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Applied Economics
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Determinants of corporate capital structure:

evidence from Hungarian firms
Emilio Colombo
Published online: 05 Oct 2010.

To cite this article: Emilio Colombo (2001) Determinants of corporate capital structure: evidence from Hungarian
firms, Applied Economics, 33:13, 1689-1701, DOI: 10.1080/00036840010015057

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 Applied Economics, 2001, 33, 1689 ± 1701

Determinants of corporate capital

structure: evidence from Hungarian Wrms
EMILIO C OLOMBO
Dipartimento di Economia Politica, UniversitaÁ Statale Milano ± Bicocca, EdiWcio U6,
Piazza Ateneo Nuovo 1, 20126 Milano, Italy, e-mail: Emilio.Colombo@unimib.it

This paper investigates the capital structure of Hungarian ® rms using a cross-section
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and a panel data approach. The data set is composed of balance sheet data and
information on market structure for 1100 ® rms from 1992 to 1996. Evidence is found
of imperfections that constrain ® rms in the achievement of their optimal capital
structure, but also some positive indications: there are no distortions typical of the
planned system and no signs of the presence of soft budget constraints.

I. INTRODUCTION of imperfections that characterize credit and ® nancial mar-

Somewhat paradoxically, the theory of capital structure
has been made famous by a contribution that showed its
irrelevance to the value of the ® rm (Modigliani and Miller,
1958). In the presence of perfect information, in fact, there
is no diŒerence between internal and external ® nance, and
therefore ® rm’s capital structure, i.e. how it allocates its
® nancial position between debt, equity and other forms
of ® nance, becomes completely irrelevant.
Forty years after Modigliani and Miller’ s seminal paper,
economic theory has shown that while the frictionless neo-
classical world is a useful theoretical benchmark, in reality
there are ® nancial market imperfections, mainly due to
informational failures, that introduce a wedge between
internal and external ® nance, creating on one hand a `peck-
ing order’ of ® nancing methods (Myers and Majluf, 1984)
and on the other hand a precise link between investment
and ® nancing decisions. The relationship between ® nancial
structure and investment has in turn led in recent years to
the development of a considerable literature that underlines
its macroeconomic eŒects (Bernanke and Gertler, 1989;
Greenwald and Stiglitz, 1993).
This work will investigate the factors that aŒect decisions
about the capital structure (and in particular about bank
debt) of a sample of Hungarian ® rms. This investigation
should reveal the existence of constraints on ® rms’ choice
allowing the inference of some considerations on the degree
kets in Hungary.
It is important to stress that this procedure, unlike the
studies that estimate investment equations,1 is not a test for
the presence of ® nancial market imperfections; it is only an
empirical investigation of ® rms’ capital structure that in-
directly can reveal the presence of such imperfections.
There is a conspicuous literature that analyses those
issues in industrialized countries (see for example Titman
and Wessels, 1988; Rajan and Zingales, 1995), but also in
the case of Eastern Europe there are several contributions:
Cornelli et al. (1998) for Hungary and Poland, Revoltella
(1998) for the Czech Republic and Carare and Perotti
(1997) for Romania. However, while in all the above
mentioned works the analysis is conducted at a cross
sectional level, both a cross-section and a panel data analy-
sis are conducted. It is believed that the additional infor-
mation and e ciency that can be extracted from a panel
can considerably improve the understanding of the rele-
vance of ® nancial market imperfections in Eastern
European economies and allows us to have a better grasp
of the determinants of ® rms’ capital structure in those
countries.
The second qualifying aspect of the present work is con-
stituted by the data set: the panel analysis is in fact allowed
by a data set that is unique for Eastern European stan-
dards, as it gives detailed information on balance sheet
and market structure for some 1100 Hungarian ® rms

