FACTORS INFLUENCING THE FINANCING DECISION t n o MULTINATIONAL CORPORATIONS LISTEDIN BURSA^VIALA v

PREPARED BY: NORASHIKIN ISMAIL WAN RAZAZILA WAN ABDULLAH KHARUDIN MOHD SALI

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FAKULTI PERAKAUNAN

Universiti Teknologi MARA Johor Km 12, Jalan Muar,85200 Segamat Johor Darul Takzim Tel: 07-9352000 Fax : 07-9352277 Email: perigarahjohor@jolior.edu.my

^J^ihhyJni 1

UNIVERSITI TEKNOLOGI MARA

Tarikh No. Fail Projek

1 6 NOKrSoeT

Penolong Naib Canselor Institute of Research, Development & Commercialization (IRDC) UiTM Shah Alam

Yang Berbahagia Prof.,

LAPORAN AKHIR PENYELIDIKAN "FACTORS INFLUENCING THE FINANCING M ^ A Y S ^ M U L A T I O N A L CORPORATIONS LISTED S A

Merujuk kepada perkara di atas, bersama-sama ini disertakan 3 (tiga) naskhah T ann Akhir Penyelidikan bertajuk "FACTORS INFLUENCING TIffi FTNANCT^G MULTINATIONAL CORPORATIONS LISTED IN B ^ S A MALAYSIA, oleh kumpulan penyelidik UiTM Cawangan Johor untuk makluman pihak

Sekian untuk makluman dan tindakan pihak Prof. Terima kasih.

SSP

Yang beirar,

NORASHIKIN BTE ISMAIL Ketua Penyelidik

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KUMPULAN PENYELIDIK

NORASHIKIN BTE ISMAIL

Ketua Penyelidik

Tandatangan

Ahli
W A N RAZAZILA BTE WAN ABDULLAH

Tandatangan

KHARUDIN M O H D SALI

Ahli

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ACKNOWLEDGEMENTS

In the name of Allah, the Most Compassionate,

the Most

Merciful.

f t u t v ' w k h ^ h f r ^ T m S h % ! T g l V i n " t h e S t r e n g t h M d P a t i e n c e t 0 c o m P l e t e this study with n the period given. We would like to extend this appreciation to those who have direct y and indirectly contributed invaluable assistance, cooperation and support in w the completion of this research. They are:

Unit of Research, Development and Commercialisation, UiTM Johor, for the financial support in conducting this study. Prof. Madya Dr. Omar Samat, Director, Universiti Teknologi MARA Johor for his continuous support and encouragement. Cik Nor Diana Abd. Rahman, Librarian, UiTM Johor for all her help and information on Data Stream System. Finally, we acknowledge the moral support from our colleagues and family members.

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ABSTRACT

mutational corporations in Malaysia with different maturity s u 2 l l o debt instruments are significantly related to financing decisions determines The evidence found indicates that financing decision of multinational corporaZZ can be influenced by size, tangibility, and growth of short term debt ratio Zd total debt rat o Also a further analysis conducted shows that the size of the firms measured by Lo TA t reiatea with LogTA as a proxy for size, but it is positively related to 1 n^Al another proxy for size. In addition, the asset structure as a p r ^ Z n w t f s f o u Z to directly influence the short term ratio and total debt J o 7f he Z c The he opportunities have positive relationships with the short term ratio %rowth Besides that, the agency cost measuredby market valu" v a l u e Z f p ^ Z d significant influenced the total debt ratio. Furthermore the dZdTuuP

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LIST OF TABLES Page Table 1: The Expected Signs of Relationship between the Leverage and Independent Variables. Descriptive Statistics of Total Debt Ratio and Independent Variables. Determinants of Debt Ratio for Multinational Firms. Descriptive Statistics of Short Term Debt Ratio and Independent Variables. Determinants of Short Term Debt Ratio for Multinational Firms. Descriptive statistics of Long Term Debt Ratio and Independent Variables. Determinants of Long Term Debt Ratio for Multinational Firms. Result of Multicollinearity Test using Variance Inflation Factor. 25

