Does the Country Effect Matter in the Capital Structure Decisions of European Firms?

Recent international financial research finds that a firm’s capital structure is not only influenced by firm- and industry-specific determinants, but also by country-specific factors. A brief review of the last decade’s studies on the country effect identifies some areas of potential development in empirical testing. We address these areas with regard to the following aspects: test design, statistical methodology, and set of determinants. Based on a sample of seven apparently similar European countries and more than 800,000 variously sized firms (from the BACH-ESD database) over a ten year period (2000-2009), by using a simultaneous equations model (SEM) never used before by any scholar in this field, we test the direct effects of country characteristics on leverage, as well as their mediating role on the effects of firm- and industry-specific determinants. The emerging empirical evidence highlights the relevance of many institutional and financial country characteristics, confirms the better ability of banks in selecting, monitoring and financing small and risky firms, and shows that the demand-side perspective can better explain some counter-intuitive effects of some determinants on leverage.