Determinants of Capital Structure: Evidence From A Major Developing Economy

Small Bus Econ (2015) 44:255–282
DOI 10.1007/s11187-014-9597-x
Determinants of capital structure: evidence

from a major developing economy
Bülent Köksal • Cüneyt Orman
Accepted: 23 June 2014 / Published online: 22 July 2014

Springer Science+Business Media New York 2014
Abstract A major shortcoming of capital structure Keywords Capital structure Non-financial firms
studies on developing economies is that they generally Pecking order theory Trade-off theory Turkey
restrict their analyses to large publicly-traded manu-
facturing firms. Consequently, we know little about JEL Classification G30 G32 L26
the applicability of various capital structure theories to
firms that are private, small, and/or outside the
manufacturing industry in these economies. In this
paper, we conduct a comparative test of the trade-off 1 Introduction
and pecking order theories using a comprehensive
firm-level dataset that covers manufacturing, non- Ever since the publication of Modigliani and Miller
manufacturing, small, large, publicly-traded, and (1958)’s ‘‘irrelevance proposition’’, there has been
private firms in a major developing economy, Turkey. extensive theoretical work on the determinants of
The trade-off theory provides a better description of firms’ capital structures. Already by the early 1980s,
the capital structures of all firm types than the pecking these efforts culminated in the development of the two
order theory. Moreover, the trade-off theory appears to major theories of capital structure. In the (static)
be particularly suitable for understanding the financ- trade-off theory, firms trade off tax savings from debt
ing choices of large private firms in the non-manu- financing against deadweight costs of possible bank-
facturing sector and when the economic environment ruptcy. The pecking order theory, on the other hand,
is relatively stable. By contrast, pecking order theory posits that, due to adverse selection, firms prefer
is most useful when it comes to small publicly-traded internal to external financing and debt to equity if
manufacturing firms, especially when the economic external financing is used. Even though neither theory
environment is relatively unstable. is completely satisfactory, they have been instrumen-
tal in identifying many of the factors that govern firms’
actual financing decisions.
Beginning with the mid-1980s, there has been an
B. Köksal
Department of Economics, Ipek University, Çankaya, outpouring of empirical research aimed at comparing
06550 Ankara, Turkey and contrasting the predictive powers of the major
theories of capital structure, often formulated as a
C. Orman (&)
contest between the trade-off theory and the pecking
Central Bank of the Republic of Turkey, Istiklal Cad.,
No: 10, Ulus, 06100 Ankara, Turkey order theory. While the earlier work concentrated on
e-mail: cuneyt.orman@tcmb.gov.tr the developed economies, particularly the United
123
256 B. Köksal, C. Orman
States, a major preoccupation of recent research has much more accurate picture of the capital structure of
been to test these theories in the context of developing the average Turkish non-financial firm. It also allows
economies. The evidence coming from both the us to investigate systematically the capital structure
developed and developing economy capital structure differences between firms of various kinds: manufac-
studies thus far is decidedly mixed; while some studies turing versus non-manufacturing firms, small versus
provide support for the trade-off theory, others lend large firms, and public versus private firms. Accord-
support for the pecking order theory. Often, studies ingly, we are able to carry out a considerably more
report conflicting findings even for a given country. In comprehensive comparative test of the trade-off and
the quest for resolving the contest between the trade- pecking order theories than previous studies.
off and pecking order theories, researchers have The extant literature reviewed in Sect. 2 has
subsequently taken a variety of routes that include identified several factors that are correlated with firm
modifying and/or improving the existing theories, leverage in both developed and developing countries.
developing new theories, and using better data and/or Following this body of work, we investigate concur-
methods. Despite considerable progress, the issue is rently the influences on leverage of four broad types of
yet to be settled, both for developed and developing variables: Firm-specific, tax-related, industry-specific,
economies, and more so for the latter. and macroeconomic. Several results emerge from our
A major shortcoming in developing economy empirical analysis. In particular, we find that, for the
capital structure studies, including Turkey, is that average Turkish non-financial firm, most of the
they generally restrict their analyses to manufacturing independent variables have the signs that would be
firms listed on the stock exchanges, which incidentally expected in light of previous theoretical work and the
tend to be relatively large firms. As such, these studies empirical findings obtained for other countries. Spe-
cannot speak to the capital structure choice of the cifically, we provide evidence that leverage (short-
average (or typical) non-financial firm, nor do they term, long-term, and total) is positively correlated with
inform us about the capital structure choices of firms firm size, potential debt tax shields, industry median
that are privately-held, firms outside the manufactur- debt ratios, and inflation, and negatively correlated
ing industry, or firms that are relatively small. This with profitability, business risk, and real GDP growth.
also implies that, by design, comparative tests of the Asset tangibility is positively correlated with long-
theory in such studies can be informative only in the term and total leverage but negatively correlated with
specific context of large public manufacturing firms. short-term leverage. Firm growth, on the other hand,
In this paper, we contribute to the capital structure does not seem to be related with firms’ leverage
literature on developing economies by investigating decisions. Our findings, therefore, confirm, from a
the capital structure choices of Turkish non-financial capital structure point of view, the statistical relevance
firms and also by doing a comparative test of the trade- of tax-related, industry-related, and macroeconomic
off and pecking order theories. Our study differs from factors in addition to firm-level factors in the context
previous studies in that we utilize a unique and of Turkish non-financial firms.
comprehensive dataset compiled by the Central Bank In addition to statistical significance, we analyze
of the Republic of Turkey (CBRT) that provides the economic significance of leverage determinants, a
financial information on small, large, public, private, first in the capital structure literature on developing
manufacturing as well as non-manufacturing non- economies. Our findings indicate that each of the four
financial firms in Turkey for the past 20 years. The fact broad types of leverage determinants does indeed play
that our dataset is substantially more comprehensive in an economically important role in shaping the capital
terms of firm types as well as leverage determinants structure decisions of Turkish non-financial firms
suggested by theory compared to the datasets used in during our sample period. Specifically, we find that
previous studies enables us to conduct a number of while potential debt tax shields are the most econom-
systematic analyses which, to our knowledge, are new ically significant determinant of short-term and total
in the context of capital structure research on devel- leverage, tangibility is the most economically signif-
oping economies. Specifically, since our dataset is icant determinant of long-term leverage. Firm size is
considerably more representative of the universe of another major determinant of leverage, second only to
Turkish non-financial firms, it enables us to take a tangibility and potential debt tax shields for long-term
123
Determinants of capital structure 257
and total leverage, respectively. Industry median of capital flows appears to be particularly strong
leverage and inflation also play a notable but smaller during the dramatic rise in capital flows after the early
role when compared to firm size, profitability, tangi- 2000s. Our findings also indicate that capital flows
bility, and tax-related determinants. influence the capital structures of different types of
We next carry out a rare exercise in the literature firms differently; increasing debt usage most in large
on corporate capital structure in developing econo- private non-manufacturing firms.
mies. Specifically, we investigate the capital struc- On the whole, our empirical findings suggest that
ture differences between manufacturing and non- the trade-off theory is a better description of the capital
manufacturing, large and small, and public and structures of Turkish non-financial firms than the
private firms. One of our main findings is that pecking-order theory. This contrasts sharply with the
regardless of their size, industrial membership, and judgments of previous researchers on the Turkish
stock market listing, firms’ short-term leverage is economy, who typically take the opposite view. There
much larger than their long-term leverage. This are two main reasons behind this difference in
indicates that short-term debt finance was and still is judgments. First, our dataset is much larger (both
the norm for Turkish non-financial firms, which is within and across time) than the datasets used in past
not desirable both from economic efficiency and studies, which allows us to estimate the leverage
financial stability perspectives. We also find that effects of different leverage determinants much more
while manufacturing firms have higher leverage precisely. Second, our dataset is much more compre-
(both short-term and long-term) than non-manufac- hensive in terms of both firm types and leverage
turing firms, large firms and public firms have determinants, which enables us to do a much more
higher long-term leverage but lower short-term comprehensive comparative test of the two theories. It
leverage than small firms and private firms, respec- is important to note the fact that our analysis of the
tively. This implies that small private manufacturing relative economic significance of leverage determi-
firms are the firms with the greatest proportion of nants also strengthens the case for the trade-off theory.
short-term debt in their capital structures. In addi- Our findings also suggest where each of the two
tion to these differences in leverage patterns, firm capital structure theories may be most fruitfully
types also differ in terms of how various determi- applied. In particular, we provide evidence that the
nants are related with leverage. The most significant trade-off theory is particularly successful in account-
differences appear to be neither between public and ing for the capital structures of large private firms in
private firms nor between manufacturing and non- the non-manufacturing sector. Moreover, the predic-
manufacturing firms but rather between small and tive power of the trade-off theory appears to be higher
large firms. when the economic environment is relatively stable.
Another novel aspect of our paper is that we explore Pecking order theory, on the other hand, although in
the implications of international capital flows for our evaluation still not as powerful as the trade-off
firms’ capital structures. Studying the capital structure theory, appears to perform best for small public firms
implications of capital flows is interesting because in the manufacturing sector and when the economic
capital flows exert, either directly or via domestic environment is relatively unstable.
capital markets, a major influence on the availability The remainder of the paper proceeds as follows.
and allocation of funds to various types of firms in Section 2 presents the links to the relevant theoretical
many developing economies, including Turkey. More- and empirical literature on capital structure. Section 3
over, both the size and volatility of capital flows grew summarizes the hypotheses regarding the relationship
rapidly during the past two decades, particularly after between leverage and its determinants. Section 4
the early 2000s, raising concerns over economic and describes the data. Section 5 presents the main results
financial stability in policy circles. Our results do in and a number of robustness checks. Section 6 sheds
fact show that there is a strong positive correlation light on the capital structure differences between firms
between capital flows and corporate leverage in of various types. Section 7 evaluates the predictive
Turkey, indicating that firms choose to intensify their abilities of trade-off and pecking order theories in light
usage of debt in response to a rise in the availability of of our empirical findings. Section 8 provides conclud-
foreign capital. Moreover, the debt-promoting effect ing remarks.
123
2 Main connections with the literature Wessels 1988). In an influential study, Rajan and
Zingales (1995) show that factors such as growth, size,
The theory of corporate finance in a modern sense profitability, and tangibility, which are correlated in
begins with the Modigliani and Miller (1958) theorem, the cross-section with firm leverage in the United
which states that in a frictionless capital market a States are similarly correlated in the other G-7
firm’s market value is independent of how it finances countries as well. Following Rajan and Zingales
its operations. Subsequent research emphasized (1995), there has been an outpouring of empirical
important departures from the Modigliani–Miller research on international comparisons of capital
assumption of frictionless capital markets such taxes, structure including, among others, Demirgüç-Kunt
transaction costs, agency costs, adverse selection, lack and Maksimovic (1996, 1999), Wald (1999), De Jong
of separability between financing and operations, time et al. (2008), and Antoniou et al. (2008). A particularly
varying financial market opportunities, and investor- important study in this line of research has been Booth
clientele effects (Frank and Goyal 2008). These efforts et al. (2001), which provides evidence that firms’
led to the development of various capital structure capital structure decisions in developing countries are
theories, the two major theories being the trade-off and affected by the same variables as in developed
pecking order theories. Kraus and Litzenberger (1973) countries. Since at least the mid-1990s, there are also
provides a classic statement of the theory that optimal a growing number of studies that explore the deter-
capital structure reflects a single-period trade-off minants of capital structure in individual developing
between the tax benefits of debt financing and the countries.2
deadweight costs of potential bankruptcy. This stan- Our paper is most closely related to this last strand
dard version of the trade-off theory is referred to as the of literature since we analyze the capital structure of
static trade-off theory.1 The standard statement of the non-financial firms in a major developing economy,
pecking order theory, on the other hand, is provided by namely, Turkey.3 This literature studies the capital
Myers (1984) and Myers and Majluf (1984), according structure choice of manufacturing firms listed on
to which, firms follow a financing hierarchy in order to Borsa Istanbul (BIST) (as the Istanbul Stock Exchange
minimize the problem of asymmetric information is called since 2013) from various angles and for
between the firm’s insiders and the outsiders. different time periods. There are three exceptions:
Thanks to the trade off, pecking order, and other Demirhan (2009) focuses on non-manufacturing firms
theories, we now know a lot more about the factors on the ISE, Okuyan and Taşçı (2010) use a dataset
that determine firms’ actual capital structure decisions. compiled by Istanbul Chamber of Industry that
In particular, these theories have been helpful in provides information on the largest 1,000 manufac-
identifying a large number of factors that seem to be turing firms in Turkey, and Aydın et al. (2006) use the
correlated with firms’ debt ratios. Frank and Goyal same dataset as ours but restrict themselves only to a
(2009) lists as many as 36 variables that are correlated descriptive analysis of firms’ capital structures. Ceb-
with the leverage decisions of U.S. firms (see, also, enoyan et al. (1995) and Dinçergök and Yalçıner
Harris and Raviv 1991). Empirical studies typically (2011), on the other hand, carry out comparative
employ a variety of variables from this list that can be studies of Turkey, Greece, Canada, and the U.S., and
justified using any of the existing theoretical models. of Turkey, Brazil, Argentina, and Indonesia, respec-
Most of the earlier empirical research attempts to tively, again using data on listed manufacturing firms.
test various theories using the developed countries,
mainly the United States, as a laboratory (e.g. Bradley
et al. 1984; Taggart 1985; Pozdena 1987; Titman and 2
See, for example, Wiwattanakantang (1999) for Thailand,
Pandey (2004) for Malaysia, Huang and Song (2006) for China,
Correa et al. (2007) for Brazil, Qureshi (2009) for Pakistan, and
1
Fischer et al. (1989) and Hennessy and Whited (2005) present Espinosa et al. (2012) for Chile.
3
different formulations of what is known as ‘‘dynamic trade-off Previous studies on the Turkish economy include, among
theory’’, where the firm has a target level of leverage and others, Durukan (1997, 1998), Gönenç (2003), Acaravcı and
deviations from that target are gradually removed over time. In Doğukanlı (2004), Aydın et al. (2006), Sayilgan et al. (2006),
this paper, trade-off theory refers to static trade-off theory, Korkmaz et al. (2007), Yıldız et al. (2009), Demirhan (2009),
unless stated otherwise. and Okuyan and Taşçı (2010).
123
In all empirical studies, including those on the appropriate measure of financial leverage than the
Turkish economy, some of the findings turn out to be ratio of liabilities (both short term and long term) to
consistent with the trade-off theory and others with the total assets because it provides a better indication of
pecking order theory.4 One of the theories is judged to whether the firm is at risk of default any time soon and
have greater explanatory power if more of the also a more accurate picture of past financing choices.
observed relationships are consistent with its predic- Debt is classified as long-term if it has a maturity of at
tions. What is clear, however, is that neither theory is least 1 year and short-term otherwise.
uniformly better than the other theory. Therefore, our Even though a complete analysis of debt maturity is
goal in this paper is to investigate the circumstances beyond the scope of this paper,5 it is still important for
under which a given capital structure theory performs us to distinguish between short-term and long-term
well, rather than look for ‘‘the theory’’ that captures leverage for two reasons. First, the trade-off and
reality in all possible circumstances. To achieve this pecking order theories sometimes have different
goal, one must use a dataset that is comprehensive in implications for the different types of debt. Second,
terms of both firm types and leverage determinants short-term debt carries a number of risks for the
suggested by theory. The dataset must also have a financial and economic health of a company. The main
sufficiently long time span that will allow the financial risk is the so called maturity risk (the
researcher to analyze the effects of variations in the potential lack of liquid assets at the time of repayment
stability of the economic environment in which the of the loan) which exposes the borrowing firm to
firms operate. This is what we do in the present paper. potential rollover difficulties and interest rate fluctu-
ations.6 Moreover, the financial health of the corporate
sector has serious implications for the health of the
3 Hypothesis development financial sector as well (Basel Committee on Banking
Supervision 2011). On the other hand, when external
In this section, we develop the hypotheses about the finance is short term, it becomes more difficult for
nature of the relationships between leverage and firms to improve their economic health by engaging in
