Towards a Capital Structure Theory for the Multinational Company.
The internationalization of firms can nowadays be described as a common phenomenon in the business realm. Firms that are operating only in their nation state are much more the exception than the rule. The multinational company (MNC) as a highly internationalized organization dominates most industries in the developed economies of our world. Business sciences have responded to this challenge. Empirical and theoretical insights concerning the internationalization of firms and the MNC have in spite of the relatively short time, academics have been dwelling on this topic, reached a considerable level (Engelhard/Dahn 1994).
The financial aspects of the multinational firm have been discussed already in the early 70ies, when the scientific debate concerning internationalization and the multinational enterprise was still in its infancy (Adler 1974, Adler/Dumas 1975, Krainer 1972, 1973, Naumann-Etienne 1974). However a look at the research literature indicates that the theoretical discussion concerning the financial management of the MNC soon seemed to vanish (Inkpen/Beamish 1994). Can this be interpreted in such a way that everything of importance regarding the financing of the MNC has already been told? Or are there other reasons, why the discussion concerning the financial management of the MNC did not fall on fertile ground(1). This article states that the latter is the case. We argue that current financial paradigms have proved to be inadequate, even incommensurable to the phenomenon of the MNC. Furthermore, we are laying out the conceptual foundations of a capital structure theory for the MNC, taking consideration of previous empirical findings.
Why do we Need a Capital Structure Theory for the MNC?
Defining the MNC
As Adler points out, a parent company with at least a subsidiary abroad (Bi-National Company) may be characterized as "... the simplest form of the MNC..." (Adler 1974, p. 120), however, when discussing financial problems of the MNC, most authors typically assume that there are at least two subsidiaries (abroad) and one parent company at home forming the MNC (Naumann-Etienne 1974, p. 861, Shapiro 1978, p. 212).
We will follow Adler's conceptual minimum demand on how a multinational should be, but not without reminding that the typical empirical configuration of a multinational can be described as consisting of much more than one (or two) subsidiaries abroad. For example, Dow Chemical, a US multinational, operates more than 150 manufacturing sites in more than 30 countries.
Most of the MNC's subsidiaries are independent companies from a legal point of view, however, from an ownership perspective these entities are linked to the parent company directly or through an intermediate subsidiary. Thus, the MNC can be interpreted as a federation of companies (with the parent company at the top) and with shareholdings as the connecting wire between them.
The MNC in the Modigliani/Miller Framework
The integration of the phenomenon of the MNC into the Modigliani/Miller(M/M)-framework has been attempted mainly in the 70ies. Krainer, Adler, Severn and Naumann-Etienne among others discussed aspects of the M/M-framework in an international context (Adler 1973, Krainer 1972, 1973, Naumann-Etienne 1974, Severn 1973). Whereas Krainer finds that the existence of exchange rate risk and repatriation risk leads to the invalidation of the M/M-theorem, which means that the capital structure of a MNC is relevant for its valuation (Krainer 1972, pp. 553 et seq.), Naumann-Etienne limits the knowledge gain of Krainer's work by noting, that the assumption on the worldwide existence of corporate income taxes alone leads to the same implications (Naumann-Etienne 1974, p. 860).
Despite the heated discussion following Krainer's paper, financial models based on the M/M-framework disputing financial aspects of the MNC soon seemed to grow out of fashion. A review of the relevant literature, which appeared in the Journal of International Business Studies at the beginning of the 80ies (Stanley 1981) seems to indicate that attempts to implant the MNC into the M/M-framework primarily were undertaken during the first half of the 70ies, but not afterwards. This appears in no way surprising if we compare the methodological ground, on which the M/M-framework is based, to the theoretical rationale of the MNC.
The capital structure theory of Modigliani and Miller is characterized as a model from the "perfect-market school" (Modigliani/Miller 1958, pp. 266 et seq., Naumann-Etienne 1974, p. 860), where assumptions are set such as the absence of taxes and transaction costs as well as the existence of absolute market transparency: a situation where market differences will be discovered and equalized as soon as they emerge and an equilibrium will always be reached. The analysis of these states of equilibrium is the main focus of the research logic based on this framework. However, in the international management literature the MNC is seen as an organizational phenomenon, that owes its very existence to the occurence of market imperfections, especially the (international) segmentation of (national) markets (Adler/Dumas 1975, Buckley 1990, Buckley/Casson 1976, Caves 1971, Dunning 1977, 1988, Dunning/Wymbs 1997, Fatemi 1988, Hymer 1960, Kindleberger 1969). In a world of perfect markets a MNC would never come into being, because there would be no market imperfections to exploit. From the viewpoint of the perfect market-paradigm the MNC is therefore an anomaly that cannot be explained. The theoretical framework of Modigliani/Miller is incommensurable(2) to the organizational phenomenon of the MNC.
The MNC and "Financial Contracting"-based Capital Structure Approaches
Theory Gap Between the MNC and "Financial Contracting"-Approaches?
In terms of scientific progress the M/M-paradigm underlying the early theoretical capital structure approaches has been substituted later by approaches based on the "financial contracting-theory" framework (for a summary see Harris/Raviv 1991, important contributions are e.g.: Brander/Lewis 1986, Jensen/Meckling 1976, Leland/Pyle 1977, Myers 1984, Myers/Majluf 1984, Ross 1977, Stulz 1988, Williamson 1988), which has its roots in the new institutional economics. These approaches explain the relevance of a firm's capital structure in the light of such aspects as the information asymmetry between "insiders" and the capital market or on the basis of agency relationships between various interest groups of the firm (Harris/Raviv 1991).
But, despite the wide spectrum of financial theories based on the "financial contracting"-framework, a transformation of these theories to the MNC case is very rarely found in the literature(3). The MNC is hardly mentioned, neither in these theories nor in approaches based on them(4). This leaves room for interpretations: either, the authors are implicitly assuming that the results of their analysis can be "translated" to the multinational case without serious problems or they are intentionally restricting their analysis to the national case(5). We are left in doubt about the real train of thought with regard to that.
If the latter is the case, then there should be agreement for the need of a capital structure theory for the MNC. Yet, if the former is the case, we argue that the MNC has several peculiarities, which have not been modelled adequately into previous "financial contracting"-based approaches or are not even considered by these theories at all. A theoretical approach, which is able to take consideration of the specifics of MNCs is not only justified but also urgently necessary. In the following we will discuss these particular properties of MNCs that have not been adequately covered by "financial contracting"-approaches up to now.
Why are Multinational Companies Different?
Capital Structure Ambiguities
From a financial perspective, the MNC consists of a set of different entities, each showing a capital structure of its own. Moreover, depending on the national accounting rules, parent companies are required to set up a consolidated statement for the MNC as a whole(6). This consolidated statement contains a consolidated capital structure. The capital structures of legally independent companies are thus interconnected via an aggregated capital structure (Lee 1986).
Function and relevance of those consolidated statements differ between nations according to different national accounting standards(7), and, consequently, investors from different nations (not being acquainted with foreign accounting standards as they are with their own national accounting standards) may interprete the information from the consolidated capital structure of the MNC differently (Choi 1993).
