Capital 4

Journal of Banking & Finance 34 (2010) 621632
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Journal of Banking & Finance

journal homepage: www.elsevier.com/locate/jbf
Capital structure, equity ownership and rm performance

Dimitris Margaritis a,*, Maria Psillaki b
a
b
Department of Finance, Faculty of Business, AUT, Auckland 1020, New Zealand

Department of Economics, University of Piraeus, Piraeus 18534, Greece
a r t i c l e
i n f o
Article history:
Received 24 April 2008
Accepted 28 August 2009
Available online 1 September 2009
JEL classication:
D24
G32
Keywords:
Capital structure
Agency costs
Firm efciency
Ownership structure
DEA
a b s t r a c t
This paper investigates the relationship between capital structure, ownership structure and rm performance using a sample of French manufacturing rms. We employ non-parametric data envelopment
analysis (DEA) methods to empirically construct the industrys best practice frontier and measure rm
efciency as the distance from that frontier. Using these performance measures we examine if more efcient rms choose more or less debt in their capital structure. We summarize the contrasting effects of
efciency on capital structure in terms of two competing hypotheses: the efciency-risk and franchisevalue hypotheses. Using quantile regressions we test the effect of efciency on leverage and thus the
empirical validity of the two competing hypotheses across different capital structure choices. We also
test the direct relationship from leverage to efciency stipulated by the Jensen and Meckling (1976)
agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and rm performance.
2009 Elsevier B.V. All rights reserved.
1. Introduction
This paper uses an estimate of a rms production efciency to
assess the role of leverage in addressing agency conicts within a
rm. More specically, we rst assess the direct effect of leverage
on rm performance as stipulated by the Jensen and Meckling
(1976) agency cost model. Second, we investigate if rm efciency
has an effect on capital structure and whether this effect is similar
or not across different capital structure choices. Throughout these
analyses we consider explicitly the role of equity ownership on
both capital structure and rm performance.
Corporate nancing decisions are quite complex processes and
existing theories can at best explain only certain facets of the
diversity and complexity of nancing choices. By demonstrating
how competing hypotheses may dominate each other at different
segments of the relevant data distribution we reconcile some of
the empirical irregularities reported in prior studies thereby cautioning the standard practice of drawing inferences on capital
structure choices based on conditional mean estimates. By using
productive efciency as opposed to nancial performance indicators as our measure of (inverse) agency costs we are able to carry
* Corresponding author. Tel.: +64 9 921 9999; fax: +64 9 921 9940.
E-mail addresses: dmargaritis@aut.ac.nz (D. Margaritis), psillaki@unipi.gr (M.
Psillaki).
0378-4266/$ - see front matter 2009 Elsevier B.V. All rights reserved.
doi:10.1016/j.jbankn.2009.08.023
out tests of the agency theory that are not confounded by factors
that may not be related to agency costs.
Our methodological approach is underpinned by Leibenstein
(1966) who showed how different principal-agent objectives, inadequate motivation and incomplete contracts become sources of
(technical) inefciency measured by the discrepancy between
maximum potential output and the rms actual output. He termed
this failure to attain the production or technological frontier as Xinefciency. Based on this we model technology and measure performance by employing a directional distance function approach
and interpret the technological frontier as a benchmark for each
rms performance that would be realized if agency costs were
minimized.1 We then proceed to assess the extent to which leverage
acts as a disciplinary device in mitigating the agency costs of outside
ownership and thereby contributes to an improvement on rm performance. To properly assess the disciplinary role of leverage in
agency conicts we control for the effect of ownership structure
and ownership type on rm performance. We also allow for the possibility that at high levels of leverage the agency costs of outside
1
As we explain in Section 3, the directional distance function gives the maximum
proportional expansion of output(s) and contraction of inputs that is feasible for a
given technology thereby yielding a measure of rm efciency relative to best
practice. The directional distance function has a dual association with the prot
function and thus it provides a useful performance companion when protability is
the overall goal of the rm.
622
D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632
debt may overcome those of outside equity whereby further increases in debt can lead to an increase in total agency costs.
We turn next to analyze the effects of efciency on capital
structure using two competing hypotheses. Under the efciencyrisk hypothesis, more efcient rms may choose higher debt to
equity ratios because higher efciency reduces the expected costs
of bankruptcy and nancial distress. On the other hand, under the
franchise-value hypothesis, more efcient rms may choose lower
debt to equity ratios to protect the economic rents derived from
higher efciency from the possibility of liquidation (Demsetz,
1973; Berger and Bonaccorsi di Patti, 2006).
Thus our paper contributes to the literature in four directions:
(1) using X-inefciency as opposed to nancial indicators as a
measure of rm performance to test the predictions of the agency
cost hypothesis; (2) showing that X-inefciency as a proxy for
(inverse) agency costs is an important determinant of capital structure choices; (3) demonstrating how competing hypotheses may
dominate each other at different segments of the leverage distribution; and (4) providing new empirical evidence on the relationship
between ownership structure, capital structure and rm efciency.2
This is to our knowledge one of the rst studies to consider the
association between productive efciency, ownership structure
and leverage. In a recent study Berger and Bonaccorsi di Patti
(2006) examined the bi-directional relationship between capital
structure and rm performance for the US banking industry using
a parametric measure of prot efciency as an indicator of (inverse) agency costs while Margaritis and Psillaki (2007) investigated a similar relationship for a sample of New Zealand small
and medium sized enterprises using a technical efciency measure
derived from a non-parametric Shephard (1970) distance function.
In this paper we use a directional distance function approach on a
sample of French rms from three different manufacturing industries to address the following questions3: Does higher leverage lead
to better rm performance? Would different ownership structures
have an effect on rm performance? Does efciency exert a signicant effect on leverage over and above that of traditional nancial
measures? Are the effects of efciency and the other determinants
of corporate nancing decisions similar across different capital
structures? To what extent our results are driven by certain types
of owners e.g., family vs. non-family rms?
The reminder of the paper is organized as follows. The next section discusses the relationship between rm performance, capital
and ownership structure. Section 3 outlines the methodology used
in this study to construct measures of rms efciency. Section 4 describes the empirical model used to analyze the relationship between efciency, leverage and ownership. Section 5 describes the
data and reports the empirical results. Section 6 concludes the paper.
2. Firm performance, capital structure and ownership

Conicts of interest between owners-managers and outside
shareholders as well as those between controlling and minority
2
Most studies focus on analyzing the nancial structure-performance relationship
for large rms in the US and UK. These ndings may not be representative for
countries with different legal and institutional settings (see La Porta et al., 1998).
There is relatively little evidence for Continental Europe where the legal environment
and the nature of ownership and control are different, ownership concentration is
higher and family ownership and control are more dominant compared to US/UK (see
Faccio and Lang, 2002).
3
Civil law systems provide less investor and creditor protection than common law
systems and among the civil-law systems the French system provides the least
protection (see La Porta et al., 1998). In addition, de Jong et al. (2008) report that
creditor right protection has a signicant effect on capital structure. As legal
structures with little investor and creditor protection tend to exacerbate information
asymmetries and contracting costs, a study focusing on French rms presents some
interesting features for the purposes of our investigation.
shareholders lie at the heart of the corporate governance literature