various determinants through the lenses of the trade efficiency and capacity-enhancing investments. The
off and pecking order theories. Our discussion bene- fact that the majority of firms’ debt is short-term in
fits, among others, from the reviews by Frank and developing economies (Demirgüç-Kunt and Maksi-
Goyal (2008) and Harris and Raviv (1991). We first movic 1999) coupled with the weaknesses in institu-
introduce our measures of leverage and then consider, tional and financial infrastructures and the volatile
in turn, firm-specific, tax-related, industry-specific, nature of the economic environment imply that these
and macroeconomic determinants of leverage. risks are more pertinent for developing economies
than more stable advanced economies. In fact, there is
3.1 Measures of leverage ample evidence that short term debt did play an
important role in the crises of Mexico 1994–1995, East
We consider three different measures of leverage: Asia 1997–1998, and Brazil 1998–1999 (Schmukler
Short-term, long-term, and total debt over total assets. and Vesperoni 2006).
According to Rajan and Zingales (1995), this is a more
4
For developed economies, support for the trade-off theory can
be found, among others, in Antoniou et al. (2008) for for UK,
US, Germany, France, and Japan, and Frank and Goyal (2009)
for the US, whereas support for the pecking order theory can be 5
found in Zoppa and McMahon (2002) for Australia. For There is a related but distinct strand of literature devoted to
developing economies, support for the trade-off theory can be analyzing the determinants of corporate debt maturity. Barclay
found in Wiwattanakantang (1999) for Thailand, Huang and and Smith (1995) and Stohs and Mauer (1996) are notable early
Song (2006) for China, and Espinosa et al. (2012) for Chile, papers on the subject.
6
whereas support for the pecking order theory can be found in Another important risk is the exchange rate mismatch, which
Pandey (2004) for Malaysia, Korkmaz et al. (2007) for Turkey, may occur due to a rise in foreign currency debt, while the firm’s
Correa et al. (2007) for Brazil, and Qureshi (2009) for Pakistan. income is in domestic currency.
123
3.2 Determinants of leverage when firms go into distress. In addition, since firms
tend to match the maturity of assets with that of
3.2.1 Firm-specific determinants liabilities (Stohs and Mauer 1996), tangibility should
be positively correlated with long-term leverage. The
Rajan and Zingales (1995) use four firm-specific pecking order theory, on the other hand, is generally
independent variables in their study of capital struc- interpreted as predicting a negative relation between
tures: size, profitability, growth, and tangibility. Booth leverage and tangibility, since the low information
et al. (2001) add business risk to this list. We include asymmetry associated with tangible assets makes the
all five firm-specific variables in our analyses. issuance of equity less costly (Harris and Raviv 1991).
Empirical studies generally find a positive correlation
3.2.1.1 Size Trade-off theory predicts a positive between tangibility and total and long-term leverage.
relationship between firm size and leverage. This is Following Rajan and Zingales (1995) and Demirgüç-
because larger firms are more diversified and have Kunt and Maksimovic (1999), we define tangibility as
lower default risk. The pecking order theory, on the the ratio of net fixed assets to total assets.
other hand, is generally interpreted as predicting a
negative relationship, since large firms face lower 3.2.1.4 Growth Trade-off theory predicts a negative
adverse selection and can more easily issue equity relation between leverage and firm growth.
compared to small firms. An overwhelming majority Intangibility of the assets of growth firms implies
of empirical studies finds a positive relation between that they lose more of their value in the event of
leverage and size. Following Titman and Wessels financial distress. By contrast, the pecking order
(1988) and Rajan and Zingales (1995), among others, theory predicts a positive relation between leverage
we define size as the natural logarithm of total sales, and growth. This is because internal funds are unlikely
adjusted for inflation.7 to be sufficient to support investment opportunities for
high growth firms, which increases their demand for
3.2.1.2 Profitability Trade-off theory is generally external debt. Although the results are mixed, most
interpreted as predicting a positive relation between empirical work finds the relation between leverage and
firm profitability and leverage. This is because default growth to be negative. Since our sample consists of
risk is lower and interest tax shields of debt are more both private and public firms, we cannot use market
valuable for profitable firms. Pecking order theory, on measures such as market-to-book ratios to proxy for
the other hand, predicts a negative relation between growth. Our proxy is the percent change in sales as in
leverage and profitability, as profitable firms can use Frank and Goyal (2009) and Schoubben and Van Hulle
earnings to fund investment opportunities and hence (2004).
have less need for external debt. Empirical tests find
the relation to be robustly negative. Following Titman 3.2.1.5 Business risk Both the trade-off and pecking
and Wessels (1988) and De Jong et al. (2008), among order theories predict a negative relationship between
others, we define profitability as operating income leverage and business risk. The trade-off theory
over total assets. implies that the expected cost of financial distress
increases with risk, at least for reasonable parameter
3.2.1.3 Tangibility We use tangibility as a proxy for values. In addition, the probability of wasting interest
the type of assets. The trade-off theory predicts a tax shields increases when earnings are less than tax
positive relation between leverage and tangibility. shields (Frank and Goyal 2008). Both forces work to
This is because tangible assets are easier to reduce leverage. From a pecking order perspective,
collateralize and they suffer a smaller loss of value business risk exacerbates the adverse selection
between firms and creditors. Most empirical work
finds a negative relation between leverage and risk. In
7
We use total sales rather than total assets to alleviate the this study, business risk is defined as the standard
problem of multicollinearity since many of our variables are
deviation of operating income over total assets over
scaled by total assets, including those for debt ratios. These two
measures are highly correlated, indicating that each of them the past 3 years (including the current year) as in De
should be a sound proxy for size. Jong et al. (2008).
123
3.2.2 Tax-related determinants Building on DeAngelo and Masulis (1980) and Titman
and Wessels (1988), Shuetrim et al. (1993) propose a
The two tax-related determinants we consider are measure called the ‘‘potential debt tax shield (PDTS)’’
corporate taxes and non-debt tax shields.8 These that captures the net effect of these two forces:
determinants naturally fit in with the trade-off theory. (
Tit
Iit þ if Tit [ 0
PDTS ¼ st ;
3.2.2.1 Corporate taxes Trade-off theory predicts a 0 if Tit ¼ 0
positive relationship between corporate tax rates and
leverage. This is because features of the tax code allow where Iit and Tit denote, respectively, interest pay-
interest payments to be deducted from the tax bill but ments and tax payments by firm i at time t and st
not dividend payments, which provides a tax advantage denotes the statutory corporate tax rate at time t. PDTS
for debt. The effect of taxes on debt ratios, however, has is gross earnings minus non-debt tax shields and
been difficult to clearly identify in the data and the Shuetrim et al. (1993) show that it is equal to the sum of
available evidence is rather mixed (see, for example, interest paid and taxable income after all non-debt tax
Frank and Goyal 2008; Antoniou et al. 2008). One deductions have been made as shown in the above
explanation for this might be the uncertainty about what expression.9 They scale this sum by a firm’s total assets
would constitute a good proxy for tax effects. Another to get their final proxy of net tax shields. Note that when
explanation is that transaction costs make it difficult to tax payments are zero (i.e. tax is exhausted), the relative
identify tax effects even when they are an element of the proportions of income shielded by interest payments and
firm’s problem (Hennessy and Whited 2005). by non-debt tax shields cannot be determined and hence
PDTS is set to zero. In order to control for this
3.2.2.2 Non-debt tax shields DeAngelo and Masulis possibility, we follow Shuetrim et al. (1993) and include
(1980) were probably the first to formally introduce firms’ state of tax exhaustion as a separate regressor in
the concept of non-debt tax shields to the literature. our analyses. It is a dummy variable that is equal to 1 for
Examples of such shields include depreciation all observations when the tax paid by a firm is equal to
deductions, depletion allowances, and investment tax zero. Its value can be interpreted as the mean effect of
credits. These shields can be considered as substitutes PDTS on leverage taken over all observations with zero
for the corporate tax benefits of debt financing. tax payments. From a trade-off perspective, the pre-
Accordingly, firms with higher amounts of non-debt dicted relation between this dummy variable and
tax shields will choose to have lower levels of debt. leverage is positive. Note that both PDTS and tax
Thus, the trade-off theory predicts a negative exhaust determinants can be calculated at the firm level.
relationship between leverage and non-debt tax
shields. More often than not, empirical studies find 3.2.3 Industry-specific determinants
results that are supportive of this prediction.
Rather than including corporate taxes and non-debt The extant literature reviewed in articles such as Harris
tax shields separately in our analyses, we use a single and Raviv (1991) and Frank and Goyal (2008) suggests
indicator that simultaneously takes into account the that industry membership may be an important deter-
presence of both effects. Whether a firm actually minant of firms’ capital structures. According to Frank
enjoys a positive tax advantage for debt financing and Goyal (2009), this is mainly because industry
depends on the trade-off between these two effects. reflects a number of otherwise omitted factors common
to all firms. For example, supply and demand condi-
tions or the extent of competition may differ from
8
Studies such as Miller (1977) and Rajan and Zingales (1995) industry to industry. From a trade-off perspective,
recommend including both personal and corporate taxes in therefore, although imperfect, the industry median
studies of capital structure. However, in Turkey, tax rates on
equity and debt income at the personal level are extremely
complicated and have gone through several reforms during the
9
past two decades. This makes it almost impossible to come up This measure is also desirable because it takes into account the
with good indicators of personal tax rates on different sources of actual statutory tax rates and the fact that firms focus on the
income that would also be consistent over time. As a result, we amount of income that can be shielded from tax using interest
are forced to do away with personal taxes in our analyses. payments.
123
leverage is likely to be a proxy for firms’ target capital Table 1 Definitions and hypotheses
structure. Not entirely coincidentally, empirical evi- Definition Pecking Trade-
dence on industry effects is rather mixed. For instance, order off
while Hovakimian et al. (2001) find that firms adjust theory theory
their debt ratios towards industry median debt ratios,
Debt ratios
Mackay and Phillips (2005) provide evidence that
Short-term Short-term debt/total assets N/A N/A
there is significantly more variation in leverage within leverage
industries than across industries. For a given year, we Long-term Long-term debt/total assets N/A N/A
define industry median leverage as the median of leverage
(short, long, or total) debt to total assets in that industry Total Total debt/total assets N/A N/A
(that is, one for each of the two broad industry leverage
categories, manufacturing and non-manufacturing).
Firm-specific determinants
3.2.4 Macroeconomic determinants
Size Natural logarithm of total - ?
net sales
Many studies including Deesomsak et al. (2004) and
Profitability Operating income/total - ?
de Jong et al. (2008) show that the health and stability assets
of the economic environment exert considerable effect Tangibility Net fixed assets/total assets - ?
on the firms’ capital structures. In order to explore the Growth Percent change in net sales ? -
influence of the economic environment on firms’ Business SD of operating income/ - -
capital structures, we include key macroeconomic risk total assets
variables in our analyses. Specifically, we include
inflation and GDP growth as indicators of the general
economic environment and the size of capital flows as Tax-related determinants
an indicator of financial development. Potential Interest payments ? tax ? ?
debt tax payments/corporate tax
shields rate
3.2.4.1 Inflation According to Taggart (1985), Tax exhaust Dummy equal to 1 if firm ? ?
features of the tax code in the U.S. increases the real pays no tax
value of interest tax deductions on debt when inflation is
expected to be high. Thus, the trade-off theory predicts
Industry-specific determinants
a positive relationship between leverage and expected
Industry Industry median of (short, ? ?
inflation. By contrast, it is hard to see why inflation median long, or total) debt to total
would matter for firms’ leverage decisions in a model of leverage assets
pecking order (Frank and Goyal 2009). Empirical
studies generally find a positive relation between
leverage and inflation. In the absence of inflation Macroeconomic determinants
expectations data that spans the whole sample period, Inflation Percent change in CPI ? ?
we follow previous studies and use data on the realized GDP Percent change in real GDP ? -
growth
inflation. Specifically, we use the percentage change in
Capital Net capital flows/GDP ? ?
the annual consumer price index (CPI) as a rough proxy
flows
for expected inflation. It is important to note that the
debt-bias in the U.S. tax system alluded to by Taggart This table describes the dependent and independent variables
and the theoretical predictions for the relations between the
(1985) is also a feature of the tax systems of many dependent and independent variables. While the sign ‘‘?’’
countries around the world, including that of Turkey. denotes a positive association with leverage, the sign ‘‘-’’
denotes a negative association
3.2.4.2 GDP growth Real Gross Domestic Product
(GDP) growth can be viewed as a measure of the growth assets relative to available investment opportunities
opportunities available to firms in an economy. In a implies a higher loss of value when firms go into
high growth environment, the scarcity of firms’ tangible distress. Hence, the trade-off theory predicts a negative
123
relation between leverage and GDP growth. By In our sample, there are on average about 9000 firms each
contrast, the pecking order theory predicts a positive year, of which roughly 2 percent are publicly traded firms.
relation between leverage and macroeconomic growth, The sample includes nearly all large firms in Turkey as
since a high ratio of growth opportunities to internal well as a large number of small and medium-sized
funds would imply a greater need for external finance. enterprises (SMEs) and micro-sized firms.12 Altogether
Empirical studies generally find a negative association our sample firms employ a total of about 1.5 million
between leverage and macroeconomic growth (see, for workers each year, accounting for roughly 11 % of
example, Demirgüç-Kunt and Maksimovic 1996). employment in Turkey during 1996–2009.13 This is
Following common practice, we define GDP growth substantially larger than the corresponding figure for non-
as the percent change in the annual real GDP. financial firms listed on BIST during the same period (225
thousand workers), indicating that the SBS dataset is
3.2.4.3 Capital flows Empirical studies such as significantly more representative of the population of
Demirgüç-Kunt and Maksimovic (1996) and Antoniou Turkish non-financial firms than BIST.
et al. (2008), among others, provide evidence on the The two broad industry categories we use are
importance of capital markets for firms’ capital ‘manufacturing’ and ‘non-manufacturing’. The man-
structures. The size and structure of capital markets ufacturing industry consists of 13 sub-industries
play a key role in determining the availability and (comprising roughly 53 % of all firms) whereas the
allocation of funds to various types of firms within an non-manufacturing industry consists of 4 sub-indus-
economy. Domestic capital markets, in turn, are heavily tries (comprising roughly 47 % of all firms).14 Our
shaped by the flows of international capital in many
developing economies, including that of Turkey (see, Footnote 11 continued
for example, Kose et al. 2009). While inflows of capital who report consolidated balance sheets. This should not be a
lead to increases in the size of domestic capital markets, serious problem for our analyses since most of the sample firms
are stand-alone enterprises. Still, some care is warranted in
outflows lead to declines. In order to study the impact of interpreting the results.
capital flows (and hence financial development) on 12
By micro-sized, small and medium-sized, and large-sized
firms’ capital structures, we include the ratio of net firms we mean firms with 1–9 employees, 10–249 employees,
capital flows to GDP as an additional explanatory and [250 employees, respectively. According to this classifi-
variable in our regression equations. cation, there are on average about 1,350 (15 %) micro-sized
firms, 6,390 (71 %) SMEs, and 1,260 (14 %) large firms in our
Table 1 summarizes the definitions of various sample. Classifications based on sales or assets would likely
leverage measures and leverage determinants as well yield similar size distributions.
as the theoretical predictions for the relations between 13
The ratio of the total number of workers employed by the
the dependent and independent variables. SBS firms to non-financial sector employment in Turkey is
likely to be considerably greater than 11 %. Unfortunately, the
non-financial sector employment number is not published by the
Turkish Statistical Institute. Moreover, although the lack of
4 Data appropriate data makes the calculation impossible, the fact that
almost all large firms and a large number of medium-sized firms
Our firm- and industry-specific data come from the are included in our dataset implies that our sample is likely
considerably more representative of the Turkish non-financial
survey-based Sectoral Balance Sheets (SBS) dataset of the sector in terms of sales; at least about 40–50 % in any given year.
CBRT, which is the largest source of annual balance sheet 14
The manufacturing industries are: (1) food products, bever-
and income statement data on Turkish non-financial ages, and tobacco, (2) textiles and textile products, (3) leather
firms.10,11 Our sample period covers the years 1996–2009. and leather products, (4) wood and wood products, (5) pulp,
paper, paper products, publishing, and printing, (6) chemicals,
10
chemical products, and man-made fibers, (7) rubber and plastic
For confidentiality purposes, the SBS data are not available products, (8) other non-metalic mineral products, (9) basic
to the general public in its raw form. However, an aggregated metals and fabricated metal products, (10) machinery and
version of the data is available on the Bank’s website at http:// equipment N.E.C., (11) electrical and optical equipment, (12)
www.tcmb.gov.tr/sektor/mainmenu.htm along with a report transport equipment, and (13) furniture, manufacturing N.E.C.
based on the data annually. The non-manufacturing industries are: (1) construction, (2)
11
SBS firms report unconsolidated balance sheets. As noted by wholesale and retail trade, (3) hotels and restaurants, and (4)
Rajan and Zingales (1995), this may cause firms to incorrectly transport, storage, and communications. On the other hand, we
appear to have lower leverage than otherwise identical firms exclude some industries from our analyses. These are: (1)
123
Table 2 Descriptive Observations First Mean Median Third Coefficient

