International Journal of Managerial Finance

Impact of the cost of capital on the financing decisions of Brazilian companies

Tatiana Albanez
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Tatiana Albanez , (2015),"Impact of the cost of capital on the financing decisions of Brazilian companies", International
Journal of Managerial Finance, Vol. 11 Iss 3 pp. -
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 1

1. Introduction
An important aspect of financial management is the way companies decide on their sources of
financing. Understanding the factors that guide firms’ financing decisions, and consequently
their capital structure, remains a challenge to managers, shareholders and creditors and is a
central theme in many academic works.
After the seminal studies of Modigliani and Miller (1958; 1963), other theories were
formulated to try to explain what determines the use of equity versus debt capital by
companies. Among these, the trade-off and pecking order theories stand out.
According to Myers (2001), the trade-off theory emphasizes taxes and predicts that
firms seek target debt levels that allow them to balance the tax benefits and costs of financing,
represented by the costs of bankruptcy (or reorganization) and agency costs. The main
empirical relationship expected is that the more profitable firms are, the more they will tend to
rely on debt financing due to the tax benefits.
In turn, according to the pecking order theory developed by Myers and Majluf (1984)
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and Myers (1984), companies follow a hierarchy of preferences in choosing financing

sources, first using internal resources, followed by financing through debt, and finally raising
funds by issuing shares. This order is based on the information transmitted by each type of
financing mechanism, with preference given to those less sensitive to the information
conveyed. According to this theory, firms will opt for debt over equity when their internal
resources are not sufficient to finance their capital expenditures.
However, in citing some facts on the financial behavior of companies, Myers (1984)
stated that firms tend to issue shares rather than use debt financing when their stock prices are
high, a pattern previously verified by Taggart (1977), Marsh (1982) and many other authors.
For Myers (1984), this fact undermines both the trade-off and pecking order theories. In this
scenario, the theory of equity market timing emerged as an alternative to understand firms’
financing decisions. Here I follow this approach.
Although previous studies (e.g., Taggart,1977; Marsh,1982; Jalilvand and Harris,
1984; Asquith and Mullins,1986) indicated the tendency for firms to issue shares when their
market value is high in relation to their book or historic market value, the development of the
market timing theory is attributed to the influential work of Baker and Wurgler (2002). They
defined equity market timing as the practice of issuing shares when the firm believes its stock
price is overvalued and repurchasing shares when this price is considered undervalued, with
the intention of exploiting temporary fluctuations in the cost of equity capital in relation to
other sources of financing. Therefore, the capital structure should be the cumulative result of
past attempts to issue shares at moments considered favorable. Under this approach, analysis
of the market-to-book ratio can indicate the best moments to issue either shares or bonds.
Baker and Wurgler (2002) performed regressions in which leverage was the dependent
variable and the independent variable was a measure of the historic average market-to-book
ratio weighted by issues of new equity and debt. They found a persistently negative relation
between these variables, indicating that the higher the firm’s market value, the less will be the
use of debt financing, because issuing shares is more advantageous.
After the article by Baker and Wurgler (2002), many other studies were conducted to
test market timing hypotheses. Some of these studies, carried out in countries other than the
United States, found evidence supporting the market timing theory while others did not find
persistent effects, such as Hovakimian (2006), Alti (2006) and Kayhan and Titman (2007).
In Brazil, studies applying the approach of Baker and Wurgler (2002), such as Mendes
et al. (2009) and Vallandro et al. (2010), have not found strong evidence of market timing.
These results apparently indicate that market timing does not play a strong role in determining
the capital structure of Brazilian firms. However, it can also indicate that the model employed
is not able to identify market timing attempts by these firms, since a large portion of them did
 2

not issue new shares after initially floating capital in the periods analyzed. These firms still
might be attentive to the cost of different forms of funding in their decisions, seeking to take
advantage of windows of opportunity. This is particularly the case given the presence of
sources of debt capital with widely disparate interest rates (e.g., subsidized rates from official
banks versus much higher rates from private banks).
Furthermore, various authors (e.g., Alti, 2006; Hovakimian, 2006; Kayhan and
Titman, 2007) have criticized the use of the market-to-book ratio as a proxy for managers’
market timing perceptions. According to these authors, the negative relation found between
market value and leverage can indicate more than must market timing attempts, because the
market-to-book variable can also be related to growth opportunities, also leading to a negative
relation.
Based on this view, it is important to use alternative models that consider direct
measures for the cost of fund raising and the effects on firms’ financing decisions, as in
Huang and Ritter (2009), who investigated the determinants of leverage in function of proxies
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for the cost of equity capital, seeking to shed light on market timing behavior. Therefore,
based on the central idea of Huang and Ritter (2009), here I investigate the market timing
behavior in obtaining funding by direct analysis of the impact of the cost of capital (equity
and debt) on the financing decisions of Brazilian firms. Thus, my main goal is to examine the
existence of opportunistic behavior in choosing different funding sources by listed Brazilian
companies, to check whether they try to benefit from temporary variations in the relative costs
of these different sources.
Although the work of Huang and Ritter (2009) serves as a theoretical and empirical
foundation for analysis of the relation between the cost of capital and leverage, my study
stands out by using different proxies for the cost of equity capital and two proxies for cost of
debt capital. Besides this, I also used different panel data models and control variables. Since
many listed Brazilian corporations do not have credit ratings, I analyze two samples: the first
composed of 235 firms with shares listed for trading on the BM&FBovespa in the period from
2000 to 2011 and the second composed of 75 firms listed on the same exchange with credit
ratings from one of the main agencies, analyzed in the period from 2005 to 2011.
The Brazilian literature on capital structure is extensive, but most of the articles have
examined the trade-off and pecking order theories. Only a few have probed firms’ market
timing behavior, among them Mendes et al. (2009) and Vallandro et al. (2010), mentioned
previously, Rossi Jr. and Jiménez (2008) and Rossi Jr. and Marotta (2010). Here I analyze the
relation between cost of capital and financing decisions in a more comprehensive and direct
form than previous studies of Brazilian firms. The period analyzed also differs from the other
papers, by including more recent years, during which important changes occurred in the
Brazilian market, such as 2007 when there was a boom in IPOs.
Since the Brazilian capital market has been developing intensely in recent years, it is
relevant to study the capital structure of listed Brazilian companies, seeking to understand
how they reach financing decisions, a theme of great importance to various market agents,
such as current and potential shareholders, analysts and regulators. Therefore, by employing a
theoretical approach little explored in Brazil, I hope to shed light on the variables that affect
the financing decisions of Brazilian firms, to discover if they act to maximize value
generation for their owners.
The rest of the paper is organized into three sections. The second one presents the
sample, operationalization of the variables and the models used to analyze the firms’ capital
structure; the third presents and discusses the results; and the fourth presents the conclusions.
 3

2. Research design
2.1 Sample
The original sample of firms listed on the BM&FBovespa (excluding financial institutions,
fund administrators, insurers and holding companies) contained 313 companies, with the data
obtained from the Economatica database[1]. I then applied the following filters to construct the
variables: exclusion of firms with negative equity in all the years; exclusion of firms with
market-to-book ratios (M/B) above 10; and omission of the leverage variable for any year in
which a firm had negative equity. After application of these filters, the final sample was
composed of 235 firms, analyzed over the period 2000-2011.
Besides the capital cost indicator based on financial expenses, I also used an indicator
of each firm’s risk, represented by its rating. Due to the relatively small number of Brazilian
firms with credit ratings from one of the main agencies, I analyzed this variable in a second
sample. This sample consisted of all firms (nonfinancial) with risk classification by Standard
& Poor’s, Moody’s or Fitch, according to the Bloomberg database. In this process, I obtained
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104 firms with ratings on long-term debt by one of the three agencies in at least one year.
After calculating all the variables and applying the same filters as described for sample 1, the
second sample was composed of 75 firms. I analyzed this sample in the period from 2005 to
2011 due to the lack of data from previous years.