1
See for example Bond and Meghir (1994) and the literature quoted in Schiantarelli (1997).
Applied Economics ISSN 0003± 6846 print/ISSN 1466± 4283 online # 2001 Taylor & Francis Ltd 1689
http://www.tandf.co.uk/journals
DOI: 10.1080 /0003684001001505 7
 1690
from 1992 to 1996, allowing to test precisely the relevant
hypothesis.
The remainder of the paper is organized as follows:
Section (II) introduces the theoretical framework, Section
(III) describes the data set and some descriptive statistics,
Section (IV) explains the methodology used, Section (V)
presents the empirical ® ndings, Section (VI) concludes.
II. THE THEORY
As stressed in the introduction, the analysis of the capital
structure of ® rms assumes relevance mainly in the presence
of ® nancial market imperfections; it is due to such imper-
fections that diŒerent ® nancing methods become imperfect
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substitutes and determine the presence of an `optimal capi-
tal structure’ . There are two very good reasons for which
those imperfections are likely to be particularly severe in
Eastern Europe. First, during the planned-type system
banks did not exercise any monitoring or risk assessment
activity: they were lending to ® rms simply because this was
what the plan stated, but they were not concerned about
the solvency of the borrower (the solvency of the whole
system was guaranteed by the state itself). Therefore,
even if there existed a relationship between borrowers
and lenders, this relationship was completely uninforma-
tive. With the beginning of transition, lenders had to be
concerned about the creditworthiness of borrowers, but on
one hand the former did not have any experience in mon-
itoring activity, on the other hand the latter did not have
any reputation or credit history to show. Second, is the
economic instability that characterized the early stages of
transition: in the presence of an unstable economic system,
current performances are a very poor indicator for future
performances. Therefore, not only borrowers do not have
any reputation deriving from the past, but also they have
relevant di culties in building one ex novo.
In this situation the informational problems that are
likely to emerge may cause severe forms of credit rationing
and may in general constrain ® rms in their capital structure
decisions.
The following will analyse the factors that most likely
aŒect the capital structure of ® rms in the sample from the
theoretical point of view. Theories based on tax con-
sideration that give rise to what are called static trade-oŒ
models will not be considered.2 Instead, the paper focuses
on the theories that stress the relevance of informational
failures, known also as `pecking order’ theories (see Harris
and Raviv, 1991). The reason for such a choice is twofold:
® rst as recently shown by Shyam-Sunde r and Myers (1999)
the pecking order theory describes extremely well corporate
2
Those models de® ne an optimal capital structure that arise from trading oŒthe tax advantages of borrowing money and the bankruptcy
costs caused by an excessive level of debt, see Bradley et al. (1984).
E. Colombo
structure decisions, moreover tests on the static trade-oŒ
theories do not have su cient statistical power.
The second and more important reason is due to the fact
that our data set has a limited time horizon and the meas-
ure of debt used is short-term debt (see Section IV). It is
well known that tax rates are virtually ¯ at over short-time
periods and that they are more likely to aŒect long-term
debt decisions rather than short-term, therefore the proper
instruments are not available to measure the eŒects of tax
considerations on our sample.
Nevertheless also `pecking order’ theories have to be
amended in order to apply them to the context of
Eastern Europe. In particular the limited size of equity
markets in transitional economies has so far excluded an
important element in the choice about the capital structure;
on the other hand the widespread use, inherited from the
planned system, of trade credit has introduced an addi-
tional element that aŒect ® rms’ decisions. Finally, owner-
ship characteristics may also constitute an important
variable to be considered. The next paragraphs will analyse
those aspects more in detail. In principle it is important to
distinguish between demand and supply side factors deter-
mining the capital structure; this distinction can be made at
theoretical level but, as it will be stressed later, it is very
di cult to be made at empirical level.
Supply side
Collateral. There should be an unambiguous positive
relationship between tangibility and debt (see Harris and
Raviv, 1991). Assets that serve as collateral, in fact, pro-
vide an explicit guarantee over debts and reduce the risk
of investment from the banks. Two measures of collateral
are used: the ® rst is the ratio of ® xed to total assets; this
measure however carries the problem of the precise eva-
luation of assets that are classi® ed as ® xed. This problem
is particularly relevant in transitional economies where
® xed assets are often inherited from the old socialist
system where prices did not represent a proper measure
of value and where it does not exist an e cient secondary
market where those assets can be traded. The ratio of
inventories to total assets was therefore included as an
alternative measure; inventories should reduce the two
above mentioned problems because it is easier to deter-
mine a `correct’ price for them and because they can be
re-sold on the primary market.
ProWtability and growth opportunities . If current pro® ts
are a good indication of future pro® ts a positive relation-
ship between pro® ts and debt should be observed (Ross,
1977). At the same time if a ® rm displays good growth
 Determinants of corporate capital structure
opportunities banks should be more keen to lend to it.
The pro® tability of a ® rm is measured by the ratio of
after tax pro® ts over total assets and its growth opportu-
nities by the ratio of investments over total assets.
Size. It is usually assumed a positive relationship
between ® rm size and leverage. Big ® rms tend to have
diversi® ed activities, which reduce the risk of bankruptcy.
Moreover reputational reasons induce big ® rms to be