Table 2:

30

Table 3: Table 4:

31 33

Table 5:

34

Table 6

36

Table 7

38

Table 8

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TABLE OF CONTENTS Acknowledgements Abstract List of Tables Table of Contents CHAPTER 1: INTRODUCTION 1.0 11 1.2 1.3 Introduction The Problem Statement Objectives of the Study Chapter Organization 1-4 4 4 5-6
in

Page
i

iv

CHAPTER 2: LITERATURE REVIEW 2.0 2.1 2.2 Chapter Description Introduction Theories Related to Capital Structure 2.2.1 2.2.2 2.2.3 2.2.4 2.3 2.4 2.5 2.6 Trade Off Theory Agency Cost Theory Free Cash Flow Theory Pecking Order Theory 8-9
10-11

11 11-13 13 14-15 15 16-19

Growth to Debt Equity Theory Industry and Capital Structure Strategic Assets and Capital Structure Studies on Determinants of Capital Structure

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CHAPTER 3: RESEARCH METHODOLOGY 3.0 3.1 3.2 3.3 3.4 3.5 Chapter Description Research Setting Research Design Hypotheses Development Problems and Limitations Summary 20 20 21-^6 26 28 2g

CHAPTER 4: DISCUSSION OF RESEARCH FINDINGS 4.0 4.1 Chapter Description Research Findings 4.1.1 4.1.2 4.1.3 4.2 4.3 4.4 Total Debt Ratio Short Term Debt Ratio Long Term Debt Ratio
30

29 29 _
32

32-35 35-38
38

Multicollinearity Test Heteroskedasticity Test Summary

_
40

39

4 Q 4 1

CHAPTER 5: CONCLUSION AND FURTHER RESEARCH 5.0 5.1 Conclusion Further Research , 42-43 44

REFERENCES APPENDICES

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FACTORS INFLUENCING THE FINANCING DECISION FOR MULTINATIONAL CORPORATIONS LISTED IN BURSA MALAYSIA.

CHAPTER ONE INTRODUCTION 1.0 Introduction

Over the past two decades market liberalization has emerged as a major issue affecting international business (Toulan, 2002; Tatoglu and Glaister ,1998). After many years of experiment with heavy state intervention in the economy, a consensus emerged that the achievement of more dynamic economic growth requires a greater role from the private sector. As a result, many developing countries have introduced market reform programmes aimed at reversing economic decline and at generating sustainable growth and development. Investment by multinational corporations (MNCs) was one of the means to continue access to international capital (Lecraw, 1992:41). Foreign Direct Investments (FDIs) by MNCs have become an increasingly important source of developing countries' capital flows compared to other sources such as commercial and concessional loans (Bergsman and Shen, 1995).

The MNCs operate in the global market and are exposed to different legal regimes, political theorists and foreign exchange risk compared to domestic firms. How these factors affect the financial decision of MNCs is an unsolved issue. Financial theory predicts that MNCs should have higher leverage levels because of their larger size, lower cash flow volatility and increased access to international capital markets in comparison to their domestic peers.

To date, most of the previous studies have used the U.S. or other developed countries as their samples. It is possible that their results are peculiar only to the U.S. case. This study examines the capital structure of MNCs and DCs using a Malaysian sample from the fiscal year 1999 to 2006 to examine whether the puzzling results observed in the developed countries market also hold true for Malaysia.

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The Malaysian capital market is substantially smaller compared to that in the developed countries. This could potentially constraint the supply of capital especially for large firms. The comparison of the leverage of Malaysian MNCs and DCs could provide some insights into whether capital supply factors could affect leverage as argued by Faulkender and Petersen (2004). In sum, these differences provide us an independent sample to test the predictions of several capital structure theories.