(Berle and Means, 1932; Jensen and Meckling, 1976; Shleifer and
Vishny, 1986). While there is a relatively large literature on the effects of ownership on rm performance (see for example, Morck
et al., 1988; McConnell and Servaes, 1990; Himmelberg et al.,
1999), the relationship between ownership structure and capital
structure remains largely unexplored.4 On the other hand, a
voluminous literature is devoted to capital structure and its effects
on corporate performance see the surveys by Harris and Raviv
(1991) and Myers (2001). An emerging consensus that comes out of
the corporate governance literature (see Mahrt-Smith, 2005) is that
the interactions between capital structure and ownership structure
impact on rm values. Yet theoretical arguments alone cannot
unequivocally predict these relationships (see Morck et al., 1988)
and the empirical evidence that we have often appears to be contradictory. In part these conicting results arise from difculties empirical researchers face in obtaining direct measures of the magnitude of
agency costs that are not confounded by factors that are beyond the
control of management (Berger and Bonaccorsi di Patti, 2006). In
the remainder of this section we briey review the literature in this
area focusing on the main hypotheses of interest for this study.
2.1. Firm performance and capital structure
The agency cost theory is premised on the idea that the interests of the companys managers and its shareholders are not perfectly aligned. In their seminal paper Jensen and Meckling (1976)
emphasized the importance of the agency costs of equity arising
from the separation of ownership and control of rms whereby
managers tend to maximize their own utility rather than the value of the rm. These conicts may occur in situations where
managers have incentives to take excessive risks as part of risk
shifting investment strategies. This leads us to Jensens (1986)
free cash ow theory where as stated by Jensen (1986, p. 323)
the problem is how to motivate managers to disgorge the cash
rather than investing it below the cost of capital or wasting it
on organizational inefciencies. Thus high debt ratios may be
used as a disciplinary device to reduce managerial cash ow
waste through the threat of liquidation (Grossman and Hart,
1982) or through pressure to generate cash ows to service debt
(Jensen, 1986). In these situations, debt will have a positive effect
on the value of the rm.
Agency costs can also exist from conicts between debt and
equity investors. These conicts arise when there is a risk of default. The risk of default may create what Myers (1977) referred
to as an underinvestment or debt overhang problem. In this
case, debt will have a negative effect on the value of the rm.
Building on Myers (1977) and Jensen (1986), Stulz (1990) develops
a model in which debt nancing is shown to mitigate overinvestment problems but aggravate the underinvestment problem. The
model predicts that debt can have both a positive and a negative
effect on rm performance and presumably both effects are present in all rms.5 We allow for the presence of both effects in the
empirical specication of the agency cost model.
However we expect the impact of leverage to be negative overall. We summarize this in terms of our rst testable hypothesis.
4
Recent international studies in this area include Brailsford et al. (2002) for
Australian rms, Short et al. (2002) for UK rms, and King and Santor (2008) for
Canadian rms.
5
A common element in the models of Myers, Jensen and Stulz is the focus on the
link between the rms investment opportunity set and the effects of debt on the
value of the rm. Thus a reasonable conjecture will be that for rms with few growth
opportunities the positive effect of debt on rm performance will be more dominant
whereas the opposite effect will apply for rms with high growth opportunities (see
McConnell and Servaes, 1995).
According to the agency cost hypothesis (H1) higher leverage is expected to lower agency costs, reduce inefciency and thereby lead
to an improvement in rms performance.
2.2. Reverse causality from rm performance to capital structure
But rm performance may also affect the choice of capital structure. Berger and Bonaccorsi di Patti (2006) stipulate that more efcient rms are more likely to earn a higher return for a given
capital structure, and that higher returns can act as a buffer against
portfolio risk so that more efcient rms are in a better position to
substitute equity for debt in their capital structure. Hence under
the efciency-risk hypothesis (H2), more efcient rms choose higher leverage ratios because higher efciency is expected to lower
the costs of bankruptcy and nancial distress. In essence, the efciency-risk hypothesis is a spin-off of the trade-off theory of capital
structure whereby differences in efciency, all else equal, enable
rms to ne tune their optimal capital structure.
It is also possible that rms which expect to sustain high efciency rates into the future will choose lower debt to equity ratios
in an attempt to guard the economic rents or franchise value generated by these efciencies from the threat of liquidation (see
Demsetz, 1973; Berger and Bonaccorsi di Patti, 2006). Thus in addition to a equity for debt substitution effect, the relationship between efciency and capital structure may also be characterized
by the presence of an income effect. Under the franchise-value
hypothesis (H2a) more efcient rms tend to hold extra equity capital and therefore, all else equal, choose lower leverage ratios to
protect their future income or franchise value.
Thus the efciency-risk hypothesis (H2) and the franchise-value
hypothesis (H2a) yield opposite predictions regarding the likely
effects of rm efciency on the choice of capital structure. Although
we cannot identify the separate substitution and income effects
our empirical analysis is able to determine which effect dominates
the other across the spectrum of different capital structure choices.
2.3. Ownership structure and the agency costs of debt and equity
The relationship between ownership structure and rm performance dates back to Berle and Means (1932) who argued that
widely held corporations in the US, in which ownership of capital
is dispersed among small shareholders and control is concentrated in the hands of insiders tend to underperform. Following
from this, Jensen and Meckling (1976) develop more formally
the classical owner-manager agency problem. They advocate that
managerial share-ownership may reduce managerial incentives to
consume perquisites, expropriate shareholders wealth or to engage in other sub-optimal activities and thus helps in aligning
the interests of managers and shareholders which in turn lowers
agency costs. Along similar lines, Shleifer and Vishny (1986) show
that large external equity holders can mitigate agency conicts
because of their strong incentives to monitor and discipline
management.
In contrast Demsetz (1983) and Fama and Jensen (1983) point
out that a rise in insider share-ownership stakes may also be associated with adverse entrenchment effects that can lead to an increase in managerial opportunism at the expense of outside
investors. Whether rm value would be maximized in the presence
of large controlling shareholders depends on the entrenchment effect (Claessens et al., 2002; Villalonga and Amit, 2006; Dow and
McGuire, 2009). Several studies document either a direct (e.g.,
Shleifer and Vishny, 1986; Claessens et al., 2002; Hu and Zhou,
2008) or a non-monotonic (e.g., Morck et al., 1988; McConnell
and Servaes, 1995; Davies et al., 2005) relationship between ownership structure and rm performance while others (e.g., Demsetz
and Lehn, 1985; Himmelberg et al., 1999; Demsetz and Villalonga,
623
2001) nd no relation between ownership concentration and rm

performance.6
Family rms are a special class of large shareholders with unique incentive structures. For example, concerns over family and
business reputation and rm survival would tend to mitigate the
agency costs of outside debt and outside equity (Demsetz and
Lehn, 1985; Anderson et al., 2003) although controlling family
shareholders may still expropriate minority shareholders (Claessens et al., 2002; Villalonga and Amit, 2006). Several studies (e.g.,
Anderson and Reeb, 2003a; Villalonga and Amit, 2006; Maury,
2006; King and Santor, 2008) report that family rms especially
those with large personal owners tend to outperform non-family
rms. In addition, the empirical ndings of Maury (2006) suggest
that large controlling family ownership in Western Europe appears
to benet rather than harm minority shareholders. Thus we expect
that the net effect of family ownership on rm performance will be
positive.
Large institutional investors may not, on the other hand, have
incentives to monitor management (Villalonga and Amit, 2006)
and they may even coerce with management (McConnell and Servaes, 1990; Claessens et al., 2002; Cornett et al., 2007). In addition,
Shleifer and Vishny (1986) and La Porta et al. (2002) argue that
equity concentration is more likely to have a positive effect on rm
performance in situations where control by large equity holders
may act as a substitute for legal protection in countries with weak
investor protection and less developed capital markets where they
also classify Continental Europe.
We summarize the contrasting ownership effects of incentive
alignment and entrenchment on rm performance in terms of two
competing hypotheses. Under the convergence-of interest hypothesis (H3) more concentrated ownership should have a positive effect on rm performance. And under the ownership entrenchment
hypothesis (H3a) the effect of ownership concentration on rm performance is expected to be negative.
The presence of ownership entrenchment and incentive alignment effects also has implications for the rms capital structure
choice. We assess these effects empirically. As external blockholders have strong incentives to reduce managerial opportunism they
may prefer to use debt as a governance mechanism to control
managements consumption of perquisites (Grossman and Hart,
1982). In that case rms with large external blockholdings are
likely to have higher debt ratios at least up to the point where
the risk of bankruptcy may induce them to lower debt. Family
rms may also use higher debt levels to the extent that they are
perceived to be less risky by debtholders (Anderson et al., 2003).
On the other hand the relation between leverage and insider
share-ownership may be negative in situations where managerial
blockholders choose lower debt to protect their non-diversiable
human capital and wealth invested in the rm (Friend and Lang,
1988). Brailsford et al. (2002) report a non-linear relationship between managerial share-ownership and leverage. At low levels of
managerial ownership, agency conicts necessitate the use of
more debt but as managers become entrenched at high levels of
managerial ownership they seek to reduce their risks and they
use less debt. Anderson and Reeb (2003b) nd that insider ownership by managers or families has no effect on leverage while King
and Santor (2008) report that both family rms and rms controlled by nancial institutions carry more debt in their capital
structure.
6
McConnell and Servaes (1995) indicate that the relation between ownership
structure and rm performance may differ between low- and high-growth rms.
Their conjecture is that ownership is likely to be more important for low-growth than
for high-growth rms.
624
3. Benchmarking rm performance
4. The empirical model
In this section we explain how we benchmark rm performance. More technical details are given in the appendix. We rely
on duality theory and the use of distance functions. Directional distance functions are alternative representations of production technology which readily model multiple input and multiple output
technological relationships. They measure the maximum proportional expansion in outputs and contraction in inputs that rms
would be able to achieve by eliminating all technical inefciency
relative to the performance of their best performing peers. They
are the primal measures; their dual measures are the more familiar
value functions such as prot, cost and revenue. We interpret these
inefciencies to be the result of contracting costs, managerial slack
or oversight. They differ from allocative inefciencies which are
due to the choice of a non-optimal mix of inputs and outputs.7
We estimate the production technology and derive rm efciency measures using data envelopment analysis (DEA) which is
a non-parametric technique that employs linear programming
methods to construct a piecewise linear representation of the frontier technology. DEA is a deterministic enveloping technique and
hence it is not subject to standard econometric problems. There
are no regression parameters to estimate, there is no functional
form, no error term and no distinction between dependent and
independent variables. Hence there are no endogeneity problems
to handle. In addition, by modelling technology using a directional
distance function we allow rms to optimize in both input and output directions rather than in a single direction as for example is the
case with the more traditional Shephard type distance functions.
DEA is purely a data driven technique. It operates by tting the
tightest cone enveloping the data. At each segment of the piecewise frontier it identies a peer group of efcient rms for each
individual rm being evaluated. As it makes no accommodation
for noise it envelopes the data set fully rather than nearly the
way for example a stochastic frontier does (see Fried et al.,
2008). While it may be more sensitive to the presence of outliers,
DEA has several advantages over parametric stochastic frontier
methods; e.g., it avoids functional form misspecication problems
and the effects of endogeneity or incorrect error term distribution
assumptions that can impact signicantly on efciency measures.
More importantly, in our context DEA provides efciency measures
(performance index numbers) that are not subject to the endogeneity bias problems that arise when stochastic frontier estimates
of rm inefciency are used as explanatory variables in second
stage regressions.
A rms ability to achieve best practice relative to its peers will
be compromised in situations where it is forced to forego valuable
investment opportunities, participate in uneconomic activities that
sustain growth at the expense of protability or being subject to
other organizational inefciencies. Following Leibenstein (1966)
we use technical or X-inefciency as a proxy for the (inverse)
agency costs arising from conicts between debt holders and equity holders or from different principal-agent objectives. These conicts will give rise to resource misallocations and potential output
will be sacriced. The magnitude of agency costs will vary from
rm to rm (see Jensen and Meckling, 1976) and thus individual
rms with similar technologies can be benchmarked against their
best performing peers. As in Berger and Bonaccorsi di Patti
(2006) we view these best practice rms as those which minimize
the agency costs of outside equity and outside debt.
We use a two equation cross-section model to test the agency