more averse to bankruptcy than small ® rms. In transi-
tional economies an important factor to be considered is
the implicit bailout clause that exists for large state
owned ® rms. Often those ® rms are considered `too big to
fail’ both because their bankruptcy could have a destabi-
lizing eŒect on the whole economic system and because
the loss in terms of employment could be socially unac-
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ceptable. The existence of an implicit bailout clause may
in turn trigger some perverse behaviour by the banks that
may `gamble for bailout’ re® nancing loss making state
owned ® rms (BergloÈf and Roland, 1995, 1997).
Size is measured with two variables: one that captures
more the `economic’ considerations and is constituted by
(the logarithm of) net sales; the other captures more the
`political’ considerations and is constituted by the level of
employment.
Market share. As for the ownership variable (see below)
in this case it is crucial to distinguish the issue of the
growth of the ® rms from the one of the risk of the invest-
ment in those ® rms. Generally speaking, in transitional
economies, more competitive ® rms are mainly new pri-
vate ® rms which are the ® rst to react to the changing
environment and to the new standards imposed by inter-
national competition. Those ® rms should have better pro-
spects of growth with respect to traditional state owned
enterprises; it should therefore be expected that banks
will favour in their lending behaviour the former type of
® rms over the latter. Firms which retain a consistent mar-
ket power are conversely less dynamic state owned enter-
prises; even if their long-term perspectives are not
extremely attractive, in the short run their relevant mar-
ket share often provides good pro® tability associated
with low risk. Whether banks’ debt is positively or nega-
tively related to ® rms’ market power depend on how
strong is the growth eŒect compared to the risk eŒect.
Market power is measured with the share of sales in the
four digit industry covered by the ® rm.
Ownership. With respect to the ownership issue similar
considerations can be applied to those applied to the
issue of market share. State owned ® rms are often big
® rms with limited ¯ exibility and ability to compete at
international level. Their growth opportunities should
therefore be limited. On the other hand the shield deter-
mined by their market power, reduces the risk of lending
1691
to them. Moreover there is the issue of the implicit bail-
out clause that is referred to big companies and that con-
tributes signi® cantly in reducing the investment risk.
Again it is a question of how strong is the risk aspect
compared to growth opportunities.
A diŒerent issue is that one of foreign ownership: foreign
owned ® rms or ® rms in which foreign companies have a
signi® cant share should represent certainly the best possible
investment opportunit y from banks perspective. Those
® rms in fact have a substantially lower bankruptcy risk
and adopt faster international standards in terms of prod-
uct quality and internal e ciency. Ownership is measured
with two dummies one that represent whether or not a ® rm
is state owned and the other whether or not there is a
consistent (greater than 10% ) foreign share.
Demand side
Cash Xows. If there is a `pecking order’ in ® rms’ ® nan-
cing decisions, the use of internal resources is certainly
preferred to bank debt. As a consequence ® rms with a
higher cash ¯ ows will be characterized by reduced lever-
age as they substitute external with internal ® nance.
This paper’s measure of cash ¯ ows is quite standard and
is given by pro® ts before tax, interest and depreciation.
Interenterprise debt. The issue of interenterprise debt has
been controversial. At the early stages of transition sev-
eral authors (see for example Calvo and Coricelli, 1994)
argued that interenterprise arrears could be a major chan-
nel through which soft budget constraints could be car-
ried over. Later studies (Bonin and SchaŒer, 1995;
SchaŒer, 1998) showed that ® rms learned fast how to
implement hard budget constraints in the lending posi-
tions among themselves and that interenterprise debt did
not constitute a form of soft budget constraint. But inter-
enterprise debt can still convey some information about
the capital structure of ® rms. In the absence of soft bud-
get constraints associated with interenterprise arrears the
observation of a negative correlation between bank debt
and interenterprise debt can be a signal of the existence
of a pecking order of ® rms’ ® nancial decisions (® rms with
no access to bank credit would resort to trade credit as a
substitute). Interenterprise debt is measured as the ratio
of the net trade credit position (payables± receivables) to
total assets.
III. THE DATA SET AND SOME
DESCRIPTIVE STATISTICS
Data set
The data set used in the analysis is constructed merging the
information from two sources. The study ® rst used a data
 1692 E. Colombo
Table 1. Share of employment and sales of the sample in the manu- Descriptive statistics
facturing and service sectors.
Employment and ownership structure. The ownership
Year Employment Sales structure of ® rms in the sample changed considerably
1992 32.1 38.8 during the period 1992± 1996. As Table 2 con® rms the
1993 31.7 37.4 share of state owned ® rms dropped from 27.8% in 1992
1994 28.0 34.7 to 7.3% in 1995 while the share of private ® rms rose
1995 22.6 20.6 from 27.7% in 1992 to over 63% in 1995.9 This pattern
of ownership is quite common in transitional economies.
Total employment in the sample dropped heavily from
1992 to 1995 with a cumulative contraction of almost
29% (Table 3). The employment contraction is bigger
than the one displayed by o cial statistics on industrial
set deriving from the Hungarian Ministry of Finance that
employment which shows a cumulative contraction
contains information on all ® rms that paid corporate or
between 1992 and 1995 of approximately 20% . This
pro® t taxes from 1992 to 1995; this data set covers almost
result is probably due to a sample selection bias as
the totality of Hungarian ® rms, with the exclusion of small
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mainly large and medium sized ® rms were considered for