Besides, investors of the MNC face another ambiguity, which investors of a national company (without subsidiaries) are not confronted with: When assessing the risk of lending to (or investing money into) entities of the multinational group, the investor can not be quite sure, which capital structure should be taken in order to evaluate the risk of default. For example, a bank which lends money to a subsidiary does not know for sure, whether the parent company would let the subsidiary default on its debt (unless the parent company is willing to guarantee its subsidiary's debt). If the parent company would, then the capital structure of the subsidiary should be the appropriate measure of financial risk, however, if the parent company would not, then the capital structure of the parent or precisely the consolidated capital structure of the parent plus all entities, which the parent company would not let default, would serve better(8).
The same problem may arise for the shareholders of the parent company. How should they evaluate the parent company leverage in relation to the leverage of the consolidated group?
This ambiguity caused by the particular configuration of the MNC (divergence of legal separation and economic unity) is a characteristic, which is not sufficiently captured by the "financial contracting" based capital structure theories up to now. Theorists have discussed the capital structure of firms as a signal in order to reduce the uncertainty of investors (e.g. Ross 1977). However in the case of the MNC, investors are even uncertain, which capital structure is the appropriate risk measure.
Decision Processes Regarding the Capital Structures in the MNC
Furthermore, from empirical studies it is known that the decisions concerning the capital structures of foreign subsidiaries are made to a large extent at the company's headquarters (Eckert 1997a, Giesel 1982, Goehle 1980, Kimber 1976, Pausenberger 1981, Pausenberger/Volker 1985). This finding has important implications.
First, in some "financial contracting"-based capital structure theories the capital structure of firms is interpreted as a tool to convey private information to company outsiders. However, in the MNC context, another important aspect is that information is also conveyed from insiders to insiders: when arranging the capital structure of foreign subsidiaries the decision makers inside the company's headquarters are transferring signals not only to the external investors of the subsidiary but also to the management of the subsidiary.
Second, if we concentrate on the class of corporations, where management and ownership are separated (at least to a large extent), which undoubtly may be characterized as the typical governance configuration of the MNC, we find that for the national firm (without subsidiaries) (as well as for the parent company of the MNC) the majority of those who invest equity does usually have little direct control over the capital structure of the firm, (resp. the capital structure of the parent company of the MNC). But, according to empirical results we face a different situation regarding the subsidiaries of the MNC: those who decide about investing equity into the subsidiary do also have the control over the capital structure of the subsidiary. Consequently, we do not only face a different setting concerning capital structure decisions in the MNC compared to the national firm, but in the MNC we are also confronted with differing settings concerning the decisions on the arrangement of different capital structures simultaneously.
Complex Network of Stakeholders
The firm's shareholders as well as a whole spectrum of other stakeholders9, such as workers and lenders, are concerned with the way the capital structure of a firm is arranged (Cornell/Shapiro 1987). However, in the multinational case the complexity of the network of interest groups increases substantially as the number of interest groups grows through multiplication by the number of entities of the MNC; and, in principle, by each decision that affects the capital structure of one entity of the multinational group, the interest groups of all other entities of the multinational group are affected, too.
Members of the same stakeholder-category, e.g. creditors, may have conflicting interests, depending on the entity, to which their stake is directly bound (Slovin/Sushka 1997). For example, creditors of the parent company may oppose a measure like the parent company injecting more equity into a subsidiary located in a country with high political risk, which would impair the risk-position of their stake. However, creditors of this subsidiary may welcome this measure, since the risk-position of their stake is improved.
Furthermore, the interests and expectations of stakeholders, belonging to the same stakeholder category, may vary according to the national regulatory system, in which they are embedded. And their interests and expectations may also vary due to cultural differences (cf. Schuler/Rogovsky 1998).
As a result, in the MNC case there is not only a higher multitude of interest groups compared to the national case, but also a much greater variety of interests and expectations that have to be considered.
Cultural Diversity arid Utility Maximization
As international management researchers have pointed out, the most important characteristic of the MNC is cultural diversity, meaning that the MNC operates in different cultural environments simultaneously and that in the MNC actors with differing cultural backgrounds are making decisions that affect actors with differing cultural backgrounds inside and outside of the MNC (Schmid 1996). This phenomenon has to be considered, all the more since empirical evidence regarding cultural influences on the financing decisions of firms has been provided (e.g. Schmidl 1997, Sekely/Collins 1988).
However, up to now, cultural diversity has not been a topic in the "financialcontracting"-based capital structure theories. This does not seem very surprising, if the theoretical background of these theories is reflected. They are grounded in the new institutional economics(10) framework and focus on the explanation of economic institutions, e.g. financing contracts. The basic assumption of these approaches is, that human behavior is characterized by the universal principle of "utility maximization" (albeit subject to "bounded rationality", see Williamson 1988).
Culture can be understood as a set of values, norms, attitudes, beliefs and basic assumptions, that is shared among the members of a society (Schein 1984, Schmid 1996, Trompenaars 1993). Cultural diversity means that values, norms, attitudes, beliefs and basic assumptions vary between different societies and that (in the MNC case) individuals with different cultural backgrounds, i.e. different systems of values, norms, attitudes, beliefs and basic assumptions interact with each other.
Hofstede characterizes culture as "collective programming of the mind" (Hofstede 1980). How can "financial contracting"-approaches take consideration of cultural diversity, if they presume, that all humans would be "programmed" in one and the same way: as self-interest seeking utility maximizers? The key to the compatibility of cultural diversity and utility maximization seems to be the definition of utility.
One alternative is to define utility in a very broad sense, covering all values conceivable, e.g. money, power, honour, loyalty, altruism (Tietzel 1990, p. 17). Whatever a person does, is done in order to maximize its own utility (McKenzie 1978). However, if utility is defined in such a way, the (empirical) falsification of the basic assumption (utility maximization as the absolute determinant of human behavior) is no longer possible. Therefore, from this perspective, the basic assumption can not be qualified as a "good" theory in a methodological sense and neither can theories based on that assumption (Gerum 1988).
A second alternative is to define utility in a more limited sense, covering only return (in the sense of monetary compensation and non-, but near-monetary perquisites such as private, firm jets) and risk(11) from the viewpoint of the acting individual(12). Under these circumstances, falsification of the basic assumption is possible, to be sure. However, we are forced to confess that utility maximization then is no longer compatible to cultural diversity. Differing cultural values can not be incorporated into this concept sufficiently as the only values which are considered are return and risk.
To sum up, "financial contracting"-approaches must either be qualified as "bad" theories, because of their basic premise, i.e. utility maximization, or they are incommensurable to cultural diversity and hence can not contribute sufficiently to an academic discussion about the financing decisions of the MNC(13)
Need for a New Paradigm
As a result of these considerations, we can conclude that neither the M/M-framework, nor the "financial contracting"-approaches are the appropriate playground to combine capital structure-considerations with the phenomenon of the MNC. While the M/M-framework is clearly incompatible to the phenomenon of the MNC, approaches based on "financial contracting"-theories have up to now neglected important specifics of the MNC, such as stakeholders' uncertainty about the appropriate capital structure for evaluating the risk of their stake, different settings concerning decisions on the different capital structures of the MNC, and increased complexity of the network of interest groups affected by capital structure actions. While, in principle, these specifics of the MNC could still be modelled into an approach based on previous "financial contracting"-theories (albeit - up to now - the attempt has never been made, presumably due to the exceeding complexity that would be the result, which would neutralize the analytical value inherent in these approaches and obstruct any application to empirical reality, cf. Steiner/Kolsch 1989, p. 421), the following can definitely not. As has been shown, the "financial contracting"-theories do not appear to be appropriate to capture the influence of cultural diversity on financial decisions in the MNC. Rather, the basic premise of these theories appears to be incompatible to cultural diversity(14).