statistics quartile quartile of variation
Debt ratios
Short-term leverage 74,155 3.48 20.37 15.08 31.57 97.12
Long-term leverage 74,155 0.00 6.81 0.00 7.73 195.37
Total leverage 74,155 7.73 27.20 23.87 42.17 81.18
Size 74,155 12.93 14.01 14.04 15.15 12.72
Profitability 74,155 0.01 0.09 0.07 0.15 156.83
Tangibility 74,155 10.82 31.36 25.87 46.78 78.39
Growth 74,155 -18.94 44.35 1.57 24.07 1,005.70
Business risk 74,155 0.03 0.07 0.05 0.10 100.96
Tax-related determinants
Potential debt tax 74,155 0.00 0.04 0.00 0.04 188.91
shields
Tax exhaust 74,155 0.00 0.37 0.00 1.00 130.65
This table presents the
descriptive statistics for the
dependent and independent Industry-specific determinants
variables described in
Table 1. All variables (other Short-term industry 28 10.68 13.64 12.69 17.28 30.34
than industry-specific and median leverage
macroeconomic variables) Long-term industry 28 0.00 0.46 0.00 0.04 217.86
are winsorized at 0.50 % median leverage
level in both tails of the Total industry median 28 17.05 22.04 22.78 26.87 28.32
distribution. The sample leverage
period is 1996–2009. All
numbers are reported in two
Macroeconomic determinants
decimal places. Agricultural
firms, financial firms and Inflation 14 10.51 50.61 54.40 84.64 70.14
firms that operate in GDP growth 14 0.66 3.56 6.16 7.58 143.92
regulated industries are Capital flows 14 2.14 2.91 3.02 4.85 104.37
excluded
data on macroeconomic and tax-related variables, on To minimize the effects of outliers in the data on
the other hand, are collected from a variety of sources our results, we use winsorization, in which the most
including SBS, BIST, Turkish Statistical Institute, extreme tails of the distribution are replaced by the
Undersecretariat of Treasury of the Republic of most extreme value that has not been removed (Frank
Turkey, and World Development Indicators. and Goyal 2008). Following common practice, we
winsorize each tail at 0.5 percent. The final sample is
an unbalanced panel of 11,726 firms with 74,155 firm-
year observations. We do not have 14 years of data for
Footnote 14 continued
agriculture, hunting, and forestry, (2) fishing, (3) mining, (4) all firms because each year some firms enter or exit the
electricity, gas, and water supply, (5) real estate, renting, and sample.15
business activities, (6) education, (7) health and social work, and
(8) other community, social, and personal service activities.
Unlike the industries included in our analyses, these industries
15
are generally under the influence of various sorts of government Possible bias introduced by firm entry or exit is discussed in
intervention that distort the operation of market forces. Sect. 5.4.
123
Table 3 Determinants of leverage: full sample results

