The cutoff of capital inflows that triggered the East Asian crisis in 1997 was followed by a remarkably wide range of output responses. For example, the real GDP of Indonesia contracted by 14 percent in 1998, whereas for Taiwan Province of China real GDP expanded by 5 percent. What explains this wide disparity? This paper posits that cross-country differences in corporate leverage help explain the wide range of post-crisis output adjustment.
This explanation is motivated by the fact that the cutoff of capital inflows affected all countries in the region, whereas the output contractions were most severe for those countries with high levels of corporate debt. Further, investment and inventory contractions in these countries accounted for the bulk of their output declines in 1998, and significant sales of physical capital were made at large discounts.
How does the capital structure of firms differ across countries? We document the relation between firm size and leverage for two new comprehensive datasets of firms in two countries: Ecuador and the UK. We find that leverage, defined as the ratio of liabilities relative to assets, is on average higher in firms in the UK relative to firms in Ecuador. We also find that the relation between firm size and leverage ratios differ across the two countries. In the UK small firms tend to have larger leverage ratios than large firms.
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.