2.2 Definitions of the dependent and independent variables

Table 1 presents the variables used and the expected relationship between each of them and
leverage, according to the capital structure theories.

Insert Table 1 here

I applied the control variables traditionally used in studies of capital structure (e.g., by
Rajan and Zingales, 1995; Frank and Goyal, 2009, among others), and added three more:
Risk, Liquidity and a dummy variable to control for the effect of the crisis, equal to 1 in 2008
and 0 for the other years. The choice of 2008 alone as the crisis year is due to the fact that the
Brazilian market recovered quickly (there was recession in the last quarter of 2008 and first of
2009, followed by a healthy recovery). These variables are discussed in the third section.
Below are the details on the indicators of cost of capital (equity and debt) used as explanatory
variables in the leverage models.

2.2.1 Proxies for cost of equity capital - Ke

According to the capital asset pricing model (CAPM), developed by Sharpe (1964) and
Lintner (1965), the investment decision takes into consideration the combination of a risk-free
rate plus a premium for the risk of the market portfolio. Therefore, the cost of equity capital
can be obtained by the following formula:

Kei = RF + βi (MR - RF)

where Kei: cost of equity of firm i; RF: riskfree rate of return; βi: market beta of firm i, which
measures the sensitivity of the stock return of that firm to variation in the overall market
return; and MR: return of the market portfolio. Therefore, (MR - RF) is equal to the market
risk premium (or premium per unit of risk measured by beta).
Even though the CAPM is the most often used model by market agents in general,
various authors (e.g., Assaf Neto et al., 2008; Damodaran, 2012; among others) have pointed
out problems from using it in emerging markets, such as the absence of a rate or return that
can be considered risk free, and problems in estimating the market risk premium and betas
 4

due to the low liquidity of the stock market and high volatility of the various financial indexes
in the national market.
Therefore, the proxies suggested in this article have the purpose of making the CAPM
more suitable for application to the Brazilian market. I used four indicators to analyze the
consistency of the proxies employed in relation to their statistical significance and the signs
obtained. Table 2 summarizes the methods for calculating the four indicators of the cost of
equity capital used.

Insert Table 2 here

To obtain the leveraged beta of each firm, the following steps are necessary:
1) Classify each firm in one of the American sectors used by Damodaran (2012, online);
2) Obtain the average unleveraged beta of the reference American sector for each firm,
which is calculated and disclosed by Damodaran (2012, online);
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3) Leverage the beta obtained in step 2 by the market leverage of each Brazilian
company, as follows:

BetaLev = BetaUnlev x [1 + (D/Emv) x (1 - T)];

where BetaLev: leveraged beta; BetaUnlev: unleveraged beta; D/Emv: market leverage of the
firm, given by the ratio between Financial Debts and Market Value of Equity; T: corporate
income tax rate, estimated at 34% (25% Corporate Income Tax and 9% Social Contribution
on Net Profit[2]). The data were obtained from Economatica.
The procedure used to obtain beta was based on the literature. According to
Damodaran (1999), beta can vary greatly depending on how the regression is performed in
terms of time period, return interval and market index used, a problem that is worse in
emerging markets, where the market index is not widely diversified. Another difficulty that
arises when working with betas for Brazilian companies’ returns in relation to a local market
index (such as the Ibovespa) is the impossibility of obtaining average sectorial betas for
various sectors, because many are composed of one or only a few companies, besides the
frequent presence of betas below 1.
In relation to the market risk premium (MR - RF), for the indicators Ke1 and Ke2 I
used the historic moving average of the ex-post return of the S&P500 market portfolio minus
the return on T-Bonds, considering a long period (1928 to present). According to Damodaran
(2012), the premium used should reflect the risk of a mature stock market, adequate for
application of the CAPM. Again, these data were obtained from Damodaran (2012, online).
According to Damodaran (2003), even when an investor has a well-diversified portfolio
containing stocks from different countries, the high correlation between markets suggests
there will always be a portion of non-diversifiable risk related to the risk of each country,
justifying its addition. The paper by Donadelli and Prosperi (2011) supports this argument.
Damodaran (2003) suggests some ways of measuring the country risk premium, such
as the country bond default spread, which represents the difference of the yields of the
country’s bonds traded abroad in relation to T-Bonds with equivalent maturity (as measured
by the EMBI or by the difference in sovereign ratings).
Therefore, for the first method of calculating the cost of equity capital (Ke1) I used the
Emerging Market Bond Index Plus - Brazil (EMBI+Br) as the average country risk (CR),
while the second indicator (Ke2) incorporated nearly all the components of the first indicator,
differing only in the country risk premium.
According to Damodaran (2003), the stock market risk premium of a country should
be higher than the default risk premium of the bond market. Therefore, consideration should
 5

go to the volatility of the stock market in relation to the volatility of the bond market in
calculating the country risk, plus the cost of equity indicator, so that the adjusted country risk
will be equal to the default risk spread of the country times an indicator given by the volatility
of the stock market over the volatility of the country’s sovereign bond market.
Since the sovereign bonds of emerging countries are not widely traded, thus presenting
low volatility, and the stock market presents high volatility due to the number and volume of
trades, Damodaran (2012) applies the figure of 1.5 to adjust the country risk of all emerging
markets, reflecting a historic value of this indicator (data obtained from Damodaran, 2012,
online).
The third and fourth methods of calculating the cost of equity permitted estimating an
indicator of the potential financial cost of issuing stocks by a company at a determined
moment, and for this reason the market premiums used were ex-ante, calculated based on
analysts’ expectations for the future earnings of the firm in question.
This method, proposed by Damodaran (2012), estimates the expected return of the
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S&P500 and obtains the risk premium by the difference between the expected return and the
risk-free rate considered. By this approach, the stock value can be represented in the
following form:

t=N
E ( FCFE t ) E ( FCFE N +1 )
Stock Value = ∑ t
+ ,
t =1 (1 + re ) ( re − g N )(1 + re ) N
(5-year flow) (perpetuity)

