Proceedings

It is standard in literature to estimate the capital structure by financial leverage. As for
the definition of financial leverage, the ratio of total liabilities to total assets is the
broadest one and used in many empirical studies. However, Rajan and Zingales
(1995) point out that this definition is inappropriate for financial leverage since total
liabilities includes items used for transaction purposes (e.g. account payable) rather
than financing. Also, Rajan and Zingales (1995) suggest that total debt to capital
probably best represents the effects of past financing decisions.
The goal of this paper is to express the linkage between financial leverage and
characteristics of the company, in an emerging market such as the Romanian one. To
address this problem, we used a simple linear regression model throughout the
analysis in order to put the focus on within-company changes in financial leverage.
We consider factors related to the demand for and the supply of debt financing.
Together, the magnitude of the estimated effects of supply and demand factors
appears large enough to account the most or the entire long-term trend in emerging
market debt ratios.
On the demand side, theory suggests, and prior empirical evidence of companies, that
fundamental company-level characteristics influence the degree to which companies
take on debt. Although numerous potential company-level determinants of capital
structure have been tested, the variables that have most consistently survived
empirical tests are company size, profitability, asset tangibility, and growth
opportunities (Rajan & Zingales, 1995).
We find that within-company trends in each of these four variables are significantly
correlated with within-company trends in debt ratios. In each case, the correlation is in
the direction consistent with previous literature: larger size, lower profitability, higher
asset tangibility, and lower growth opportunities are all associated with higher levels
of debt. Moreover, the trend in each of these four variables over the time was in the
direction that would imply an increase in leverage. On average, emerging market
companies experienced increases in size, decreases in profitability, increases in asset
tangibility, and decreases in growth opportunities in last three decades (Mitton, 2008).
Estimates of economic significance suggest that changes in these company-level
fundamentals can explain the majority of the increase in emerging market debt over
this period. Debt ratios have increased in emerging markets in large part because
companies have changed in such a way that their optimal level of debt has increased.
The increase in debt ratios may also depend on supply factors, or in other words, the
ability of companies to obtain external financing in emerging markets. If companies
are financially constrained, then increases in credit market development may lead to
higher debt ratios. Increases in stock market development (which allow companies to
substitute equity for debt) may lead to decreases in debt ratios.
This study complements and adds to Mitton’s (2008) survey of capital structure in 34
emerging markets (Romania was not included in the sample). We complement
Mitton’s work as we analyze company-level factors that affects capital structure for
Romanian companies, also an emerging market with reduced liquidity and imperfect
transactions mechanisms. According to another study realized over Romanian
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