Given these findings, the question is, how to proceed. We think, that in order to progress, we have to take one step back and - as a starting point - describe the functional properties of the capital structure and the technical relationship between the capital structure (as an instrument) and potentially corresponding capital structure goals, especially taking consideration of the MNC. based on these considerations, empirical findings on the decision processes regarding the capital structures of MNCs can be incorporated. Thus, we try to provide a framework for further empirical research concerning the capital structures of MNCs, which is able to capture the particular properties of the MNC. This way we provide the foundation for the development of a capital structure theory for the MNC.
Fragments of a Capital Structure Theory for the MNC
Functional Properties and Technical Relationships of the MNC's Capital Structures
The Capital Structure Reconsidered
Though the term capital structure is often used in academic publications, it is rarely defined explicitly. In spite of this researchers confine themselves to analyzing the effects of certain "capital structure"-determinants on the amount of leverage a company choses, thus implicitly defining capital structure as the relationship between a company's debt and equity (see for example Berger/Ofek/Yermack 1997, Castanias 1983, Chen/Cheng/He/Kim 1997, Harris/Raviv 1990b, Masulis 1983, Modigliani/Miller 1958). Other aspects of the capital structure such as the priority structure of the different claims or the duration of availability of certain financial resources are hardly consideredl's
The combination of financing contracts, that a firm has chosen in order to finance its investments, shall be termed capital structure. Those financing contracts contain a whole bundle of agreements, e.g. agreements about the nature of returns paid: should they be fixed or variable; if they are variable, should they depend on the company's amount of earnings. Financing contracts contain agreements about the time-period for which the financial resources are at the firm's disposal, about the currency, in which the financial resources shall be denominated and so on.
These agreements are bundled into financing contracts of an increasing variety. This is exemplified by the emergence of financing forms such as preferred stock, subordinated debt, convertible debt, etc. Consequently, to distinguish only between equity and debt (which are nothing but labels for two archetypes of financing contracts) concerning a firm's capital structure may be oversimplified and misleading.
We should try to capture the different aspects that are substantial for financing contracts in a capital structure definition: our proposal is that the capital structure of a firm can be seen from several perspectives, which we call "capital structure-dimensions", namely: priority, maturity, origin, currency, yield and participation. Each of these shall be shortly explained in the following - with special regard to the MNC.
Along this dimension the firm's capital is differentiated according to the priority of the claims, which are agreed upon in the financing contracts with the firm's various investors (Barclay/Smith 1995b). E.g., a firm's capital structure can be composed of ordinary debt, which has to be satisfied before fulfilling the claims of the holders of common stock and those of the holders of subordinated debt, subordinated debt, which has to be satisfied before fulfilling the claims of the holders of common stock, and common stock.
Furthermore, the priority dimension delivers information, whether there are other actors that can be charged to fulfill the claims of certain investors, if the firm itself is not able to meet these claims (e.g. in the case of guarantees, letters of comfort, etc.). Regarding the priority dimension, the capital structures of MNCs' subsidiaries often contain external debt, which is in some way assured by the parent(16).
Along this dimension the firm's capital is distinguished concerning the time period the financial funds are still at the firm's disposal (Barclay/Smith 1995a, Guedes/Opler 1996). E.g., the firm's capital can be at the firm's disposal for an infinite period of time or it may mature after an a-priori agreed period of time. And if the latter is the case, it can be ranked according to how long the capital is still at the firm's disposal.
Concerning the maturity dimension, empirical research has shown that subsidiaries of the MNC tend to differ from independent firms. The former tend to have a much higher quota of short term debt to total assets than the latter (Brooke/Remmers 1973, p. 289, Giesel 1982, p. 171 et seq.). Reasons for this are that the subsidiaries do not have the adequate credit standing, that the parent company has cost advantages, when it comes to borrowing long-term funds, or simply that the MNC makes flexible use of short-term funds in order to react to expected exchange rate changes (Eckert 1997a, p. 159, Robbins/Stobaugh 1972, p. 61).
The participation dimension contrasts the various kinds of capital concerning the decision rights and control rights that the financing contract provides for the investor(17).
Regarding this dimension in the MNC case, the class of subsidiaries' capital that implies the utmost decision and control rights (at least during the "going-concern"-situation) usually comes to a large extent (if not exclusively) from the parent company. Frequently, the differentiation between joint ventures and wholly owned subsidiaries as different kinds of subsidiaries is based on the specific arrangement of this dimension (Gatignon/Anderson 1987, Gomes-Casseres 1989, Langefeld-Wirth 1990, Larimo 1992).
This dimension describes the capital structure in terms of the specific currency, in which the financial funds are denominated.
In the case of the MNC the currency structure of the parent depends to a large extent on the organization and strategy of the firm's foreign exchange risk management. (E.g., on the decision whether the funds necessary to build up a foreign subsidiary are financed by debt from the host country, thus implying foreign currency debt on the balance sheet of the parent). The capital structure of foreign subsidiaries is usually composed of two major blocs regarding the currency the funds are denominated in: funds denominated in parent country currency and funds denominated in host country currency (Krackov 1989). Third-country currency obligations tend to be of minor importance at the balance sheet of foreign subsidiaries(18)
The capital structure can also be differentiated concerning the type of yield, which is agreed upon in the financing contract. In this context the financing contracts can be distinguished into one category, where fixed returns are agreed upon between the investor and the firm and another category of financing contracts, which implies variable returns. The latter category again can be subdivided into capital, where the yield is related to the firm's performance and capital, where it is not.
And the capital of a firm can also be contrasted according to its origin. Thus it can be differentiated into internal capital, i.e. financial funds which are generated by the firm itself, and external funds, which are acquired from the outside (Btischgen 1997). Funds that stem from outside the firm can be further classified in detail according to their origin, so that information about the concentration of capital regarding the various investors is given (Johnson 1998, 1997, Schmidl 1997, p. 37 et seq.).
