Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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ANSWERS TO CHAPTER DISCUSSION QUESTIONS 453

the rate of adjustment toward an optimal capital structure varies significantly

across countries. Firms in common law countries adjust to optimal leverage

much faster than do firms in civil law countries. With respect to the financial

orientation of the economy, firms in market-based economies adjust to optimal

leverage faster than do firms in bank-based economies. This is because a market-

based structure imposes lower adjustment costs and higher benefits of adjusting

to an optimal capital structure.

4. Firms in less-developed markets, bank-based economies, and civil law countries

have higher information asymmetry and therefore higher costs of raising equity

and lower costs of financial distress due to opaqueness, illiquid capital markets,

and lower protection to creditor rights. As a result, these firms rely more on

internally generated funds or on borrowing from the banking system to meet

their financing needs. The pecking order theory predicts a positive relationship

between the debt ratio and financing deficit. Evidence shows that when control-

ling for the deviation from target leverage, firms across various countries have a

positive and significant relationship between debt level changes and financing

deficit, with a higher magnitude in civil law countries. This is consistent with

the argument that information asymmetry and legal systems play an important

role in explaining ...