shops. 3 Due to substantial changes in accounting data de® -
nitions occurred in 1992, the data set results incomplete in
some variables in 1994 and 1995. A second data set was
then used deriving from the Hungarian Central Statistical
O ce that contains end of year ® nancial statements of
medium-large size ® rms, from 1993 to 1996.4 Merging the
information from the two sources data was obtained on
® nancial variables (bank debt, interest payments, assets,
trade credit etc.) plus information on ownership, employ-
ment and on market structure (the degree of concentration
in the four digit industry).5 The analysis was concentrated
on the manufacturing and on the service sector, therefore
® rms belonging to the following sectors were dropped from
the sample: agriculture, ® nance, mining, electricity, gas,
water, post and telecommunication, public administration,
education and health. After some consistency checks6 the
study was left with cross sections of approximately 1100
® rms that kept the same identi® cation number from 1992
to 1996. 7 These cross sections allowed the construction of a
balanced panel.
The sample is fairly representative, ranging from 32.1%
and 37.4% to 22.6% and 20.6% of respectively total
employment and sales of the manufacturing and service
sectors as a whole (see Table 1).8
which labour in excess was comparatively larger than for
other ® rms; moreover since the sample does not consider
® rms that entered the market between 1993 and 1996 the
growth in employment generated by such ® rms is not
captured.
The amount and distribution of debt. One of the features
of Eastern European ® nancial markets that was most
concerning was the problem of the initial stock of debt
with which ® rms and banks started the transition process.
The presence of a high stock of debt that some ® rms are
unable to repay, may force banks to roll over the debt in
order to keep the ® rms viable and at the same time keep
open the option of having (part of) the debt repaid some
time in the future.
A simple test for the presence of debt rollover is to cal-
culate the correlation coe cients between the change in
short-term debt in period t ‡ 1 and the level of short-
term debt in period t. Table 4 shows those coe cients. In
the presence of debt rollover the correlation is expected to
be positive. In fact the correlation coe cients are all nega-
tive for the years considered. The correlation is greater for
small ® rms than for big ® rms;10 no clear pattern emerges

3
The total number of ® rms ranges from 35 000 in 1992 to over 90 000 in 1995.
4
The number of ® rms belonging to this samples ranges from 5000 in 1993 to approximately 7000 in 1996.
5
The data resulting from the intersection of the two data sets described above suŒers from a sample selection bias: as the small data set
contains information on medium-large enterprises, in the sample those ® rms will be over-represented. It is acknowledged that the
presence of this problem but also noted that, since large ® rms are the ones that should generally be the least constrained in the
achievement of their optimal capital structure, ® nding evidence of such constraint for those ® rms allow the conclusions to be extended
a fortiori to small ® rms.
6
Those consistency checks are described in the Appendix, which also describes the procedure used to identify outliers.
7
Using this procedure one could not avoid the following problem: when a big ® rm is split, a branch or a part of it will keep the same
identi® cation number of the original ® rm while a diŒerent identi® cation number will be assigned to the other parts or branches. While the
original ® rm and the branch that keeps the same id are de facto diŒerent ® rms, in the sample they are recorded as the same ® rm.
8
The drop in the sample’s share documented by Table 1 is explained by the fact that from 1992 to 1995 the total number of manu-
facturing ® rms increased considerably, mainly due to the birth of new ® rms.
9
The big fall in the share of co-operatives in 1994 is due to a change in the de® nition of co-operatives implemented by the Central
Statistical O ce at the end of 1993.
10
Big ® rms are de® ned employing more than 300 employees.
 Determinants of corporate capital structure 1693
Table 2. Ownership structure of Wrms: share of each class on the total number of Wrms