In the case of the MNC, its entities find on the one side the option to finance themselves on the basis of their own cash flow(19). On the other side they can be financed from the outside, where they can either be financed by other entities within the multinational system (intra-MNC) or by investors from outside (external) (Pausenberger/Volker 1985). Empirical studies show that the capital structures of smaller subsidiaries tend to consist of intra-MNC finance to a large extent. These intra-MNC funds usually come either from the subsidiary's own cash flow (Buschgen 1997, Brooke/Returners 1973, Giesel 1982, Robbins/Stobaugh 1973, Scharrer 1989), the parent company, a finance subsidiary or from regional headquarters. Intersubsidiary financial links tend to be rather rare (Eckert 1997a, Robbins/Stobaugh 1972)(20). External finance - if it occurs - usually is short term to a large extent (Eckert 1997a) and consists mainly of local supplier credits and local bank debt (Brandt 1982, Brooke/Remmers 1973, Scharrer 1989). With increasing size of the subsidiary its financial autonomy, however, tends to grow. This is reflected in more financing by extra-MNC funds, like long-term bank credits by host country banks. Capital market financing can be found usually only at very large subsidiaries (e.g. acquisitions of formerly independent companies) (Scharrer/Kragenau 1990) and especially capital market funds that include voting rights are very rare in the case of MNCs' subsidiaries(21)
Summarizing, the capital structure of a firm is to be interpreted as a particular combination of financing contracts, where each consists of a bundle of agreements regarding the several capital structure dimensions(22). These capital structure dimensions [ILLUSTRATION FOR EXHIBIT 1 OMITTED] should serve as the basis of an analysis of the MNC's capital structures. To be sure, the information available from firms' annual reports is not sufficient in every respect to fulfill all the information needs that would be raised by this concept. Nevertheless, it could work as a usable foundation for analyzing and discussing capital structure topics (of the MNC) as it attempts to take a different perspective in contrast to previous approaches by focusing explicitly on the whole spectrum of financing agreements decided upon in the firm's financing contracts.
In the MNC case, it would seem especially interesting to analyze systematically how the capital structures of parent company and subsidiaries differ regarding to the combination of agreements, which are included in the financing contracts. As has been mentioned before already, previous empirical evidence underlines the supposition that there are significant differences between the capital structures of parent companies and the capital structures of subsidiaries.
And it should be worthwhile to contrast empirically the parent-subsidiarycapital-structure-patterns according to certain contingencies such as the MNC's home country: This means on the one hand comparing the capital structures of parent companies from different nations (resp. the consolidated capital structures of MNCs). Previous empirical evidence concerning international differences in the leverage ratios of firms (e.g. Aggarwal 1981, 1982, 1990, Francfort/Rudolph 1992, Rajan/Zingales 1995, Sekely/Collins 1988, Stonehill/Stitzel 1969), as well as empirical results regarding the international differences in corporate ownership structures (Pedersen/Thomsen 1996) highlight the importance of nationality and culture for explaining the capital structure of parent companies (cf. also Engelhard/Eckert 1999)(23). And on the other hand, the capital structures of foreign subsidiaries have to be analysed with regard to specific contingencies such as nationality of the subsidiary, parent company's home country (Hennart/Larimo 1998), capital structure of the parent company, operative function of the subsidiary, mode of ownership of the subsidiary, etc.
Decisions Affecting the Capital Structure
Since the term "capital structure decision" tends to imply some plan or concept on the "optimal" capital structure of a firm in the mind of the decision maker(s), we chose to define "capital structure decision" as the act of intentional determination how the capital structure of a company should look like or should not look like.
Examples for capital structure decisions are: "We will have at least 70 percent of our fixed assets covered by equity" (Pohle 1980, p. 153) or "Generally, we would hope to keep our capital gearing (loans as a percentage of total capital employed) below 30 percent ..." (Clements 1980, p. 143). The financing guidelines of a German MNC say: "Consolidated equity should at least amount to 25% of the consolidated total assets ... equity should cover 50% of fixed assets ... equity and long-term debt should cover all fixed assets and 50% of all stocks"(24).
Capital structure decisions do not necessarily affect all capital structure dimensions, but can instead be restrained to one or a few capital structure dimensions, and they also do not necessarily affect the cash flow of the firm as long as any capital structure resulting from the financing activities does not conflict with the planned capital structure.
Capital structure decisions can take the shape of informal corporate policies or of official corporate guidelines. They work as contraints(25) in the decision process when it comes to deciding how to finance a certain investment. This latter kind of decision, which directly influences the cash flow of the firm and directly affects each of the capital structure dimensions simultaneously, shall be termed "financing decision".
Empirical research has shown that the capital structure decisions, that are common in MNCs, mostly do not cover the whole spectrum of a certain capital structure dimension, but instead focus on a specific capital "section", which is characterized by properties from two or more dimensions (Eckert 1997a). For example, a guideline like "No inter-company loans for joint ventures"(26) firstly presupposes that (for that specific kind of subsidiaries) capital from a category called "loan" is allowed. What is the crucial criterion concerning this category in this respect? The term "loan" typically stands for capital, that implies fixed returns; the claims of its holders are of first priority; it is capital that matures after a time period, agreed upon at the beginning of the contract; and it does not include voting-rights for the holder. The first three aspects (fixed returns, first priority, definite maturity) seem to lead to an increase in the financial risk of the entity that is financing via loans. The last condition (non-voting capital), however, leads to a stabilization of who has power over the funding entity, since the distribution of voting rights remains unchanged. Therefore, it seems plausible to assume that to fund subsidiaries via non-voting capital is the crucial aspect concerning this pre-decision, because the acquiring of nonvoting capital is the gain, that the decision makers trade against the price of fixed returns, definite maturity, and first priority. based on this, the second part of the decision ("No inter-company loans ...") restricts the potential sources of non-voting capital: No non-voting capital shall be given from entities of the MNC in order to finance joint ventures. As a result, this restriction implies specific consequences with regard to the capital structures of joint ventures of this MNC.
Capital structure decisions and financing decisions shape the capital structure of firms. If we do assume technical rationality (Thompson 1967) for a moment, we may suppose that these decisions are all driven by operative goals (Perrow 1961).
Goals Affecting the Capital Structure
In order to delineate a spectrum into which goals that drive capital structure decisions (i.e. capital structure goals) and goals that drive financing decisions (i.e. financing goals) can be categorized, the functional properties of the capital structure should be considered.
First, the capital structure (i.e. the particular combination of financing contracts) of a firm influences the firm's overall risk-return-structure, as several agreements which are part of the financing contract (capital structure dimensions: currency, yield, maturity, priority) affect the financial risk-return-structure of the firm. Therefore, we conclude that goals related to decisions concerning the capital structure can be classified into a spectrum, which is framed by two extremes: reducing risk versus increasing return.
In the MNC case, each single entity has its own risk-return-structure, however due to the ownership-interdependence of the MNC's entities, their risk-return-structures are closely interrelated(27). If we assume the extreme case, that the parent would never allow any of its subsidiaries to go bust, then the risk-returnstructures of the separate entities of the MNC would melt into one risk-returnstructure for the MNC as a whole.
Second, the capital structure affects the distribution of power between the firm's management and the various stakeholders of the firm; and, the capital structure also influences to a considerable extent, how responsibility for the consequences of a firm's activities is divided between these parties. From the goals "increasing power" and "reducing responsibility" a trade-off relationship similar to the risk-return-relationship can be constructed: If an actor's power over a firm is increased, then there is a tendency that his responsibility for the actions of that firm also rises (e.g. Coffee 1990, p. 1547).
Thus, those who decide about the capital structure of a firm, are able to influence the power-responsibility relations between the firm and its various interest groups by arranging the capital structure (Kirsch 1968)28. A second spectrum for the classification of capital structure goals and financing goals can therefore be identified. This spectrum is marked by the extremes: increasing power versus reducing responsibility(29).
The classification of capital structure goals and financing goals into these two spectrums should enable the comparison of different capital structure strategies. Potential fields of further research could cover questions, such as, whether there are systematically different goal preferences with regard to specific contingencies, such as the home country of the MNC (Eckert 1997b), the MNC's industry, the ownership structure of the parent company, etc.