Short-term Leverage Long-term leverage Total leverage
Size 1.079*** 0.843*** 1.918***
(0.100) (0.0734) (0.114)
Profitability -15.260*** -5. 358*** -20.690***
(0.677) (0.454) (0.755)
Tangibility -0.072*** 0.097*** 0.025***
(0.006) (0.005) (0.007)
Growth -0.0002 0.0000 -0.0002
(0.0001) (0.0001) (0.0002)
Business risk -1.527 -4.245*** -5.692***
(1.189) (0.751) (1.306)
Potential debt tax shields 40.080*** 10.350*** 50.280***
(1.461) (0.938) (1.566)
Tax exhaust 4.221*** 2.261*** 6.500***
(0.170) (0.122) (0.189)
Industry median leverage 0.329*** 0.423*** 0.234***
(0.041) (0.057) (0.021)
Inflation 0.037*** 0.015*** 0.057***
(0.003) (0.002) (0.004)
GDP growth -0.000 -0.105*** -0.071***
(0.016) (0.013) (0.019)
Capital flows 0.106*** 0.119*** 0.188***
(0.0328) (0.0226) (0.0361)
Number of observations 74,155 74,155 74,155
Number of firms 11,726 11,726 11,726
Adjusted R-squared 0.650 0.612 0.673
P
This table presents the results from the estimation of our fixed effects panel regression Eq. (1): Lit ¼ b0 þ k bk Fk;it þ li þ eit , where Li
is one of the three measures of leverage (short, long, or total leverage) of firm i in year t; F is the vector of the four types of leverage
determinants (firm-specific, tax-related, industry-specific, and macroeconomic determinants); li are the time-invariant unobservable
firm-specific effects; and ei is the error term. The variables are the same as those defined in Table 1 and all (except growth) are reported in
three decimal places. Heteroskedasticity and serial correlation robust standard errors are reported in parentheses
***, **, and * Significance levels at the 1, 5, and 10 % levels, respectively
Table 2 presents the descriptive statistics for all of the long-term debt ratio as the majority of firms have
our variables during 1996–2009. The median is below little to no long-term debt. Moreover, firm growth
the mean for all three debt ratios. The divergence rates have the largest variance, with the mean signif-
between the mean and median debt ratios is larger for icantly greater than the median.
123
5 Empirical model and results profitability is consistent with the pecking order
theory. These findings are also in line with the
In this section, we present our empirical model, empirical evidence found in previous studies.
discuss the main results, and perform a number of Tangibility is negatively associated with short-term
robustness checks. leverage but positively associated with long-term and
total leverage. Thus, firms with more tangible assets
5.1 Empirical model tend to have more long-term and less short-term debt
in their capital structure. The fact that the signs of the
We model leverage as a function of various determi- estimated coefficients of the tangibility determinant
nants discussed in the previous section. Specifically, are opposite in the short- and long-term leverage
we estimate the following fixed effects panel data equations can be interpreted as evidence that firms in
model: Turkey match the maturity of their assets with their
X liabilities. Demirgüç-Kunt and Maksimovic (1999)
Lit ¼ b0 þ bk Fk;it þ li þ eit ; ð1Þ
report similar findings in their sample of nineteen
k
developed and developing countries (Turkey is
where Lit is one of the three measures of leverage included) and Gönenç (2003) for industrial firms
(short, long, or total leverage) of firm i in year t; F is listed on the ISE. Overall, the results are consistent
the vector of the four types of leverage determinants with the prediction of trade-off theory but not with the
(firm-specific, tax-related, industry-specific, and mac- pecking order theory.
roeconomic determinants); li are the time-invariant Finally, while firm growth appears to be unrelated
unobservable firm-specific effects; and eit is the error with leverage, the estimated coefficient of our business
term. We estimate Eq. (1) using standard errors that risk variable is significantly negative in the long-term
are robust to heteroskedasticity and serial correlation. and total leverage equations. So, increases in a firm’s
We calculate robust standard errors using Newey and riskiness reduce the level of long-term debt in its
West (1987)’s variance estimator which produces capital structure but does not have a significant effect
consistent estimates when there is heteroskedasticity on the level of short-term debt relative to total assets.
and autocorrelation in standard errors. This is consistent with the view that firms that are
viewed as risky by creditors find it more difficult to
5.2 Results borrow long-term (see, for example, Diamond 1991 or
Demirgüç-Kunt and Maksimovic 1999). Our results
Table 3 presents the results from estimating Eq. (1). In concerning the business risk determinant can be
what follows, we summarize the results and evaluate understood within the framework of either trade-off
them in light of theoretical hypotheses and previous or pecking order theories.
empirical findings.
5.2.2 Tax-related determinants
5.2.1 Firm-specific determinants
The upper middle section of Table 3 presents the
The first five rows of Table 3 display the estimated estimated coefficients for our PDTS and tax exhaus-
coefficients for our firm-specific determinants. The tion variables. The coefficients of both variables are
coefficients of size, profitability, and tangibility are significant at the 1 percent level in all leverage
significant at the 1 % level in all leverage equations. equations and have the signs predicted by the trade-off
Size is positively associated with all three debt ratios, theory. The positive and significant coefficient on
suggesting that ceteris paribus large firms have more PDTS suggests that the tax advantage of debt is greater
debt in their capital structures. By contrast, the relation than the tax advantage due to non-debt shields. The
between profitability and various debt ratios is nega- positive and significant coefficient on the tax exhaus-
tive, implying that more profitable firms have lower tion dummy, on the other hand, indicates that the tax
debt ratios. While our result on size is consistent with distortions caused by the tax system are also important
the prediction of trade-off theory, our result on for firms that pay no tax.
123
5.2.3 Industry-specific determinants Maksimovic 1999). Overall, our findings on inflation