Year State Cooperatives Joint Ventures Private

1992 27.8 20.3 24.2 27.7 100

1993 17.6 20.4 28.3 33.7 100
1994 11.2 0.8 29.4 58.6 100
1995 7.3 0.8 28.5 63.4 100

Table 3. Percentage change in sample’s employment with respect shows a `hint’ of a bimodal distribution with approxi-
to the previous year mately 9% of bank debt being concentrated in ® rms with
1993 1994 1995
heavy losses compared to total assets; to check if this small
peak is showing a real pattern or just picking up some eŒect
714.8 77.8 76.2 peculiar to 1992, Fig. 1b reports the conditional distri-
bution for 1993 which shows that the peak completely dis-
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appears. Total debt can also be split between long-term and

short-term debt (Figs 1c± f) and in fact it is discovered that
Table 4. Correlation coeYcients between the change in short-term
debt in t1 1 and the level of short-term debt in t. The year identiWes whatever problem the `little peak’ in 1992 might cause, it is
time t not due to long-term debt, on the contrary it is due to
short-term debt (less than 1 year).
1992 1993 1994 1995 In the light of this evidence it can therefore be concluded
Total 70.28 70.38 70.28 70.21 that, at least for the sample of ® rms investigated, there was
State 70.18 70.50 70.15** 70.19* not a stock problem with huge amount of bank debt
Private 70.39 70.37 70.29 70.21 (mainly long-term debt) being concentrated among loss
Big 70.33 70.34 70.26 70.11** making ® rms, and therefore the determinants of debt that
Small 70.26 70.40 70.31 70.29
will be investigated in the next sections should be deter-
mined principally by demand and supply considerations.
The graphs used before can be a useful starting point to
for state versus private ® rms. The coe cients marked with investigate issues related to the ¯ ows of debt rather than to
a * or with ** denote respectively values that are not sig- the stock. In assessing whether or not banks are lending to
ni® cant and values that are signi® cant at 10% level. `good’ ® rms the conditional distribution of debt can be
It seems therefore that the initial stock of debt was not looked at time t ‡ 1 over pro® ts at time t, and comparing
excessively problematic, at least not to the point of trigger- diŒerent years one can determine how this conditional dis-
ing debt rollover. This is consistent with the evidence tribution changes over time, extracting some information
advanced by Cornelli et al. (1998) that ® rms in Eastern about the dynamics of the relationship between debt and
Europe were not overloaded by debt (compared to the pro® ts. This is done in Fig. 2. 11 The ® gure shows an unam-
standards of western economies) but rather underloaded. biguous pattern: the distribution of debt is progressively
Nevertheless, even if ® rms were not on average exposed to shifting the majority of the mass (and therefore the
an excessive debt burden, things can still be problematic if mean) towards higher values of pro® tability. While in
it turns out that the distribution of debt is source of con- 1993, 42.3% of total debt was allocated to ® rms that in
cern. If debt is in fact concentrated mainly among loss the previous years displayed a negative pro® t/asset ratio,
making ® rms, bankruptcy may really become a serious the percentage dropped to 22.6% in 1996.12 It seems there-
issue. fore that banks are extracting money from loss making
The conditional distribution of debt (total, short-term ® rms and reallocating their debt towards more pro® table
and long-term) was plotted over ® rms’ after tax pro® ts of ® rms; this could be interpreted as evidence against the pres-
the same year. Looking at Fig. 1a it is noteworthy that the ence of soft budget constraints.
distribution is fairly unimodal. This is in line with the ® nd- In order to be more precise on this issue the analysis of
ings of Bonin and SchaŒer (1995) and contrasts with what SchaŒer (1998) can be followed looking at the relationship
found by Gomulka (1994) in Poland where a bimodal dis- between new credit allocation and pro® tability. New
tribution was observed with a large proportion of debt credit is measured by Net Bank Financing, i.e. the change
concentrated in loss making ® rms. To be precise Fig. 1a in bank debt minus interest payments normalized by total

11
The fact that this procedure is not rigorous is acknowledged, nevertheless it is useful to get an idea of the dynamic evolution of debt.
12
Similar results are obtained with the distribution of short-term and long-term debt.
 1694 E. Colombo
.4
.4
Total debt. Fraction

Total debt. Fraction

.3
.3

.2
.2

.1
.1

0
0
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4

Before tax profits over total assets. 1992 Before tax profits over total assets. 1993

(a) (b)
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.4
.4
Long term debt. Fraction

Long term debt. Fraction

.3
.3

.2
.2

.1 .1

0 0
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4 -.4 -.3 -.2 -.1 0 .1 .2 .3 .4
Before tax profits over total assets. 1992 Before tax profits over total assets. 1993

(c) (d)
.4
.4
Short term debt. Fraction

Short term debt. Fraction

.3
.3

.2
.2

.1
.1

0
0
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4

Before tax profits over total assets. 1992 Before tax profits over total assets. 1993

(e) (f)
Fig. 1. Distribution of bank debt, 1992± 1993

assets; 13 this measure indicates the direction of ¯ ows between economic viable and non-viable ® rms;14 if a ® rm
between banks and ® rms (i.e. from banks to ® rms if NBF is economically non-viable it is unable to cover its operat-
is positive, from ® rms to banks if NBF is negative) and is ing costs and should not receive any injection of new loans
plotted against ® rms pro® tability. The sample is divided from the banking sector. Figure 3a shows that for the
13
The formula used in NBF i;t ˆ …Bi;t ¡ Bi;t¡1 ¡ Ii;t †=Ai;t , where B ˆ bank debt, I ˆ interest payment and A ˆ total assets, see SchaŒer
(1998).
14
Economic viability is de® ned as earnings before interest, pro® t tax, depreciation and extraordinary charges.
 Determinants of corporate capital structure 1695
.4 .4
Total debt 93. Fraction

Total debt 94. Fraction

.3 .3

.2 .2

.1 .1

0 0
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4 -.4 -.3 -.2 -.1 0 .1 .2 .3 .4