where Stock Value: value of the S&P500; N: years of high growth expected; gN: stable growth
rate after the high-growth years (equal to the 10-year T-Bond yield); re: rate of return
expected by investors; and E(FCFE), expected free cash flow to equity: cash flow after taxes,
reinvestments and debt payments (i.e., potential dividends), represented by the dividend yield
(dividend per share over share price) + buybacks (percentage of shares repurchased by the
firm).
According to this framework, the stock value is a function of the expected flow of
future earnings (five-year horizon), with application to the E(FCFE) of an earnings growth
rate forecast by analysts for the next five years. In turn, in perpetuity the earnings are deemed
to grow at a riskfree rate, represented by the T-Bond yield. From the expected market return
(re) of the above formula, the market risk premium is given by the difference between the
market return and the risk-free rate of return.
Damodaran (2012) calculated the market risk premium for Brazil in the 2000-2011
period using the Ibovespa to represent the market portfolio. For comparative purposes, the
historic risk premium used in the indicators Ke1 and Ke2 presented an average of 6.0% per
year, while the expected risk premium of the S&P500 index presented an average of 4.5% per
year and the expected risk premium of the Ibovespa averaged 7.0% a year. These were used in
indicators 3 and 4, respectively.
As the last method of estimating the cost of equity (Ke4), I considered the return of the
Brazilian stock market, represented by the Ibovespa, making it unnecessary to add a country
risk premium to calculate the cost of capital, since this is already implicit in the return
expected by investors.
For all the equity cost indicators I first obtained an indicator in nominal terms in U.S.
dollars. Then, to obtain the real cost of capital I eliminated American inflation (the 10-year
moving average), represented by the Consumer Price Index (CPI). To obtain the nominal cost
of capital in Brazilian currency (the Real, R$), I added Brazilian inflation, represented by the
Comprehensive Consumer Price Index (IPCA). The CPI and IPCA can be obtained from
Economatica.
 6

In Figure 1, the left-hand vertical axis shows the averages of the four equity cost
indicators in each year for the 235 firms in the sample. The right-hand axis indicates the
average market value of debt of these firms (broken line). It can be seen that the firms’
leverage is positively related to the cost of equity capital in the period, which can reflect
market timing behavior.

Insert Figure 1 here

It can also be seen in Figure 1 that the historic risk premium, utilized in indicators 1
and 2 because it represents a long-term average, is much more stable than the expected risk
premiums used in indicators 3 and 4, which capture the market expectations at each moment
by means of analysts’ forecasts about dividend flows, making them more volatile.
Furthermore, an interesting market movement is the approximation of the expected risk
premium of the Brazilian and American markets in recent years.
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In Brazil, analysts widely use the form of calculation of indicator 1 (Ke1) to obtain the
cost of equity capital and to value firms. Nevertheless, I tested different proxies to provide
more robust results.

2.2.2 Proxies for cost of debt capital - Kd

One of the most common methods to calculate the cost of debt capital reflects the average
cost of financial debts recorded in the balance sheet. It is an ex-post measure given that it
considers historic values of financial expenses from borrowings and bond issues. The
indicator is calculated as follows:

Financial Expenses x (1 - T)
Kd _ Net = ,
Average Financial Debts

where Kd_Net: indicator of the cost of debt capital net of taxes; Financial Expenses x (1 – T):
financial expenses net of taxes, T: corporate income tax rate, estimated at 34%; Average
Financial Debts from t-1 to t; Financial Debts: loans, bonds and financial leasing obligations
(short and long term), data obtained from Economatica.
Although this formula is widely used, it has come under criticism, mainly because of
the possibility that the value of financial expenses includes not only the interest and other
financial expenses of Brazilian firms, but also amounts such as exchange rate variation on
foreign loans, which vary greatly depending on the firm’s sector. Moreover, the amounts are
booked according to the accrual accounting regime so they do not represent the expected cost
of raising capital of a firm at a determined moment, but are rather a reflection of the financial
expenses generated over time according to past conditions.
On the other hand, other articles have indicated a close relationship between credit
ratings of Brazilian firms and their cost of capital, such as Valle (2002). Therefore, I believe
that the use of a debt cost metric directly related to a firm’s credit risk can better approximate
the true cost of capital, besides representing an ex-ante measure, based on the future
expectations of the firm’s solvency at a determined moment in time.
Therefore, I obtained the credit ratings, at the end of each year, of the 75 Brazilian
firms active on the BM&FBovespa with such data available from the Bloomberg database. I
used the national ratings for issuance of long-term debt rather than those for issuance of debt
in foreign currency, since my intention is to have a cost of debt capital indicator in local
currency.
Most of these firms had a rating from both Standard & Poor’s and Fitch, but some had
classifications from only one of them or from Moody’s, so I analyzed the equivalence
 7

between the three ratings agencies, which in any event rarely diverge greatly in their ratings
of the same debt issue when there are multiple ratings.
After obtaining the risk ratings at the end of each year for each company, I attributed
the cost of capital according to the method used by the Center for Capital Market Studies
(CEMEC) of the Brazilian Capital Market Institute (IBMEC), according to the following
steps (CEMEC, 2010):
1) Obtain the indicative rate of a sample of bonds priced[3] in the secondary market,
according to the Brazilian Association of Financial and Capital Market Institutions
(ANBIMA), indexed (or remunerated) by the Interbank Deposit Rate (DI%). In Brazil
most tradable debt securities are indexed to the DI[4], but there are other forms of
remuneration. These numbers are only available starting in 2005 from the CEMEC[5].
2) Obtain the rating of these bonds by the rating agencies, as disclosed by ANBIMA, for
each bond issue in the sample, and then calculate the average of the indicative rate by
rating.
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3) Multiply the average indicative rate, according to the rating, by the reference rate,
consisting of the Pre-DI swap rate for 720 days[6] of the BM&FBovespa, to obtain a
proxy for the cost of debt capital by rating based on market expectations.

Thus I obtained the cost of debt capital attributed to each company according to its
credit rating by estimating an average market cost in nominal terms. Figure 2 presents the
average cost by rating, at the end of each year, for the sample of bonds indexed to the DI%
priced by ANBIMA. As expected, the better the rating, the lower the cost. Note also that the
estimated cost of debt capital reflects the market conditions at the moment. It was particularly
high in 2005, when the basic interest rate in the country was extremely high, and then fell
progressively until increasing again in 2008 due to the crisis.

Insert Figure 2 here

The sample of bonds selected by ANBIMA for pricing in the secondary market,
according to various liquidity criteria, only included bonds with ratings of AAA, AA, A and
BBB[7]. In the sample of 75 firms, there were eight observations of four firms with ratings in
the BB, B or CCC groups, which had to be dropped from the sample because of the
impossibility of attributing a cost of debt capital for those ratings based on the indicative rates
disclosed by ANBIMA.
Figure 3 shows the average annual cost of debt capital of sample 2 (75 firms), obtained
according to each firm’s rating, as well as the leverage (financial debts over assets). A
negative relation can be noted between the cost of debt and leverage, as expected by the
market timing theory, except for the crisis year (2008).