History has showed us that the combination of debt and equity will affect a firm's value and investment. This combination, also known as the leverage factor, is being used by firms as well as the market as a measure of financing or capital choices (i.e. between debt and equity). Hence, a firm's decision on capital choices will affect investment decision, cost of capital, and required rate of return as well as the value of its security. The public, on the other hand, values the rate of return as well as the value of securities of firms as a measure of strength. Several studies have explored the characteristics and factors which have influence a firm's capital structure such as agency cost, age, bankruptcy cost, growth, taxes, profitability, firm size and tangibility.

Agency cost exists because managers prefer activities that are personally beneficial to them than activities that benefit the firms. Jensen and Meckling (1976) state that firms prefer to be in debt to overcome the conflicts between the stakeholders and the managers. By having more debts, then less cash is available to be privately used by managers for their personal gain. Myers and Majluf (1984) claim that the information on the potential of success in investment is private to managers and it is not known to investors. Conflicts among stakeholders and the debtholders, according to Jensen and Meckling (1976), is another form of agency problem. This exists when firms choose debt and the fund is suboptimally invested by the equityholder. In the event of big profits, the equityholders will get more return at the expense of fixed return to the debtholders. On the other hand, in the event of losses, the debtholders will have to bear the losses.

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Capital acquisition through debt offering or public issues is much more attainable by firms that have been long established than by new firms. This is the element of age. Gertler (1992) discovers, information asymmetries are likely to be large for young firms. A young firm is a relatively unknown institution and the cost of outside finance includes a premium to cover the risk implied by this uncertainty. Berger and Udell (1990) discover that young firms need to establish reputation from the initial funds they obtain. They also find that relatively less experienced firms tend to borrow less than experienced firms. The choice of debt means an increase in debt ratio that exposes firms to the potential of bankruptcy. Scott (1977) states that bankruptcy cost lessens the equity value of the firm. He suggests that firms that have low revenues as compared to interest payment have three ways to avoid bankruptcy: increase in the selling of debt (for e.g. subordinated debt), assets and equity. Nevertheless, issuing of debt is not permissible if increase in the claims by the debtholder is bigger than the firm value. Haugen and Senbet (1978) propose firms that have direct cost of bankruptcy will be better off by issuing additional equity.

The optimum capital structure will have to consider the effect of corporate tax and personal tax as suggested by DeAngelo and Masulis (1980). According to Miller (1977) debt is preferred because of tax reduction. However, DeAngelo and Masulis (1980) claim that if the marginal cost of debt financing equals to zero, the use of debt is less significant in the capital structure formation. The effect on the debt on a firm's value was studied by Fama and French (1998). Dividends are positively correlated to the firm's value while taxes are negatively correlated. They suggest that the financial policy should give priority on the effects on the firm's value apart from consideration on the high corporate tax.

The level of collateralized assets or tangibility indicates the ability of the firms to raise capital either through bank borrowing or through selling of debt instruments. Myers and Majluf (1984) and Scott (1977) suggest that firm may find it advantageous to sell secured debt. Scott (1977) states that, by selling secured debt, firms increase the value of their equity by expropriating wealth from their existing unsecured creditors.

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A firm growth opportunities, as observed by Titman and Wessels (1988), Harris and Raviv (1991), among others include research and development expenses, capital expenditures and growth of total assets. These variables are expected to generate future investments for the firms. However, for small firms, the potential for corporate opportunity is high, and their assets are largely in the form of intangible assets and these cannot be used as collateral. Therefore, a small firm's debt mainly consists of short term debt. Hence, the small firm's growth can be used to increase the firm's value, but the assets cannot be used as collateral and do not generate current taxable income.

Several authors, among others, Warner (1977), and Ang et. al. (1982), claim that relatively large firms tend to be more diversified and less prone to bankruptcy than smaller firms. This suggests that large firms should be highly leveraged. Meanwhile, according to Titman and Wessels (1988), the costs of issuing debt and equity instruments are related to the size of the firm. In particular, small firms pay a higher cost than large firms to issue long term debt and new equity. This suggests that small firms may be more leveraged than large firms and may prefer to borrow short term loan rather than issue long term debt because of the lower fixed costs associated with these alternatives.

