EH.Net Abstracts in Economic History

Historical Evidence from
Germany

EHS Abstract Submission
(c) 1998 EH.Net
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Name:  Caroline Fohlin
Email:  cfohlin at eh.net
Institution:  California Institute of Technology

Co-author:  None.

Title:  Bank Oversight and Firm Capital Structure: Historical Evidence from
Germany

Internet Address of abstracted work: Not available on the internet.

By mail:
Humanities and Social Sciences
Mail Code 228-77
California Institute of Technology
Pasadena CA 91125 USA

Language:  English

Abstract:
According to the pecking-order theory of financial decision making,
corporations prefer to finance out of retained earnings whenever possible
and prefer to issue debt rather than equity if they do turn to outsiders.
Such behavior arises because of information asymmetries between the sources
and uses of external funds generally, and because of the negative signals
new equity in particular sends to potential investors.	Since availability
and quality of information vary from firm to firm, optimal capital
structure should differ accordingly.  Thus, the theoretical literature
identifies several firm characteristics and circumstances that should
correlate systematically with the relative extent of debt and equity
financing used as well as with the choice between bank debt and bonds.
Firms with mild information-related problems may face low relative costs of
equity finance and may decrease their leverage in order to avoid the risk
of having to match net operating returns to fixed debt payments.

Capital structure, because it depends on the accessibility and reliability
of information, may also vary due to the organization of financial
intermediaries.  In particular, institutions that facilitate access to
information about firms may temper the problems that lead to inefficient
financing decisions.  Bank oversight may lower the relative costs of and
increase access to bank finance, so that bank-attached firms may have
higher leverage than independent firms on average.  Another way
interlocking directorates may be useful, however, is by equalizing
information between the operators of firms and those who provide
securities-based finance.  If bank relationships improve firms' ability to
gain positive reputations in capital markets, then such involvement should
minimize the cost gap between debt and equity.	Firms may then reduce their
leverage.  The fact that German banks provide both investment banking and
brokerage as well as commercial services should further facilitate this
adjustment.  In short, formal universal banking relations should speed
firms' movement through the pecking order of financial instruments.

This paper investigates both the role of asymmetric information and the
effects of bank oversight in the patterns of German corporate capital
structure at the start of the 20th century.  The results indicate that
information-based theories seem to apply to the German industrialization
context.  In particular, most hypothesized determinants of leverage P such
as cash flow and firm size P are also systematic predictors in the current
sample.  Controlling for these other factors, leverage also declines
significantly over firms' life cycles.	The effects of formal bank
oversight, however, seem to be minimal.  Capital structure changes little
with formalized bank relationships.  Moreover, controlling for other firm
attributes, attachment to a universal bank offers no consistent speeding of
firms' progress through the pecking order of financing modes but does
heighten firms' response to increasing cash flow.  Finally, a comparison of
debt maturities reveals no significant variation between bank-attached and
independent firms in the relative use of short- and long-term debt or in
factors associated with that choice.  Thus, the results generally fall in
line with predictions of information-based theories of capital structure
but undermine the traditional emphasis on formal bank-firm relationships
for ameliorating information problems, increasing access to bank debt, and
accelerating reputation-acquisition in capital markets.

Bibliography:  Fohlin, Caroline. "Bank Oversight and Firm Capital
Structure: Historical Evidence from Germany."  Paper presented at 1998
Cliometrics Conference, Washington University, St. Louis, May 8-10, 1998.

Subject:  W
Geographical Area:  4
Country/Region: Germany
Time Period:  8

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