and GDP growth appear to be consistent with the
The lower middle section of Table 3 presents the trade-off theory.
estimated coefficients for our industry median debt Finally, capital flows are positively and highly
ratios. The coefficient of industry median leverage is significantly correlated with all three measures of
positive and highly significant in all three leverage leverage, indicating that capital flows do in fact play
equations. Moreover, the association appears to be an important role in shaping firms’ capital structures.
quantitatively strong: A 10 percentage point increase Consistent with expectations, measures of leverage
in the industry median short-term, long-term, and total rise with inflows of capital and fall with outflows.
leverage increases the average firm’s short-term, long- While capital inflows are in principle beneficial for
term, and total leverage by 3.29, 4.23, and 2.34 developing economies, particularly for those with low
percentage points, respectively. From a trade-off saving rates such as Turkey,16 they can also lead to
perspective, these findings can be interpreted as economic overheating, excessive currency apprecia-
evidence of target adjustment behavior in leverage. tion, or pressures in particular sectors of the economy,
such as sectoral credit booms or asset price bubbles
(Ostry et al. 2011). In particular, rapid growth in
5.2.4 Macroeconomic determinants private indebtedness induced by capital inflows might
be characteristic of the early stages of financial
The bottom section of Table 3 presents the estimated instability (Mishkin 1997) and might cause banking
coefficients for our macroeconomic determinants. In crises (Reinhart and Rogoff 2011). Our results,
all equations, inflation is positively related with therefore, indicate that the surge in international
leverage and with coefficients that are significant at capital flows since the early 2000s, which were only
1 percent. Therefore, firms’ indebtedness increases briefly interrupted by the global financial crisis,
with inflation. This finding is consistent with the trade- continue to pose serious risks to economic and
off theory in which, given the tax-deductibility of financial stability. Reflecting these concerns, policy-
nominal interest payments, an inflation-induced makers in many developing economies have been very
increase in nominal interest rates increases the tax keen on finding appropriate ways to deal with the
advantage of debt financing. In addition, the impact of adverse effects of capital flows, particularly in the
inflation appears to be quite strong: The fact that aftermath of the crisis. For example, Brazil and South
inflation has come down from over 80 percent to less Korea have chosen to implement capital control
than 10 percent between 1996 and 2009 would suggest measures whereas Turkey and Indonesia have pre-
roughly a 5 percent decline in the average firm’s total ferred macroprudential measures.
leverage due solely to the fall in inflation, all else
equal. 5.3 Economic significance of leverage
On the other hand, the coefficient on GDP growth is determinants
negative and highly significant in the long-term and
total leverage equations, but not the short-term In the previous subsection, we investigated whether a
leverage equation. One explanation of this finding given leverage determinant, holding other determi-
might be that the scarcity of firms’ tangible assets nants constant, was statistically significant in account-
relative to available investment opportunities is exac- ing for various debt ratios. However, statistical
erbated in a high growth environment. The implied significance need not imply economic significance.
higher loss of value in the event of a distress, in turn, In order to study the relative economic significance of
reduces firms’ ability to raise longer-term debt. Put various leverage determinants, we standardize all
differently, creditors reduce the amount of long-term
debt they extend because it allows them to review the
16
firms’ decisions more frequently and, if necessary, to Dell’Ariccia et al. (2008)among others, argue that capital
inflows can ease financing constraints for productive investment
vary the terms of financing before sufficient losses
projects, foster the diversification of investment risk, promote
have accumulated to make default by the borrower intertemporal trade, and contribute to the development of
optimal (Diamond 1991 and Demirgüç-Kunt and financial markets.
123
Table 4 Economic significance of leverage determinants

Standardized coefficients Rankings
Short-term Long-term Total Short-term Long-term Total
leverage leverage leverage leverage leverage leverage
Size 0.097 0.113 0.155 4 2 2
Profitability -0.106 -0.055 -0.129 2 4 4
Tangibility -0.089 0.179 0.028 5 1 7
Growth -0.005 0.001 -0.004 _ _ _
Business risk -0.006 -0.024 -0.019 _ 9 9
Potential debt tax shields 0.142 0.054 0.160 1 5 1
Tax exhaust 0.103 0.082 0.142 3 3 3
Industry median leverage 0.063 0.037 0.059 6 7 6
Inflation 0.056 0.033 0.077 7 8 5
GDP growth 0.000 -0.038 -0.016 _ 6 10
Capital flows 0.014 0.024 0.023 8 10 8
This table presents the findings on the relative economic significance of various leverage determinants. The estimated standardized
coefficients show the impact of a one standard deviation change in an independent variable on the dependent variable. The
magnitudes of the standardized coefficients are comparable across different leverage determinants. The left panel shows these results.
The right panel sorts the leverage determinants according to their economic significance, where the ordering is based on the absolute
value of the standardized coefficients. When a variable has a statistically insignificant coefficient it is denoted by ‘‘–’’ and left out of
the economic significance rankings. The variables are the same as those defined in Table 1 and all are reported in three decimal
places. Heteroskedasticity and serial correlation robust standard errors are reported in parentheses
variables and rerun our regressions. Now, the esti- leverage by 0.1595 standard deviations. PDTS is also the
mated standardized coefficients show the impact of a most important determinant for short-term leverage,
one standard deviation change in an independent followed by profitability. For long-term leverage, tangi-
variable on the dependent variable. Accordingly, the bility is by far the most economically important deter-
magnitudes of the standardized coefficients are com- minant, followed by size. Tax exhaust is consistently
parable across different leverage determinants for a among the top three important determinants.
given leverage equation (short-term, long-term, or A few general lessons can be drawn from these
total leverage). The left panel of Table 4 reports these results. Tax-related determinants are overall the most
results. The right panel of Table 4 sorts the leverage economically significant leverage determinants, sug-
determinants according to their economic signifi- gesting that they in fact do play an important role in
cance, where the ordering is based on the absolute shaping firms’ capital structures. This finding is
value of the standardized coefficients. particularly interesting in light of the fact that tax
The results indicate that PDTS, our tax-shield mea- effects on leverage have historically been notoriously
sure, is the most economically significant determinant for difficult to detect in the data. A close second in terms
firms’ total leverage, with size a very close second. A one of economic significance is firm-specific determinants
standard deviation increase in PDTS increases total such as size, tangibility, and profitability, while
123
business risk and firm growth play little or no role. also estimate our empirical model only for those firms
Industry median leverage, on the other hand, appears that have data for T years or more, where T = 2,
to have a fairly important influence on firms’ leverage 3,…,14 (T = 1 corresponds to the full sample results
decisions. Macro-level determinants generally score we report in Sect. 5.2). We find no evidence of the
lower than firm-level (i.e. tax-related and firm-spe- impact of attrition bias on our results.
cific) determinants and industry-level determinants in Third, all the variables (i.e. dependent as well as
the economic significance rankings, which is perhaps independent) in our estimations are measured in year t,
not surprising given that they have only a single as is typically done in the capital structure literature.
observation per year. Among the macro-level deter- Nevertheless, in order to take the possibility that year
minants, inflation stands out both in terms of statistical t - 1 determinants are more relevant than year
and economic significance, even surpassing in ranking t determinants for a firm’s capital structure in year t,
the industry median debt ratio in the total leverage we re-estimate our equations this time replacing the
equation. The only case in which inflation is not the current values of our independent variables with the
highest ranking macro-level determinant is the long- lagged values. According to the results we do not
term leverage equation, where it is second only to report here, the results are qualitatively virtually the
GDP growth and only by a small margin. These same as before, suggesting that from a capital structure
findings are particularly important in light of the fact perspective the information contents of year t and year
that inflation in Turkey has only recently come down t - 1 independent variables are qualitatively quite
to single digits after decades of extremely high levels. similar.
A second general lesson is that the economic Fourth, apart from the net capital inflow, the supply of
importance of a given leverage determinant is different domestic capital can in principle also affect firms’ capital
for different measures of leverage. For example, while structure decisions. In order to explore this possibility, we
tangibility appears to be a key determinant of long-term also included as independent variables the size of debt
leverage, it is not as important for short-term leverage. A markets (domestic credit to the private sector over GDP),
third and final lesson is that leverage determinants that the size of equity markets (stock market capitalization
are more closely associated with the trade-off theory over GDP), and the size of government debt (total
such as tax-related determinants and size generally have government debt over total domestic non-financial debt)
higher rankings (in addition to having the correct signs in our regression equations. We find that the size of debt
and higher levels of statistical significance as shown in markets is positively correlated with long term leverage
Sect. 5.2) than those that are more closely associated (at 5 percent significance level) and negatively correlated
with the pecking order theory such as profitability. The with short-term leverage (at 10 percent significance
evidence in favor of the trade-off theory is particularly level). So, the deepening of debt markets appears to
strong for the long-term and total debt ratios. reduce firms’ short-term leverage while increasing long-
term leverage. This finding is not surprising given the fact
5.4 Robustness checks that banks have a comparative advantage in the provision
of long-term debt. Second, unsurprisingly, we find that
We perform a number of checks to confirm that our the size of equity markets is negatively correlated with all
results are robust.17 First, it doesn’t matter whether the measures of leverage and its coefficients are highly
data are winsorized or not; estimated coefficients are significant (at the 1 percent level). Finally, we find that
qualitatively and quantitatively very similar. This the size of government borrowing is unrelated with firms’
suggests that outliers in our dataset are not a significant leverage decisions, suggesting that government borrow-
problem for estimates. ing does not crowd out private borrowing during our
Second, the fact that some firms in our dataset enter sample period. Unreported results also indicate that the
or exit the sample might potentially induce attrition relationships between leverage and the rest of the
bias in our estimations. To see if this is the case, we independent variables are both quantitatively and qual-
itatively very similar to the previous case.
17 Finally, we split the sample into two seven-year
To economize on space, we do not report detailed results for
our robustness analyses, except for the last one. However, these periods, namely, 1996–2002 and 2003–2009, to test
results are available upon request. for any structural breaks in the firms’ capital structure
123
Table 5 Robustness of full sample results to alternative time periods