1.1

The Problem Statement

Based on Modigliani and Miller (1998) studies, if optimal capital structures exist, these structures would maximize the value of firm. The optimal financing structure may have important implications on firm valuation, capital budgeting decisions and long term corporate profits. It is important to understand the way that firms maximize value. Decisions regarding financial structures may have important implications with regards to the shareholders' wealth.

1.2

Objectives of the Study

The main objective of this study is to identify which financial variables influence financing decisions of multinational corporations. The second objective is to analyse

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various measures of debt depending on the maturity structure to determine the financing decisions.

1.3

Significance of the Study

Since financing decision has important implications on shareholders' wealth, this study aims to contribute to the shareholders, either existing or potential investors on the matters of financing decisions of multinational corporations. In addition, it also provides an understanding on the determinants of financing choice available for the firms.

The findings may not be applicable in other settings since it will only be based on companies listed on Bursa Malaysia. However, this study will contribute towards the literature on capital structure.

1.4

Chapter Organization

This research is organized into five chapters. The first chapter provides a brief introduction on the overall research including the objectives and the significance of this study.

The second chapter starts with the issues of financial leverage, taxes and firm value, the trade off theory, the agency costs, the free cash flow theory, the pecking order theory, factors influencing capital structure and factors affecting capital structure. In addition, this chapter also discusses on multinational companies and previous studies on the determinants of capital structure.

The following chapter discusses the method and data used for this research. The focus of this chapter is on how the research was conducted in order to derive at the findings and conclusions. The research process focuses on the settings, measurement procedure, hypothesis statements and data analysis method.

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In chapter four, the findings of the research are discussed. This is the essential part of the research as it explains the findings according to the objectives stated in chapter one. The findings identify which financial variables have influence over financing decisions of multinational corporations. Besides that, this chapter also analyses various measures of debt depending on the maturity structure to determine the financing decisions.

The final chapter concludes the research and gives a summary of the study as well as some recommendations for future research.

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CHAPTER TWO LITERATURE REVIEW

2.0

Chapter Description

This chapter discusses the capital structure issues, the financial leverage, taxes and firm value, the trade off theory, the agency costs, the free cash flow theory, the pecking order theory, factors influencing capital structure and factors affecting capital structure. In addition, this chapter also discusses on multinational companies and previous studies on the determinants of capital structure.

2.1

Introduction

Basically there are two sources of financing which are equity financing and debt financing. Financing decisions and arrangements will determine how the value of the firm is sliced up. Debt represents something that must be repaid. It is the result of borrowing money. Debt is not an ownership interest in the firm and the creditors usually have no voting rights in the firm. Normally when corporations borrow, they are required to make regular scheduled interest payments and to repay the original amount borrowed. The interest payment on debt is considered a cost of doing business and it is fully tax exempted. This is also known as a direct tax subsidy or tax shield since interest expense can be used to reduce the amount of taxes to be paid to the government. Anyway, unpaid debt is a liability of the firm. In addition, creditors can legally claim the assets of the firms, which will lead to liquidation and bankruptcy.

However, shares of common stock are the fundamental ownership units of the corporation. When corporations issued shares of stock, they are authorized by law to pay dividends to the holders of those shares. Dividends paid to shareholders represent a return on the capital contributed to the corporation by the

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shareholders. As compared to interest payment, dividend payment is not considered as a business expense and not deductible for corporate tax purposes. Dividends are paid out after tax profits of the corporation and it is up to the decisions of the board of directors. It is the choice of firms in deciding the best alternatives for their financing. Kochhar (1997) states that debt holders and equityholder are associated with different levels of risk, benefits and control. Even though debtholders exert lower control, they earn fixed rate of return and are protected by contractual obligations with respect to their investment. However, equityholders are the residual claimants, bearing most of the risk and correspondingly have greater control over decisions. Since the instruments of the securities to be issued are large, there are many factors to be considered before a firm's debt-to-equity ratio is finalized.

2.2

Theories Related to Capital Structure

There are many theories that are related on and contribute to the debate and development of capital structure decisions.