cost hypotheses (H1) and (H3/H3a) and the reverse causality
hypotheses (H2 and H2a).
7
Duality theory provides the basis for the decomposition of prot efciency into
allocative efciency and the technical efciency component captured by the
directional distance function and described in terms of input and output quantities
(see Fre et al., 2008). However, we cannot measure prot efciency since we do not
have data on input and output prices.
4.1. Firm performance

The regression equation for the rm performance model is given by:
EFF i;t a0 a1 LEV i;tl a2 LEV 2i;tl a3 Z 1i;tl ui;t ;
where EFF is the rms efciency measure8; LEV is the debt to total
assets ratio; Z1 is a vector of control variables; u is a stochastic error
term; and as we explain in Section 5 we allow for lagged effects in
the specication of the empirical model.
According to the agency cost hypothesis the effect of leverage
(LEV) on efciency should be positive. However, the possibility exists that at sufciently high leverage levels, the effect of leverage
on efciency may be negative.9 The quadratic specication in (1)
is consistent with the possibility that the relationship between leverage and efciency may not be monotonic, viz. it may switch from positive to negative at higher leverage. Leverage will have a negative
effect on efciency for values of LEV < a1/2a2. A sufcient condition
for the inverse U-shaped relationship between leverage and efciency to hold is that a2 < 0.
The variables included in Z1 control for rm characteristics.
More specically, we assume that protability, size, asset structure, growth opportunities, ownership structure and ownership
type are likely to inuence rm efciency.
Protability (PR) is measured by the ratio of prots (EBIT) to total
assets. In general we expect a positive effect of (past) protability
on efciency. More protable rms are generally better managed
and thus are expected to be more efcient.
Firm size (SIZE) is measured by the natural log of the rms
sales. The effect of this variable on efciency is likely to be positive
as larger rms are expected to use better technology, be more
diversied and better managed. Larger rms may also enjoy economies of scale in monitoring top management (Himmelberg et al.,
1999). But larger rms may suffer from hierarchical managerial
inefciencies and also incur larger monitoring costs (see Williamson, 1967). Thus as in Himmelberg et al. (1999) we allow for nonlinearities in the effect of rm size on performance by including the
square of the natural log of sales in the efciency equation.
Tangibility (TANG) is measured as the ratio of xed tangible assets divided by the total assets of the rm. Tangibles are easily
monitored and provide good collateral and thus they tend to mitigate agency conicts (Himmelberg et al., 1999). As in Himmelberg
et al. (1999) we allow for nonlinearities in the effect of asset structure on rm performance by including the square of the tangibles
to assets ratio.
Intangibility (INTG) is measured by the ratio of intangible assets
to the rms equity. This variable may be considered as an indicator of future growth opportunities (see Titman and Wessels, 1988)
but its effect on rm performance is generally ambiguous
8
In the empirical part of the paper efciency is measured as 1=1 DT where DT is
the value of the directional distance function (see the Appendix). This has the
advantage of restricting the efciency measures in the 01 range and hence facilitates
comparisons with more conventional e.g., Shephard type efciency measures where
a fully efcient rm has a score of 1.
9
Highly levered rms may face nancing constraints that will prevent them from
adjusting their capital to labor ratios and thus attain more efcient production
allocations (see Spaliara, 2009). Debt nancing may also have a negative effect on rm
performance for rms with plentiful growth opportunities (see Myers, 1977; Jensen,
1986; McConnell and Servaes, 1995).
especially if these opportunities are the result of excessive risktaking behavior given the size of equity (see Myers, 1977).
Sales growth (GROWTH) this variable can also serve as a proxy
for growth prospects and investment opportunities. It is likely to
have a positive effect on rm performance (see Claessens et al.,
2002; Maury, 2006; King and Santor, 2008).
We consider both the effects of ownership concentration and
ownership type on rm performance. We measure ownership concentration (OWNC) by the percentage of shares held by those classied as large shareholders. We allow the effect of ownership to
vary in a piecewise linear form (see Morck et al., 1988) across
different segments of ownership concentration by introducing
dummy variables (Independence Indicators) dened over three different ranges of ownership holdings: low concentration (OWN1)
with no owner holding more than a 25% stake in the company;
intermediate concentration (OWN2) with the largest shareholder(s) holding between 25% and 50%; and high concentration
(OWN3) representing equity holdings in excess of 50%. Hence the
piecewise ownership structure variable (OWNER) used in the
empirical model is the product of OWNC times OWN.
To the extent that large or block owners are more capable of
monitoring and aligning management to their objectives ownership concentration would be expected to have a positive effect of
rm performance (see Jensen and Meckling, 1976; Shleifer and
Vishny, 1986; Jiraporn and Gleason, 2007). But increased ownership share may adversely affect performance because it raises the
rms cost of capital due to decreased market liquidity or decreased diversication opportunities (Fama and Jensen, 1983).
Morck et al. (1988) argue that concentrated ownership may be
associated with a negative (entrenchment) effect on rm performance where the overall effect on rm value may be positive at
low concentration but negative at high concentration levels. They
also suggest that the relationship between ownership structure
and rm performance is likely to vary across industries. These predictions are corroborated by McConnell and Servaes (1995) who
report that ownership has a positive effect on performance for
low growth rms but an insignicant albeit positive effect for high
growth rms. Demsetz (1983) on the other hand argues that
although different types of ownership may intensify agency problems, they also generate compensating advantages so that overall
ownership structure should not have any signicant effect on rm
performance. This view is supported by the empirical ndings of
Demsetz and Lehn (1985) and Demsetz and Villalonga (2001).
We control for the effect of ownership type by dividing ultimate
owners into three groups: (1) rms owned by families or related
individuals (Family); (2) rms owned by nancial institutions
banks, mutual funds, investment and insurance companies (Financial); and rms with other types of ownership (Other). The latter is
a generic category that includes non-nancial companies holding
shares in other companies (cross-holding structures). Small rms
are more likely to be family controlled and their owners are likely
to be involved in the management of the company while nancial
companies are more likely to be widely held with no owner
involvement in the companys management. Since family ownership reduces the classic owner-manager conict, agency theory
would predict a positive effect of family ownership on rm performance (Morck et al., 1988; Anderson and Reeb, 2003a; Villalonga
and Amit, 2006). This effect may be offset in situations where family managed rms forego the opportunity to hire professional managers that may be able to run the business more efciently.
Similarly, while there may be positive effects of cross-ownership
ties on rm performance (e.g., technology transfers, vertical ties),
such structures also entail offsetting entrenchment effects, increasing hierarchical group structure monitoring costs (see Williamson,
1967) or other costs associated with inefcient business
diversication.
625
4.2. The leverage model