Capital Structure Relevance
The term "relevance" is used to describe the technical interrelationships between goals and means, i.e. the importance of certain instruments for the fulfillment of particular goals. Goals require the existence of a decision maker, who decides on the goals. Therefore, the relevance of a certain means (as the ability of an instrument to promote the fulfillment of goals) can only be assessed from the perspective of the decision maker.
Relevance, consequently, depends on the one hand on the progress concerning goal realization, which can be achieved through the use of a particular instrument (potential efficiency effect), and on the other hand on the degree of possibility to substitute the particular instrument by another one (substitutability).
As empirical studies have shown, financing decisions as well as capital structure decisions in the MNC are centralized at the parent to a high degree. Therefore in order to explain MNCs' capital structure policies, we have to focus on the relevance from the eyes of the decision makers, i.e. the management of the parent company. Given the functional properties of the capital structure, delineated above, from the perspective of the management of the parent company different types of relevance can be distinguished (see Exhibit 2).
The capital structure of the parent provides on the one side a tool for the company's management to influence the power-responsibility relations between the management of the parent company and the parent company's various stakeholders (power-responsibility-relevance of the parent company's capital structure).
On the other side, the capital structure of the parent can be used to influence the parent company's risk-return-structure. In this context, two different mechanisms have to be taken into consideration:
The capital structure, as has been mentioned before, can be interpreted as the particular combination of financing contracts, a firm has agreed upon with its investors. The way the parent company is financed (i.e. the capital structure of the parent company) directly influences the structure of the cash flows of the parent company and this way also affects the risk-return-structure of the parent company (risk-return-relevance of the parent company's capital structure type 1).
Investors respond to changes in the capital structure by readjusting the company's cost of capital. Thus, if the parent company changes its capital structure, its risk-return-structure is not only affected by the shift in the characteristics of the firm's obligations towards its investors, but also because of adjustments in the costs of capital undertaken by the firm's investors, which arise due to the perceived capital structure change (risk-return-relevance of parent company capital structure type 2). This response of the parent company's investors could be based again on two different mechanisms of evaluation. The parent company's investors can on the one side evaluate the company's financial risk by looking at the capital structure of the parent company (type 2a). On the other side investors of the parent company may be aware of the interconnectedness of the MNC's entities and may base their risk evaluation on the consolidated capital structure of the MNC as a whole (Adler 1974, Business International 1979, Eckert 1997a, Pausenberger 1981, 1982, Shapiro 1996). Because the parent company's capital structure is part of this capital structure, a change in the capital structure of the parent can alter the capital structure of the consolidated group, thus influencing the demands of the parent company's investors (type 2b1)(30).
Furthermore, investors of other entities of the MNC that evaluate the risk of financing on the basis of the consolidated capital structure may also change their demands towards the particular entity, they are committed to, according to changes in the consolidated capital structure, caused by changes in the capital structure of the parent. These changes in the costs of capital of subsidiaries lead to modifications of the risk-return-structures of subsidiaries and, due to the interdependence of the risk-return-structures of parent company and subsidiaries, the risk-returnstructure of the parent is also affected (type 262).
The capital structure of the MNC's subsidiaries can be used to control the power-responsibility relationships between the parent company and the other stakeholders of a subsidiary (power-responsibility-relevance of the subsidiary's capital structure) (cf. Gatignon/Anderson 1987).
Executives often associate a subsidiary's debt/equity ratio with the parent company's responsibility. For example, the financial executive of a German MNC, talking about a joint venture, which had a very high equity ratio (50%) compared to the company's wholly owned subsidiaries (around 30% in most cases), argued: "Minority shareholdings (of the MNC) have to stand on their own feet ... we did not want the company (i.e. the joint venture) to stand on wobbly legs"(31)
Second, the capital structure of the subsidiary can be used to influence the risk-return-structure of the subsidiary. The latter, however, is not an end in itself seen from the perspective of the parent company management. In spite, because of the close interconnectedness to the risk-return-structure of the parent company, it is used as a tool to influence the parent company's risk-return-structure(32). Two mechanisms of interdependence have to be considered.
On the one hand, changes in the capital structure of the subsidiary alter the subsidiary's cash flows. As those cash flows include cash flows between the subsidiary and the parent, the risk-return-structure of the parent is also affected (riskreturn-relevance of the subsidiary's capital structure type 1).
On the other hand, stakeholders of the subsidiary respond to changes in the capital structure of the subsidiary, by adjusting their demands concerning the returns of their claims or by restructuring their commitment, thus altering the risk-returnstructure of the subsidiary and - due to the interdependence of the risk-return-structures of the parent and the subsidiary - also affecting the risk-return-structure of the parent (risk-return-relevance of the subsidiary's capital structure type 2a).
In Business International (1986) the treasurer of a Swedish MNC is quoted: "If we are forming a new manufacturing sub we almost always inject more equity ... our foreign sub may have to show its balance sheet and financial statement to local trade creditors. So we want the entity to look solid and substantial" (Business International 1986, p. 26).
Moreover, if the capital structure of the subsidiary is consolidated into the aggregated capital structure of the MNC as a group, changes in the capital structure of the subsidiary can affect the consolidated capital structure of the MNC (Livnat/Sondhi 1986)(33).
Investors that evaluate the risk of financing on the basis of the consolidated capital structure will adjust their expectations and demands and this way affect the risk-return-structure of the parent company (risk-return-relevance of the subsidiary's capital structure type 2b). Investors of the subsidiary may adjust their costs of capital, thus modifying the risk-return-structure of the subsidiary and as the risk-return-structures of subsidiaries and the parent are interconnected, the risk-return-structure of the parent is finally affected (type 262). And also, investors of the parent company may adjust their demands according to changes in the consolidated capital structure, that are caused by changes in the capital structure of subsidiaries and thus the risk-return-structure of the parent company is also modified (type 2b1).
Finally, investors of other subsidiaries of the MNC, that evaluate the risk of financing on the basis on the consolidated capital structure may adjust the costs of capital due to changes in the consolidated capital structure that are caused by a change in the capital structure of another subsidiary and - as the risk-return-structures of the parent and other subsidiaries are also interrelated -- in the end, the risk-return-structure of the parent may be altered this way, too (type 2b2).
In sum, a complex web of technical dependencies between its different capital structures is distinctive for the financial structure of the MNC. The degrees of relevance may be rather different for the identified types of relevance, ranging from marginal to significant. Nevertheless, due to certain circumstances, these particular degrees of relevance may vary and it should be a research quest to analyze empirically the determinants(34).
Starting Point for the Development of a Capital Structure Theory for the MNC
This framework explicitly takes account of important specifics of the MNC that have not been incorporated adequately into previous "financial contracting"-approaches.
Capital structure ambiguity is included, as the variety of capital structures in the MNC is considered explicitly. The multiple interrelationships between the capital structures of an MNC and the various risk-return-structures of different entities of the MNC provide the playground for an investor's uncertainty concerning the evaluation of different capital structures with regard to their influence on the risk-return-structure, which is relevant to her. Emphasis is laid on differentiating between the real capital structure, i.e. the combination of financing contracts a firm has chosen, and the capital structure perceived, which is the reflection of the combination of financing contracts as investors perceive them due to the firm's external reporting. As perceptions may vary, different stakeholders may interprete capital structures of the MNC differently with regard to their relative degree of relevance and with regard to their substance.