Before tax profits over total assets 92 Before tax profits over total assets 93

(a) (b)
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.4 .4
Total debt 95. Fraction

Total debt 96. Fraction

.3 .3

.2 .2

.1 .1

0 0
-.4 -.3 -.2 -.1 0 .1 .2 .3 .4 -.4 -.3 -.2 -.1 0 .1 .2 .3 .4

Before tax profits over total assets 94 Before tax profits over total assets 95

Fig. 2. Distribution of total bank debt with respect to previous year’s proWts

majority of economically non-viable ® rms NBF is in fact Finally, one issue is analysed that has profound implica-
negative, though there are some ® rms receiving new credit. tions for the methodological approach (Section IV).
Figure 3b shows another interesting fact: the majority of Approximately 30% of ® rms in the sample do not use
® rms is economically viable and display positive pro® ts, bank debt at all as a form of ® nancing. This ® gure is
nevertheless banks are extracting money from them and quite impressive and needs further investigation.
not providing new funds. Can this be taken as evidence Firstly, ® rms that do not use debt are on average smaller
for the presence of credit rationing? The answer is di cult than ® rms which use debt: in 1994 the former have less
because to see money ¯ owing from pro® table ® rms to than a half of the number of employees of the latter and
banks is not per se evidence of credit rationing as the latter one third of the value of net sales (see Table 5). This can
arises when ® rms willing to take on loans are denied credit. signal the presence of forms of credit rationing that are
In fact in this case pro® table ® rms may be unwilling to
cutting out of the market small ® rms. However, it is also
borrow because for instance of high interest rates, prefer-
noted that ® rms that do not use bank debt are on average
ring instead internal ® nance. This interpretation, advanced
more pro® table and can dispose of a higher amount of cash
by SchaŒer (1998), is certainly part of the story.
¯ ows. This may suggest that, due to the high cost of exter-
Nevertheless performing the same analysis for each year
nal ® nance, ® rms that can do so, use internal ® nance at the
of the sample, it is noted that while the average cost of
borrowing (i.e. the real interest rate on bank loans) maximum even to the point of not using bank ® nance at
between 1993 and 1996 fell from more than 14% (1993) all. Probably the truth is in the middle, i.e. what is observed
to less than 7% (1996) (source National Bank of Hungary, is a combination of credit rationing and high cost of exter-
1997), the proportion of economically viable ® rms with nal ® nance, nevertheless the outcome is a particular distri-
positive pro® tability and characterized by negative NBF bution of debt across ® rms that in turn aŒects heavily the
increased from 42± 58% . This pattern suggests that forms methodology used in the empirical analysis. The next sec-
of credit rationing were at work during this period. tion investigates this issue.
 1696 E. Colombo

30
attention was restricted to short-term bank debt. The
choice is motivated by the fact that the time horizon con-
sidered (1992± 1996) is still very close to the pre-transition
Net Bank Financing 1995

20

period where presumably the majority of decisions con-

10 cerning long-term debt have been taken. Concentrating
on short-term debt (de® ned as debt with less than 1 year
0 maturity) avoid mixing pre-transition with post-transition
decisions about the capital structure. Short-term debt is in
-10 any case the predominant form of debt for the ® rms inves-
tigated (it accounts for more than 80% of total bank debt);
-20
at the same time short-term debt has a time horizon su -
ciently limited to capture all the relevant changes one is
-30
interested in.
-50 -40 -30 -20 -10 0 10
Profitability 1994
Since a limited fraction of the ® rms are quoted, only
book value measures are available for the relevant vari-
(a) ables. It can be argued that decisions about ® rms’ capital
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structure are taken considering market value ® gures; for-

30
tunately, as shown by Bowman (1980), the cross sectional
correlation between book and market value of debt is very
Net Bank Financing 1995

20
high, reducing the potential misspeci® cation problem
10
deriving from the use of book value measures.15
The observation that 30% of ® rms in the sample do not
0
use debt conditions heavily the econometric methodology
used. This aspect makes the distribution that applies to the
-10 sample data a mixture of a continuous and discrete distri-
bution calling for the use of a censored regression (Tobit)
-20 model. The general formulation of the Tobit model is con-
structed as follows: let y¤ be the original variable and let y
-30 be a new random variable transformed from the original
-30 -20 -10 0 10 20 30 40 one. The estimated model is:
Profitability 1994
y¤i;t ˆ ­ xi;t
0
‡ "i;t …1†
Fig. 3. Net bank Wnancing versus proWtability: (a) economically
non-viable Wrms, (b) economically viable Wrms. Data are weighted yi;t ˆ y¤i;t if y¤i;t > 0
by total debt
yi;t ˆ 0 otherwise
Table 5. Firms that use or do not use debt. Average values, 1994
Censored regressions in cross sections is now routine analy-
Firms with Debt Firms without Debt sis, but when considering panel data this estimation
method is not so straightforward. The basic problem is
Employment 480 204 that it is not possible to sweep away ® xed eŒects using
Net sales (Mil. Ft.) 2.92 0.94
Cash ¯ ows/total assets 0.051 0.073 the within transformation . The reason is that in presence
of a censored distribution the ­ and the individual eŒects
(·) are not anymore asymptotically independent (unless the
time horizon is in® nite) resulting in an inconsistent estimate
of ·i that is transmitted into inconsistent estimates of ­ i :
IV. METHODOLOGY Unlike ® xed eŒects estimates, random eŒect estimates are
consistent. Recently Honore (1993) used symmetry con-
In order to investigate the determinants of capital structure ditions for the conditional distribution of yi,t on xi,t to
choice the approaches of Rajan and Zingales (1995) and derive a GMM estimator for ® xed eŒects. This approach
Cornelli et al. (1996) were followed in estimating a reduced is not used here because of the limited time horizon.
form equation with a measure of leverage as the dependent Typically in fact GMM estimators sweep out ® xed eŒects
variable. Among the diŒerent measures of leverage that can by taking ® rst diŒerences; moreover to satisfy the ortho-
be used (total liabilities, total debt, coverage ratio, etc.), gonality conditions the natural candidates are lagged vari-