2.2.1

Trade off theory

The value of firms is the sum of the market value of the debt and the market value of the equity. Shareholders should care about maximizing the value of the entire firm because changes in capital structure benefit the stockholders if and only if the value of the firm increases. Therefore, it is the role of managers to choose the capital structure that they believe have the highest firm value. Since interest payment is tax deductible, it provides tax benefit to the firm which will increase the firm value.

However, according to Modigliani and Miller's (1958) proposition I (in a world with no taxes), the value of the levered firm is the same as the value of the unlevered firm. They contend that if levered firms are priced too

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high, rational investors would simply borrow on their personal accounts to buy shares in unlevered firms. In their proposition H, Modigliani and Miller argue that the expected return on equity is positively related to leverage, because the risk to equity holders increase with leverage. In a world with taxes, Modigliani and Miller (1963) claim that the firm's value is positively related to its debt due to the tax shield of the interest that is deductible from taxes. Tax shield increases with the amount of debt and as a result, the value of the firm is positively related to debt. Anyway, the risk of equity increases with leverage.

Besides providing tax advantages, debt puts pressure on the firm due to the fact that interest and principal payments are obligations. Failure to meet these obligations will make the firms face financial distress, whereby the worth is facing bankruptcy situation where ownership of the firm's assets is legally transferred from the stockholders to the bondholders. Therefore, bankruptcy has a negative value of the firm. Nevertheless, the costs associated with bankruptcies that lower the firms value is not bankruptcy itself. Hence, Cassar (2001) claims that firms which have high distress costs would have incentives to decrease outside financing to lower these costs. The integration or the trade off between benefits of debt (tax shield is the chief benefit) and distress cost is known as the optimal amount of debt.

As claimed by Graham and Harvey (2002), in their study on Chief Financial Officers (CFOs), capital budgeting and capital structure decision, 44.9% of CFOs say tax advantage of debt is important in their financing decision. Furthermore, 57.1% of CFOs are concerned about credit ratings which indicates distress. The evidence by Graham and Harvey (2002) provides moderate support for the trade off theory.

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2.2.2

Agency Costs

The agency theory focuses on the financial contracts established between the organization and the providers of liabilities. This contract creates two agency relationship between i) the managerial relationship, set up between shareholders and managers, and ii)the borrowing relationship, set up between debtholders and the shareholders. The clash of interest among the different agents involved initiate conflicts and agency costs. Conflicts of interest may arise between stockholders and bondholders, whereby

shareholders are tempted to pursue selfish strategies to help themselves while hurting the bondholders. The market value of the whole firm will be lowered if all these selfish strategies are undertaken. Examples of selfish strategies include incentive to take large risks project, incentive toward underinvestment, and milking the property in paying out extra dividends of other distributions in times of financial distress, leaving less in the firm for the bondholders. Jensen (1986) argues that when a firm has an ample free cash flow, managers can squander the cash by consuming perquisites or operating ineffectively. These create a need for debtholders to restrict and monitor the firms' behaviour.

Cassar (2001) stated that costly monitoring devices or contractual covenants need to be incorporated into debt agreements to protect debtholders from this potential behaviour. It is therefore these costs that will increase the cost of capital offered to the firm. A weak evidence is found by Graham and Harvey (2002) on the importance of

underinvestment in debt policy.

However, using a cross sectional sample that consists of 1,014 exchange listed non-financial firms in 18 emerging markets with both ultimate ownership data for 1995-1996, Ilarvey et al. (2003) finds evidence that debts create shareholder value for firms that face potentially high

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managerial agency costs. The incremental benefit of debt is concentrated in firms most likely to have overinvestment problems because they have either high levels of assets in place or limited growth opportunities. In addition, they claim that the results support the recontracting hypothesis that shareholders value compliance with monitored covenants, particularly when firms are most likely to face extreme agency problems.