The complexity of the network of stakeholders can be considered, as the MNC is dissected concerning its various entities, and hence, the stakeholders of different entites and also their (varying) interests, expectations, and demands can be contrasted. The term stakeholders should in this respect include all groups and individuals affected by capital structure changes regardless of whether they are outsiders or insiders of entities of the MNC. By differentiating between the various stakeholders of the different entities of the MNC, the information function of capital structure changes (signalling) can be considered in more detail with regard to all the different stakeholders affected.
Furthermore, the differentiation of the various capital structures of the MNC and the consideration of the power-responsibility relationships between the MNC's stakeholders, makes it possible to take account of different settings regarding the distribution of power among those involved in the decision making concerning the capital structures in the MNC.
So far, technical rationality has been presumed. This assumption given, the functional properties of capital structure as well as the technical relationships between the MNC's different capital structures and potential goals have been delineated. From this starting point on, further empirical research could concentrate on questions such as, which financial strategies (covering capital structure decisions as well as financing decisions) are used for the achievement of particular goals. And based on that, further questions of interest would be, whether there are significant differences between firm's financial strategies to be found, e.g. depending on the home country of the MNC, or whether the choice of strategy for the achievement of particular goals is influenced by culture.
And attention should be drawn towards deviations from technical rationality. Which other goals, such as management's prestige, are pursued by the decision makers, when shaping the capital structures of the MNC? Does culture influence these deviations from technical rationality? Is even technical rationality a cultural construct? Empirical evidence concerning these questions is still lacking and thus the need for cross-cultural research in this field should be highlighted.
Only by explicitly considering the contextual framework of the MNC (e.g. working in different nation states, different cultural contexts, different regulatory environments etc.), will we be able to develop a capital structure theory appropriate for the MNC. But, the influence of the contextual framework can only be understood, if the decision processes, in which capital structure goals and financing goals are enacted and the instruments for their achievement are selected, are empirically analyzed in depth. In the following, we will shortly summarize the previous empirical knowledge with regard to that.
Empirical Indications Regarding Decision Processes Directing the Capital Structure
The Weakness of Technical Rationality Concerning Financial Decisions in the MNC
Empirical findings regarding the decision processes in MNCs have shown36, that explicitly expressed goals that are governing decisions on the capital structure(s) of the MNC tend to be rather general and strategic, but without a definite operationalization. However, as recent empirical research has proven, not all the members of the finance function of a MNC are aware of the existence of such goals (Eckert 1997a, Price Waterhouse 1994). Where explicitly declared goals are existing, they tend to maintain an umbrella function, being directed towards all kind of financing activities, e.g., "minimizing the company's cost of capital", "preserving liquidity", or "preserving independence" (Eckert 1997a).
Who are the people involved in defining those financing goals? Empirical findings show, that in MNCs those goals are exclusively expressed by actors of the parent company. Inside the parent company different hierarchical levels may be involved, ranging from the board of directors, the chief financial officer to the treasurer as well as staff from the treasury department (Eckert 1997a, p. 309 et seq.).
Goals that explicitly guide the processes on the elaboration of capital structure decisions could - at least up to now - not be identified in empirical research. This could be interpreted either in a way, that while there had been goals, which were agreed upon during the process of elaborating capital structure decisions, they have not been explained to those not taking part in the decision process. Or it could raise the suspicion, that there has been no clear agreement on the goals, that these decisions should promote, at all.
Nevertheless, the financing decisions in many MNCs follow certain capital structure guidelines. These guidelines work as constraints in the decision processes concerning the financing of entities of the MNC. Many actors from different hierarchical levels of the parent company as well as executives from the subsidiary and regional headquarters can be involved in the process of composing these capital structure guidelines (Buschgen 1997). Anecdotal empirical evidence provides reason to assume, that the process leading to the emergence of these capital structure decisions tends to be rather informal (Eckert 1997a). Guidelines concerning the capital structures in MNCs do very often come into being as the consequence of a certain stream of decisions, that proved to be effective in the past, and not as the result of some intended elaboration on a company-working-session. If the decision makers, involved in the decision process believe in the general effectiveness of that decision, the decision becomes a rule, a "guideline". And the longer such a decision rule is already accepted inside the organization, the harder it gets for organizational members to reflect the rationality of that decision objectively. This becomes even more evident, since the comprehension of the rationality behind those guidelines, i.e. the goals-means-relationship (if there have been any goals at all), very often happens to get lost in a process, which can be characterized as "traditionalizing" the capital structure decision (Eckert 1997a, Hofstede et al. 1990).
E.g., in a recent study, the representative of a huge German MNC was cited explaining, that there should be no guarantees for the subsidiaries' external borrowings, because this would have a bad effect on the capital structure of the parent company. However, when asked whether investors of the parent company would align the cost of capital according to the balance sheet of the parent or the consolidated balance sheet, the same executive replied without hesitation, that they would be clearly orientated towards the consolidated balance sheet of the MNC (cf. also Pellens 1994, p. 160). But, from the perspective of the consolidated balance sheet, it does not matter, whether subsidiaries external borrowings are secured by the parent or not (e.g. Shapiro 1978, p. 218). When the executive's attention was drawn towards this contradiction, he admitted, that under these circumstances, the guideline "... ought to be critically questioned" (Eckert 1997a, p. 332 et seq.)
Summarizing, the scarce empirical knowledge leads us to conclude that the decision processes shaping the capital structures of an MNC tend to consist of a multitude of singular decisions, which appear to be only weakly coordinated. The ones making the decisions, that affect the capital structures of the MNC seem to be guided by explicitly expressed financing goals or/and their own assumptions what financing goals are to be pursued. They tend to follow capital structure decisions, which are ambiguous to them concerning their reasons.
As a result, the technical relations between means and goals appear to be rather weak in the case of the MNC's capital structure decision making. This structure of decision making given, culture's significance for the explanation of the MNC's financing activities has to be emphasized: In the MNC actors with differing cultural backgrounds are shaping the various capital structures. As unambiguous goals appear to be lacking, the importance of personal values (shaped by the individual's cultural backgrounds) in the decision processes regarding the capital structures of MNCs should be highlighted.
The Significance of Culture for Explaining Financial Decisions in the MNC
In a recent survey(37), executives from US-MNCs mostly declared the minimization of the company's cost of capital as the overall financing goal, whereas executives from German companies tended to enumerate a range of financing goals, where preserving the company's liquidity had the highest priority (Eckert 1997b, cf. also Reintges 1988, p. 665). When the representative of a US MNC was asked about the weight of the goal "liquidity" for the finance function of the company, he - being upset because of this seemingly foolish question - angrily replied: "... providing liquidity is not a mission (for the finance function) ...", and explained that this can only be the task of the operative business, whereas the task of the finance managers would be to control the "... cost of money ... (i.e.) to minimize interest income minus interest expense (after tax)".
