Is the Use of Bank Debt as a Governance Mechanism Conditioned by the Financial System? The Case of Chile and Spain

Abstract

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This paper studies the partial adjustment process to the optimal debt ratio of Chilean firms through the dynamic trade-off theory. We use a sample of 196 quoted Chilean firms for the years 1995 to 2005. The existence of growth opportunities involves the potential agency problems of asset substitution and underinvestment. Thus, the first hypothesis is that those firms with growth opportunities will have a slower adjustment to the target debt ratio than those firms without growth opportunities. Additionally, due the characteristics of the institutional environment in Chile, the second hypothesis expects a direct relationship between the growth opportunities and the debt level, appositively to the results observed in the previous literature in common-law countries. The key findings are, first, that the firms follow optimal long-term debt ratios according to the trade-off theory arguments. Second, the Chilean financial system and the characteristics of the institutional environment dominated by the civil-law foster a positive relationship between the future growth opportunities and the leverage, opposing to the fact observed empirically in market oriented common-law countries. Third, firms with growth opportunities experience higher adjustment cost to the target debt ratio than firms without growth opportunities. That means that the agency costs that the growth opportunities entail are asymmetrically distributed between these two groups of firms.