15
Virtually all studies on ® rms’ capital structure (see Rajan and Zingales, 1995; Titman and Wessels, 1988) do not ® nd any diŒerence
between using market and book value variables.
 Determinants of corporate capital structure 1697
ables; this is particularly true for dynamic panel data (see Table 6. Cross-section estimates; dependent variable: sdtat1 1 (t-
Arellano and Bover, 1997) for which the process of diŒer- values in parentheses). The year refers to variables at time t.
encing and constructing lags takes between four and ® ve 1992 1993 1994 1995
time periods. For this reason, given the limited time
domain of the data set a random eŒect Tobit model lsalt 0.021 0.038 0.047 0.040
using ML estimators is estimated; to control for possible (3.98) (6.88) (8.58) (6.37)
cftat 70.048 70.139 70.264 70.105
endogeneity the explanatory variables were lagged by one (70.95) (73.07) (75.85) (72.03)
period. Individual invariant time eŒect was also controlled tatat 0.105 0.073 0.093 0.025
by using a two-way error component model. Equation 1 (3.46) (2.59) (3.14) (0.72)
becomes iatat 70.220 70.219 70.309 70.214
(75.13) (75.60) (77.80) (74.60)
invntat 0.325 0.280 0.326 0.281
y¤i;t ˆ ­ xi;t
0
‡ ·i ‡ ¶t ‡ ui;t (7.27) (6.82) (7.77) (6.05)
invtat 0.010 70.006 0.050 0.098
where ·i denote unobservable, individual, time invariant, (0.19) (70.09) (0.70) (1.39)
eŒects, ¶t accounts for any individual invariant time eŒect dfshrt 70.005 0.002 0.024 0.004
(70.41) (0.23) (2.06) (0.35)
and ui,t is the remaining stochastic disturbance.16
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dempt 0.027 0.008 0.11 0.045

Finally to reduce the problem of heteroscedasticity the (2.12) (0.71) (0.91) (2.97)
relevant variables are normalized by total assets.17 mpshrt 0.012 70.054 70.028 70.028
The distinctions made at a theoretical level (Section II) (0.27) (71.24) (70.66) (70.47)
down t 70.041 70.047 70.012 70.008
can be very rarely carried over at the empirical level. This (73.23) (74.01) (70.77) (70.38)
problem arises also in the present work, where the esti- const 70.353 70.557 70.734 70.597
mated reduced form equations do not allow demand to (74.83) (77.41) (79.52) (76.91)
be distinguished from supply side eŒects. The cause of À2 119.78 174.66 259.96 177.94
Uncens. obs. 610 642 643 650
most concern is pro® tability: it has already been stressed Cens. obs 386 403 410 396
that supply side considerations predict a positive relation-
ship between banks’ debt and pro® ts. But pro® ts are also a
major determinant of cash ¯ ows, and demand side consid- sdta ¤i;t‡1 ˆ ¬ ‡ ­ 1 lsali;t ‡ ­ 2 cfta i;t ‡ ­ 3 tata i;t
erations predict a negative relationship between debt and
‡ ­ 4 iata i;t ‡ ­ 5 invnta i;t ‡ ­ 6 invta i;t
cash ¯ ows (if debt is more costly than internal ® nance,
® rms that have higher internal cash will try to substitute ‡ ­ 7 dfshr i;t ‡ ­ 8 mpshr i;t ‡ ­ 9 demp i;t
debt with it). Therefore the sign of the coe cient is going to ‡ ­ 10 downi;t ‡ "i;t‡1 …2†
depend on the relative strength of those two eŒects. In the
case of Eastern Europe, the shock of transition, and the The variables are identi® ed as follows: sdta 5 short-term
consequent massive change that it entailed, caused short- debt over total assets; lsal 5 logarithm of net sales, cfta 5
term performance to be a very poor indicator of future cash ¯ ows over total assets; tata 5 tangible assets over
long-term performance, while on the other hand the wide- total assets; invnta 5 inventories over total assets; invta 5
spread presence of credit rationing induced ® rms to rely investment over total assets; dfshr 5 dummy for foreign
heavily on internal ® nance. Pro® ts are therefore expected ownership (takes value of 1 if foreign share of capital is
to capture a demand rather than a supply eŒect and pro® ts greater than 10% ); mpshr 5 share of net sales over total
have been included in the regressions as part of cash ¯ ows sales in the four digit industry; demp5 dummy for employ-
ment (takes value of 1 if employment is greater than 300);
and not as an isolated regressor.
down 5 dummy for ownership (takes value of 1 if the ® rm
is state-owned); " identi® es the remaining stochastic dis-
turbance. Table 6 shows the results.18
Size (approximate d by the logarithm of net sales) is posi-
V . E M P I R I C A L R ES U L T S
tively related with debt indicating that big ® rms tend to
have an easier access to bank credit with respect to small
Cross sectional evidence
® rms. The positive eŒect of size is much more weak when
For each year t Equation 1 becomes we consider the more `political’ measure, that is the number
16
It is assumed that ui;t ¹ IID…0; ¼2u †.
17
An alternative normalization by total sales yielded the same results.
18
The table does not show a measure for Pseudo-R 2 . As it is well known the widely used formula Pseudo-R 2 ˆ 1 ¡ L1 =L0 (where L1 and
L0 are respectively the constant-only and full model Log-Likelihoods) works only in the presence of discrete distributions. It breaks down
with mixed continuous/discrete distributions like Tobit. For this reason the model À2 is reported insead.
 1698
of employees. The employment dummy is in fact positive
and signi® cant only in 1992 and 1995 but it is not signi® -
cant (with very low t statistics) in 1993 and 1994.19 It seems
therefore that the eŒect of size indicates that big ® rms tend
to be facilitated in accessing bank debt, because they are
more diversi® ed, more than because big ® rms are `politi-
cally’ protected by the concern on their employment level.
Another aspect that has to be analysed jointly with size is
the issue of ownership. As big ® rms are mainly state owned
® rms which could be protected by an implicit bailout clause
by the government, they may have easier access to credit
simply because they are state-owned. The study is reas-
sured by the fact that the dummy for ownership, when
signi® cant (1992 and 1993), is negative indicating that pri-
vate ® rms are the ones that take on more debt, suggesting
that private ownership and not state ownership conveys a
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E. Colombo
which have the better growth prospects. The signalling
eŒect of past investment do not seem to enable ® rms to
take on more leverage as investment turns out to be always
insigni® cant in the regressions.22
Turning now to the two `® nancial’ variables, cash ¯ ows
and interenterprise arrears, they seem to indicate the exist-
ence of a `pecking-order’ theory of ® nance with internal
funds preferred over trade credit preferred over bank
debt. The availability of internal funds is measured by
cash ¯ ows which display a negative coe cient (with the
exception of 1992 when the coe cient is not signi® cant)
suggesting that ® rms substitute external with internal
® nance when they have the opportunity to do so (i.e. exter-
nal ® nance is more costly than internal ® nance). At the
same time the negative coe cient on interenterprise arrears
show that ® rms tend to substitute bank with interenterprise

