The Composite Effect of Stock Markets, Bank Stability, and Country- Level Institutional Factors, on Leverage

Abstract

This paper analyses the relation between firms’ leverage, financial development, and firm-level characteristics namely, firm size, investment, accounting standards, tangibility of assets, and profitability. The paper finds that there is a negative correlation between financial development, measured as stock market turnover ratio or stock market capitalisation and firm’s leverage, while there is a positive correlation between financial development, measured as the stability of a country’s commercial banking system and firm’s leverage. As stock markets become more developed, leverage decreases. This decrease is more pronounced for smaller firms, compared to larger firms. As banks become more stable, leverage increases, and this increase is more pronounced for larger firms, compared to smaller firms. The paper also finds that leverage is lower for firms in politically unstable and more corrupt countries. Conversely, firms are more levered in countries with stronger protection of creditor rights. A higher restrictiveness on foreign direct investment significantly increases leverage ratios of firms.

Keywords: Leverage, Financial Development

View PDF