Page 22 - FINAL CFA II SLIDES JUNE 2019 DAY 6

These factors fall into 3 broad categories: READING 21: CAPITAL STRUCTURE

MODULE 21.2: FACTORS AFFECTING CAPITAL STRUCTURE
Institutional and Legal Factors
• Strength of legal system: Weak legal systems = greater agency costs due to the lack of legal protection for investors. Hence use more leverage
and greater reliance on short-term debt.
• Information asymmetry: High levels = greater use of (short-term) debt, due to greater enforceability of rights. In countries where auditors and
financial analysts have a greater presence, information asymmetries are reduced, hence lower financial leverage.
• Taxes: The tax shield from debt = greater debt financing; as long as dividends is not taxed lower. Taxing dividends lower reduces the return that
investors require on equity capital, thus the lower cost of equity will cause firms in such countries to have less debt in their capital structure.

Financial Markets and Banking System Factors
• Liquidity of capital markets: Larger and more liquid capital markets tend to allow longer maturity debt;
• Reliance on banking system: Companies operating in countries that are more reliant on the banking system than corporate bond markets as a source of
corporate borrowing tend to be more highly leveraged.
• Institutional investor presence: There is some evidence that firms in countries with active institutional investors issue relatively more long-term debt
compared to short-term debt. We may also observe marginally lower debt-to-equity ratios in these countries.

Macroeconomic Factors
• Inflation: Firms operating in countries with high inflation tend to use less debt financing, and the debt used has a shorter maturity.
• GDP growth: Firms operating in countries with higher GDP growth tend to use longer maturity debt.