Industry Influence on Capital Structure - Revisited

In 1975 I co-authored a paper that documented the influence of industry on corporate capital structure with my colleague Dave Scott. By current standards our study was based on an exceedingly small sample and an unsophisticated research design. However, at the time the paper helped solidify the evidence regarding the role of industry affiliation on firm capital structure. In this study I re-visit the industry - capital structure relationship on a scale unimaginable in 1975. Specifically, I examine a sample of more than two thousand firms from 45 countries representing both developed and developing financial markets, and that have been classified into industries using varying levels of aggregation (i.e., Fama-French industry groups of 5, 17, 30 and 49 industries). The research is divided into two phases. In the first I re-examine the fundamental relationship between industry and capital structure. The results confirm our earlier findings as well as numerous more recent studies. Industry affiliation is found to be a powerful predicter of capital structure explaining roughly 20 percent of the variation in capital structure ratios. This result was observed (i) for firms listed in both developed and developing financial markets, (ii) using both market-based (Debt-to-Enterprise Value) and book value based (Debt-to-Invested Capital) leverage ratios, and (iii) where industry is defined in using as few as five or as many as 49 industry groups. The second phase of the research investigates the origins of the industry effect. Specifically, we investigate whether the industry effect reflects a combination of firm characteristics and country attributes of the financial market and legal/governance system of the country in which the firm’s equity is listed. We learn that much of the predictive power of industry affiliation on firm capital structure ratios can indeed be attributed to attributes of firms themselves and the attributes of the countries where their shares are listed. However, even after incorporating consideration for both firm and country effects, industry still accounts for a significant portion of the variation in capital structure ratios