1996–2002 2003–2009
Size 0.074 0.442*** 0.519** 1.185*** 0.721*** 1.890***
(0.212) (0.121) (0.222) (0.121) (0.095) (0.141)
Profitability -14.100*** -3.970*** -18.010*** -16.570*** -6.660*** -23.320***
(0.986) (0.583) (1.044) (1.001) (0.740) (1.141)
Tangibility -0.036*** 0.070*** 0.035*** -0.060*** 0.124*** 0.064***
(0.0106) (0.00748) (0.0113) (0.00825) (0.00663) (0.00918)
Growth 0.0002 0.0002 0.0004 -0.0003** 0.0001 -0.0003
(0.0005) (0.0003) (0.0004) (0.0002) (0.0001) (0.0002)
Business risk -3.927** -2.838*** -6.578*** -2.674 -3.433*** -6.165***
(1.778)c (0.965) (1.864) (1.733) (1.200) (1.931)
Potential debt tax 31.890*** 4.263*** 35.970*** 54.620*** 16.120*** 70.820***
shields (1.756) (1.039) (1.807) (3.516) (2.481) (3.701)
Tax exhaust 6.188*** 2.205*** 8.390*** 2.968*** 1.837*** 4.828***
(0.331) (0.218) (0.349) (0.208) (0.159) (0.230)
Industry median 0.453*** _a 0.443*** 0.412*** 0.135 0.206***
leverage (0.127) (0.090) (0.099) (0.101) (0.041)
Inflation 0.027* 0.007 0.030** 0.060*** 0.038*** 0.132***
(0.015) (0.005) (0.013) (0.017) (0.012) (0.016)
GDP growth 0.033 -0.033* 0.022 -0.011 -0.231*** -0.166***
(0.028) (0.018) (0.028) (0.024) (0.030) (0.039)
Capital flows 0.039 -0.018 -0.042 0.101** 0.224*** 0.311***
(0.074) (0.038) (0.076) (0.045) (0.027) (0.046)
Number of 31,732 31,732 3,1732 40,717 40,717 40,717
observations
Number of firms 7,311 7,311 7,311 8,447 8,447 8,447
Adjusted R-squared 0.738 0.701 0.758 0.726 0.711 0.763
This table presents the findings on the robustness of full sample results considering separately the period before 2002 and the period
after 2002. The variables are the same as those defined in Table 1 and all (except growth) are reported in three decimal places.
Heteroskedasticity and serial correlation robust standard errors are reported in parentheses
a
Since most of the firms did not have long-term debt before 2002, the median debt for manufacturing and non-manufacturing
industries were zero. Thus, there is no variation in industry median leverage variable in the 1996–2002 period and its coefficient
cannot be estimated
123
choices. 18 The results displayed in Table 5 indicate considerably better framework than the latter to
that firm-specific and tax-related leverage determi- understand the capital structure of the average Turkish
nants generally have the same pattern of signs and non-financial firm. However, as Myers (2003) argued,
significance as those we obtained for the full sample. different factors might affect different types of firms in
The only significant change here is that the coefficient fundamentally different ways. To see if this is the case,
of firm growth turns significant in the short-term we now systematically investigate the capital structure
leverage equation in the 2003–2009 subsample, differences of three main types of firms: manufactur-
perhaps reflecting the improved growth prospects ing versus non-manufacturing firms, large versus
during this period. It is also interesting to note that the small firms, and public versus private firms. These
relative magnitude of the coefficient on tax exhaust exercises can also be viewed as additional robustness
(PDTS) is larger in the former (latter) period, which checks on our main results in Sect. 5.
suggests that the tax distortions caused by the tax Figure 1 displays the ratios of short-term, long-
system during the earlier period are larger (smaller) for term, and total indebtedness by industry membership,
firms that pay no tax (pay tax). Also, the coefficient of firm size, and stock market listing averaged over the
business risk in the short-term leverage equation turns whole sample period. Panel A of Fig. 1 shows that
significant in the 1996–2002 subsample, most likely a while manufacturing firms generally have higher debt
reflection of the volatile state of the economy during ratios than non-manufacturing firms, the difference is
this period. Finally, there are some changes in the more apparent in the short-term debt ratios. In Panel B
signs and significance of some of the industry-level of Fig. 1, firms are divided into quartiles by value of
and macro-level determinant coefficients.19 Specifi- total assets and the average debt ratios of the smallest
cally, the coefficient of industry median debt ratio 25 %, the largest 25 %, and those in between are
turns insignificant in the long-term leverage equation reported. This panel shows that larger firms have
in both subsamples and there is a loss of significance in higher long-term leverage and lower short-term
the coefficients of inflation, GDP growth, and capital leverage than smaller firms. By contrast, there do not
flow variables. In the case of capital flows, the contrast appear to be differences in total debt ratios across firm-
is particularly stark, where the coefficient is significant size quartiles. Finally, Panel C shows that, overall,
only in the 2003–2009 subsample, most likely reflect- public firms are less levered. The figure also shows
ing the surge in capital inflows during this period. that public firms have higher long-term and lower
Overall, our results indicate that the predictive power short-term debt ratios than private firms, but that the
of the trade-off theory is higher in the 2003–2009 difference is larger in the former. This appears to be
period, during which the economic environment in due mainly to improved profitability (as we will see
Turkey was substantially more stable. momentarily) and better access to equity markets,
which allows public firms to substitute the debt in their
capital structure with internal and external equity,
6 Capital structures of firms in various respectively. However, improved access to debt
circumstances markets allows public firms to also improve the
maturity of debt in their capital structure.
Although both the trade-off theory and the pecking Examining panels A, B, and C of Fig. 1 simulta-
order theory have their strengths and weaknesses, our neously, we also determine a number of general
analysis thus far indicates that the former provides a themes. Specifically, we observe that regardless of
firm size, industry, or stock market listing, firms’
18
Dividing the sample period in this way is reasonable given
short-term leverage is much higher than their long-
the fact that the Turkish economy went through a dramatic term leverage, implying that the majority of firms’
transformation following the 2001 crisis. See, for example, debt is short-term. This seems to be particularly true
Turhan (2008). for small private manufacturing firms. By contrast,
19
This is, to some extent, expected as each of the industry- and large public manufacturing firms have the highest
macro-level factors (unlike the firm-level factors) has only two
levels of long-term debt ratios, indicating that the
and one observations per year, respectively, and splitting the
sample into two further reduces the sample size, making precise usage of long-term debt is most pronounced in such
estimation of their coefficients difficult. firms.
123
Panel A. Panel B.
35 Manufacturing 35 Small
Non-manufac. Medium
30 30
Large
25 25
20 20
15 15
10 10
5 5
0 0
STD/TA LTD/TA TD/TA STD/TA LTD/TA TD/TA
Panel C.
35 Public
Private
30
25
20
15
10
0
STD/TA LTD/TA TD/TA
Fig. 1 Patterns of leverage for different types of firms. Panels panel b firms are divided into quartiles by value of total assets. A
a–c of this figure display the ratios of short-term, long-term, and firm is classified as ‘‘small’’ if it is below the first quartile,
total debt to total assets, respectively, by industry, firm size, and ‘‘medium’’ if it is between the first and third quartiles, and
stock market listing averaged over the entire sample period. In ‘‘large’’ if it is above the third quartile
6.1 Manufacturing firms versus non-manufacturing capital structures. Importantly, there are no material
firms differences in the relations between debt ratios and the
determinants that we identified in Sect. 5.3 as the most
As discussed previously in Sect. 3, industry member- economically important such as size, profitability,
ship may be an important determinant of firms’ capital tangibility, tax-related determinants, and inflation.
structures. In order to investigate in detail the capital The few small differences relate to the remaining
structure implications of industry membership, we re- less economically important determinants. For
run regressions separately for manufacturing and non- instance, while firm growth is positively associated
manufacturing firms. The results displayed in Table 6 with long-term leverage for manufacturing firms
suggest that manufacturing and non-manufacturing (consistent with the pecking order theory), it is
firms are in general quite similar in terms of their negatively correlated with short-term leverage for
123
Table 6 Sample split between manufacturing and non-manufacturing firms

Manufacturing firms Non-manufacturing firms
Size 1.432*** 1.207*** 2.615*** 0.787*** 0.632*** 1.395***
(0.176) (0.134) (0.202) (0.123) (0.086) (0.138)
Profitability -20.000*** -6.553*** -26.510*** -10.420*** -4.267*** -14.770***
(0.900) (0.604) (0.995) (1.024) (0.698) (1.153)
Tangibility -0.120*** 0.104*** -0.017** -0.010 0.090*** 0.080***
(0.008) (0.006) (0.009) (0.009) (0.00709) (0.0104)
Growth 0.0001 0.0008* 0.0010 -0.0002* -0.0000 -0.0002
(0.0008) (0.0005) (0.0007) (0.0001) (0.0001) (0.0002)
Business risk -2.646 -2.883*** -5.317*** -1. 340 -5.406*** -6.559***
(1.664) (1.005) (1.785) (1.702) (1.121) (1.911)
shields (1.772) (1.143) (1.910) (2.486) (1.614) (2.636)
Tax exhaust 4.733*** 2.366*** 7.107*** 3.405*** 2.153*** 5.583***
(0.211) (0.151) (0.234) (0.285) (0.206) (0.314)
Industry median 0.421*** 0.489*** 0.334*** 0.264*** 0.426*** 0.204***
leverage (0.060) (0.077) (0.038) (0.070) (0.092) (0.029)
Inflation 0.036*** 0.019*** 0.057*** 0.037*** 0.010** 0.056***
(0.005) (0.003) (0.005) (0.006) (0.004) (0.007)
GDP growth -0.005 -0.098*** -0.081*** 0.013 -0.109*** -0.035
(0.020) (0.018) (0.024) (0.026) (0.021) (0.032)
Capital flows 0.046 0.075** 0.115** 0.151*** 0.169*** 0.210***
(0.041) (0.030) (0.046) (0.054) (0.036) (0.060)
Number of 42,998 42,998 42,998 31,134 31,134 31,134
observations
Number of firms 6,262 6,262 6,262 5,566 5,566 5,566
Adjusted R-squared 0.646 0.577 0.658 0.657 0.654 0.692
This table presents the findings considering separately manufacturing and non-manufacturing firms. The variables are the same as
those defined in Table 1 and all (except growth) are reported in three decimal places. Heteroskedasticity and serial correlation robust
standard errors are reported in parentheses
non-manufacturing firms (consistent with the trade-off manufacturing firms respond more to changes in size
theory). Also, comparison of the magnitudes of and profitability than non-manufacturing firms. The
coefficients suggests that the debt ratios of most striking difference relates to the impact of capital
123
flows, however. In particular, the coefficient on capital determinants are related with debt ratios. For example,
flows is both much more significant and considerably the coefficient on industry median leverage is much
larger in the non-manufacturing equations. This more significant and remarkably larger for large firms,
finding might suggest that international capital has suggesting that target adjustment is a much more
tended to flow remarkably more to the sectors outside pertinent phenomenon among large firms. One expla-
manufacturing, thereby influencing the financing pat- nation of this finding could be that there are funda-
terns of the firms in such sectors to a greater extent mental technological differences between small and
during our sample period. large firms and hence naturally follow different
Overall, our findings on the relationships between financial policies a la Maksimovic and Zechner
leverage and various determinants appear to be more (1991). Or, as shown by Demirgüç-Kunt and Maksi-
in line with the predictions of trade-off theory than movic (1999) and World Bank Group (2010), it could
with the pecking order theory, particularly in the case reflect differences between small and large firms in
of non-manufacturing firms. access to external finance, which prevent small firms
from following an optimal financial policy.
6.2 Large firms versus small firms With respect to macro-level determinants, the most
striking difference between large and small firm
Previous research (e.g. Maksimovic and Zechner 1991, capital structures is in inflation. Specifically, while
and Demirgüç-Kunt and Maksimovic 1999) provides inflation does not seem to be related with the leverage
evidence that small firms may follow financial policies decisions of small firms, large firms’ leverage
that differ from those of large firms due to differences in, increases with inflation. This might suggest that, once
among other things, technology and access to financial the direct leverage impact of taxes is taken into
markets and institutions. To see if this is the case, we re- account, inflation does not induce a further tax benefit
run our regressions separately for the smallest and for debt financing for small firms. Capital flows also
largest firms. Results displayed in Table 7 suggest that appear to influence large and small firms differently,
there are marked differences across firm sizes in how with capital flows having a remarkably greater impor-
various determinants are related with debt ratios. tance for the leverage decisions of large firms. This
At the firm level, the most striking differences are in might be explained by the fact that large firms are more
the effects of firm size and business risk variables. diverse and informationally more transparent than
Specifically, for small firms, the association between small firms, which increases their ability to secure
leverage and size is relatively weak. In fact, firm size funds from domestic sources as well as directly from
appears to become relevant for leverage decisions only foreign sources. Finally, the association of leverage
when a firm is sufficiently large. This may be and GDP growth seems to be significantly stronger in
indicative of a ‘‘threshold effect’’ in size in the sense the case of large firms, likely reflecting the fact that
that marginal changes in the size of firms smaller than a large firms are usually better equipped to capture the
certain threshold have little effect on such firms’ ability benefits of economic growth.
to raise external debt. The business risk variable, on the Overall, our findings on the relationships between
other hand, is highly significant in all leverage leverage and various determinants appear to be more
regressions for small firms but always insignificant in line with the predictions of trade-off theory than
for large firms. Thus, while small firms’ ability to raise with the pecking order theory, particularly in the case
debt seems very sensitive to their riskiness, large firms’ of large firms.
access to debt is not hindered by that at all. Finally, the
debt ratios of large and small firms appear to be 6.3 Publicly-traded firms versus private firms
affected differently by firm growth rates. Specifically,
while firm growth is not related with leverage for small Stock markets play a key role in managing conflicts of
firms, there is some evidence that short-term and total interest between various stakeholders in a firm,
leverage go down with firm growth for large firms. provide entrepreneurs with opportunities to diversify
Our results in Table 7 also suggest that there are their portfolios, and transmit information about firms’
interesting differences between large and small firms prospects to potential investors and creditors (see, for
in how industry-related and various macroeconomic example, Allen, 1993, and Demirgüç-Kunt and
123
Table 7 Sample split between small and large firms

