Thailand), it can argued that in the bank-based countries, liberalization significantly increased the pool of funds available from banking sector to corporate borrowers. Liberalization did not produce an immediate shift towards market-based systems and more reliance on stock markets for external financing. It is plausible that some of economies were not integrated with global equity markets. Excessive lending by banks led to moral hazards culminating in banking crisis later.

  24. English common law is made by judges and subsequently incorporated in legislature. French, German and Scandinavian laws are part of the scholar and legislator-made civil traditions (La Porta et al. 1997, p. 1131).

  25. Our half-life analysis shows that deviations from targets were halved in 1.54 years in Pakistan and 1.66 years in South Korea during full liberalization period compared to 4.4 years and 6.5 years in partial liberalization period respectively.

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  1. Accounting Research Institute, Faculty of Accountancy, Universiti Teknologi Mara, Shah Alam, Selangor, 40450, Malaysia

    Rashid Ameer

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Ameer, R. Financial liberalization and firms’ capital structure adjustments evidence from Southeast Asia and South America. J Econ Finan 37, 1–32 (2013). https://doi.org/10.1007/s12197-010-9158-3

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