State ownership and corporate leverage

In their seminal paper, Modigliani and Miller (1958) established that, in the absence of friction and transaction costs, the capital structure of a firm is irrelevant. Since then, economists have developed various theories describing friction and transaction costs that drive the choice of corporate financing decisions, including tax, bankruptcy costs, corporate problems, and informational inconsistencies. All of these factors can affect debt and equity financing differently and therefore affect a firm’s optimal capital structure.

An important source of distortion in financial markets is political economy (Lambert et al. 2021). For example, Faccio et al. (2006) have shown that politically affiliated entities are significantly more likely to be granted bail than similar non-affiliated entities. Markets understand this and should therefore be more willing to provide (cheap) credit to such companies. Indeed, this is a recent study by Busolo et al. (2021) shows: Despite being less productive, politically affiliated entities borrow more than similar non-affiliated entities.

The ultimate form of political connection is state ownership. If governments are more likely to bail out state-owned entities than privately owned companies, more of the former debt should be used. However, governments can not only guarantee (implicit or explicit) bailouts, they can also use state-owned enterprises for political purposes. For example, especially in countries with weak institutions, state-owned enterprises (ab) can be used to get maximum votes for ruling parties and politicians (e.g. Bircan and Saka 2019) rather than maximizing shareholders’ value and ability to repay debts. The politicization of the business decisions of the state-owned enterprise is against the interests of the lenders and may result in high cost of borrowing.

Which of these reciprocal forces predominates is an empirical question. The existing literature mostly supports the first argument. For example, Dewenter and Malatesta (2001) consider the 500 largest non-US firms and show that state-owned enterprises are given more benefits. They also show that leverage decreases after privatization. Similarly, Bubkri and Cassette (1998, 79 large companies), D’Souza and Maginson (1999, 85 large companies), and Maginson et al. (1994, 61 large companies) discovered that, after privatization, companies reduced their debt ratio. Boubakri and Saffar (2019, 453 large companies) find a positive relationship between state ownership and leverage.

These existing studies analyze data from all major and most listed companies. In a recent study (De Haas et al. 2022), we consider a more comprehensive dataset covering 4 million companies in 89 countries. Most of these companies are small or medium-sized; Very few of them are listed. Our data bureau comes from splitting different historical versions of Van Dyke’s Orbis dataset. They span twenty years (2000-2019) and include 20 million annual observations (thus an average of five observations per firm).

The broad nature of this new dataset allows us to compare state-owned and private firms while controlling leverage not only for conventional farm-level determinants (e.g. size, profitability, asset clarity and non-debt tax shield). Sector-country-year specific effects. We find that, on average, state ownership is negatively related to leverage, which is defined as total assets from a firm’s debt (Villar-Burke 2013). In other words, for most companies, the negative impact of state ownership is more than offset any benefit companies can receive from the state as a shareholder (in terms of borrowing power). This effect is increasing the level of state ownership but it is significant even if there is little ownership part of the state. The level of impact is substantial: within the same country-sector-year, the average debt / wealth ratio of companies with ownership of any state is less than 5 percentage points. This is about one-fourth of the average leverage of 19% in our sample.

This strong negative relationship between state ownership and corporate leverage probably reflects the corporate governance risks of state ownership. Lenders may fear state interference in the firm’s operations and may therefore be less willing to lend to such firms. Indeed, we see that the negative effects of state ownership on leverage are much stronger in countries with weak rule of law, control of corruption, protection of investors, and bankruptcy procedures. These results are consistent with the view that state ownership is costly, especially in countries with weak political and legal institutions.

The negative relationship between state ownership and corporate leverage extends across most firm-sized distributions – (previously studied) with significant exceptions to very large firms. Consistent with the previous literature on the subject, we show that (only) among the largest companies in our sample (with more than $ 3 billion in assets), state ownership is associated with high corporate leverage (see Figure 1). In other words, only the largest companies in a country benefit from (partial) state ownership through bailout guarantees and cheap loans. The market believes that these guarantees are most credible for the ‘national champions’ that the state will probably behave in a particularly favorable manner.

Figure 1 The effect of state ownership on firm leverage by firm size

Comments: This figure reports the average marginal impact of state ownership on strong leverage with a 95% confidence interval.
Formula: De Haas et al. (2022).

We complement our cross-firm results based on panel data for privatized initiatives through an in-depth analysis. We observe similar changes in capital structure over time in these firms compared with changes in leverage between similar but non-private state-owned enterprises. The results are very similar to the qualitative and quantitative cross-firm analysis. We find that firms typically increase their leverage by about 5 percentage points (27% of the sample average) five years after privatization, compared to comparable (combined) non-private firms (see Figure 2). Interestingly, leverage began to rise two years before the actual privatization – perhaps reflecting the fact that privatization took time to implement and that the impact of future privatization pushed credit market prices forward.

Figure 2 Privatization and Strong Leverage: Event Study

Comments: This figure provides a graphic representation of an average treatment in treated (ATT) analysis. The points are consistent with the annual ATT estimates with a bias-consistency term. Whiskers represent a 95% confidence interval.
Formula: De Haas et al. (2022).

Our results can also be seen in the light of recent literature (Bento and Restuccia 2018) that underlines the substantial misallocation of capital and labor between companies – even within the narrowly defined industrial sector and within the same country. State ownership can be an important source of such allocation inefficiency and as a result the total factor puts a strain on productivity. Our results highlight a mechanism by which state ownership can lead to distortion and mismanagement of assets: it interferes with the ability of everyone except the largest corporations to access credit.


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