Insert Figure 3 here

2.3 Models for analysis

Based on the central idea of Huang and Ritter (2009), I formulated analytical models of the
possible determinants of leverage, considering control variables identified in the literature as
important determinants of the capital structure, besides the proxies for cost of equity and debt
capital.
The expectation of the market timing theory is that the higher the cost of equity, the
more firms will rely on debt, leading to a positive relation between the cost of equity and
leverage. Likewise, the higher the cost of debt is, the lower should be the use of this funding
source, with preference given to issuing equity or using internal resources, leading to a
 8

negative relation between the cost of debt and leverage. The models tested for the two
samples are described as follows:

Book_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + (1)

+ β6(Risk)it + β7(Dcrisis)it + β8(Ke)it + uit

Market_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + (2)

+ β6(Risk)it + β7(Dcrisis)it + β8(Ke)it + uit

Book_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + (3)

+ β6(Risk)it + β7(Dcrisis)it + β8(Kd)it + uit

Market_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + (4)

+ β6(Risk)it + β7(Dcrisis)it + β8(Kd)it + uit
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where Book_Lev: book leverage, equal to financial debts over book value of assets;
Market_Lev: market leverage, equal to financial debts over market value of assets; Tang:
tangibility, equal to property, plant and equipment over book value of assets; Profit:
profitability, equal to return on assets (ROA), in turn equal to net income plus financial
expenses (net of taxes) over financial debts plus stockholders’ equity; Size: natural logarithm
of net operating revenue; M/B: market-to-book ratio, equal to total assets minus book value of
equity plus market value of equity over total assets; Liq: liquidity, equal to current assets over
current liabilities; Risk: standard deviation of ROA; Dcrisis: crisis dummy, equal to 1 in 2008
and 0 in other years; Ke: proxy for the cost of equity capital; and Kd: proxy for the cost of
debt capital.
I used regression models with panel data, applying the Hausman test to decide
between fixed- and random-effects models. Additionally, I tried to verify if a model without
those effects (pooled model) should be applied, for which purpose I used the test of Breusch
and Pagan (1980).
Given the possible existence of heteroscedasticity and autocorrelation of the residuals,
I used the Newey-West method (Newey and West, 1987) to obtain robust parameters. I also
checked for the existence of multicollinearity by testing the correlation between the
explanatory variables. These were not high, reducing the chances of multicollinearity
problems in the panel data models.

3. Analysis of the results

3.1 Analysis of the determinant of leverage of sample 1: 235 listed companies
Table 3 presents the descriptive statistics of the dependent and explanatory variables used in
the models of the determinants of leverage for the first sample, composed of 235 Brazilian
companies active on the BM&FBovespa during the period from 2000 to 2011.

Insert Table 3 here

The dependent variables used in the panel data regression models consisted of
indicators of leverage at book and market value, while the explanatory variables were the
control variables tangibility, profitability, size, market-to-book, liquidity and risk (besides a
dummy variable for the crisis year) and the proxies for cost of equity (Ke1 to Ke4) and cost of
debt (Kd_Net).
Tables 4 and 5 show the results of the models, Table 4 for book leverage and Table 5
for market leverage.
 9

Insert Tables 4 and 5 here

The aim of the proxies for the cost of equity and debt capital is to capture the firms’
market timing behavior. I formulated five models for book leverage and five for market
leverage. Each of the quadrants of the tables presents the results of the corresponding model
considering the proxy for the cost of capital indicated in the third line of the table.
All of the quadrants in the two tables report the coefficients of the variables and their
respective level of significance for the fixed-effects model as well as the fixed-effects model
made robust to heteroscedasticity and autocorrelation by the method of Newey and West
(1987). Below I first analyze the control variables indicated as determinants of leverage by the
capital structure literature.
The tangibility variable presents a negative sign in all the models, both for book and
market leverage, and is only not statistically significant in the models in which leverage (book
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and market) is explained by the cost of debt capital. According to the formulation of Frank
and Goyal (2003), the relationship found here is in accordance with the pecking order theory,
by which firms with more tangible assets face less serious problems related to information
asymmetry, favoring the use of equity financing and leading to a negative relation with
leverage.
The profitability variable has a negative sign in relation to indebtedness, and is
significant in all the book and market leverage models, making it the most representative
among the control variables used. This sign is also in line with the pecking order theory,
according to which more profitable firms need fewer external resources to finance their
investment opportunities, leading to a negative relation between profitability and leverage.
The size variable has a positive sign, indicating that larger firms tend to be more
leveraged, and is significant in all the models of book leverage, but is not significant in the
last two market leverage models, where it also has a negative sign. A positive sign is in line
with the argumentation of Rajan and Zingales (1995) and Fama and French (2002) that larger
companies have lower probability of bankruptcy and less volatile earnings, increasing their
capacity to obtain debt financing, besides reducing the cost of this financing, factors that favor
the use of debt.
The market-to-book ratio can represent different attributes according to the trade-off,
pecking order and market timing theories. For the trade-off and pecking order theories, the
market-to-book ratio is related to growth opportunities, so it should be negatively related with
leverage. However, for Baker and Wurgler (2002), the market-to-book ratio can represent
market timing opportunities, i.e., windows of opportunity to issue shares. Thus, at moments
when a firm’s stock price is overvalued, the tendency will be to issue shares and reduce
leverage. In this sense, the relationship between the market-to-book ratio and leverage also
should be negative. According to the results here, the market-to-book ratio is negatively
related to the book and market leverage metrics, and is significant to explain the capital
structure in all the models. The effect of this variable on leverage may have been generated by
growth opportunities or market timing. Therefore, it is important to analyze the relation
between the cost of capital and leverage.
The liquidity and risk variables confirm their importance in the panel data models,
with negative signs and significance in all the models. The negative sign between liquidity
and leverage is consistent with the pecking order theory, by which the use of internal
resources is preferable to using other financing sources. Myers and Majluf (1984) provided
the theoretical foundation for this negative relation, stressing that financial slack permits firms
to avoid external financing, mainly at moments when it is not advantageous to issue shares.
Therefore, firms use their financial slack to preserve their financing capacity and avoid
 10

problems of underinvestment, leading to a negative relation between liquidity and leverage. In

