Cross-Country Variations in Capital Structures: The Role of Bankruptcy Codes

We conduct a theoretical and empirical investigation of the impact of bankruptcy codes on firms? capital-structure choices. In our theoretical framework, costs of financial distress are endogenously determined as a function of the bankruptcy code. Anticipated liquidation values emerge as the key variable in the capital structure-bankruptcy code link: among other things, the theory predicts that the difference in leverage between a debt-friendly bankruptcy code (such as the UK?s) and a more equity-friendly code (such as the US?s) should be a monotone function of liquidation values. We examine empirical support for the theory by comparing leverages in the US and the UK for the period 1990 to 2002. Our tests use two (inverse) proxies of liquidation values: asset-specificity of the firm, and the fraction of the firm?s assets that are intangibles. We find the theory is strongly backed by the data. The results are robust to considerations such as employing net leverage (debt net of cash holdings) and controlling for other firm characteristics that affect leverage.