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FACT ORS INFL UENCING TH E F INANCING DECIS ION t n oM UL T I NAT I ONAL CORPORAT I ONS L I ST EDI N BURSA V IALA v

PREPARED BY :N ORASH IK IN I SM A ILWAN RAZAZIL A W AN ABDUL L AHK HARUDIN M OHD SAL I

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FAKULTIPERAKAUNAN

TarikhNo. Fail Projek

Universiti Teknologi M A RA J ohorK m 12, J alan Muar,85200 SegamatJ ohor Darul TakzimT el: 07-9352000 Fax : 07-9352277Email :[email protected]

16 NOKrSoeT

^ ^hhyJni1UNIVERSITITEKNOLOGIMARA

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

Y ang Berbahagia Prof.,

LA PORAN AK HIR PENY ELIDIK AN "FACTORS INFLUENCING THE FINANCINGM ^ A Y S ^ M U L A T I O N A L CORPORATIONS L ISTED S A

M erujuk kepada perkara di atas, bersama-sama ini disertakan 3 (tiga) naskhah T annAkhir Penyelidikan bertajuk "FACTORS I NFLUENCING T I ff i FTNA NCT GM UL TINATIONA L CORPORATIONS LISTED IN B ^S AMALAY SIA , oleh kumpulan penyelidik UiTM Cawangan J ohor untuk makluman pihak

Sekian untuk makluman dan tindakan pihak Prof. Terima kasih.

Y ang beirar, SSP -

NORASHIK IN BTE ISM A ILK etua Penyelidik

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mailto:[email protected]:[email protected]


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K U M P U L A N P E N Y E L I D I K

N O R A S H I K I N B T E I SM A I LKetua Penyelidik

Tandatangan

AhliW A N R A Z A Z I L A B T E W A N A B D U L L A H

Tandatangan

K H A R U D I N M O H D SA L IAhli

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ACK NOWLE DGE M E NT S

I n the name of Allah, the Most Compassionate, the Most M erciful.

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 gt h M d P a t i e n c e t 0 c o m P l e t e thisstudy with n the period given. W e would like to extend this appreciation to those whohave direct y and indirectly contributed invaluable assistance, cooperation and support inthe completion of this research. T hey are: w

Unit of R esearch, Development and C ommercialisation, U iT M J ohor,for the financial support in conducting this study.

Prof. M adya Dr . Omar Samat, Dir ector ,Universiti Teknologi M A R A J ohor

for his continuous support and encouragement.C ik Nor Diana A bd. R ahman, L ibrarian, U iT M J ohor

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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A B S T R A C T

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

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L IST OF TABL ES

Table 1:

Table 2:

Table 3:Table 4:

Table 5:Table 6

Table 7

Table 8

The Expected Signs of Relationship between the Leverageand Independent V ariables.Descriptive Statistics of Total Debt Ratio and IndependentVariables.Determinants of Debt Ratio for Multinational Firms.Descriptive Statistics of Short Term Debt Ratio andIndependent Variables.Determinants of Short Term Debt Ratio for MultinationalFirms.Descriptive statistics of L ong Term Debt Ratio andIndependent Variables.Determinants of Long Term Debt Ratio for MultinationalFirms.Result of Multicollinearity Test using Variance InflationFactor.

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TABLE OF CONTENTS

AcknowledgementsAbstractL ist of TablesTable of ContentsCHAPTER 1: INTRODUCTION

1.0 Introduction1 1 The Problem Statement1 .2 Objectives of the Study1.3 Chapter Organization

CHAPTER 2: L IT ERAT URE REV IEW2.0 Chapter Description2.1 Introduction2.2 Theories Related to Capital Structure

2.2.1 Trade Off Theory2.2.2 Agency Cost Theory2.2.3 Free Cash Flow Theory2.2.4 Pecking Order Theory

2.3 Growth to Debt Equity Theory2.4 Industry and Capital Structure2.5 Strategic Assets and Capital Structure2.6 Studies on Determinants of Capital Structure