turn, the negative relation between risk and leverage is also as expected, since firms
considered riskier have a greater chance of insolvency, reducing their capacity to obtain debt
financing.
Regarding the impact of the crisis, it is possible to expect a positive relation between
the crisis dummy and leverage, since the liabilities of Brazilian firms with foreign currency
debts increased dramatically with the devaluation of the Brazilian real against the dollar
during this period. As expected, the dummy variable inserted to capture the effect of the crisis
in 2008 on the capital structure predominantly presented a positive sign, and was significant
in nearly all the leverage models computed at market value. For the models using book value
to compute leverage, the results were mostly not significant.
The effect of market timing on the capital structure of listed Brazilian companies was
analyzed by means of proxies for the cost of equity and debt capital inserted in panel data
models. In Tables 4 and 5 all the proxies for cost of equity capital show a positive sign with
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the debt level of the firms and are statistically significant in all the models.
This positive relation between the cost of equity and leverage is as expected,
indicating that firms increase the use of debt as a financing source at moments when the cost
of equity is high, leading to a positive relation between cost of equity and leverage. This result
can reflect market timing, i.e., opportunistic behavior by Brazilian firms in obtaining funding.
Huang and Ritter (2009) found in their study that firms cover a smaller portion of their
financing deficit through issuance of debt when the cost of equity is low and use a lower
amount of debt capital when their market value is high in relation to their book value. In
Brazil, Rossi Jr. and Jiménez (2008) also found that firms more often finance themselves by
issuing shares when the cost of equity capital is low and use less debt capital when their
market values are high in relation to book value. Recent studies of other countries also have
found evidence in favor of the market timing theory, such as Bougatef and Chichti (2010),
Dong et al. (2012) and Setyawan and Frensidy (2012). All these authors found that firms
prefer debt over equity when their market value is low in relation to their book value.
The results here on the relation between the cost of debt capital and leverage
corroborate the hypothesis of the existence of market timing behavior by Brazilian firms. To
strengthen the findings, I built another proxy for the cost of debt based on the firms’ credit
ratings, applied to the reduced sample 2, whose results are presented next.

3.2 Analysis of the determinants of leverage of sample 2: 75 listed companies

Table 6 reports the descriptive statistics of the dependent and explanatory variables used in
the models of the determinants of leverage for the sample of 75 Brazilian firms with ratings
attributed by the main risk classification agencies, in the period from 2005 to 2011.

Insert Table 6 here

Tables 7 and 8 present the models of the determinants of book leverage and market
leverage for sample 2, respectively. In this sample, besides the four proxies for cost of equity
capital and the Kd_Net used in the models of the first sample, I added the proxy for the cost of
debt capital based on ratings, Kd_Rating.

Insert Tables 7 and 8 here

The explanatory power of the models is higher in sample 2, remaining statistically

significant in all of them. In relation to the control variables, tangibility, profitability, size end
market-to-book continue to be significant and have the same sign as obtained with sample 1.
 11

In contrast, the liquidity and risk variables lose significance in the second sample. The
dummy for the crisis year continues having a positive and significant sign in all the market
leverage models.
The proxies for cost of equity also remain significant in sample 2. The sign obtained
ratifies the market timing behavior of Brazilian companies: the higher the cost of equity was
during the sample period, the greater was the use of debt, leading to a positive relation with
leverage.
With respect to the proxies for cost of debt, the Kd_Net variable continues having a
negative relation with the two leverage indicators, but is only significant in the model of book
leverage of Table 7. In turn, the Kd_Rating variable is significant and has the expected sign in
the market leverage model of Table 8. However, the proxies Kd_Net and Kd_Rating are
different. This difference can be explained by the way of constructing each variable. Also, the
results reached with sample 2 for the proxies for the cost of debt capital is also limited by the
small number of companies.
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Nevertheless, the analysis of the results provides strong evidence of the influence of
market timing on the capital structure of Brazilian firms, confirming the hypothesis raised. As
expected, the higher the cost of equity, the greater the use of debt financing, while when the
cost of debt is high, firms use it less. This result can reflect opportunistic behavior regarding
the funding choices of Brazilian companies.

4. Conclusions
The aim of this study was to analyze the effects of market timing on the capital structure of
listed Brazilian companies, by relating measures of the cost of capital (equity and debt) with
these firms’ debt levels, to examine the existence of opportunistic behavior in obtaining
funding.
The results provide strong evidence that during the years studied the firms took
advantage of windows of opportunity to obtain funding: the higher the cost of equity, the
greater was the use of debt, while the higher the cost of debt, the less the firms relied on debt
financing. The proxies for cost of capital were the most significant variables, exerting a strong
influence on the capital structure of these firms.
These results are in conformity with those of Huang and Ritter (2009), indicating that
when the cost of equity is high, firms follow a pecking order, giving preference to debt
financing. However, the decision factor (debt-equity choice) is based on the cost of various
alternative sources of financing, not only on the hierarchy established by the pecking order
theory due to the information asymmetry between market agents.
Recent years have witnessed a large increase in the number of IPOs in Brazil, even by
firms that have the capacity to obtain debt financing. This reflects the fact that at some
moments the issuance of shares is more advantageous than the use of debt, running counter to
the pecking order theory. However, these firms have carried out few follow-on placements, as
can be verified at the BM&FBovespa website.
Therefore, while previous studies of the Brazilian market did not find strong evidence
of market timing (Mendes et al., 2009; Vallandro et al., 2010), these authors did not analyze
the direct relation between the cost of capital (equity and debt) and leverage, as done here.
This demonstrates the importance of using different empirical approaches to analyze the
effects of market timing on firms’ financing decisions, and of considering the particularities
of the markets in which the firms operate.
In Brazil, firms have debt funding alternatives at highly heterogeneous interest rates.
Consequently, the results obtained in this study indicate that the cost of these alternative
sources affects firms’ capital structure decisions. This assumption is particularly relevant in
Brazil considering the country’s institutional factors, which certainly affect firms’ financing
 12

decisions. Chief among these is the availability of funding at below-market interest rates
(even negative in real terms) from the National Bank for Economic and Social Development
(BNDES). BNDES is Brazil’s main government development bank and is the leading source
of long-term financing for Brazilian companies. The interest rates charged are subsidized by
the government and are well below the rates charged in the market. In this context, there is a
need to investigate the role of development banks in emerging markets, particularly the extent
to which the availability of financing at subsidized interest rates affects the development of
local capital markets.
In any event, the results here show that Brazilian companies pay heed to different
sources when making their financing decisions, taking advantage of windows of opportunity,
in line with the market timing theory.

Notes
1. I used data from the consolidated financial statements of the companies in the original
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currency.
2. Social contributions differ from taxes in that the revenues are reserved for specific uses
rather than going into the general fund. The Social Contribution on Net Profit basically
falls on the same taxable income as Corporate Income Tax.
3. The bond pricing method developed by ANBIMA is available (in Portuguese) at its
website at the links “Deliberação 3” and “Deliberação 4”
(http://www.debentures.com.br/biblioteca/publicacoestecnicas.asp), as well as the sample
of priced bonds.
4. The DI rate is the interest rate paid on interbank certificates of deposit (CDIs in the
Portuguese initials), which are the main instruments used by banks to obtain funding
from other banks. The CDI (or DI) rate is used as a reference rate for the cost of money
and is employed as an index for many financial transactions in Brazil. It is approximately
the same as the Central Bank’s benchmark rate, the SELIC, which at this writing is about
11% per annum.
5. Available at: http://www.cemec.ibmec.org/.
6. The market yield curve represented by Pre-DI interest rate swaps of the BM&FBovespa
is today the main curve used by the financial market for pricing purposes. The reference
Pre-DI swap rates can be obtained at: http://www.bmfbovespa.com.br/.
7. Since there was no pricing of bonds indexed to the DI% with BBB rating before February
2011, I estimated this cost for previous periods based on the average spread in relation to
the A rating. In the sample analyzed, of the 399 observations of cost of debt capital
(Kd_Rating), 65 refer to the BBB rating, the others having AAA, AA or A rating.

