Recently Hackbarth et al. (2006) note that “little attention has been paid to the effects of macro economic conditions on […] capital structure choices” and they propose a model where leverage is countercyclical, in line with some evidence obtained earlier by Korajczyk and Levy (2003) on a sub-sample of financially unconstrained U.S. firms.
This limited theorizing and empirical investigation relating business cycles to analyses of leverage is surprising since business cycles influence many underlying determinants of capital structures. So for instance they are known to influence shareholders’ default policies (Hackbarth et al., 2006; Chen, 2010), marginal tax benefits (Graham, 1996), investment sets (Gomes and Schmid, 2010), the cost of debt (Hackbarth et al., 2006), credit spreads and bond prices (Chen, 2010), the value of collaterals (Jimenez et al. 2006; Benmelech and Bergman, 2010), market capitalizations (for instance they should modify optimal portfolio allocation, Avramov and Chordia, 2006). Hence the theoretical expectation is that business cycles should influence capital structure policies because they influence the underlying variables when the perspectives taken by the trade-off, pecking order, signaling or market timing theories are retained.
We note in passing that survey evidence provides some ground to the mere idea that expected booms and busts are considered by financial executives in the planning and execution of their financial policies (Graham and Harvey, 2001; Bancel and Mitoo, 2004; Brounen et al., 2006).
In this paper we investigate the suggestion that this lack of aggregate evidence may be partly related to the mediating effect that ownership dispersion has on the relation between business cycles and capital structures. In fact we show that that empirical evidence, as derived from a sample based on European listed firms, is consistent with the idea that ownership dispersion polarizes financial policies followed by firms, in response to anticipated business cycles.
Interestingly, the literature on ownership dispersion and capital structure is about as limited as the one on business cycles and capital structure. Margaritis and Psillaki (2009: p. 622) note that “the relationship between ownership structure and capital structure remains largely unexplored”. They mention three international one-country studies. On the same subject, King and Santor (2008, p. 2425) cite a number of theoretical approaches, mostly from the 80s, and some empirical literature, primarily on U.S. data, all of which is focused on the marginal effects of entrenchment on capital structure, in a context where ownership is presumed to range from wide dispersion to limited concentration.
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Do agency relations mediate the interaction between firms’ financial policies and business cycles?