These differences in financing goals between German and US MNCs could be explained in several ways. Different propensities for risk, different corporate governance systems as well as different traditions in academic education concerning corporate finance in Germany and the US (cf. Eisele 1980, Grunwald/Stehle 1993) may have contributed to this phenomenon. We will not try to evaluate the relative importance of each of those factors as they are strongly intertwined. This notwithstanding, what seems to be most striking is the reaction of the respondent when confronted with the question, why not "liquidity" as the financing goal of the MNC. His vehement reaction can be seen as an (albeit anecdotal) indication that financing goals can be interpreted as (culturally shaped) basic assumptions of the people in the finance function of an MNC. As Schein argues:
"To really understand a culture and to ascertain more completely the group's values and overt behavior, it is imperative to delve into the underlying assumptions, which are typically unconcious but which actually determine how group members perceive, think, and feel. Such assumptions are themselves learned responses that originated as espoused values. But, as a value leads to a behavior, and as that behavior begins to solve the problem which prompted it in the first place, the value gradually is transformed into an underlying assumption about how things really are. As the assumption is increasingly taken for granted, it drops out of awareness. Taken-for-granted assumptions are so powerful because they are less debatable and confrontable than espoused values. We know we are dealing with an assumption when we encounter in our informants a refusal to discuss something, or when they consider us "insane" or "ignorant" for bringing something up" (Schein 1984, p. 3 et seq.)
Another empirical finding of the same study was, that financial executives from German MNCs tend to follow capital structure guidelines when financing foreign subsidiaries much more than executives in US MNCs do. The treasurer of a US MNC replied: "We don't care so much about subsidiary financing".
This second example illustrates differences in the importance of rules for the financing of an MNC. Hofstede explains such differences as the consequence of the different degree of uncertainty avoidance of a culture (Hofstede 1993, p. 141 et seq.). Indeed, the empirical research of Hofstede, who found that the German culture is characterized by a relatively high degree of uncertainty avoidance compared to a relatively low degree of uncertainty avoidance in the case of the US-American culture, seems to confirm that the differences apparent here are artefacts of different national cultures (cf. Hofstede 1993, p. 141 et seq.)
As a result of this anecdotal evidence, the influence of culture on financial decisions should be emphasized. A theory of capital structure for the MNC should not employ a universal model of human behavior as utility maximizing (albeit subject to bounded rationality). Whereas bounded rationality is surely a concept which is of high significance in the case of the MNC, the universal concept of utility maximizing excludes cultural diversity, an important characteristic of the MNC. Instead, the concept of cultural diversity as well as the concept of bounded rationality should be enclosed in the model of man applied: human behavior should be viewed as guided by individual interests, values, norms, attitudes, beliefs and basic assumptions which are prone to be culturally influenced(38).
Naumann-Etienne argued in 1974: "There exists a considerable body of theory on financial decisions of the firm in the one-country environment. The emergence of the multinational corporation (MNC) raises the question of whether the same concepts are applicable to a firm operating in in a number of countries" (Naumann-Etienne 1974, p. 859). We argue, that they are not. Traditional capital structure theories seem to be inadequate, if not incommensurable to the phenomenon of the MNC.
Only a framework that is able to incorporate cultural diversity, an important characteristic of the MNC, will prepare the way for the development of a capital structure theory that is appropriate for the MNC. Given the empirical significance of the MNC in modern economies, the importance of culture for explaining the processes of financial decision making in the MNC, and the growing tendency to internationalize management teams (of the finance function of MNCs), which should further increase the weight of culture in the decision making processes in the MNC, the development of a capital structure theory, which is able to cover the specifics of the MNC seems to be overdue.
With a concept of man like the one suggested above, however, it becomes clear that the range of testable hypotheses that can be employed should be rather short. Due to the merely infinite variety of situations and contexts that could occur in an MNC, if we consider the different cultures involved, and due to the - up to now - relatively low state of knowledge concerning decision making about the MNC's capital structures, a move towards qualitative studies may be the most effective way to improve our understanding. "Thick descriptions" (Geertz 1997, Hansen 1995) of decision making in MNCs regarding the MNC's capital structures may be the appropriate next step. The concept outlined in this article may be helpful as a first heuristic framework guiding empirical research in this field.
In his much-cited article about "The cost of capital and valuation of a two-country firm", Adler closes with the sentence: "The surface has only been scratched" (Adler 1974, p. 131). Let's move deeper now.
1 In 1975 Adler and Dumas express "...the pressing need for a financial theory of the multinational firm" (Adler/Dumas 1975, p. 1) because "These concerns have so far largely escaped attention in the financial literature" (Adler/Dumas 1975, p. 1).
2 Concerning the meaning of "incommensurability" see Chalmers 1982.
3 Although from 1986, the argumentation from Lee is still valid: "...optimal capital structure theories of a firm have been discussed amply, though inconclusively, in the finance literature. In the international finance area, however, the issue on the optimal capital structure of the MNC, which seems to exist in the real world, has not often been discussed" (Lee 1986, p. 32).
4 There have been some recent attempts to combine internationalization and the MNC with the framework of previous "financial contracting"-based theories. Burgman 1996, Chen/Cheng/He/Kim 1997, Lee 1986 and Lee/Kwok 1988 discuss (among other things) the effects of multinationality on the agency costs of a firm, which again should affect the (consolidated) debt/equity-ratio. But, as we will explain in the following, the MNC has several specifics, that have not been adequately captured by previous attempts based on "financial contracting"-theories for the MNC case. Thus, these applications of "financial contracting"-theories are not able to deliver the appropriate framework for an analysis of the financing of the MNC.
5 In a similar way Burgman notes: "Most of the empirical literature on capital structure has either completely ignored international factors, or implicitly assumed that they can be adequately proxied by the standard business risk measures" (Burgman 1996, pp. 553 et seq.)
6 Rajan/Zingales note: "...not all countries require firms to report consolidated balance sheets, although the majority of firms in each country do it" (Rajan/Zingales 1995, pp. 1425 et seq.)
7 For example in Germany the consolidated statement is seen as a completion of the annual report of the parent company - at least in legal terms - and fulfills the task of providing stakeholders with additional information, whereas in the United States the consolidated statement works as a substitute for the parent company report and fulfills additional tasks besides providing information, cf. Eisolt 1992.
8 Empirical evidence concerning the willingness of MNCs to support their subsidiaries' debt even if it is not explicitly guaranteed has been found in surveys from Stobaugh (1970) as well as Business International (Business International 1979, p. 320). This tendency has been confirmed to some considerable extent by a recent survey (Eckert 1997a). However, as the empirical results show, several aspects such as the size of the parent (Stobaugh 1970) or the mode of ownership of the subsidiary (Eckert 1997a) have to be considered in order to evaluate the probability that the parent will be prepared to meet the obligations of its subsidiary.
9 We will use the terms "stakeholder" and "interest group" as synonyms, which embrace the whole spectrum of actors interested in or affected by actions of the MNC.
10 Katterle describes this branch of theories as "neoclassical" neo-institutional economics, cf. Katterle 1991, p. 137.
11 Although typically risk aversion is assumed, cf. Eisenhardt 1989, May 1995, it has to be conceded that the risk-preference-function, which is applied in theoretical models may vary, cf. e.g. Noe/Rebello 1996.
12 Davis argues: "The market for corporate control described by agency theorists is an associal conceptualization ...: actors are self-interested and atomistic, and the market is largely uninfluenced by social relations. But, managerial action, like all social action, is embedded in ongoing social structures and is not determined entirely by economic incentives and information asymmetries ..." (Davis 1991, p. 584).