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8- 91 0 - 1 1

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CHAPTER 3: RESEAR CH M ETH ODOL OGY3.0 Chapter Description 203.1 Research Setting 203.2 Research Design 21- 63.3 Hypotheses Development 263.4 Problems and L imitations 283.5 Summary 2g

CHA PTER 4: DISCUSSI ON OF RESEARC H FI NDINGS4.0 Chapter Description 294.1 Research Findings 29

4.1.1 Total Debt Ratio 3 0 _ 3 24.1.2 Short Term Debt Ratio 32- 354.1.3 Long Term Debt Ratio 35- 38

4.2 M ulticollinearity Test 3 8 _ 3 94.3 Heteroskedasticity Test 4 04.4 Summary 4 Q 4 1

CHAPTE R 5: CONCL USION AND FURTH ER RESEARCH5.0 Conclusion ,42-435.1 Further Research 44

REFERENCESAPPENDICES 4 5 " 4 7

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FACT ORS INFL UENCING THE F INANCING DECISION FORM ULT INAT IONAL CORPORATIONS L ISTED IN BURSA M AL AY SIA .

CHAPTER ONEINTRODUCTION

1.0 I ntroduction

Over the past two decades market liberalization has emerged as a major issue affectinginternational business (Toulan, 2002; Tatoglu and Glaister ,1998). A fter many years ofexperiment with heavy state intervention in the economy, a consensus emerged that theachievement of more dynamic economic growth requires a greater role from the privatesector. As a result, many developing countries have introduced market reformprogrammes aimed at reversing economic decline and at generating sustainable growthand development. Investment by multinational corporations (M NCs) was one of themeans to continue access to international capital (L ecraw, 1992:41). Foreign DirectInvestments (FDIs) by M NCs have become an increasingly important source ofdeveloping countries' capital flows compared to other sources such as commercial andconcessional loans (Bergsman and Shen, 1995).

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

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

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The Malaysian capital market is substantially smaller compared to that in the developedcountries. This could potentially constraint the supply of capital especially for largefirms. The comparison of the leverage of Malaysian MNCs and DCs could provide someinsights into whether capital supply factors could affect leverage as argued by Faulkenderand Petersen (2004). In sum, these differences provide us an independent sample to testthe predictions of several capital structure theories.

History has showed us that the combination of debt and equity will affect a firm's valueand investment. This combination, also known as the leverage factor, is being used byfirms as well as the market as a measure of financing or capital choices (i.e. between debtand 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 ameasure of strength. Several studies have explored the characteristics and factors whichhave 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 tothem than activities that benefit the firms. J ensen and Meckling (1976) state that firmsprefer 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 fortheir personal gain. Myers and Majluf (1984) claim that the information on the potentialof success in investment is private to managers and it is not known to investors. Conflictsamong stakeholders and the debtholders, according to J ensen and Meckling (1976), isanother form of agency problem. This exists when firms choose debt and the fund issuboptimally invested by the equityholder. In the event of big profits, the equityholderswill 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 byfirms 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 includesa premium to cover the risk implied by this uncertainty. Berger and Udell (1990) discoverthat young firms need to establish reputation from the initial funds they obtain. They alsofind 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 ofbankruptcy. 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 threeways 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 claimsby the debtholder is bigger than the firm value. Haugen and Senbet (1978) propose firmsthat 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 andpersonal tax as suggested by DeAngelo and Masulis (1980). A ccording to M iller (1977)debt is preferred because of tax reduction. However, DeAngelo and Masulis (1980) claimthat if the marginal cost of debt financing equals to zero, the use of debt is less significantin the capital structure formation. The effect on the debt on a firm's value was studied byFama and French (1998). Dividends are positively correlated to the firm's value whiletaxes are negatively correlated. They suggest that the financial policy should give priorityon 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 raisecapital either through bank borrowing or through selling of debt instruments. Myers andMajluf (1984) and Scott (1977) suggest that firm may find it advantageous to sell secureddebt. Scott (1977) states that, by selling secured debt, firms increase the value of theirequity by expropriating wealth from their existing unsecured creditors.

