Cross-country variations in capital structures: The role of bankruptcy codes

We investigate the impact of bankruptcy codes on firms’ capitalstructure choices. We develop a theoretical model to identify how firm characteristics may interact with the bankruptcy code in determining optimal capital structures. A novel and sharp empirical implication emerges from this model: that the difference in leverage choices under a relatively equity-friendly bankruptcy code (such as the US’s) and one that is relatively more debt-friendly (such as the UK’s) should be a decreasing function of the anticipated liquidation value of the firm’s assets. Using data on the US and the UK over the period 1990–2002, we subject this prediction to both parametric and non-parametric tests, using different proxies for liquidation values and different measures of leverage. In support for the theory, we find that our proxies for liquidation value are both statistically and economically significant in explaining leverage differences across the two countries. In contrast, many of the other factors that are known to affect within-country leverage (e.g., size) cannot explain differences in leverage across countries. 2010 Elsevier Inc. All rights reserved. 1042-9573/$ see front matter 2010 Elsevier Inc. All rights reserved. doi:10.1016/j.jfi.2010.02.001 q An earlier version of this paper was completed when the first author was at the London Business School. We are grateful to Barry Adler, Philippe Aghion, Patrick Bolton, Matias Braun, Murillo Campello, Julian Franks, Leora Klapper, Marco Pagano, Robert Rasmussen, Alan Schwartz, Henri Servaes, David Skeel, Karin Thoburn, Paolo Volpin, Elu von Thadden (editor) and two anonymous referees for their detailed comments and suggestions. We also had the benefit of feedback from participants at a number of seminars at Carnegie-Mellon, Cornell, London Business School, New York University, Ohio State, Texas A&M, Temple, University of Illinois at Urbana-Champaign, University of North Carolina at Chapel Hill, University of Zurich, and the Institute for Financial Management and Research, and at the following conferences: the 2004 CEPR Workshop on Corporate Finance at Gerzensee, the 2004 Contemporary Corporate Finance Issues Conference at Dartmouth, the 2005 AFA meetings in Philadelphia, the 2005 NYU-Penn Law and Finance Conference at NYU, the 2005 Financial Distress, Bankruptcy, and Corporate Restructuring Conference at Wharton, the 2005 Summer Research Conference at the Indian School of Business, and ETH–ECGI–Wharton Conference on Alternative Corporate Governance at Zurich. Rong Leng provided superb research assistance. The usual disclaimer applies. * Corresponding author. Fax: +1 212 995 4256. E-mail addresses: [email protected] (V.V. Acharya), [email protected] (R.K. Sundaram), [email protected] (K. John). J. Finan. Intermediation 20 (2011) 25–54