13 In an analysis of the corporate governance structures in the USA, Germany and Japan, Roe argues: "If agency theory were universal, we should expect structures similar to the American to have arisen in Japan and Germany. But we do not" (Roe 1993, p. 47) "... modern agency theory must be reinterpreted as a special American case" (Roe 1993, p. 38).
14 Moreover the previous "financial contracting"-based capital structure approaches mostly focus on a small set of potential variables influencing the capital structure, without trying to take account of a wider spectrum of variables in a more integrated way. The capital structure is either interpreted for instance as the result of information asymmetries between managers and investors (Ross 1977) or as a consequence of the structure of the product markets a firm is operating in (Brander/Lewis 1986, Maksimovic 1988) or as the outcome of conflicts of interest between the management and certain interest groups (Jensen/Meckling 1976) or as a result of bankruptcy costs and tax advantages (Castanias 1983) to name a few. Though the partial nature of analysis is sometimes explicitly emphasized in these studies (e.g. Brander/Lewis 1986, p. 969), the consequences of this shortcoming have been hardly taken into account: an integrated theoretical model of the determinants of capital structure is still lacking.
Summarizing the results of previous capital structure research we are confronted with a "laundry list" of determinants (see Harris/Raviv 1991), but without sufficient empirical results to quantify the importance of these different variables. As Harris and Raviv point out: "... which of these factors is important in various contexts remains a largely unanswered empirical question" (Harris/Raviv 1990a, p. 68).
15 There are nevertheless tendencies in the finance literature to widen the meaning of capital structure just in this way, cf. Barclay/Smith 1995a, 1995b, Goshwami/Noe/Rebello 1995.
16 Cf. Giesel 1982, pp. 52 et seq. Whether this secured debt appears in the balance sheet/annual report of the parent depends on the legal reporting requirements in the home country and the kind of confirmation the parent has given. In any case, if the financial risk of the MNC as a whole is examined there is no need to consider any intra-MNC relationships concerning financial backing, cf. Shapiro 1978.
17 The hierarchical ranking of the various types of investors concerning their rights to decide and control the firm can however change according to the firm's situation. Whereas normally the shareholders have the right to chose management and control its activities, in the case that the firm cannot meet its obligations, control is shifted towards the firm's debtholders, cf. Berglof 1990.
18 Scharrer (1989) accounts that of all trade credit of German foreign subsidiaries, 70% is denominated in DM, more than 25% is denominated in host-country currency and only about 3% is denominated in third-country currency, see Scharrer 1989, p. 50. An exception, where other currencies are more likely to appear is either in the case of finance subsidiaries or when subsidiaries from different countries are vertically linked, i.e. exchanging goods and services between them, cf. Robbins/Stobaugh 1972, p. 59.
19 A study by Scharrer estimates for German foreign subsidiaries a relation between cash flow and real investment of more than two to one, cf. Scharrer 1989, pp. 92 et seq. Thus on aggregate these subsidiaries are able to finance their expansion from their own cash flows.
20 Albeit the extent of intersubsidiary financial links tends to vary, depending on specific contingencies, such as their degree of interconnection concerning production.
21 Nevertheless there is a growing tendency for the going public of subsidiaries, implying that in these cases a certain percentage of subsidiaries' voting capital is not in the hands of the parent, but is dispersed among the participants of the capital market, cf. Slovin/Sushka 1997.
22 It should be noted, that the agreements which are included in the financing contract do not necessarily have to be invariable. Financing contracts may include options concerning specific capital structure dimensions, e.g. convertible debt.
23 Nevertheless, it should be noted, that the recent study by Rajan/Zingales 1995 seems to indicate that international differences in firm's leverage are not as distinct as previous research leads us to conclude.
24 Further examples for such guidelines are "Let the equity quota for sales subsidiaries range between 15 to 20% and the equity quota for manufacturing subsidiaries between 35 and 40%" or "Long-term borrowing for subsidiaries should always be via inter-company loans". And more examples are to be found in Clements 1980, Eckert 1997a, Pausenberger 1980, 1982, Pausenberger/Volker 1985, Pohle 1980, Robbins/Stobaugh 1973, Schoop 1983, Zenoff 1980.
25 The rigidity of a certain constraint may however vary to a large extent.
26 The empirical examples cited in this text are taken from a recent qualitative survey. For details concerning the research design cf. Eckert 1997a.
27 For example, the parent company uses subsidiaries' earnings in order to compensate for decreasing earnings of the parent company, cf. Giesel 1982, pp. 49 et seq., Pohle 1980, p. 149. The problem resulting from that interconnectedness has been highlighted by such events as the crisis of the German MNC Metallgesellschaft, which arose due to the financial crisis of its US-subsidiary, cf. Lenel 1996.
28 An example for a responsibility reducing-policy approach of the parent company is to strengthen subsidiaries' autonomy by equiping them with the locally appropriate amount of equity. As Pohle states: "It is general policy to give our subsidiaries with manufacturing facilities a capital structure whereby they can stand on their own feet" (Pohle 1980, p. 148, cf. also Obermeier 1994).
29 Concerning this second set it has to be considered that for national firms as well as the parent companies of MNCs, management works as the primary force in the decision process how to arrange the capital structure: the group of actors that controls the decision process concerning a change in the power-responsibility relations between the firm and its stakeholders - i.e. the management of the firm - does not receive its power from the financial resources it provides (at least if the separation of ownership and management is assumed), but from formal delegation and information advantages. This is different with regard to the subsidiary of the MNC. As was already pointed out, the competence to decide on the capital structure of the subsidiary lies to a very large extent in the hand of the management of the parent company. In this case the actors that control the decision process (the management of the parent company) receive their power mainly from providing financial resources.
30 It should be noted, that the "objective" importance of type 2a versus type 2b depends on the attitudes of the MNC's investors. The "subjective" importance, seen from the management's perspective, depends on the management's believes about the attitudes of the MNC's investors, which could be biased by such aspects as national accounting rules and accounting policies.
31 Cf. endnote 26.
32 Brooke/Remmers remark: "... general policies and particularly financial policies in multinational companies are specifically designed to further the goals of the parent company ..." (Brooke/Remmers 1973, p. 289).
33 A drastic example may be the introduction of SFAS No. 94 in the US, which requires the consolidation of finance subsidiaries, something that has been avoidable for US-corporations before, cf. Heian/Thies 1989.
34 E.g., the mode of the subsidiary, i,e. wholly owned subsidiary or joint venture, may be an important factor, Robbins/Stobaugh 1972 report of a small MNC, where the management of the parent "... did not know the extent of foreign borrowing" (p. 60). The reason was that their "... subsidiaries were joint ventures not consolidated into its annual report" (p. 60).
35 Explanation of abbreviations: P-R stands for power-responsibility-relevance, R-R stands for risk-return-relevance.
36 Cf. endnote 26.
37 Cf. endnote 26.
38 A move into this direction may also be, what Katterle describes as the heterodox neo-institutionalism, cf. Katterle 1991, p. 138 et seq.
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|Author:||Eckert, Stefan; Engelhard, Johann|
|Publication:||Management International Review|
|Date:||Jul 15, 1999|
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