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

Several authors, among others, Warner (1977), and Ang et. al. (1982), claim thatrelatively large firms tend to be more diversified and less prone to bankruptcy thansmaller fi rms. This suggests that large firms should be highly leveraged. Meanwhile,according to Titman and Wessels (1988), the costs of issuing debt and equity instrumentsare related to the size of the firm. In particular, small firms pay a higher cost than largefirms to issue long term debt and new equity. T his suggests that small firms may be moreleveraged than large firms and may prefer to borrow short term loan rather than issuelong 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, thesestructures would maximize the value of firm. The optimal financing structure may haveimportant implications on firm valuation, capital budgeting decisions and long termcorporate profits. It is important to understand the way that firms maximize value.Decisions regarding financial structures may have important implications with regards tothe shareholders' wealth.

1.2 Objectives of the Study

The main objective of this study is to identify which financial variables influencefinancing 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 financingdecisions.

1.3 Significance of the Study

Since financing decision has important implications on shareholders' wealth, this studyaims to contribute to the shareholders, either existing or potential investors on the mattersof financing decisions of multinational corporations. In addition, it also provides anunderstanding 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 oncompanies listed on Bursa Malaysia. However, this study will contribute towards theliterature on capital structure.

1.4 Chapter Organization

This research is organized into five chapters. The first chapter provides a briefintroduction on the overall research including the objectives and the significance of thisstudy.

The second chapter starts with the issues of financial leverage, taxes and firm value, thetrade 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 thedeterminants of capital structure.

The following chapter discusses the method and data used for this research. The focus ofthis chapter is on how the research was conducted in order to derive at the findings andconclusions. 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 theresearch as it explains the findings according to the objectives stated in chapter one. Thefindings identify which financial variables have influence over financing decisions ofmultinational corporations. Besides that, this chapter also analyses various measures ofdebt 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 assome recommendations for future research.

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CHAPTER TWOL I TERA TU RE REV IEW

2.0 Chapter Description

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

2.1 I ntroduction

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

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

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shareholders. A s compared to interest payment, dividend payment is notconsidered 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 thedecisions of the board of directors. It is the choice of firms in deciding the bestalternatives for their financing. K ochhar (1997) states that debt holders andequityholder are associated with different levels of risk, benefits and control.Even though debtholders exert lower control, they earn fixed rate of return and areprotected by contractual obligations with respect to their investment. However,equityholders are the residual claimants, bearing most of the risk andcorrespondingly have greater control over decisions. Since the instruments of thesecurities to be issued are large, there are many factors to be considered before afirm's debt-to-equity ratio is finalized.

2.2 T heories Related to Capital Structure

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

2.2.1 T rade off theory

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

However, according to Modigliani and M iller's (1958) proposition I (in aworld with no taxes), the value of the levered firm is the same as the valueof 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 tobuy shares in unlevered firms. In their proposition H, M odigliani andM iller argue that the expected return on equity is positively related toleverage, because the risk to equity holders increase with leverage. In aworld with taxes, Modigliani and M iller (1963) claim that the firm's valueis positively related to its debt due to the tax shield of the interest that isdeductible from taxes. Tax shield increases with the amount of debt and asa result, the value of the firm is positively related to debt. A nyway, therisk of equity increases with leverage.

Besides providing tax advantages, debt puts pressure on the firm due tothe fact that interest and principal payments are obligations. Failure tomeet these obligations will make the firms face financial distress, wherebythe worth is facing bankruptcy situation where ownership of the firm'sassets is legally transferred from the stockholders to the bondholders.Therefore, bankruptcy has a negative value of the firm. Nevertheless, thecosts associated with bankruptcies that lower the firms value is notbankruptcy itself. Hence, Cassar (2001) claims that firms which have highdistress costs would have incentives to decrease outside financing to lowerthese costs. The integration or the trade off between benefits of debt (taxshield is the chief benefit) and distress cost is known as the optimalamount of debt.

