The Effect of Financial Development on Firms Capital Structure Choice

This study examines the relationship between financial development and capital structure choice in 10 countries in Asia by using fixed effect panel data regression method. The finding shows that the effect of financial development on leverage ratio is different between developed and developing financial market. In already developed financial market, further development in banking sector will favor the use of leverage in capital structure by firms while further development in stock market development will favor equity financing. In less-developed financial market, both of banking sector and stock market development will reduce the amount of the debt used in firms’ capital tructure. amp;#65279;This study also examines whether these impacts are the product of various country-specific condition. Thus, this study employs conditional variables that consist of governance index, shareholder and creditor protection index, law enforcement index, legal traditions where the particular country commercial law derived from, inflation rate and country income groups. The result shows that conditional variables of French legal tradition and middle income group can enhance the negative effect of stock market development to the debt-equity ratio. Conditional variables of governance, common and French civil law legal tradition, shareholders and creditors right protection can mitigate the positive impact of banking sector development to debt-equity ratio. Except French civil law legal tradition, the aforementioned conditional variables also mitigate the negative effect of stock market development to debt-equity ratio. Conditional variables of law enforcement and inflations rate do not have significant impact in describing the relationship between financial development and capital structure choice. amp;#65279;Finally, this study concludes that the financial development effect on the capital structure choice in the already developed financial market does not hold in less-developed financial market. The cross-country specific condition might cause such variation to occur.