The capital structure equation relates the debt to assets ratio to
our measure of efciency as well as to a number of other factors
that have commonly been identied in the literature to be correlated with leverage (see Harris and Raviv, 1991; Myers, 2001).
The leverage equation is given by:
LEV i;t b0 b1 EFF i;tl b2 Z 2i;tl v i;t ;
where Z2 is a vector of factors other than efciency (EFF) that correlate with leverage; v is a stochastic error term and again we allow
for lagged effects in the empirical specication of the model. Under
the efciency-risk hypothesis, efciency has a positive effect on leverage, i.e. b1 > 0; whereas under the franchise-value hypothesis, the effect of efciency on leverage is negative, i.e. b1 < 0. We use quantile
regression analysis to examine the capital structure choices of different subsets of rms in terms of these two conditional hypotheses. This is in line with Myers (2001) who emphasized that there
is no universal theory but several useful conditional theories
describing the rms debtequity choice. These different theories
will depend on which economic aspect and rm characteristic we
focus on.
The variables included in Z2 control for rm characteristics that
are likely to inuence the choice of capital structure (see Harris
and Raviv, 1991; Rajan and Zingales, 1995). They are the same variables used in the agency cost model such as protability, size, asset
structure, growth opportunities, and ownership structure and type.
There are conicting theoretical predictions on the effects of
protability on leverage (see Harris and Raviv, 1991; Rajan and
Zingales, 1995; Booth et al., 2001). Myers (1984) predicts a negative relationship because he argues rms will prefer to nance
new investments with internal funds rather than debt. According
to his pecking order theory rms nancing choices follow a hierarchy in which internal cash ows (retained earnings) are preferred
over external funds, and debt is preferred over equity nancing.
Thus more protable rms are more likely to nance their growth
by retained earnings whereas less protable rms will use more
debt nancing. Most empirical studies report a negative relationship between protability and leverage although this association
may be complicated by the presence of strong investment opportunities (see Booth et al., 2001).
The effect of size on leverage is expected to be positive. As larger rms are more diversied and tend to fail less often than smaller ones, we would expect that they have better access to credit
and are able to sustain more debt (Friend and Lang, 1988).
The tangibility of the rms assets can serve as a proxy for the
agency costs of debt and the costs of nancial distress (Myers,
1977; Booth et al., 2001). Firms with more tangible assets have
in general greater ability to secure debt as these assets can be used
as collateral (Jensen and Meckling, 1976). Thus asset tangibility is
expected to have a positive effect on leverage (Titman and Wessels,
1988). Arguably the use of collateral as a device to lower agency
costs associated with debt may play an even more important role
in countries like France where creditor protection is relatively
weak in comparison to other developed countries (see La Porta
et al., 1998).
The degree of asset intangibility measured by the ratio of intangible assets to total assets can serve as both a proxy for growth
opportunities and as a source of collateral. Growth opportunities
are generally associated with an increase in the agency costs of
debt and are thus expected to have a negative effect on leverage
(Myers, 1977). To the extent that intangibles may be perceived
by lenders as providing some form of security they will have a positive effect on leverage. The overall effect of intangibles on leverage is likely to be negative; especially for rms that have greater
opportunities to expropriate bondholder wealth by substituting
626
safer assets for riskier assets (see Booth et al., 2001; Anderson et al.,
2003).
Sales growth may be considered as another indicator of future
growth opportunities. Low growth rms will have less opportunities to substitute low risk for high risk (high return) investments;
hence they should incur lower agency costs of debt and should
be able to carry more debt in their capital structure. High growth
rms on the other hand may face a more intense debt overhang
problem of the type described by Jensen and Meckling (1976)
and Myers (1977). But if recontracting costs are kept low the
underinvestment incentives are much smaller (see Booth et al.,
2001). And if growth opportunities are viewed as an indicator of
a successful business the effect of growth on leverage may be positive. This effect may be reinforced by owners of smaller private
especially closely held companies who are fearful to lose control
or are unable to issue new equity and thus opt to fund growth
opportunities with leverage (see Giannetti, 2003).
Ownership structure may have a positive or a negative effect on
the amount of debt held in the rms capital structure. Firms where
shareholders rights are weak are expected to carry more debt in
their capital structure as these rms are expected to incur higher
agency costs (Jiraporn and Gleason, 2007). Because of their longterm commitments to the rm, family owned rms have stronger
incentives to mitigate agency conicts with debt claimants and as
a result they may face lower costs of debt nancing (Anderson
et al., 2003). Thus family rms may carry more debt in their capital
structure. On the other hand diversied shareholders have incentives to expropriate debtholder wealth by investing in risky projects (Jensen and Meckling, 1976) in which case we would expect
debt holders to require a higher return. Similarly, when leverage
is high the risk of bankruptcy increases which may then induce
rms to lower debt. For example, an increase in insider ownership
may push rms to reduce leverage for fear of bankruptcy or loosing
control to banks (Friend and Lang, 1988). Firms owned by nancial
institutions may have better access to nance but nancial institutions also tend to be risk averse in their investment strategy.
5. Empirical results
In this section we provide answers to the questions of Section 1.
As stated in the introduction we are interested in examining how
capital structure choices affect rm performance as well as the reverse relationship between efciency and leverage. More precisely,
we want to examine if leverage has a positive effect on efciency
and whether the reverse effect of efciency on leverage is similar
across the spectrum of different capital structures. We are also
interested in assessing empirically the effects of ownership structure on capital structure and on rm performance.
As explained in Section 3, we measure rm efciency using the
directional distance function. We choose to estimate the directional distance function using deterministic non-parametric frontier methods (DEA). The DEA model is constructed using a single
output (value-added) and two inputs (capital and labor) technology. The labor input is measured by the total number of full-time
equivalent employees and working proprietors whereas capital is
measured by the rms xed tangible assets. We set the elements
of the directional vector (g) equal to the sample averages of the input and output variables (see the Appendix).
Table 1 (Panel A) gives the descriptive statistics of the rms in
the sample for 2005. The data comprises samples of French rms
from two traditional manufacturing industries (textiles and chemicals) and a growth industry (computers and related activities and
R&D). We collect data from 2002 to 2005 to allow for sufcient
lagged dynamic structure to resolve the identication and endogeneity problems in the empirical specication of the cross-section
model. We limit the data to all rms that report non-negative values for all inputs and output. The source of the data is the Diane
database compiled by the Bureau van Dijk.10 On average rms in
the chemicals industry are much larger and more capital intensive
than rms in the computers and textiles industries. Firms in the
computers and R&D industry have higher intangibles to assets ratios
and carry on average more debt in their capital structure. Protability appears to be much higher on average in the textiles industry but
its distribution is highly skewed note that the median chemicals
rm is more protable than the median textiles rm. Firms in
the computers industry appear to be closer on average to the technological frontier compared to those in the chemicals and textiles
industries. We do not nd any signicant differences in efciency
performance over time (i.e. from 2002 to 2005). There appears to
be a slight improvement in performance for rms in the chemicals
industry and a slight decline on average for rms in the textiles
industry.
Panel B of Table 1 shows that family ownership is highest in the
textiles industry and comparatively low in the chemicals industry.
While ownership is quite concentrated across all industries, rms
in the computers and R&D industry appear to have the least concentrated ownership structure. This observation is consistent with
the predictions of the Mahrt-Smith (2005) model. For growth rms
where long-term project discovery and development investments
are more important than short-term projects, ownership is likely
to be more dispersed as managers are motivated to protect these
long-term rents.
Table 2 shows how efciency, protability and leverage vary
across family vs. non-family rms; and across rms with dispersed
(<25%) vs. more concentrated (>25%) ownership.11 We nd that
family rms are much more efcient and more protable than
non-family rms. These differences are statistically signicant on
average across all industries. We also nd that family rms in the
computers and R&D and textiles industries carry less debt in their
capital structure than non-family rms and these differences are statistically signicant on average. This is an interesting nding since
family rms in both industries are also shown to be more efcient.
As Anderson et al. (2003) point out family monitoring and control
may result in better operating performance for family rms and this
may also mitigate the owner-manager agency conicts and hence
the need to use debt as a disciplinary device. There is no evidence
of statistically different debt ratios between family and non-family
rms in chemicals.
Table 2 shows that the net effect of ownership concentration on
efciency varies across industries. We nd that efciency is higher
on average for rms with more concentrated ownership in computers and R&D and for rms with more dispersed ownership in
chemicals. These differences in efciency between higher and lower concentration are statistically signicant on average. On the
10
We collect data for rms with at least ve employees and an annual turnover
greater than EUR 200,000. The majority of these rms are small (dened as those with
550 employees), followed by medium-sized rms (those with 51500 employees).
In particular, 60% of the rms in chemicals are small, 32% are medium-sized and 8%
are large rms (more than 500 employees). In computers and R&D, 85% of the rms
are small, 13% are medium and 2% are large. In textiles, 75% of the rms are small, 23%
are medium and 2% are large.
11
As in Claessens et al. (2002) and Anderson et al. (2003) we do not separate family
ownership from family management and we do not expect this distinction to be
important in smaller unlisted rms. Faccio and Lang (2002) report that about twothirds of French family controlled rms have top managers from the controlling
family and this ratio is expected to be much higher for unlisted rms. Similarly, we do
not expect a signicant wedge between ownership and control for the type of rms
we consider and hence we do not control for mechanisms that may be used to
enhance control. Such mechanisms (e.g., cross-holdings, dual class shares) are rare in
France (see Faccio and Lang, 2002) or are used infrequently (e.g., pyramidal
structures) especially by smaller family rms.
627
Table 1
Descriptive statistics. The table reports the 2005 sample statistics for inputs, output, efciency measures and rm characteristics for the three industries (Chemicals, Computers
and R&D, and Textiles). In Panel A, output (Y) is value-added; labor (L) is the number of employees; tangibles (K) is xed tangible assets; Y/L is labor productivity; K/L is capital
intensity; efciency is measured as 1/(1 + distance function value) and is reported for 20032005; prot is earnings before interest and taxes; PR is the prot to assets ratio; LEV is
the debt to assets ratio; INTG is the intangibles to total assets ratio; TANG is the tangibles to equity ratio; growth is the percentage change in sales revenue; OWNC is the
proportion of largest shareholder(s) equity ownership. In Panel B all variables are 0/1 dummy variables, OWN1 denotes low, less than 25% ownership concentration; OWN2
denotes intermediate, greater than 25% but less than 50% ownership concentration; OWN3 denotes high, greater than 50% ownership concentration; family, nancial and other
are ownership type variables.
Chemicals
Mean
Computers and R&D
Textiles
Std. Dev.
Median
Mean
Std. Dev.
Median
Mean
Std. Dev.
Median
63789.21
467.06
37225.20
209.82
123.25
0.24
0.24
0.23
258236.50
51290.61
416953.10
191354.70
38017.68
0.13
0.26
0.10
3.58
0.30
0.27
2363.00
37.00
719.00
65.05
20.07
0.94
0.92
0.91
8338.50
213.00
5621.00
2928.50
38.50
0.06
0.56
0.01
0.32
0.05
0.90
4413.77
55.95
341.01
78.78
7.11
0.87
0.86
0.87
8245.26
395.53
7134.45
4175.51
643.29
0.08
0.69
0.08
0.23
0.14
0.65
21226.04
235.44
2888.03
130.61
83.32
0.17
0.16
0.16
35689.20
5338.94
44318.08
20492.68
5595.82
0.26
0.42
0.14
3.88
0.34
0.30
997.00
15.00
35.00
64.14
2.06
0.93
0.92
0.93
1816.00
75.00
1092.00
679.00
11.00
0.05
0.65
0.01
0.08
0.09
0.52
2568.00
51.09
711.32
51.43
11.95
0.78
0.79
0.80
9283.36
432.97
6407.74
3271.51
252.55
0.15
0.56
0.05
0.37
0.02
0.68
6491.76
94.16
2186.38
36.71
25.70
0.22
0.20
0.19
21864.07
3192.63
19825.20
8747.22
1299.80
0.05
0.30
0.10
2.36
0.30
0.27
976.00
23.00
137.50
41.95
5.42
0.86
0.86
0.87
3129.00
71.00
1879.50
867.50
15.00
0.05
0.54
0.01
0.15
0.00
0.51
OWN2
OWN3
OWN1
OWN2
OWN3
OWN1
OWN2
OWN3
Panel B: ownership concentration tabulation by ownership type (%)