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

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2.2.2 A gency Costs

The agency theory focuses on the financial contracts established betweenthe organization and the providers of liabilities. This contract creates twoagency relationship between i) the managerial relationship, set up betweenshareholders and managers, and ii)the borrowing relationship, set upbetween debtholders and the shareholders. The clash of interest among thedifferent agents involved initiate conflicts and agency costs. Conflicts ofinterest may arise between stockholders and bondholders, wherebyshareholders are tempted to pursue selfish strategies to help themselveswhile hurting the bondholders. The market value of the whole firm will belowered if all these selfish strategies are undertaken. Examples of selfishstrategies include incentive to take large risks project, incentive towardunderinvestment, and milking the property in paying out extra dividendsof other distributions in times of financial distress, leaving less in the firmfor the bondholders. J ensen (1986) argues that when a firm has an amplefree cash flow, managers can squander the cash by consuming perquisitesor operating ineffectively. These create a need for debtholders to restrictand monitor the firms' behaviour.

Cassar (2001) stated that costly monitoring devices or contractualcovenants need to be incorporated into debt agreements to protectdebtholders from this potential behaviour. It is therefore these costs thatwill increase the cost of capital offered to the firm. A weak evidence isfound by Graham and Harvey (2002) on the importance ofunderinvestment in debt policy.

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

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managerial agency costs. The incremental benefit of debt is concentratedin firms most likely to have overinvestment problems because they haveeither high levels of assets in place or limited growth opportunities. Inaddition, they claim that the results support the recontracting hypothesisthat shareholders value compliance with monitored covenants, particularlywhen firms are most likely to face extreme agency problems.

2.2.3 F ree Cash Flow

The free cash flow hypothesis states that firms with high free cash floware more likely to make bad acquisitions than firms with low free cashflow. This will give a vital implication for capital structure because anincrease in dividends should benefit the stockholders by reducing theability of managers to pursue wasteful activities. In addition, the debtobligations in terms of interest and principal will also ensure that cashleaves the firms. In fact debt will give greater effects than dividends sincefirms have no legal obligation to pay dividends. T herefore, the free cashflow hypothesis argues that a shift from equity to debt will boost firmvalue.

2.2.4 T he Pecking Order T heory

Contradictory to trade off theory, the pecking order theory assumes thatfirms do not target a specific ratio instead internal financing should beused first before deciding issuing securities either debt or equity. Thetheory suggests that if outside financing is required, debt should be issuedbefore equity. Equity should only be issued when firms have fully utilizedtheir debt capacity. M yers (1984) suggests that managers have a peckingorder to meet their financial needs, in which retained earnings representedthe 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 andtraditional corporations where the more profitable the firm, the lower thedebt ratio. Their finding is consistent with the pecking order theory andthey claim that external financing is costly and therefore should beavoided by firms.

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

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

In contrast, Frank and Goyal (2003) finds evidence that contradicts what isoften suggested about pecking order theory. Using a broad cross section ofpublicly traded American firms over the period 1971-1998, they contendthat internal financing is not sufficient to cover investment spending onaverage. Thus, external financing is heavily used. Anyway Frank, andGoyal (2003) notes that time period and firm size play major roles to theresults obtained. They assert that in 1990s, many more small firms andunprofitable firms become publicly traded, which generally do not behaveaccording 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 notincrease the current level of debt needed to shield today's income from today'staxes but growth increases the value of equity. T herefore, high-growth firms willhave lower debt ratios than low-growth fi rms. According to M yers (1977), growthopportunities have significant negative impacts on capital structure based on theargument that firms with higher investment intangible assets are to use less debtto reduce the agency costs associated with risky debts. In contrast Pao et. al.(2003) finds that growth opportunities have insignificant impacts on capitalstructure for the high technology corporations and positive impact on capitalstructure for the traditional corporations. A ccording to the study conducted byRoden and Lewellen (1995) on capital structure decision of leverage buyoutfirms, the target firm's growth rate affects both the proportion and thecomposition of the debt. They find that the greater the prospective future growthopportunities, the smaller the proportion of bank financing and the larger thecomponent of subordinated debt securities.