2.2.3

Free Cash Flow

The free cash flow hypothesis states that firms with high free cash flow are more likely to make bad acquisitions than firms with low free cash flow. This will give a vital implication for capital structure because an increase in dividends should benefit the stockholders by reducing the ability of managers to pursue wasteful activities. In addition, the debt obligations in terms of interest and principal will also ensure that cash leaves the firms. In fact debt will give greater effects than dividends since firms have no legal obligation to pay dividends. Therefore, the free cash flow hypothesis argues that a shift from equity to debt will boost firm value.

2.2.4

The Pecking Order Theory

Contradictory to trade off theory, the pecking order theory assumes that firms do not target a specific ratio instead internal financing should be used first before deciding issuing securities either debt or equity. The theory suggests that if outside financing is required, debt should be issued before equity. Equity should only be issued when firms have fully utilized their debt capacity. Myers (1984) suggests that managers have a pecking order to meet their financial needs, in which retained earnings represented the first choice, followed by debt financing, and then equity. Pao et. al.

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(2003) obtains a consistent result in both high technology corporations and traditional corporations where the more profitable the firm, the lower the debt ratio. Their finding is consistent with the pecking order theory and they claim that external financing is costly and therefore should be avoided by firms.

In addition, Allen (1991) in his investigation of financial managers' perceptions of the board determinants of listed Australian company capital structure decision found that companies appear to follow a pecking order with respect to funding sources and also report policies of maintaining spare debt capacity. A consistent result to pecking order theory is obtained by Graham and Hervey (2002), where they found that CFOs generally agree that insufficient internal funds influence on the decision to issue debt, and firms avoid equity when they perceive that it is undervalued.

Moreover, Shyam-Sunder and Myers (1999) studied the static trade off against pecking order models of capital structure of US firms form 1971 1989. Due to restrictions on continuous data, only 157 firms were used as a sample. From their empirical results, Shyam-Sunder and Myers (1999) claim that the pecking order is an excellent first-order descriptor of corporate financing behaviour for their mature corporations.

In contrast, Frank and Goyal (2003) finds evidence that contradicts what is often suggested about pecking order theory. Using a broad cross section of publicly traded American firms over the period 1971-1998, they contend that internal financing is not sufficient to cover investment spending on average. Thus, external financing is heavily used. Anyway Frank, and Goyal (2003) notes that time period and firm size play major roles to the results obtained. They assert that in 1990s, many more small firms and unprofitable firms become publicly traded, which generally do not behave according to the pecking order theory.

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2.3 Growth and Debt-to-equity Ratio

The introduction of future growth opportunities increases firm value. It does not increase the current level of debt needed to shield today's income from today's taxes but growth increases the value of equity. Therefore, high-growth firms will have lower debt ratios than low-growth firms. According to Myers (1977), growth opportunities have significant negative impacts on capital structure based on the argument that firms with higher investment intangible assets are to use less debt to reduce the agency costs associated with risky debts. In contrast Pao et. al. (2003) finds that growth opportunities have insignificant impacts on capital structure for the high technology corporations and positive impact on capital structure for the traditional corporations. According to the study conducted by Roden and Lewellen (1995) on capital structure decision of leverage buyout firms, the target firm's growth rate affects both the proportion and the composition of the debt. They find that the greater the prospective future growth opportunities, the smaller the proportion of bank financing and the larger the component of subordinated debt securities.

In addition, Noronha et. al. (1996) in her study on the interaction of capital structure and dividend decisions finds that for subsample of companies with alternative mechanism for monitoring equity agency costs and with high expected growth, the payouts rate of firms are not related to proxies for agency variables and no interaction between capital structure and dividend decisions is observed. However, for the subsample with lower availability of alternative mechanisms and low growth, the payout rate is related to agency variables, and strong simultaneity is observed.

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2.4 Industry and Capital structure

The nature of competition varies across industries and this affects optimal debt policy. In addition, some countries impose variety of tax rates across industry. According to Hatfield et. al. (1994), in their study on 183 firms which announced a new debt issue for the period January 1982 through December 1986, they find that the relationship between a firm's debt level and that of its industry does not appear to be of concern to the market. They conclude that the market doesn't consider industry averages for leverage as discriminators for firms' financial leverage. Their findings are consistent with the original Modigliani and Miller (1958) proposition that financial leverage is irrelevant to the value of the firm. Moreover, Graham and Harvey (2000) find little evidence that product market factors affect real world debt policy and modest evidence that managers are concerned about the debt levels of their competitors.