3.87
24.16
71.97
11.83
23.63
64.54
4.92
21.90
72.21
Of which:
Family
Financial
Other
1.94
0.42
1.51
4.22
2.65
4.96
15.48
2.27
5.88
35.58
4.92
24.04
2.80
1.14
0.98
17.74
0.59
3.57
40.21
9.18
22.82
Obs.
1188
Panel A: summary statistics

Output (Y)
17855.81
Labor (L)
166.24
Tangibles (K)
10101.60
Y/L
94.89
K/L
47.76
Efciency_05
0.82
Efciency_04
0.81
Efciency_03
0.81
Revenue
69714.61
Prot
5973.86
Total assets
66863.22
Total debt
33239.00
Intangibles
3771.61
PR
0.07
LEV
0.58
INTG
0.04
TANG
0.70
Growth
0.07
OWNC
0.76
OWN1
18.86
0.76
4.50
13.89
8.00
50.18
3253
1705
other hand there is no statistical evidence of such differences in

efciency for rms in the textiles industry.
We turn next to empirically assess the relationship between
leverage and efciency controlling for the effect of ownership
and other rm characteristics. The simultaneous equation system
given by (1) and (2) above requires adequate structure to be properly identied. An obvious way to deal with the identication
problem is by imposing relevant restrictions on the structural system. Undoubtedly the task of both properly identifying the system
of equations for efciency and leverage and ensuring that the conditioning variables entering these two equations are indeed exogenous is fraught with difculty.
We have dealt with the identication and endogeneity issues in
the following way. Arguably both the effect of leverage on efciency and the reverse effect from efciency on leverage are not
expected to be instantaneous. Time lags are also likely to prevail
when considering the effect of other conditioning variables on efciency and leverage. For example, the pecking order theory states
that it is past not current protability that is envisaged to have
an effect on leverage.12
An explicitly account of the dynamics in the relationship between efciency and leverage would thus help solve the identica-
tion problem while rendering a structure that is more robust to

simultaneity bias problems. Based on this we have proceeded to
estimate the agency cost and leverage equations using both static
and dynamic model specications.13 We have estimated structural
forms of these equations using instrumental variables techniques
and their dynamic or reduced form specications using OLS and
quantile regressions. The results we obtained from different models
or estimation techniques appear to be quite robust, particularly in
relation to assessing the predictions of the agency cost and efciency
hypotheses. We only report the results obtained from estimating dynamic models for both the efciency and leverage equations. The
regressors in these equations are predetermined (lagged endogenous
or exogenous) variables thereby circumventing simultaneity problems. Parsimonious forms of these equations were obtained by
applying a standard general to specic methodology starting with
models that used variables with up to three year lags. We use
two-year average to mitigate the effects of year to year uctuations
in some of these variables.
Table 3 reports the estimates of the rm performance equation.
We report both cross-section results (Panel A) and panel estimates
with random-effects (Panel B). The panel estimates use larger samples of rms-years. The results show that leverage has a signicant
12
Given the stability of ownership patterns that we observe in our sample we treat
ownership as an exogenous variable rather than the endogenous outcome of
competitive selection as advocated by Demsetz (1983). This is contrary to the
results of Demsetz and Lehn (1985), Himmelberg et al. (1999) and Demsetz and
Villalonga (2001) for large publicly traded US rms but consistent with the stable
ownership structures of Continental European rms and in particular smaller unlisted
companies that comprise the bulk of the rms in our sample.
13
Given the limited number of time periods for which data is available we focus on
cross-section rather than panel model estimates. This ensures sufcient dynamic
conditioning of the rm performance and leverage equations. In addition, it would
have been difcult to apply quantile regression methods to panel data as quantiles of
convolutions of random variables are highly intractable objects (see Koenker and
Hallock, 2001). For completeness, we present panel estimates for the rm performance model.
628
Table 2
Distribution of efciency, protability and leverage by ownership type and ownership concentration. The table reports the 25th (p25), 50th (p50) and 75th (p75) percentiles of the
efciency, prot to assets ratio (protability) and debt to assets ratio (leverage) distributions by ownership type (family vs. non-family) and by ownership concentration (less
than 25% vs. greater than 25%). Also reported are the means and standard deviations by ownership type and concentration and the F-statistics with p-values in brackets for testing
the hypotheses of equal means across ownership types and concentration, respectively.
p25
*
**
p50
p75
Mean
Std. Dev.
F-statistics
Obs.
0.952
0.603
0.934
0.720
0.984
0.850
0.975
0.935
0.994
0.963
0.990
0.985
0.949
0.751
0.927
0.815
0.097
0.257
0.257
0.237
227.74*
(0.000)
10.05*
(0.002)
412
776
46
1142
Protability
Family
Non-family
Low (<25%) concentration
High (>25%) concentration
0.012
0.002
0.012
0.004
0.072
0.052
0.063
0.056
0.137
0.127
0.142
0.129
0.083
0.057
0.079
0.065
0.124
0.132
0.106
0.131
9.900**
(0.017)
0.43
(0.514)
412
776
46
1142
Leverage
Family
Non-family
0.387
0.412
0.370
0.402
0.560
0.565
0.539
0.565
0.745
0.736
0.655
0.736
0.571
0.579
0.541
0.579
0.229
0.266
0.259
0.258
0.19
(0.666)
0.95
(0.330)
412
776
46
1142
Panel B: computers and R&D