positive signal to the credit market.20 debt.

Considering the other variables, except for 1995, tan- The results presented in Table 6 show, somewhat surpris-
gibility is positive and signi® cant; this is in line with the ingly, that the degree of market power of the ® rm does not
results usually obtained in western-type economies (see seem to have any eŒect on the amount of leverage. The
Rajan and Zingales, 1995) where debt has a strong positive variable mpshr is never signi® cant for the years considered;
relation with tangible assets. However, it contrasts with the some diŒerent speci® cations were also tried, replacing the
results of Cornelli et al. (1998) who ® nd a negative correla- continuous variable with a dummy and using as an alter-
tion between tangible assets and debt, in Poland and native measure of the market power the number of ® rms in
Hungary. The results of Cornelli et al. (1998) for the four digit industry. Firms’ market power does not
Hungary are probably due to the diŒerent estimation tech- determine an easier access to the credit market.
niques (they estimate a normal OLS regression): in fact if Finally, with the exception of 1994, foreign ownership
on the sample, instead of a Tobit, we run a simple OLS dummy is never signi® cant. The result seems quite robust
regression, the positive eŒect of tangibility disappears. (diŒerent cut-oŒvalues as 20 and 30% ) were tried. This
As stressed previously in transitional economies ® xed ® nding is puzzling mainly when referred to the initial years
assets are probably not a good measure of collateral as one would expect that with time and the improvement of
because they may be overvalued21 or because there may e ciency of ® nancial markets the positive signalling role of
be an ine cient secondary market. Inventories were there- foreign ownership would diminish.23
fore included in the regression as an alternative measure of On the other hand the non-signi® cance of this variable
collateral. Inventories should reduce both the problems of can indicate the inability to distinguish between demand
evaluation and of the e ciency of a secondary market. The side and supply side eŒects. From the demand side in
coe cient on inventories is in fact positive and strongly fact it was expected that banks would favour foreign
signi® cant denoting that they provide a good proxy for owned ® rms but from the supply side foreign owned
collateral. Apart for the risk of default, banks should ® rms may have access to cheaper internal (i.e. through
also be concerned for ® rms’ future prospects. In the sample the foreign owner) ® nance, reducing in this way the amount
® rms that have invested more are taken as proxies of ® rms of external ® nance.24
19
A diŒerent speci® cation was tried using the dummy at 500 employees obtaining analogous results.
20
The non-signi® cance of the ownership dummy for 1994 and 1995 is probably due to the change in the classi® cation of ® rms occurred in
1993. Stated owned ® rms were classi® ed as both co-operatives and state owned ® rms (see Table 2); the signi® cant drop in the number of
co-operatives occurred after 1993 explains therefore the nonsigni® cance of the coe cient.
21
This is very likely if ® xed assets are recorded by their book value.
22
The presence of investment as a regressor may rise doubts about the existence of possible multicollinearity with other variables, in
particular with cash ¯ ows. If a ® rm invested in the past and the investment turned out to be successful it will have higher pro® ts in the
subsequent period and therefore higher cash ¯ ows. In the sample multicollinearity between those two variables does not seem to be a
problem; more precisely the pairwise correlation is always below 30% , and neither the sign of the coe cients nor their signi® cance
change when one of the variable is deleted. The investment variable can also create a possible problem of endogeneity.
23
In fact Csermely and Vincze (1999) with a similar sample ® nd no signi® cant eŒect of foreign ownership on ® rms’ debt for the year 1996.
24
Moreover in general one has to be cautious when assessing the role of foreign ownership in capital structure decisions of Eastern
European ® rms. At least in the initial years of transition foreign ownership in fact could represent both solid Western European or also
very risky Eastern European (mainly Russian) capital. In the sample the opportunity of distinguishing foreign ownership by country of
origin is not present.
 Determinants of corporate capital structure
Table 7. Panel estimates: dependent variable sdtat1
CoeŒ. Std. Std. err.
lsal t 0.033 0.003
cftat 70.060 0.021
tatat 0.033 0.017
iatat 70.117 0.020
invntat 0.183 0.026
invtat 0.051 0.024
À2 271.19
Uncens.obs 2536
Cens. Obs. 1607
The results of the cross sections suggest the presence of
an underlying problem of asymmetric information in the
credit market; this informational problem aŒects the ability
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of ® rms in achieving their optimal capital structure.
Evidence for this is provided by the relevance of variables
like cash ¯ ows and interenterprise debt that suggest the
existence of a `pecking order’ in ® rms’ ® nancing choices.
But on the other hand there are some positive and reassur-
ing signs, as bank debt does not seem to be related to state
ownership or market power; this in turn suggests that
banks are correctly discriminating between ® rms’ types.
Panel evidence
The panel analysis follows the same Tobit procedure than
the cross section; Equation 2 becomes now:
sdta ¤i;t‡1 ˆ ¬ ‡ ­ 1 lsal i;t ‡ ­ 2 cfta i;t ‡ ­ 3 tata i;t
‡ ­ 4 iata i;t ‡ ­ 5 invntai;t ‡ ­ 6 invta i;t
‡ ¯t‡1 ‡ ²i ‡ "i;t‡1
All the variables are de® ned as in the cross section.
Ownership and market share dummies were not included
in the regression, as they did not add anything to the ® nd-
ings of the cross section (the results of course do not
change if we include those variables). Table 7 presents esti-
mated coe cients, standard errors and t values.
The panel results con® rm fully what is found in the
cross-section: all variables maintain their sign and degree
of signi® cance. There is only one diŒerence between the
cross-section and the panel estimate and it is constituted
by investment.25 Now investment is positive and signi® -
cant, suggesting that if a ® rm invested in the past it is
more likely to get credit from the banks. As stressed in
the theoretical part this may be due to the fact that past
investment can be a signal of future growth opportunities
and therefore generate a positive relationship with debt.
There is one consideration that has to be done on this
25
As explained in the Appendix the estimates presented in Table 7 present a precise and reliable information on the sign and the
signi® cance but not on the size of the parameters. For this reason in interpreting the results we will only look at the sign and signi® cance.
26
One dummy (1992 in this case) had to be dropped to avoid perfect collinearity.
1699
1 issue: if past investment has been ® nanced by bank debt,
the estimated coe cient would eŒectively capture the
t
eŒects of another (latent) variable and therefore invalidate
8.864 the inference about the variable of interest.
72.925 However, the choice of the dependent variable should
1.925 reduce the above mentioned problem as short-term debt
75.864
7.100 is rarely used to ® nance investment projects. The correla-
2.086 tion coe cient was calculated between past debt and
investment and it resulted quite low (around 30% ). In
any case the results about investment should be taken
with a bit of caution. Two of the three year dummies26
(not reported in Table 7 are signi® cant, indicating the pres-
ence of some time eŒect that is individual invariant. This
most likely captures the eŒects of business cycle factors on
the aggregate level of leverage.
VI. CONCLUSIONS
This work used a panel consisting of approximately 1100
observations, over ® ve years, of Hungarian ® rms to inves-
tigate the presence of constraints to these ® rms in achieving
their optimal capital structure and more in general the
`e ciency’ of the banking sector in providing credit.
There is evidence of the existence of a `pecking order’ in
® rms’ ® nancing choices suggesting the presence of forms of
® nancial market imperfections that constrain them in the
achievement of their optimal capital structure. On the
other hand there are also reassuring signs: following the
shock of transition and in the presence of imperfections
in the ® nancial markets, banks could have reacted in two
ways: one, the easiest and the most myopic, would have
seen banks looking for the short-term safety of large mono-
…3†
polistic state owned ® rms and even gamble for bailout of
loss making state owned enterprises. The second way
would have seen banks actively trying to resolve the infor-
mational problems, allocating funds where it was possible
to obtain adequate (and correct) collateral provisions,
looking at ® rms’ long-term growth opportunities ® rms,
etc. The analysis conducted in this paper suggests that
Hungarian banks seem to have chosen the second way
raising hopes of a fast resolution of the problems that are
currently a‚ icting the ® nancial market.
ACKNOWLEDGEMENTS
This research is part of the Phare-Ace Project N. P96-6151-
R `The Role of Financial Markets in Transition’. Many
thanks to John Dri ll, Sally Srinivasan, Luca Stanca,
AÂkos Valentinyi and JaÂnos Vincze for helpful comments.
 1700
Thanks to JaÂnos Vincze for providing 1996 data. The usual
disclaimer applies.
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APPENDIX
The following consistency checks were applied to the data:
® rms which presented negative values for the following
variables were dropped from the sample: sales, employ-
ment, debt (short and long term).
The procedure used to identify outliers deserves some
attention: it is often di cult to identify in¯ uential observa-
tions (i.e. observations that, if removed, would change the
estimated coe cients markedly); the di culties increase
when multivariate data is considered. In the analysis a
method developed by Hadi (1992, 1994) was employed.
This method can brie¯ y be described as follows. Given p
variables the procedure de® nes an initial cluster of points
de® ned as r ˆ p ‡ 1, selected minimizing a measure of dis-
tance.27 Once the initial cluster is de® ned, it is then
T
…xi ¡ CR † SR¡1 …xi ¡ CR †
 Determinants of corporate capital structure
expanded taking the r ‡ 1 closest points (according to the
same measure of distance). The procedure is then repeated
until some stopping rule is satis® ed.
The programme Stata, used in the calculations, allow to
perform such routine and also to de® ne a `signi® cance’
level for the outlier cutoŒ; as usual in statistical analysis
the signi® cance level was chosen to be 5% . This procedure
has the big advantage that allows to deal easily with multi-
variate data; the routine was compared with other methods
of identifying outliers like residuals analysis, tests based on
Cook’s and Welsch distances, etc. In all cases it yielded
better results in terms of the overall ® t of the model
being more parsimonious in terms of the variables identi-
® ed as outliers.
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1701
A ® nal note is referred to the panel estimator. As stressed
in the chapter the panel estimates presented in section 5.2
are random eŒects estimates. The way the estimators are
derived is through a quadrature of the likelihood function.
This procedure is sensitive to the number of quadrature
points, in particular for large panels the approximation
may become poor. It is possible to check the sensitiveness
of parameter estimates to the variation of the number of
quadrature points. It turns out that the parameters are
sensitive to changes in the number of quadrature points,
however the sign and the degree of signi® cance of par-
ameters do not change. For this reason the results pre-
sented in Table 7 should be interpreted only as an
indication for the sign of the coe cients and not for their
exact value.