Small firms Large firms
Size 0.191 0.357** 0.524* 0.774*** 0.979*** 1.757***
(0.264) (0.146) (0.281) (0.173) (0.144) (0.205)
Profitability -12.980*** -3.992*** -17.060*** -20.560*** -8.258*** -28.850***
(1.476) (0.869) (1.599) (1.327) (1.103) (1.585)
Tangibility -0.010 0.044*** 0.033** -0.118*** 0.131*** 0.0127
(0.014) (0.009) (0.015) (0.0104) (0.00983) (0.0127)
Growth 0.0004 -0.0001 0.0002 -0.0004* -0.0000 -0.0004**
(0.0003) (0.0002) (0.0004) (0.0002) (0.0002) (0.0002)
Business risk -9.677*** -4.847*** -14.580*** 0.379 -1.431 -1.033
(2.573) (1.400) (2.781) (2.384) (1.927) (2.773)
Potential debt tax 40.170*** 1.427 41.760*** 33.850*** 14.800*** 48.160***
shields (4.289) (2.204) (4.617) (2.395) (1.802) (2.652)
Tax exhaust 3.486*** 0.677** 4.216*** 4.447*** 3.102*** 7.521***
(0.479) (0.295) (0.503) (0.282) (0.234) (0.330)
Industry median 0.117 0.105 0.111** 0.233*** 0.574*** 0.189***
leverage (0.122) (0.120) (0.053) (0.0674) (0.117) (0.0375)
Inflation 0.007 -0.004 0.007 0.067*** 0.028*** 0.094***
(0.011) (0.006) (0.012) (0.005) (0.005) (0.006)
GDP growth 0.088** -0.063** 0.062 -0.154*** -0.118*** -0.279***
(0.044) (0.031) (0.051) (0.026) (0.027) (0.033)
Capital flows 0.0795 0.118** 0.151 0.131** 0.138*** 0.263***
(0.091) (0.053) (0.094) (0.055) (0.046) (0.063)
Number of 14,843 14,843 14,843 20,883 20,883 20,883
observations
Number of firms 3,456 3,456 3,456 3,245 3,245 3,245
Adjusted R squared 0.686 0.679 0.719 0.703 0.639 0.725
This table presents the findings considering separately small and large firms. Firms are divided into quartiles by value of total assets.
A firm is classified as ‘‘small’’ if it is below the first quartile and ‘‘large’’ if it is above the third quartile. The variables are the same as
those defined in Table 1 and all (except growth) are reported in three decimal places. Heteroskedasticity and serial correlation robust
standard errors are reported in parentheses
Maksimovic 1996). As a result, compared to their equity. This implies that whether a firm is privately-
private counterparts, public firms enjoy improved held or publicly-traded can have an important influ-
access to financial markets in terms of both debt and ence on the firm’s capital structure decisions.
123
Table 8 Sample split between publicly-traded and private firms

