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Capital Structure and Financial Risk: EVIDENCE FROM FOREIGN DEBT USE IN EAST ASIA

By George Allayannis, Gregory W. Brown and Kimberly Rodgers


Using a unique dataset of East Asian non-financial companies, this paper examines a firm's choice between local currency, foreign currency, and synthetic local currency (hedged foreign currency) debt. We also exploit the Asian financial crisis of 1997 as a natural experiment to investigate the role of debt type in financial and operating performance. We find evidence of unique, as well as common, factors that determine each debt type's use thus indicating the importance of examining debt at a disaggregated level. Specifically, the use of natural local currency debt is associated primarily with factors found by many other studies to determine total debt levels such as size, profitability, and the market-to-book ratio. Foreign currency debt is used as a complement to local currency debt by firms with substantial capital needs seeking to lower the cost or extend the maturity structure of debt. However, the use of foreign currency debt is also determined by asset and income type consistent with agency cost and financial risk management theories. The use of synthetic local debt is primarily determined by risk management concerns. Finally, contrary to anecdotal reports and existing theory, we find no evidence that unhedged foreign currency debt is associated with significantly worse performance during the Asian crisis. Surprisingly, the use of synthetic local currency debt is associated with the biggest drop in market value, possibly due to currency derivative market illiquidity during the crisis

Year: 2003
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