Debt financing puzzle and internationalization

Date07 January 2019
Published date07 January 2019
AuthorKarren Lee-Hwei Khaw
Subject MatterStrategy,International business
Debt nancing puzzle and
Karren Lee-Hwei Khaw
Purpose This study aimsto examine the relation between long-termdebt and internationalization inthe
presenceof the agency costs of debt and business risk.
Design/methodology/approach Sample firms consist of 517 non-financial listed firms in Malaysia,
with 4,197 firm-yearobservations from the year 2000 to 2014.This study uses panel data regressions and
a series of robustnesstests to examine the hypotheses.
Findings The results show that multinationalcorporations (MNCs) are more likely to sustain lesslong-
term debtthan domestic corporations (DCs) to mitigatethe costs related to agency problemand firm risk.
Meanwhile, foreign-basedMNCs maintain less long-term debt than local-based firms, and the findingis
more significant at a higher degree of internationalization. Robustness tests confirm the negative
Research limitations/implications The findings indicate that the ongoing debate on the debt
financing puzzlecan be explained by internationalization.Moreover, the findings suggest that in addition
to the systematic differences between MNCs and DCs, studies on the debt financing and
internationalization shouldalso account for the systematic differences among MNCs such as the local-
based MNCs,foreign-based MNCs and DCs that later expand their business operationsabroad.
Practical implications MNCs have to be responsive to the diverseinstitutional environments as they
diversify their business operations geographically. When the adverse effects of internationalization
outweigh the benefits, MNCs could use the long-term debt financing decision to mitigate the costs of
doing business abroad. This is because debt financing is also a primary concern in the corporate
financialdecisions for the maximization of shareholders’wealth.
Originality/value This study contributes to the debt financing literature from the international
perspective by providing evidence from an emerging market. In addition, this study highlights the
importance of recognizingfirms by their firm-specific characteristics, such as internationalization,given
the systematicdifferences among firms.
Keywords Debt financing, Multinational corporations, Risk, Agency costs of debt
Paper type Research paper
1. Introduction
Firms use debt financing to address agency problem, business risk, and/or to signal the
quality of firms’ earnings. A firm that decides to finance its operations and/or growth
opportunities with debt has to decide between short-term and long-term debt because
different levels of debt maturity have different incentive characteristics. For example, firms
use long-term debt to mitigate the risks related to the frequent rollover of short-term debt
such as higher refinancing risk, interest rate risk and liquidity risk. Firms may also shift their
dependence to short-term debt to mitigate agency conflict (Myers, 1977;Barnea et al.,
1980). In addition, risky firms tend to useless long-term debt because the fixed obligation of
debt exposes firms to higher probabilityof financial distress and bankruptcy risk.
Over the years, the increasing liberalization of global markets has motivated firms to venture
abroad. International diversification enables firms to diversify their earnings to less perfectly
Karren Lee-Hwei Khaw is
based at the Department of
Finance and Banking,
Faculty of Business and
Accountancy, University of
Malaya, Kuala Lumpur,
Received 4 January 2017
Revised 6 July 2017
9 March 2018
28 April 2018
Accepted 1 June 2018
DOI 10.1108/JABS-01-2017-0001 VOL. 13 NO. 1 2019, pp. 29-52, ©Emerald Publishing Limited, ISSN 1558-7894 jJOURNAL OF ASIA BUSINESS STUDIES jPAGE 29
correlated markets that should lower their business risk and financial risk (Reeb et al.,
2001). Therefore, multinational corporations (hereafter MNCs) are expected to have higher
degree of risk tolerance compared to domestic corporations (hereafter DCs).
Internationalization also allows MNCs to have greater access to global capital markets than
DCs (Reeb et al., 2001). For these reasons, MNCs should have higher capacity to sustain
higher level of long-term debt comparedto DCs (Hughes et al.,1975;Rugman, 1976).
On the empirical side, US MNCs are generally found to maintain less long-term debt than
DCs (Burgman, 1996;Chen et al., 1997;Doukas and Pantzalis, 2003;Fatemi, 1988;Lee
and Kwok, 1988), even though their debt financing cost is relatively lower (Reeb et al.,
2001). Studies find that MNCs maintain lesslong-term debt to mitigate the adverse effect of
internationalization such as increasing agency problem and business risk that outweigh the
risk-reduction benefits of international diversification. However, evidence from the non-US
developed markets is found to be mixed (Akhtar, 2005;Akhtar and Oliver, 2009;Mittoo and
Zhang, 2008;Singh and Nejadmalayeri, 2004).
To date, most of the studies on MNCs’ debt financing structure provide evidence from the
developed markets context. To what extent the reported findings and justifications are
applicable to the emerging markets context,is still relatively unexplored. Motivated by these
arguments, this study examines if the debated debt financing puzzle also extends to MNCs
in the emerging markets. Specifically, this study seeks the answer to the question, “Do
MNCs in Malaysia also use less long-term debt than DCs to mitigate costs related to the
adverse effects of internationalization?”
Malaysian firms are characterized to have high concentrated ownership and large direct
shareholdings (Claessens and Yurtoglu, 2013;Deesomsak et al.,2009). About half of the
direct shareholdings belong to the family ownership who is actively involved in the
management. Malaysian firms also have a close relation with their banks; thus, they prefer
to use bank borrowing than debt securities (Deesomsak et al.,2009). Deesomsak et al.
(2009) find that Malaysian firms are unlikely to use debt maturity as a tool to mitigate their
agency costs, but the finding does not hold when firms are recognized by their
heterogeneous characteristics (Khaw and Lee, 2016).
This study contributes to the literature as follows: first, this study sheds additional insight to
the debated debt financing puzzle from the emerging markets’ perspective. The findings
highlight the importance of recognizing firms by their international diversification, given the
systematic differences in the agency costs and business risk between MNCs and DCs.
Consistent empirical results have reported that MNCs in Malaysia sustain proportionately
lower level of long-term debt than DCs to mitigate the costs of doing business
internationally. This finding is consistent with prior studies conducted in the developed
markets (Burgman, 1996;Chen et al.,1997;Doukas and Pantzalis, 2003;Fatemi, 1988;Lee
and Kwok, 1988;Mittoo and Zhang, 2008). This negative relation can be explained by the
market stability in the home and target markets.
Governance indicators show that Malaysia has stronger legal rights, creditor rights, legal
protection of minority shareholders and disclosure requirements than many other emerging
countries and even some of the developed countries (Claessens and Yurtoglu, 2013).
Therefore, the market is consideredrelatively stable and has lower systematic differences in
the agency costs, information asymmetry and risk compared to other emerging markets.
When Malaysian-based MNCs expand to less stable markets, they are exposed to the
adverse costs of doing business abroad. To mitigate the costs, these MNCs use less long-
term debt but more short-term debt than DCs. The findingindicates that firms do utilize debt
maturity as a disciplining tool to mitigate agency problem when they are identified by their
international operations.
Second, the relation betweendebt financing and internationalization can be affected by firm
size. For large-sized MNCs, the agency costs of debt are a significant determinant of the

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