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

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2.4 I ndustry and Capital structure

The nature of competition varies across industries and this affects optimal debtpolicy. In addition, some countries impose variety of tax rates across industry.According to Hatfield et. al. (1994), in their study on 183 firms which announceda new debt issue for the period January 1982 through December 1986, they findthat the relationship between a firm's debt level and that of its industry does notappear to be of concern to the market. They conclude that the market doesn'tconsider industry averages for leverage as discriminators for firms' financialleverage. Their findings are consistent with the original M odigliani and Miller(1958) proposition that financial leverage is irrelevant to the value of the firm.M oreover, Graham and Harvey (2000) find little evidence that product marketfactors affect real world debt policy and modest evidence that managers areconcerned about the debt levels of their competitors.

Boateg (2004) analyses the determinants of capital structure of international jointventures in Ghana based on a sample of 41 firms in Ghana with partners fromWestern Europe, North America and Asia. From the results obtained, they claimthat the size of joint venture, the type of joints venture industry, and ownershiplevel of joint venture partner have a positive bearing on the capital structure ofjoint ventures in Ghana. Firms in textile, building and construction, mining andexploration 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 capitalstructure for Australian multinational and domestic corporations. In identifyingthe industry influence on capital structure, it was found that Australian domesticcorporations that belong to basic material, consumer cyclical andtelecommunication industries have a significant negative relationship with longterm leverage. However, Australian multinational corporations that belong tobasic material, energy and industrial industries have significant positive

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

2.6 Strategic A ssets and Capital Structure

K ochhar (1997) claimed that the choice between debt and equity for financing aninvestment depends on the characteristics of the assets being financed. In hisstudy on strategic assets, capital structure and firm performance, he claims thatthe optimal debt-to-equity ratio is determined by the nature of strategic assets inthe firm. Strategic assets are defined as those assets that could generate sustainedcompetitive advantage. In addition, Barney (1991) proposes strategic assets asthose that, in addition to being valuable, resources should possess the keyattributes of being rare, imperfectly imitable, and nonsubstitutable. K ochhar(1997) contends that debt financing is suitable for low specificity assets andequity is preferred when the level of specificity is high. Since equity financing isthe mode that enables equityholders to exert influence and monitor managerialdecisions continuosly through the board of directors, equity is claimed as toprovide a superior governance functions. As a result, low specificity assets arelikely to be financed via debt, whereas high specificity assets are more likely touse equity financing.

Furthermore, Prasad et. al. (1997) discovers that there is a joint impact of bothasset structure and capital structure on systematic risk. They affirm that managersdo engage in tradeoffs to control and maintain the strategically selected level ofsystematic risk, and that trade off is stronger the higher the level of systematicrisk'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 theoryand the signalling approach, Riportella and Papis (2001) study on the analysis ofthe determining factors of Spanish SM E's firms. The result observed is that theenterprises with higher borrowing belong to the industry, whereas those withlower borrowing belong to the service sector. In addition, the enterprises withhigher borrowing are the ones dealing on average with a higher number ofcompanies. Some statistically significant differences are noticed between groupswhere the age of the relationships is generally younger for those enterprises inlower degree of borrowing. In addition, with respect to the variable ownership andcontrol structure, those enterprises with higher specialization of the functions arethe 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 firmsthat were listed in the J ohannesburg Stock Exchange's industrial sector for the1991-1998 period, it is found that there is a negative association between the taxrate variables and extend of leverage. In addition, the trade off betweeninvestments 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 multinationalcorporations (M NCs). The characteristic of M NCs such as their larger size, lowercash flow volatility and easier access to international capital markets leads to thesuggestion that MNCs should have higher leverage than domestic firms (DCs),Anyway, there is also another theory that suggests MNCs are expected to havelower debt levels. This is due to their operations in more complex political andinstitutional environment and a geographic dispersion which may increase

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