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 15

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Biographical Details:

Tatiana Albanez is a professor in the Department of Accounting and Actuarial Sciences of the College of
Economics, Business and Accounting at the University of São Paulo (FEA/USP), where she teaches classes on
finance and quantitative methods. Her research interests include corporate finance, capital markets and applied
quantitative methods.
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 16

Table 1 - Description of the variables

Expected sign
Attribute Abbreviation Proxy
with leve rage
Dependent Variables
Book Leverage Book_Lev Financial Debts / Book Value of Assets
Market Leverage Mark et_Lev Financial Debts / Market Value of Assets
Explanatory Variables
Cost of Equity Capital 1 (ex-post) Ke1 TBond + β (Historic S&P500 Premium) + EMBI Pos.
Cost of Equity Capital 2 (ex-post) Ke2 TBond + β (Historic S&P500 Premium) + Adjusted Country Risk Pos.
Cost of Equity Capital 3 (ex-ante) Ke3 TBond + β (Expected S&P500 Premium) + Adjusted Country Risk Pos.
Cost of Equity Capital 4 (ex-ante) Ke4 TBond + β (Expected Ibovespa Premium) Pos.
Cost of Debt Capital 1 (ex-post) Kd_Net Financ. Exp. (net of taxes) / Average Financial Debts Neg.
Cost of Debt Capital 2 (ex-ante) Kd_Rating Average Yield of Bonds (DI%) by Rating x DI-Pre 720 days Neg.
Control Variables Used in the Final Mode ls
Size Size Ln (Net Operating Revenue) Neg./Pos.
Tangibility Tang Fixed Assets / Total Assets Neg./Pos.
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Profitability Prof Return on Assets (ROA) Neg./Pos.

Market-to-Book M/B Market Value of Assets / Book Value of Assets Neg.
Risk Risk Standard Deviation of ROA Neg.
Liquidity Liq Current Assets / Current Liabilities Neg.
Crisis Dummy Dcrisis 2008 = 1; other years = 0 Neg./Pos.
Notes: Financial Debts: Loans, bonds and financial leasing obligations (short and long term); Market Value of
Assets: Assets minus book value of equity plus market value of shares, obtained from the Economatica
database; TBond: U.S. Treasury bonds with 10-year maturity; β: average unleveraged beta of the American
reference sector, leveraged by the level of debt at market value of the Brazilian firm in each year; Adjusted
Country Risk: Brazilian risk premium adjusted for average stock market volatility of the country in relation to
the debt market volatility for emerging countries, equal to the default risk premium x 1.5, as calculated and
disclosed by Damodaran (2012, online); Ln: natural logarithm; Return on Assets (ROA): Net income plus
financial expenses (net of taxes) over financial debts plus stockholders’ equity; Standard deviation of ROA
considering a period of 5 years.
 17

Table 2 - Description of the cost of equity capital indicators

Indicator Abbreviation Proxy
Cost of Equity Capital 1 (ex-post) Ke1 TBond + β (Historic S&P500 Premium) + EMBI
Cost of Equity Capital 2 (ex-post) Ke2 TBond + β (Historic S&P500 Premium) + Adjusted Country Risk
Cost of Equity Capital 3 (ex-ante) Ke3 TBond + β (Expected S&P500 Premium) + Adjusted Country Risk
Cost of Equity Capital 4 (ex-ante) Ke4 TBond + β (Expected Ibovespa Premium)
Notes: TBond: U.S. Treasury bonds with 10-year maturity; β: average unleveraged beta of the American
reference sector, leveraged by the level of debt at market value of the Brazilian firm in each year; Adjusted
Country Risk: Brazilian risk premium adjusted for average stock market volatility of the country in relation
to the debt market volatility for emerging countries, equal to the default risk premium x 1.5, as calculated and
disclosed by Damodaran (2012, online).
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 18

Table 3 - Descriptive statistics - sample 1

SAMPLE 1: 235 listed Brazilian companies
Std.
Variable # Obs. Mean Min. Max.
Dev.
Book_Lev 2233 0.258 0.166 0.000 0.940
Market_Lev 2013 0.230 0.163 0.000 0.953
Tangibility 2233 0.344 0.230 0.000 0.950
Profitability 2205 0.128 0.165 -2.129 1.663
Size 2195 13.486 1.963 3.434 19.313
M/B 2013 1.332 0.839 0.218 10.486
Liquidity 2232 2.437 2.519 0.000 48.748
Risk 2008 0.107 0.332 0.000 6.056
Ke1 2001 0.188 0.077 0.091 0.732
Ke2 2001 0.195 0.073 0.095 0.732
Ke3 2003 0.170 0.054 0.095 0.726
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Ke4 2001 0.153 0.077 0.073 0.780

Kd_Net 1999 0.199 0.166 0.000 0.997
Notes: Book_Lev: book leverage, equal to financial debts
over book value of assets; Market-Lev: market leverage,
equal to financial debts over market value of assets; Ke:
proxy for the cost of equity capital; Kd_Net: financial
expenses (net of taxes) over financial debts.
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19

Table 4 - Determinants of book leverage - sample 1

Regressions with panel data. Dependent variable (Book_Lev): Financial Debts over Book Value of Assets. Explanatory variables: control variables and proxy for cost of
capital (each quadrant contains the model’s results considering the cost of capital indicated in the third line of the table).

Book_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + β6(Risk)it + β7(Dcrisis)it + β8(Cost of Capital)it + uit
SAMPLE 1: 235 Brazilian listed companies active in the BM&Fbovespa
Determinants of book leverage - Dependent variable: Financial Debts / Book Value of Assets
Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost
of equity capital 1 (Ke1) of equity capital 2 (Ke2) of equity capital 3 (Ke3) of equity capital 4 (Ke4) of debt capital 1 (Kd_Net)
Independent p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val
Variables Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW)
Tangibility -0.068 0.000 0.001 -0.070 0.000 0.001 -0.059 0.002 0.003 -0.053 0.005 0.008 -0.025 0.200 0.224
Profitability -0.182 0.000 0.000 -0.177 0.000 0.000 -0.177 0.000 0.000 -0.161 0.000 0.000 -0.183 0.000 0.000
Size 0.034 0.000 0.000 0.031 0.000 0.000 0.027 0.000 0.000 0.020 0.000 0.000 0.013 0.005 0.021
Market-to-Book -0.012 0.002 0.014 -0.015 0.000 0.003 -0.013 0.001 0.011 -0.017 0.000 0.001 -0.025 0.000 0.000
Liquidity -0.015 0.000 0.000 -0.015 0.000 0.000 -0.015 0.000 0.000 -0.014 0.000 0.000 -0.013 0.000 0.000
Risk -0.039 0.000 0.000 -0.040 0.000 0.000 -0.039 0.000 0.000 -0.039 0.000 0.000 -0.034 0.001 0.000
Dcrisis 0.010 0.135 0.117 0.013 0.054 0.043 -0.001 0.891 0.886 0.003 0.630 0.611 0.009 0.223 0.231
Cost of Capital 0.509 0.000 0.000 0.515 0.000 0.000 0.673 0.000 0.000 0.450 0.000 0.000 -0.115 0.000 0.000
Constant -0.193 0.002 -0.164 0.010 -0.121 0.053 0.017 0.779 0.216 0.002
# Observations 1825.000 1825.000 1827.000 1825.000 1664.000
Prob > F 0.000 0.000 0.000 0.000 0.000
2
R 0.265 0.255 0.260 0.249 0.184
Breusch-Pagan Test
Chi2(1) = 2742.890 2721.780 2682.440 2705.400 1706.270
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000
Hausman Test
Chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 33.570 32.170 36.860 32.140 56.510
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000
Notes: Coeff.: coefficients; p-val (FE): level of significance of the coefficient for the regression with fixed effects; p-val (NW): level of significance of the coefficient for the
regression with fixed effects and standard errors robust to heteroscedasticity and autocorrelation according to the method of Newey and West (1987); Prob>F, Prob>chi2: level
of significance of the model; R2: coefficient of explanation of the model.
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20

