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Pyramiding vs leverage in corporate groups: International evidence

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Abstract

Among firms listed in Western Europe and East Asia, when creditor protection is strong, the controlling shareholder trades off retaining control in bad states through pyramiding against retaining the upside in good states via leverage. This result might arise because the controlling shareholder uses both leverage and pyramiding to expand control of resources, but in different circumstances since they have different outcomes under downside shocks. When creditor protection is weak, the controlling shareholder no longer prefers pyramiding in bad states, because creditors will not be able to seize the firm in bad states. Therefore pyramiding and leverage are used together.

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Notes

  1. We are grateful to a referee for pointing out this second possible motivation.

  2. Desai, Foley, and Hines (2004) show that foreign affiliates of multinational firms rely less on external debt in countries with weak creditor protection.

  3. However, when researchers measure leverage at book value, the relationship is not significant in Italy and Japan. It becomes significant when leverage is measured at market value. McConnell and Servaes (1995) find that for high-growth firms Q is negatively affected by leverage; for low-growth firms they find a positive correlation between Q and leverage. Lang, Ofek, and Stulz (1996) find that higher levels of leverage have a negative impact on the growth of the firm when Q<1, but a positive (though nonsignificant) impact when Q>1. They argue that debt disciplines management when Q< 1, preventing them from investing in negative NPV projects. For firms with Q>1 (i.e., good investment opportunities) high leverage does not constrain management.

  4. Another widely used proxy for growth opportunities is the historical sales growth rate, which we used as a robustness check; the results did not differ substantially. We use the Q-ratio because lenders should be more concerned about future growth (hence the ability to repay debt) than historical growth.

  5. The preceding studies do not control for this possibility in analyzing the relationship between leverage and growth, so it is not possible to distinguish between the two hypotheses.

  6. We are grateful to referees for the points made in this paragraph.

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Acknowledgements

We thank Stijn Claessens, Simeon Djankov, and Joseph Fan for providing their data for East Asia. We acknowledge helpful comments from the referees of this journal, Lemma Senbet (the Editor), as well as Amber Anand, Mark Huson, Rafael La Porta, Maria-Teresa Marchica, Ron Masulis, Ike Mathur, John McConnell, Randall Morck, Roberto Mura, seminar participants at the University of Alberta, Harvard Business School, Notre Dame, Tulane, Vanderbilt, Virginia Tech, York, and participants at the meetings of the American Economic Association, the European Financial Management Association, the Mitsui Life Symposium on Global Financial Markets, and the Western Finance Association. We also thank Sandra Sizer for editorial help. Larry Lang gratefully acknowledges the financial support of the China Guang Hua Science and Technology Foundation and the Hong Kong Government UGC Earmarked Grant.

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Authors and Affiliations

  1. Krannert School of Management, Purdue University, West Lafayette, Indiana, USA

    Mara Faccio

  2. The Chinese University of Hong Kong, Hong Kong, China

    Larry HP Lang

  3. The Asia Pacific Institute of Business, The Chinese University of Hong Kong, Hong Kong, China

    Leslie Young

Authors
  1. Mara Faccio
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  2. Larry HP Lang
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  3. Leslie Young
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Corresponding author

Correspondence to Mara Faccio.

Additional information

Accepted by Lemma Senbet, Area Editor, 21 February 2009. This paper has been with the authors for four revisions.

Appendices

Appendix A

See Table A1.

Table a1 Data sources for East Asian corporations
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Appendix B

See Table B1.

Table b1 Sources of ownership and control data for West European corporations
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Faccio, M., Lang, L. & Young, L. Pyramiding vs leverage in corporate groups: International evidence. J Int Bus Stud 41, 88–104 (2010). https://doi.org/10.1057/jibs.2009.33

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