Efciency
Family
Non-family
0.892
0.726
0.790
0.842
0.946
0.880
0.886
0.929
0.978
0.953
0.953
0.971
0.915
0.803
0.840
0.868
0.098
0.209
0.161
0.167
405.59*
(0.000)
6.65*
(0.010)
1806
1447
264
2989
Protability
Family
Non-family
0.020
0.018
0.047
0.008
0.083
0.048
0.034
0.073
0.173
0.135
0.110
0.156
0.092
0.019
0.004
0.064
0.184
0.267
0.231
0.227
75.30*
(0.000)
14.95*
(0.000)
1806
1447
264
2989
Leverage
Family
Non-family
0.484
0.515
0.428
0.500
0.629
0.681
0.608
0.655
0.768
0.843
0.751
0.814
0.648
0.739
0.596
0.697
0.312
0.521
0.276
0.430
36.98*
(0.000)
13.87*
(0.000)
1806
1447
264
2989
Panel C: textiles
Efciency
Family
Non-family
0.825
0.531
0.734
0.705
0.919
0.745
0.892
0.875
0.967
0.898
0.952
0.954
0.870
0.688
0.817
0.799
0.139
0.246
0.186
0.208
379.23*
(0.000)
0.49
(0.483)
1046
659
66
1639
Protability
Family
Non-family
0.014
0.002
0.007
0.008
0.064
0.045
0.040
0.056
0.132
0.113
0.121
0.123
0.078
0.049
0.061
0.067
0.210
0.129
0.145
0.185
9.45*
(0.002)
0.07
(0.796)
1046
659
66
1639
Leverage
Family
Non-family
0.351
0.380
0.354
0.364
0.533
0.546
0.556
0.536
0.690
0.726
0.698
0.702
0.542
0.580
0.548
0.557
0.246
0.347
0.267
0.302
6.63*
(0.010)
0.06
(0.810)
1046
659
66
1639
Panel A: chemicals
Efciency
Family
Non-family
Indicates signicance at the 1% level.

Signicant at the 5% level.
effect on efciency. This effect is positive at the mean of leverage

for each industry and it remains positive over the entire relevant
range of leverage values. Thus we nd support for the agency cost
hypothesis (H1) that higher leverage is associated with improved
rm performance. Based on the magnitude of estimated coefcients, we observe that the effect of debt on efciency appears to
be stronger for rms in the traditional (chemicals and textiles)
industries. This nding corroborates the conjecture of McConnell
and Servaes (1995), namely that debt has a fundamentally different role on performance between rms with few and those with
many growth opportunities (see footnote 5 above). The nding
that debt is more important for rm performance for industries
with less growth opportunities is also consistent with the theoretical predictions of Jensen (1986) and Stulz (1990) (see also Booth
et al., 2001).
Protability has a positive and signicant effect on efciency for
all industries. The effect of size is mostly signicant in chemicals
and is non-monotonic, i.e. positive for smaller rms but negative
for larger rms. Similarly, asset tangibility has a non-monotonic effect; negative at low xed tangibles to total assets ratios and positive at high tangibles to asset ratios. An explanation for this nding
is that a high proportion of hard tangible assets would reduce the
extent of the rms growth opportunities and as a result diminish
the agency costs of managerial discretion (see Booth et al., 2001).
629
Table 3
The rm performance model. Panel A reports least squares estimates with heteroskedasticity-consistent standard errors (SEs). The dependent variable is the rms efciency score
in 2005 computed as 1/(1 + distance function value). LEV_AVG(1) is the debt to assets average ratio for 2003 and 2004; PR_AVG(1) is the prot to assets average ratio for 2003
and 2004; LOGR(1) is log sales revenue in 2004; TANG(1) is the tangibles to assets ratio in 2004; INTG(1) is the intangibles to equity ratio in 2004; GROWTH_AVG(1) is
average sales growth for 2003 and 2004; Owner1 = OWN1 * OWNC, Owner2 = OWN2 * OWNC, and Ownwr3 = OWN3 * OWNC capture the piecewise linear effect of ownership
structure where OWN1 is a dummy variable that denotes low <25% ownership concentration; OWN2 denotes intermediate >25% but <50% ownership concentration; OWN3
denotes high >50% ownership concentration; and OWNC is the percentage of largest shareholder equity ownership; family and nancial are ownership type dummy variables.
Panel B reports random-effects GLS panel regression estimates with Huber-White robust standard errors (SEs) for the period 20022005. The dependent variable is the rms
efciency score in 2005 computed as 1/(1 + distance function value). LEV_AVG(1) is a two-year average debt to assets ratio with one period lag; PR_AVG(1) is a two-year
average prot to assets ratio with one period lag; LOGR(1) is log sales revenue with one period lag; TANG(1) is the tangibles to assets ratio with one period lag; INTG(1) is the
intangibles to equity ratio with one period lag; GROWTH_AVG(1) is a two-year average sales growth rate with one period lag.
Dependent variable: efciency (EFF)
Variable
Panel A: cross-section estimates

LEV_AVG(1)
LEV_AVG(1)_Square
PR_AVG(1)
LOGR(1)
LOGR(1)_Square
TANG(1)
TANG(1)_Square
INTG(1)
Growth_AVG(1)
Owner1
Owner2
Owner3
Family
Financial
Constant
R-squared
F-statistic
Obs.
Chemicals
***
Textiles
SE
Coefcient
SE
Coefcient
SE
0.0716*
0.0002
0.0910**
0.1469*
0.0128*
0.9508*
0.8516*
0.0015*
0.0089
0.0009**
0.0004***
0.0004*
0.0148**
0.0190
0.6393*
0.792
261.9*
1188
0.0180
0.0002
0.0386
0.0387
0.0021
0.0689
0.1037
0.0004
0.0116
0.0004
0.0002
0.0001
0.0076
0.0164
0.1669
0.0423*
0.0036*
0.0345*
0.0140
0.0071**
1.5487*
2.2679*
0.0004
0.0018
0.0007**
0.00003
0.00004
0.0099**
0.0008
1.2221*
0.653
252.0*
3253
0.0100
0.0012
0.0112
0.0462
0.0029
0.1298
0.3914
0.0004
0.0093
0.0003
0.0002
0.0001
0.0049
0.0101
0.1815
0.0769*
0.0175*
0.1101**
0.0654
0.0109**
1.4275*
1.3937*
0.0003
0.0022
0.0002
0.0001
0.0001
0.0261*
0.0087
1.0706*
0.738
226.9*
1705
0.0226
0.0048
0.0478
0.0795
0.0048
0.0654
0.1160
0.0007
0.0145
0.0003
0.0002
0.0001
0.0072
0.0137
0.3288
0.0218
0.0096
0.0199
0.0287
0.0015
0.0565
0.0799
0.0002
0.0060
0.0003
0.0002
0.0001
0.0088
0.0142
0.1287
0.0330*
0.0026*
0.0216*
0.0208
0.0072*
1.5829*
2.2904*
0.0001
0.0179*
0.0004***
0.0001
0.00001
0.0079**
0.0011
1.1822*
0.694
2655.6*
5530
0.0069
0.0090
0.0063
0.0420
0.0026
0.1051
0.3157
0.0002
0.0045
0.0002
0.0001
0.0001
0.0037
0.0082
0.1663
0.1144*
0.0488*
0.0637**
0.0443
0.0091**
0.3271*
0.1148*
0.0003
0.0499*
0.0002
0.0001
0.0002
0.0438*
0.0039
1.0280*
0.688
2210.19*
3069
0.0192
0.0126
0.0284
0.0618
0.0038
0.0206
0.0124
0.0004
0.0088
0.0003
0.0002
0.0001
0.0081
0.0135
0.2488
Panel B: panel estimates 20022005

