Modigliani and Miller Meet Chandler : Organizational Complexity, Capital Structure, and Firm Value

We study how organizational complexity affects capital structure and firm value. We measure organizational complexity as the number of layers in the firm's subsidiary structure, and focus on a sample of US firms over the period 1998-2006. We argue that organizational complexity makes the firm opaque and increases the asymmetry of information between the firm and the market. We show that organizational complexity is strongly related to standard information asymmetry proxies. In line with the predictions of the pecking order theory, firms characterized by a more complex organizational structure resort to less equity financing and more debt financing, have higher leverage, display a higher investment-cash flow sensitivity and build up greater ldquo;financial slack.rdquo; The higher information asymmetry created by organizational complexity, by reducing stock liquidity, reduces the value of equity