Private firms Publicly-traded firms
Size 1.038*** 0.843*** 1.879*** 2.285*** 0.625 2.884***
(0.101) (0.074) (0.838) (0.844) (0.472) (0.838)
Profitability -14.89*** -5.148*** -20.11*** -24.890*** -13.710*** -38.620***
(0.687) (0.461) (0.766) (3.685) (2.539) (4.212)
Tangibility -0.071*** 0.098*** 0.027*** -0.098*** 0.072*** -0.028
(0.006) (0.005) (0.007) (0.027) (0.024) (0.033)
Growth -0.0002 0.0000 -0.0002 0.0039* 0.0003 0.0041
(0.0005) (0.0001) (0.0002) (0.0022) (0.0015) (0.0028)
Business risk -1.798 -4.392*** -6.137*** 12.26 3.336 16.23*
(1.203) (0.759) (1.319) (7.582) (5.342) (8.787)
shields (1.498) (0.963) (1.606) (6.327) (4.012) (6.593)
Tax exhaust 4.104*** 2.240*** 6.362*** 7.159*** 3.160*** 10.280***
(0.173) (0.124) (0.192) (0.804) (0.625) (0.915)
Industry median 0.350*** 0.411*** 0.235*** -0.466** 0.943*** 0.128
leverage (0.042) (0.058) (0.021) (0.205) (0.279) (0.116)
Inflation 0.036*** 0.013*** 0.055*** 0.091*** 0.051*** 0.110***
(0.003) (0.002) (0.004) (0.015) (0.012) (0.015)
GDP growth 0.010 -0.111*** -0.064*** -0.231*** 0.100 -0.238***
(0.058) (0.039) (0.060) (0.068) (0.070) (0.081)
Capital flows 0.108*** 0.122*** 0.196*** 0.128 -0.015 0.020
(0.034) (0.023) (0.037) (0.142) (0.121) (0.164)
Number of 71,885 71,885 71,885 2,270 2,270 2,270
observations
Number of firms 11,520 11,520 11,520 206 206 206
Adjusted R squared 0.651 0.615 0.673 0.602 0.477 0.673
This table presents the findings considering separately publicly-traded and private firms. The variables are the same as those defined
in Table 1 and all (except growth) are reported in three decimal places. Heteroskedasticity and serial correlation robust standard
errors are reported in parentheses
In this subsection, we explore the capital structure separately for public and private firms. The results are
differences between public and private firms. Toward displayed in Table 8. The first thing that strikes the eye
this end, we re-run our capital structure regressions in Table 8 is that the estimated coefficients in the
123
private firm regressions are qualitatively and quanti- appear to have no relation with the leverage choices of
tatively almost the same as those in the full-sample public firms. There might be a number of different
results reported in Sect. 5. This is probably not explanations for this rather interesting finding. First, it
surprising in light of the fact that nearly 98 percent of might be that public firms already have nearly
the firms in our sample are private firms. unlimited access to financial markets, domestic and
Table 8 also shows that there are as many differ- foreign alike. If this is the case, then changes in the
ences as there are similarities between public and size and direction of capital flows would leave the
private firms in how various determinants are related capital structures of public firms unaffected. A second
with debt ratios. At the firm level, the most important explanation could be that public firms are much more
differences are in the leverage effects of firm growth profitable than private firms. The availability of large
and business risk. In particular, while firm growth is internal resources, in turn, makes them less dependent
not related with leverage for private firms, it is on external finance and limits the impact of fluctua-
positively correlated with short-term leverage for tions in the availability of external finance on their
public firms, a finding consistent with the pecking capital structure choices.20
order theory. Also, in stark contrast with the case for At this point, it may be worthwhile to digress a little
private firms, business risk appears to be positively and summarize our findings on capital structure effects
correlated with all measures of leverage for private of international capital flows in light of our previous
firms, although the correlation is significant only in the findings. We have the following facts. First, the impact
total leverage equation and only at the 10 % level. of capital flows, if any, is to increase the proportion of
Thus, unlike the private firms, business risk does not debt (generally both short-term and long-term) in
appear to impair the ability of public firms to secure firms’ capital structure. Second, the importance of
debt, most likely reflecting reputational effects and/or capital flows for firms’ capital structure decisions are
the presence of alternative funding sources available considerably more apparent after the early 2000s, a
to public firms. Also worth noting is the fact that the period during which capital inflows to Turkey soared.
coefficients on profitability are quantitatively much Third, capital flows have a greater influence on the
larger in public firm equations, suggesting that public capital structures of (1) non-manufacturing firms
firms can (due to higher profitability) increase the use compared to manufacturing firms, (2) large firms
of internal equity to a greater extent in their capital compared to small firms, (3) private firms compared to
structures than private firms. public firms, and in unreported results which are
There are also interesting differences between available upon request (4) mature firms than young
public and private firms in how debt ratios are related firms. Put together, these findings suggest that the
with industry median leverage. In particular, while leverage-increasing impact of capital flows is most
industry median leverage is positively correlated with significant for large, mature, private, non-manufactur-
long-term leverage for both types of firms, it is ing firms after the early 2000s in Turkey. This result is
negatively correlated with short-term leverage for in line with the findings of Falkenstein (1996) and
public firms. Therefore, it can very well be the case Gompers and Metrick (2001) who find that interna-
that improved access to financial markets in general, tional investors invest more in large and mature firms,
and debt markets in particular, may be allowing public and UNCTAD (2004) and Doytch and Uctum (2011)
firms to reduce short-term debt and increase long-term who show that in developing economies, there has
debt in their capital structure. This improvement in the been a large increase in the amount of foreign
public firms’ maturity structure of debt manifests itself investment in services relative to that of manufactur-
as a strong adjustment towards the industry median in ing from the 1990s to the 2000s
long-term leverage coupled with a ‘‘negative’’ adjust- Overall, our analyses of the public firm—private
ment in short-term leverage. firm distinction suggest that the relationships between
Last but certainly not least, there is a sharp contrast
between the impact of capital flows on the debt ratios 20
A third possibility is linked directly to our measure of capital
of public firms and that of private firms. Specifically,
flows, which is an aggregation of equity and debt flows. If public
while capital flows are positively correlated with firms take advantage of both types of flows, this might leave
leverage in all three equations for private firms, they their leverage unchanged.
123
leverage and various determinants are more in line Table 9 Comparison of theoretical predictions with data facts
with the predictions of trade-off theory than with the Pecking order Trade-off Data
pecking order theory. However, the support for the theory theory
trade-off theory is weaker and that for the pecking
order theory is somewhat stronger than before in the Firm-specific determinants
case of public firms. To see this, note that the Size - ? ?
coefficients on firm size in the long-term leverage Profitability - ? -
equation as well as on tangibility in the total leverage Tangibility - ? ?
equation are no longer significant, which are incon- Growth ? - ?
sistent with the trade-off theory. Furthermore, the Business risk - - -
coefficient on firm growth in the short-term leverage
equation is now positive and borderline significant,
which is consistent with the pecking order theory.
Potential debt tax ? ? ?
Finally, although the coefficient of industry median is shields
still positive in the long-term leverage equation, it is Tax exhaust ? ? ?
significantly negative in the short-term leverage
equation, and insignificant in the total leverage
equation, findings which are not entirely consistent Industry-specific determinants
with the trade-off theory. Industry median ? ? ?
leverage
7 Pecking order or static trade-off?
Inflation ? ? ?
GDP growth ? - -
Which of the two major theories, pecking order and
trade-off, is a better description of our findings? Our This table presents the predictions of the pecking order and
findings suggest that, on the whole, the trade-off static trade-off theories alongside with our empirical findings
for the relations between the dependent and independent
theory provides a better account of the capital structure variables
decisions of Turkish firms than the pecking order
theory. Table 9 presents the predictions of the two
theories alongside with our empirical findings. The determinants such as corporate debt tax shields, non-
table includes only those determinants for which at debt tax shields, and inflation for which the trade-off
least one of the two theories has a prediction. theory correctly predicts the nature of the association
A simple comparison of the signs in Table 9 reveals with leverage.
that the trade-off theory has more correct predictions It is important to emphasize that our conclusion is
than the pecking order theory. The main advantage of in sharp contrast with the conclusions of previous
pecking order theory over the trade-off theory is that it capital structure studies on the Turkish economy in
predicts the sign of profitability correctly. This is which the pecking order theory is often viewed as a
important because profitability is probably the only better framework than the trade-off theory for under-
leverage determinant that has a robust (negative) standing the capital structures of Turkish firms (see,
association with leverage in the data in (nearly) all for example, Acaravcı and Doğukanlı 2004; Korkmaz
countries. Note, however, that a negative sign can also et al. 2007; and Yıldız et al. 2009). We have already
be rationalized in dynamic versions of the trade-off alluded in the preceding paragraph to some of the
theory such as Fischer et al. (1989) and Hennessy and reasons that may at least partly explain this divergence
Whited (2005). On the other hand, the pecking order of conclusions. Some of the other main reasons can be
theory has difficulty accounting for the positive signs uncovered by studying the capital structure differ-
on size and tangibility as well as explaining the ences between various types of firms. This becomes all
negative association between leverage and GDP the more important since almost all of the previous
growth. Perhaps as importantly, the theory does not studies focus on public manufacturing firms whereas
generate predictions about some very key leverage we consider a comprehensive and representative
123
sample which includes manufacturing, non-manufac- favorable, the predictive power of the trade-off theory
turing, small, large, public, and private firms. In our was higher and that of the pecking order theory was
analyses, we have found that the trade-off theory is lower compared with the case in the 1996–2002
particularly successful (and pecking order theory subsample. Therefore, it might be that as the economy
particularly unsuccessful) in accounting for the capital becomes more ‘‘healthy’’ and ‘‘stable’’, the relevance
structures of firms that are private, non-manufacturing, of the trade-off theory increases and that of the
large, and/or mature. Pecking order theory, on the pecking order theory decreases. In our opinion, this is
other hand, although in our evaluation still not as an issue that deserves further and more thorough
powerful as the trade-off theory, is at its best when it investigation.
comes to public, manufacturing, small, and/or young
firms.21 Therefore, the reason some of the previous
researchers have concluded the superiority of the 8 Concluding remarks
pecking order theory over the trade-off theory is that
they have considered only public manufacturing firms In this paper, we examine the determinants of capital
and included a very incomplete set of leverage structure for non-financial firms in Turkey. The
determinants suggested by the two theories.22 novelty of our paper comes from the fact that we use
How do our findings compare with the findings on a new dataset that is substantially larger and more
other economies? Examining the literature (some of comprehensive in terms of both time and variable
which we discussed in Sect. 2), we see that there aren’t coverage than those used in previous studies on
many empirical studies that claim the superiority of individual developing economies. Our dataset
the pecking order theory for developed economies. For includes manufacturing, non-manufacturing, small,
developing economies, ‘‘votes’’ seem to be split large, listed and unlisted firms, which enables us to
roughly in half, perhaps slightly in favor of the take a more accurate picture of the capital structure
pecking order theory. Therefore, if we had to take a choices of the average non-financial firm as well as to
very rough rule of thumb sort of stance on the issue, we analyze capital structure differences between different
could say that the trade-off theory is probably more types of firms. Building on these comprehensive
suited to explaining the situation in developed econ- analyses, we perform hitherto the most comprehensive
omies, while the pecking order theory may be slightly comparative test of the trade-off and pecking order
more suited for developing economies. Several empir- theories in a developing economy context.
ical studies including Deesomsak et al. (2004) and de Our results provide evidence that the trade-off
Jong et al. (2008) show that the health and stability of theory is a better framework than the pecking order
the economic environment exert considerable effect theory to understand the capital structures of Turkish
on firms’ capital structures. In the Turkish context, we non-financial firms. This seems to be true regardless of
found that in the 2003–2009 subsample where the firm size, industry affiliation, and stock market listing.
economic environment was considerably more In other words, Turkish nonfinancial firms appear to
trade-off the tax benefits of debt against deadweight
21
costs of possible bankruptcy in order to attain an
Our finding that pecking order theory is more powerful in
optimal capital structure. The trade-off theory seems
explaining the financing behavior of young and small firms is
consistent with notion that the pecking order theory may be to be particularly successful in explaining the financ-
more suitable for explaining the financing behavior of smaller ing choices of large private non-manufacturing firms,
firms since information costs are more important for SMEs than especially when the economic environment is more
for large companies. See, for example, Zoppa and McMahon
(2002) and the references therein.
stable. The pecking order theory, on the other hand,
22 although in our assessment still not as powerful as the
Recall that our analysis of the economic significance of
leverage determinants also lends more support to the trade-off trade-off theory, appears to perform best for small
theory than to the pecking order theory. There, we found that public firms in the manufacturing sector and when the
determinants that are more closely associated with the trade-off economic environment is relatively unstable.
theory such as potential debt tax shields and firm size are
Our conclusion that the trade-off theory is a better
economically more significant than those determinants that are
more closely associated with the pecking order theory such as framework than the pecking order theory to under-
profitability. stand the capital structures of Turkish non-financial
123
firms contrasts sharply with the previous studies on the would be worthwhile to investigate in greater detail
Turkish economy, who generally take the opposite how they influence firms’ capital structures.
view. The presence of this divergence in judgments
highlights the importance of conducting sufficiently Acknowledgments We thank Erdem Başçı for stimulating
our initial interest in this topic. We also thank Cem Çebi,
comprehensive analyses in terms of both firm types
Mustafa Kılınç, Arif Oduncu, Baki Cem Şahin, Cihan Yalçın,
and leverage determinants suggested by various Erdal Yılmaz, the editor Gerald McDermott, two anonymous
capital structure theories. referees, and seminar participants at the Central Bank of the
Our results also indicate that neither the trade-off Republic of Turkey, Turkish Economic Association’s
Seventeenth National Symposium on Economics in Erzurum,
theory nor the pecking order theory can match all of
Borsa Istanbul Finance and Economics Conference in Istanbul,
the observed relationships in the data. For example, a and 10th EBES Conference in Istanbul for helpful comments.
main weakness of the more successful trade-off theory We would like to also thank Aslı Kaya, Nevin Memiş, and Gülin
is that it cannot capture the inverse relationship Tuğral for kindly answering our technical questions about the
dataset. The views expressed herein are solely of the authors and
between leverage and profitability. As shown by do not represent those of the Central Bank of the Republic of
Fischer et al. (1989) and Hennessy and Whited Turkey or its staff.
(2005), however, an inverse relationship between
leverage and profitability can be rationalized in
dynamic versions of the trade-off theory. This implies
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Small Bus Econ (2015) 44:255–282

Determinants of capital structure: evidence

Accepted: 23 June 2014 / Published online: 22 July 2014

Table 2 Descriptive Observations First Mean Median Third Coefficient

Table 3 Determinants of leverage: full sample results

5.2.3 Industry-specific determinants Maksimovic 1999). Overall, our findings on inflation

Table 4 Economic significance of leverage determinants

Table 5 Robustness of full sample results to alternative time periods

Table 6 Sample split between manufacturing and non-manufacturing firms

Table 7 Sample split between small and large firms

Table 8 Sample split between publicly-traded and private firms

what-determines-capital-structure-largest-brazilian-firms- Frank, M. Z., & Goyal, V. K. (2008). Trade-off and pecking

Myers, S. C., & Majluf, N. S. (1984). Corporate financing and https://lirias.kuleuven.be/bitstream/123456789/274828/2/

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