LEV_AVG(1)
0.0898*
LEV_AVG(1)_Square
0.0203**
PR_AVG(1)
0.0443**
LOGR(1)
0.1578*
LOGR(1)_Square
0.0131*
TANG(1)
0.8150*
TANG(1)_Square
0.6847*
INTG(1)
0.0003
Growth_AVG(1)
0.0159*
Owner1
0.0008*
Owner2
0.0005**
Owner3
0.0003*
Family
0.0177**
Financial
0.0256***
Constant
0.5487*
R-squared overall
0.802
Wald Chi-square (14)
2573.48*
Obs.
2138
**
Computers and R&D
Coefcient

The effect of intangibles is negative and signicant only for rms in

the chemicals industry while the effect of growth is insignicant
across all industries in the cross-section regressions.
Turning now to the ownership results we nd that the contrasting effects of convergence of interest (H3) and ownership entrenchment (H3a) vary across industries. Ownership concentration has a
positive and signicant effect on rm performance across different
concentration ratios in the chemicals industry but its strength
diminishes at higher concentration segments suggesting the presence of entrenchment effects (note that differences in estimated
coefcients are only statistically signicant between low and high
concentration with an F-statistic value of 2.96). On the other hand
for rms in the computers industry we nd that low ownership
concentration has a negative effect on rm performance. Higher
ownership concentration has an insignicant effect in this industry
suggesting the presence of offsetting entrenchment and incentive

alignment effects.14 For rms in the textiles industry we nd no evidence that ownership concentration has a signicant effect on performance across the three concentration segments. The absence of
a statistically signicant relationship between ownership concentration and efciency for textiles and in part for rms in computers and
R&D appears to support the views expressed by Demsetz (1983).
However we nd that ownership type has a signicant effect on rm
performance. The results of Table 3 show quite consistently that
family rms perform better on average in comparison to non-family
rms.
14
This nding provides partial support for the conjecture of McConnell and Servaes
(1995), namely that the effect of ownership on performance should be more
important for low-growth rather than high-growth rms (see also footnote 6 above).
630
Table 4
The leverage (LEV) model. The table reports least squares (OLS) estimates with heteroskedasticity-consistent standard errors and simultaneous quantile regression estimates at
leverage quantiles .20 (q20), .50 (q50) and .80 (q80) with bootstrap standard errors (SEs). The dependent variable (LEV) is the debt to assets ratio in 2005. Efciency(1) is the
rms efciency score in 2004 computed as 1/(1 + distance function value); PR_avg(1) is the prot to assets average ratio for 2003 and 2004; LogR(1) is log sales revenue in
2004; tang(1) is the tangibles to equity ratio in 2004; intg(1) is the intangibles to assets ratio in 2004; GR_avg(1) is average sales growth for 2003 and 2004;
Owner1 = OWN1 * OWNC, Owner2 = OWN2 * OWNC, and Ownwr3 = OWN3 * OWNC capture the piecewise linear effect of ownership structure where OWN1 is a dummy variable
that denotes low <25% ownership concentration; OWN2 denotes intermediate >25% but <50% ownership concentration; OWN3 denotes high >50% ownership concentration; and
OWNC is the percentage of largest shareholder equity ownership; family and nancial are ownership type dummy variables.
Coefcient
SE
OLS
***
SE
Coefcient
q20
Panel A: chemicals OLS and quantile regression estimates

0.0569
Efciency(1)
0.1840*
PR_avg(1)
0.848*
0.0847
**
0.0084
LogR(1)
0.0169
*
0.0027
tang(1)
0.0071
0.0659
intg(1)
0.187*
0.0289
GR_avg(1)
0.0870*
owner1
0.0004
0.0012
owner2
0.0003
0.0006
**
0.0003
owner3
0.0007
Family
0.0060
0.0225
Financial
0.0054
0.0248
0.1243
Const.
0.2637**
R-squared
0.23
**
Coefcient
Coefcient
SE
q80
0.0746
0.1035
0.0114
0.0178
0.0845
0.0521
0.0022
0.0009
0.0005
0.0394
0.0418
0.1753
0.1833*
0.7727*
0.0179
0.0143
0.1867**
0.0753**
0.0012
0.0004
0.0008***
0.0164
0.0302
0.2287
0.14
0.0738
0.0893
0.0130
0.0166
0.0947
0.0313
0.0013
0.0007
0.0004
0.0316
0.0286
0.1830
0.2518*
0.866*
0.0212
0.0189**
0.231***
0.0491
0.0008
0.0006
0.0009*
0.0057
0.0064
0.3113
0.15
0.0879
0.1061
0.0135
0.0093
0.1219
0.0428
0.0023
0.0007
0.0004
0.0289
0.0348
0.2031
Panel B: computers and R&D OLS and quantile regression estimates

0.0793
0.1527***
Efciency(1)
0.2826*
0.1581
0.312*
PR_avg(1)
0.897*
LogR(1)
0.0076
0.0105
0.0148
tang(1)
0.0060
0.0043
0.0184
intg(1)
0.0607
0.0938
0.0010
GR_avg(1)
0.0436
0.0494
0.1326*
owner1
0.0002
0.0011
0.0014
0.0005
0.0002
owner2
0.0016*
0.0004
0.0008**
owner3
0.0025*
Family
0.0154
0.0193
0.0025
Financial
0.0060
0.0581
0.0330
**
0.1358
0.2022
Const.
0.3081
R-squared
0.22
0.05
0.0803
0.0767
0.0096
0.0232
0.0771
0.0302
0.0010
0.0009
0.0004
0.0212
0.0358
0.1251
0.2088*
0.6829*
0.0200*
0.0189
0.0586
0.0746*
0.0018**
0.0004
0.0008*
0.0237
0.0415**
0.3195*
0.11
0.0692
0.0690
0.0079
0.0196
0.0575
0.0230
0.0008
0.0005
0.0002
0.0168
0.0110
0.1252
0.1679*
0.986*
0.0027
0.0059
0.0767***
0.0351
0.0019***
0.0010*
0.0011*
0.042**
0.0270
0.6488*
0.17
0.0414
0.0758
0.0076
0.0080
0.0451
0.0278
0.0011
0.0003
0.0002
0.0176
0.0347
0.1105
Panel C: textiles OLS and quantile regression

Efciency(1)
0.1769*
PR_avg(1)
0.868 *
LogR(1)
0.0225**
tang(1)
0.0350*
intg(1)
0.1812**
GR_avg(1)
0.0366
owner1
0.0001
owner2
0.0008
owner3
0.0006***
Family
0.0296
Financial
0.0440
Const.
0.2203***
R-squared
0.21
0.0883
0.0849
0.0154
0.0185
0.1603
0.0593
0.0009
0.0008
0.0005
0.0286
0.0299
0.1816
0.2506*
0.546*
0.0315*
0.0659*
0.2280**
0.1094***
0.0007
0.0009
0.0007*
0.0127
0.0398
0.0327
0.11
0.0614
0.1169
0.0124
0.0190
0.1129
0.0584
0.0015
0.0007
0.0004
0.0233
0.0265
0.1538
0.3018*
0.773*
0.0284
0.0513*
0.0946
0.0334
0.0018
0.0008
0.0008**
0.0293
0.0255
0.2103
0.16
0.0850
0.1329
0.0123
0.0142
0.1460
0.0407
0.0015
0.0006
0.0003
0.0248
0.0286
0.1579
estimates
0.0675
0.1270
0.0092
0.0074
0.0908
0.0443
0.0009
0.0006
0.0003
0.0194
0.0286
0.1229
0.1675**
0.593*
0.0255**
0.0067
0.181**
0.1597*
0.0003
0.0008
0.0008***
0.0065
0.0149
0.0115
0.09
SE
q50
0.0799
0.310*
0.0242
0.0393**
0.1590
0.1082***
0.0003
0.0007
0.0003
0.0081
0.0416
0.0541
0.06

