Cross-country variations in capital structures: The role of bankruptcy codes

We investigate the impact of bankruptcy codes on firms' capital-structure choices. We develop a theoretical model to identify how firm characteristics may interact with the bankruptcy code in determining optimal capital structures. A novel and sharp empirical implication emerges from this model: that the difference in leverage choices under a relatively equity-friendly bankruptcy code (such as the US's) and one that is relatively more debt-friendly (such as the UK's) should be a decreasing function of the anticipated liquidation value of the firm's assets. Using data on the US and the UK over the period 1990-2002, we subject this prediction to both parametric and non-parametric tests, using different proxies for liquidation values and different measures of leverage. In support for the theory, we find that our proxies for liquidation value are both statistically and economically significant in explaining leverage differences across the two countries. In contrast, many of the other factors that are known to affect within-country leverage (e.g., size) cannot explain differences in leverage across countries.