Table 5 - Determinants of market leverage - sample 1

Regressions with panel data. Dependent variable (Market-Lev): Financial Debts over Market Value of Assets. Explanatory variables: control variables and proxy for the cost
of capital (each quadrant contains the model’s results considering the cost of capital indicated in the third line of the table).

Market-Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + β6(Risk)it + β7(Dcrisis)it + β8(Cost of Capital)it + uit
SAMPLE 1: 235 Brazilian listed companies active in the BM&Fbovespa
Determinants of market leverage - Dependent variable: Financial Debts / Market Value of Assets

Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost
of equity capital 1 (Ke1) of equity capital 2 (Ke2) of equity capital 3 (Ke3) of equity capital 4 (Ke4) of debt capital 1 (Kd_Net)

Independent p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val
Variables Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW)
Tangibility -0.054 0.002 0.004 -0.054 0.002 0.004 -0.041 0.019 0.026 -0.032 0.078 0.091 -0.001 0.974 0.974
Profitability -0.145 0.000 0.000 -0.139 0.000 0.000 -0.138 0.000 0.000 -0.117 0.000 0.000 -0.170 0.000 0.000
Size 0.018 0.000 0.000 0.015 0.000 0.001 0.009 0.031 0.052 -0.001 0.857 0.871 -0.005 0.277 0.347
Market-to-Book -0.059 0.000 0.000 -0.063 0.000 0.000 -0.060 0.000 0.000 -0.066 0.000 0.000 -0.080 0.000 0.000
Liquidity -0.014 0.000 0.000 -0.013 0.000 0.000 -0.013 0.000 0.000 -0.012 0.000 0.000 -0.012 0.000 0.000
Risk -0.034 0.000 0.000 -0.035 0.000 0.000 -0.034 0.000 0.000 -0.033 0.000 0.000 -0.034 0.002 0.001
Dcrisis 0.021 0.001 0.001 0.025 0.000 0.000 0.006 0.349 0.333 0.012 0.066 0.053 0.016 0.029 0.038
Cost of Capital 0.709 0.000 0.000 0.702 0.000 0.000 0.943 0.000 0.000 0.612 0.000 0.000 -0.065 0.001 0.003
Constant -0.006 0.925 0.041 0.495 0.094 0.110 0.289 0.000 0.488 0.000
# Observations 1825.000 1825.000 1827.000 1825.000 1664.000
Prob > F 0.000 0.000 0.000 0.000 0.000
2
R 0.423 0.400 0.416 0.389 0.283
Breusch-Pagan Test
Chi2(1) = 2435.710 2358.100 2334.080 2277.740 1371.060
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000
Hausman Test
Chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 15.200 15.050 21.710 33.290 50.930
Prob>Chi2= 0.050 0.050 0.006 0.000 0.000
Notes: Coeff.: coefficients; p-val (FE): level of significance of the coefficient for the regression with fixed effects; p-val (NW): level of significance of the coefficient for the
regression with fixed effects and standard errors robust to heteroscedasticity and autocorrelation according to the method of Newey and West (1987); Prob>F, Prob>chi2: level
of significance of the model; R2: coefficient of explanation of the model.
 21

Table 6 - Descriptive statistics - sample 2

SAMPLE 2: 75 listed Brazilian companies with ratings
Std.
Variable # Obs. Mean Min. Max.
Dev.
Book_Lev 502 0.312 0.149 0.000 0.777
Market_Lev 475 0.233 0.138 0.000 0.778
Tangibility 502 0.344 0.246 0.000 0.911
Profitability 492 0.156 0.154 -0.121 1.663
Size 501 14.912 1.510 9.438 19.313
M/B 475 1.672 1.043 0.551 8.888
Liquidity 501 1.986 1.184 0.300 8.910
Risk 484 0.065 0.075 0.005 0.571
Ke1 475 0.165 0.061 0.091 0.708
Ke2 475 0.176 0.063 0.095 0.732
475 0.159 0.049 0.095 0.726
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Ke3
Ke4 475 0.146 0.068 0.073 0.780
Kd_Net 474 0.144 0.113 0.003 0.849
Kd_Rating 399 0.135 0.014 0.111 0.177
Notes: Book_Lev: book leverage, equal to financial debts
over book value of assets; Market-Lev: market leverage,
equal to financial debts over market value of assets; Ke:
proxy for the cost of equity capital; Kd_Net: financial
expenses (net of taxes) over financial debts; Kd_Rating:
average yield of bonds (DI%) by rating x DI-Pre 720 days.
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22

Table 7 - Determinants of book leverage - sample 2

Regressions with panel data. Dependent variable (Book_Lev): Financial Debts over Book Value of Assets. Explanatory variables: control variables and proxy for cost of
capital (each quadrant contains the model’s results considering the cost of capital indicated in the third line of the table).

