“Cost Structure and Capital Structure” by Laura Xiaolei Liu
Laura Xiaolei Liu
The Hong Kong University of Science & Technology
University of Stavanger
The stakeholder theory of capital structure proposed by Titman (1984) argues that non-financial stakeholders, such as customers and employees, may care about a firm's financial health. The firm will thus take into account these stakeholders' preferences when making capital structure decisions. In particular, firms selling specialized products will choose a lower leverage ratio. We propose a cost structure measure to capture the uniqueness of products. We documented that this single factor can explain about 16% to 23% of the cross-sectional variation in capital structure. One standard deviation increase in the cost structure variable relates to an 8% to 10% decrease of debt ratio. The association is stronger among firms with higher default probability. The results are robust to using the IV method where the instrument variable is the income per job in the state where the firm's headquarters is located. Further, using the changes in the enforceability of noncompetition laws as a natural experiment, we document that cost structure changes caused by the reduction of enforceability results in changes in firms' leverage ratios. Lastly, we isolate the channels through which stakeholders affect capital structure. We find evidence for a "brand value" effect channel where consumers using specialized products to signal status care about the brand value of the products, which is attached to the image of the company. We conclude that, consistent with stakeholder theory, cost structure has a causal impact on a firm's leverage choices and is one of the most important determinants of capital structure in the cross-section.