Boateg (2004) analyses the determinants of capital structure of international joint ventures in Ghana based on a sample of 41 firms in Ghana with partners from Western Europe, North America and Asia. From the results obtained, they claim that the size of joint venture, the type of joints venture industry, and ownership level of joint venture partner have a positive bearing on the capital structure of joint ventures in Ghana. Firms in textile, building and construction, mining and exploration have a higher gearing compared with firms in food processing, agriculture, financial services, automobile and transport.

In addition, Akhtar (2005) conducts a study to evaluate the determinants of capital structure for Australian multinational and domestic corporations. In identifying the industry influence on capital structure, it was found that Australian domestic corporations that belong to basic material, consumer cyclical and

telecommunication industries have a significant negative relationship with long term leverage. However, Australian multinational corporations that belong to basic material, energy and industrial industries have significant positive

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relationship with leverage. Therefore, Akhtar (2005) proposed that industries play a significant role on the capital structure determination of domestic corporations and multinational corporations.

2.6 Strategic Assets and Capital Structure

Kochhar (1997) claimed that the choice between debt and equity for financing an investment depends on the characteristics of the assets being financed. In his study on strategic assets, capital structure and firm performance, he claims that the optimal debt-to-equity ratio is determined by the nature of strategic assets in the firm. Strategic assets are defined as those assets that could generate sustained competitive advantage. In addition, Barney (1991) proposes strategic assets as those that, in addition to being valuable, resources should possess the key attributes of being rare, imperfectly imitable, and nonsubstitutable. Kochhar (1997) contends that debt financing is suitable for low specificity assets and equity is preferred when the level of specificity is high. Since equity financing is the mode that enables equityholders to exert influence and monitor managerial decisions continuosly through the board of directors, equity is claimed as to provide a superior governance functions. As a result, low specificity assets are likely to be financed via debt, whereas high specificity assets are more likely to use equity financing.

Furthermore, Prasad et. al. (1997) discovers that there is a joint impact of both asset structure and capital structure on systematic risk. They affirm that managers do engage in tradeoffs to control and maintain the strategically selected level of systematic risk, and that trade off is stronger the higher the level of systematic risk's.

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2.7 Studies on Determinants of Capital Structure

By taking the basic rules established by agency theory, the pecking order theory and the signalling approach, Riportella and Papis (2001) study on the analysis of the determining factors of Spanish SME's firms. The result observed is that the enterprises with higher borrowing belong to the industry, whereas those with lower borrowing belong to the service sector. In addition, the enterprises with higher borrowing are the ones dealing on average with a higher number of companies. Some statistically significant differences are noticed between groups where the age of the relationships is generally younger for those enterprises in lower degree of borrowing. In addition, with respect to the variable ownership and control structure, those enterprises with higher specialization of the functions are the ones with lower degree of borrowing.

Considering that taxes do influence the extent of leveraging up, Negash (2002) studies the relationship of corporate tax and capital structure. Using data for firms that were listed in the Johannesburg Stock Exchange's industrial sector for the 1991-1998 period, it is found that there is a negative association between the tax rate variables and extend of leverage. In addition, the trade off between investments related tax shields and debt related tax shield are not observed. However, Negash (2002) claims that factors such as cash flows, asset tangibility, size and actual taxes paid explain leverage.

There is a contrary opinion regarding the level of debt for multinational corporations (MNCs). The characteristic of MNCs such as their larger size, lower cash flow volatility and easier access to international capital markets leads to the suggestion that MNCs should have higher leverage than domestic firms (DCs), Anyway, there is also another theory that suggests MNCs are expected to have lower debt levels. This is due to their operations in more complex political and institutional environment and a geographic dispersion which may increase

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