Table 4 reports the estimates of the leverage model. We report

OLS results and estimates for three leverage quantiles (0.20, 0.50
and 0.80); estimates for other quantiles are available from the
authors. The results from the OLS and quantile regressions show
that the effect of efciency on leverage is positive and signicant
in the low to high range of the leverage distribution supporting
the efciency-risk hypothesis (H2): more efcient rms with relatively low levels of debt tend to choose higher debt ratios because
higher efciency lowers the expected costs of bankruptcy and
nancial distress. However there is no evidence to suggest that
the franchise-value effect (H2a) outweighs the efciency-risk effect
even for the most highly levered rms.
Consistent with pecking order theory, protability has a negative effect on leverage for all industries on average and also across
different capital structures. The effect of protability appears to be
stronger for rms with higher debt. For example, the F-statistic for
the null hypothesis of no difference in protability coefcients in
the chemicals industry is 4.74 at leverage quantiles (.20 and .80)
which is signicant at the 5% level. We also nd that a higher proportion of tangible assets are more important in increasing debt
capacity for the smaller typically riskier rms in the textiles industry. The effect of intangible assets is negative in chemicals, positive
in textiles and generally not signicant for rms in computers and
R&D. Growth has a positive effect on leverage on average (OLS estimates) for rms in chemicals as well as for low to medium leveraged rms across all industries. The owners of these rms appear
to opt for debt nance for reasons we have discussed earlier on.
We nd that in general rms with more concentrated ownership carry more debt in their capital structure. For mid- to highleveraged rms in the computers and R&D industry we nd that
631
low ownership concentration has a negative effect on leverage. Finally, our results show that the effect of ownership type on leverage is generally non-signicant across all industries with the
exception of some rms in computers and R&D. In particular, we
nd that among the highly levered rms in this industry, family
rms opt to carry less debt in their capital structure.
(2008) we assume that rms employ N inputs denoted by

x x1 ; . . . ; xN 2 RN to produce M outputs denoted by y
15
Technology may be characterised by a technoly1 ; . . . ; yM 2 RM
.
ogy set T, which is the set of all feasible inputoutput combinations, i.e.
6. Conclusion
The technology set is assumed to satisfy a set of reasonable axioms. Here we assume that T is a closed, convex, nonempty set with
inputs and outputs which are either freely or weakly disposable.16
To provide a measure of efciency we use a directional technology
distance function approach. This function completely characterizes
technology (i.e., it is equivalent to T), it is dual to the prot function
and allows for adjustment of inputs and outputs simultaneously.
Thus the directional distance function entails an extremely exible
description of technology without restricting rms to optimize by
either increasing outputs proportionately without changing inputs
or by decreasing inputs proportionally for given outputs. To dene
it we need to specify a directional vector, denoted by g = (gx, gy)
where g x 2 RN and g y 2 RM
. This vector determines the direction in
which technical efciency is assessed, i.e. the path of the projection
of the observed data to the frontier of technology. The directional
technology distance function is dened as:
This paper investigates the relationship between efciency,

leverage and ownership structure. This analysis is conducted using
directional distance functions to model the technology and obtain
X-inefciency measures as the distance from the efcient frontier.
We interpret these measures as a proxy for the (inverse) agency
costs arising from conicts between debt holders and equity holders or from different principal-agent objectives. Using a sample of
French rms from low- and high-growth industries, we consider
both the effect of leverage on rm performance as well as the reverse causality relationship while controlling for the effects of
ownership structure and ownership type. We nd support for the
core prediction of the Jensen and Meckling (1976) agency cost
hypothesis in that higher leverage is associated with improved efciency over the entire range of observed data. The contrasting
alignment and entrenchment agency effects of ownership concentration vary across industries and across concentration ratios. We
nd that while more dispersed rms face higher agency costs in
computers and R&D; the reverse is true for rms in the chemicals
industry. Moreover, we nd that family rms outperform non-family rms.
We have also investigated the reverse causality relationship
from efciency to leverage in terms of two competing hypotheses:
the efciency-risk hypothesis and the franchise-value hypothesis.
Using quantile regression analysis we show that the effect of efciency on leverage is positive in the low to high ranges of the leverage distribution supporting the efciency-risk hypothesis. We also
nd that more concentrated ownership is generally associated
with more debt in the capital structure. However, we generally nd
no evidence that ownership type has an effect on leverage choices.
Our methodology has gone some way in reconciling some of the
empirical irregularities reported in prior studies. In particular, we
have shown how competing hypotheses may dominate each other
at different segments of the relevant data distribution thereby cautioning the standard practice of drawing inferences on capital
structure choices using conditional mean (OLS) estimates. By using
productive efciency as opposed to nancial performance indicators as our measure of (inverse) agency costs we have been able
to carry out tests of the agency theory without the confounding
problems that may be associated with the more traditional nancial measures of rm performance. In future research it will be of
interest to extend this analysis across different countries and
across different industries as well as examine further aspects of
ownership and governance characteristics.
Acknowledgements
We are grateful to an anonymous referee and the Editor (Ike
Mathur) for helpful comments and suggestions. We also thank
the participants at the 2008 EFMA Conference in Athens and at a
Massey University seminar for helpful comments and Chris Yung
for research assistance.
Appendix A
This section outlines the specication of the efciency
measures. Following Fre and Grosskopf (2004) and Fre et al.
T fx; y : x can produce yg;
x 2 RN :
~
DT x; y; g x ; g y supfb : x bg x ; y bg y 2 Tg:
A:1
A:2
The directional distance function expands outputs in the direction gy and contracts inputs simultaneously in the direction gx to
the frontier T. If the observed input output bundle is technically
efcient, the value of the directional distance function would be
zero. If the observed input output bundle is interior to technology
T, the distance function is greater than zero and the rm is techni which implies
cally inefcient. In this paper we choose g
x; y
y
and inputs dex; y
that output(s) may be increased by ~
DT x; y;

x; y
x for a rm to eliminate all technical inefcreased by ~
DT x; y;
ciency relative to its best performing peers.
The directional distance function can be estimated non-parametrically using DEA a mathematical programming enveloping
technique under a VRS (variable returns to scale) technology as
follows:
~
DT x; y; g x ; g y max b
A:3
subject to:
XK
kx
k1 k kn
xkn bg x ;
ky
k1 k km
ykm bg y ;
XK
XK
k
k1 k
1;
n 1; . . . ; N;
m 1; . . . ; M;
kk 0; k 1; . . . ; K:
The intensity variables kk form combinations of inputs and

outputs from the observed set of inputs and outputs of the rms
in the sample, one for each activity or observation (k) of data. These
are non-negative variables whose solution value may be interpreted as the extent to which an activity is involved in frontier production. Thus at each segment of the piecewise frontier DEA
identies a peer group of best practice reference rms (i.e. those
with non-zero kk ) for each rm being evaluated. Each rm (k)
can produce no more output using no less input than a linear combination of all the rms inputs and outputs in the sample. Therefore the technology is constructed from the data xk ; yk by forming
15
In the empirical section of the paper technology is restricted to a specication
that uses two inputs (capital and labor) to produce a single output.
16
Input weak disposability means that if all inputs increase proportionally then
output will not decrease. Strong or free disposability on the other hand requires that
output does not decrease if any or all feasible inputs are increased. Disposable outputs
are similarly dened.
632
the tightest convex cone that includes all data hence the descriptive title data envelopment analysis. Constraining the intensity
variables to add up to one imposes the VRS technology.
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Journal of Banking & Finance 34 (2010) 621632

Contents lists available at ScienceDirect

Journal of Banking & Finance

Capital structure, equity ownership and rm performance

Department of Finance, Faculty of Business, AUT, Auckland 1020, New Zealand

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

2. Firm performance, capital structure and ownership

shareholders lie at the heart of the corporate governance literature

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

2001) nd no relation between ownership concentration and rm

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

4. The empirical model

We use a two equation cross-section model to test the agency

4.1. Firm performance

EFF i;t a0 a1 LEV i;tl a2 LEV 2i;tl a3 Z 1i;tl ui;t ;

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

4.2. The leverage model

LEV i;t b0 b1 EFF i;tl b2 Z 2i;tl v i;t ;

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

Computers and R&D

Panel B: ownership concentration tabulation by ownership type (%)

Panel A: summary statistics

other hand there is no statistical evidence of such differences in

tion problem while rendering a structure that is more robust to

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

Panel B: computers and R&D

Indicates signicance at the 1% level.

effect on efciency. This effect is positive at the mean of leverage

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

Panel A: cross-section estimates

Panel B: panel estimates 20022005

Computers and R&D

Signicant at the 1% level.

The effect of intangibles is negative and signicant only for rms in

suggesting the presence of offsetting entrenchment and incentive

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

Panel A: chemicals OLS and quantile regression estimates

Panel B: computers and R&D OLS and quantile regression estimates

Panel C: textiles OLS and quantile regression

Signicant at the 1% level.

Table 4 reports the estimates of the leverage model. We report

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

(2008) we assume that rms employ N inputs denoted by

This paper investigates the relationship between efciency,

T fx; y : x can produce yg;

The intensity variables kk form combinations of inputs and

D. Margaritis, M. Psillaki / Journal of Banking & Finance 34 (2010) 621632

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