Book_Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + β6(Risk)it + β7(Dcrisis)it + β8(Cost of Capital)it + uit
SAMPLE 2 : 75 listed Brazilian companies active on the BM&FBovespa with risk rating
Determinants of book leverage - Dependent variable: Financial Debts / Book Value of Assets
Explanatory variable: Explanatory variable:
Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost
cost of debt capital 1 cost of debt capital 2
of equity capital 1 (Ke1) of equity capital 2 (Ke2) of equity capital 3 (Ke3) of equity capital 4 (Ke4)
(Kd_Net) (Kd_Rating)
Independent p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val
Variables Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW)
Tangibility -0.089 0.001 0.003 -0.089 0.001 0.003 -0.088 0.001 0.002 -0.085 0.001 0.003 -0.065 0.012 0.020 -0.056 0.049 0.052
Profitability -0.202 0.000 0.001 -0.203 0.000 0.001 -0.198 0.000 0.001 -0.200 0.000 0.001 -0.107 0.034 0.056 -0.240 0.000 0.004
Size 0.061 0.000 0.000 0.062 0.000 0.000 0.058 0.000 0.000 0.059 0.000 0.000 0.057 0.000 0.000 0.053 0.000 0.000
Market-to-Book -0.017 0.015 0.027 -0.017 0.016 0.028 -0.017 0.016 0.028 -0.016 0.021 0.036 -0.019 0.010 0.010 -0.011 0.227 0.251
Liquidity -0.006 0.233 0.388 -0.006 0.225 0.379 -0.005 0.288 0.449 -0.005 0.281 0.434 -0.004 0.464 0.577 0.003 0.573 0.635
Risk 0.082 0.344 0.346 0.082 0.344 0.347 0.075 0.380 0.377 0.081 0.347 0.344 0.160 0.064 0.052 0.096 0.296 0.283
Dcrisis 0.015 0.141 0.141 0.017 0.093 0.095 0.010 0.332 0.331 0.015 0.144 0.143 0.027 0.009 0.010 0.032 0.003 0.003
Cost of Capital 0.221 0.002 0.014 0.204 0.003 0.020 0.333 0.000 0.001 0.205 0.001 0.009 -0.191 0.000 0.000 0.259 0.421 0.483
Constant -0.542 0.001 -0.556 0.001 -0.517 0.002 -0.505 0.002 -0.458 0.007 -0.453 0.037
# Observations 462.000 462.000 462.000 462.000 447.000 385.000
Prob > F 0.000 0.000 0.000 0.000 0.000 0.000
R2 0.269 0.267 0.279 0.272 0.273 0.207
Breusch-Pagan Test
Chi2(1) = 519.060 520.010 500.620 516.080 485.030 429.350
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000 0.000
Hausman Test
Chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 33.420 41.350 32.426 63.010 31.090 22.390
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000 0.000
Notes: Coeff.: coefficients; p-val (FE): level of significance of the coefficient for the regression with fixed effects; p-val (NW): level of significance of the coefficient for the
regression with fixed effects and standard errors robust to heteroscedasticity and autocorrelation according to the method of Newey and West (1987); Prob>F, Prob>chi2: level
of significance of the model; R2: coefficient of explanation of the model.
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23

Table 8 - Determinants of market leverage - sample 2

Regressions with panel data. Dependent variable (Market-Lev): Financial Debts over Market Value of Assets. Explanatory variables: control variables and proxy for the cost
of capital (each quadrant contains the model’s results considering the cost of capital indicated in the third line of the table).

Market-Levit = α + β1(Tang)it + β2(Profit)it + β3(Size)it + β4(M/B)it + β5(Liq)it + β6(Risk)it + β7(Dcrisis)it + β8(Cost of Capital)it + uit
SAMPLE 2 : 75 listed Brazilian companies active on the BM&FBovespa with risk rating
Determinants of market leverage - Dependent variable: Financial Debts / Market Value of Assets
Explanatory variable: Explanatory variable:
Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost Explanatory variable: cost
cost of debt capital 1 cost of debt capital 2
of equity capital 1 (Ke1) of equity capital 2 (Ke2) of equity capital 3 (Ke3) of equity capital 4 (Ke4)
(Kd_Net) (Kd_Rating)
Independent p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val p-val
Variables Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (FE) (NW) Coeff. (RE) (W)
Tangibility -0.068 0.005 0.015 -0.067 0.006 0.017 -0.064 0.005 0.016 -0.063 0.006 0.017 -0.029 0.246 0.285 -0.030 0.214 0.202
Profitability -0.163 0.000 0.002 -0.166 0.000 0.002 -0.155 0.000 0.002 -0.157 0.000 0.002 -0.134 0.006 0.019 -0.172 0.000 0.004
Size 0.061 0.000 0.000 0.063 0.000 0.000 0.056 0.000 0.000 0.057 0.000 0.000 0.052 0.000 0.000 0.013 0.056 0.060
Market-to-Book -0.044 0.000 0.000 -0.044 0.000 0.000 -0.044 0.000 0.000 -0.042 0.000 0.000 -0.053 0.000 0.000 -0.067 0.000 0.000
Liquidity -0.012 0.005 0.049 -0.012 0.005 0.048 -0.011 0.010 0.066 -0.011 0.011 0.070 -0.013 0.006 0.040 -0.008 0.077 0.153
Risk 0.008 0.922 0.915 0.008 0.924 0.917 -0.006 0.936 0.930 -0.007 0.926 0.920 0.105 0.206 0.148 0.032 0.686 0.706
Dcrisis 0.040 0.000 0.000 0.044 0.000 0.000 0.030 0.001 0.002 0.040 0.000 0.000 0.042 0.000 0.000 0.056 0.000 0.000
Cost of Capital 0.437 0.000 0.000 0.407 0.000 0.000 0.663 0.000 0.000 0.470 0.000 0.000 -0.071 0.124 0.151 -0.723 0.013 0.026
Constant -0.621 0.000 -0.652 0.000 -0.575 0.000 -0.563 0.000 -0.401 0.013 0.297 0.015 0.022
# Observations 462.000 462.000 462.000 462.000 447.000 # Observations 385.000
Prob > F 0.000 0.000 0.000 0.000 0.000 Prob > Chi2 0.000
2 2
R 0.470 0.465 0.505 0.508 0.415 R 0.414
Breusch-Pagan Test
Chi2(1) = 341.360 341.680 324.490 348.810 334.340 308.920
Prob>Chi2= 0.000 0.000 0.000 0.000 0.000 0.000
Hausman Test
Chi2(7) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 48.053 47.080 55.023 56.530 23.720 13.110
Prob>Chi2= 0.000 0.000 0.000 0.000 0.003 0.108
Notes: Coeff.: coefficients; p-val (FE): level of significance of the coefficient for the regression with fixed effects; p-val (NW): level of significance of the coefficient for the
regression with fixed effects and standard errors robust to heteroscedasticity and autocorrelation according to the method of Newey and West (1987); p-val (RE): level of
significance of the coefficient for the regression with random effects; Prob>F, Prob>Chi2: level of significance of the model; R2: coefficient of explanation of the model.
 24

35.0% 0.35

30.0% 0.30

25.0% 0.25

20.0% 0.20

15.0% 0.15
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10.0% 0.10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Ke1 - Historic S&P500 Premium + EMBI Ke2 - Historic S&P500 Premium + Adj. CR
Ke3 - Expected S&P500 Premium + Adj. CR Ke4 - Expected Ibovespa Premium
Leverage

Figure 1 - Average of the equity capital cost indicators and leverage (sample 1)
 25

18.0%

17.0%

16.0%

15.0%

14.0%

13.0%

12.0%
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11.0%

10.0%
2005 2006 2007 2008 2009 2010 2011
AAA AA A BBB

Figure 2 - Average cost of debt by rating - ANBIMA sample (Bonds DI%)

 26

18.0% 0.35

16.8%
17.0%
0.33
16.0%

15.0%
0.31
14.3%
14.0% 13.5%
13.5%
0.29
13.0% 13.5%
13.1%

12.0%
0.27
11.0% 11.4%
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10.0% 0.25
2005 2006 2007 2008 2009 2010 2011

Kd_Rating Leverage

Figure 3 - Average cost of debt capital (Kd_Rating) versus leverage - sample 2