International Capital Structures

Companies’ capital structures vary among the large industrial countries. For example, the Organization for Economic Cooperation and Development (OECD) recently reported that on average, Japanese firms use 85 percent debt to total assets (in book value terms), German firms use 64 percent, and U.S. firms use 55 percent. One problem, however, when interpreting these numbers is that different countries often use very different accounting conventions with regard to (1)reporting assets on a historical-versus a replacement-cost basis, (2) The treatment of leased assets, (3) pension plan funding, and (4) capitalizing versus expensing R&D costs. These differences make is difficult to compare capital structures.

One recent study, by Raghuram Rajan and Luigi Zingales of the University of Chicago, attempts to control for differences in accounting practices. In their study, Rajan and Zingales used a database which covers fewer firms than the OECD but which provides a more complete breakdown of balance sheet data. Rajan and Zingales concluded that differences in accounting practices can explain much of the cross country variation in capital structures.

Rajan’s and Zingales’ results are summarized in table 18.5. There are a number of different ways to measure capital structure. One measure is the average ratio of total liabilities to total assets this is similar to the measure used by

Median Capital Structures among Large Industrialized Countries (Measured in Terms of Book Value)

	Total Liabilities to Total Assets (Unadjusted for differences in accounting differences)	Debt to total Assets (Unadjusted for accounting differences)	Total Liabilities to Total Assets (Adjusted for Differences in accounting differences)	Debt to Total Assets (Adjusted for accounting differences)	Times Interest Earned (TIE) Ratio
Country	(1)	(2)	(3)	(4)	(5)
Canada	56%	32%	48%	32%	1.55×
France	71	25	69	18	2.64
Germany	73	16	50	11	3.20
Italy	70	27	68	21	1.81
Japan	69	35	62	21	2.46
United Kingdom	54	18	47	10	4.79
United States	58	27	52	25	2.41
Mean	64.4%	25.7%	56.6%	19.7%	2.69×
Standard Deviation	8.1%	6.9%	9.5%	7.7%	1.07×

The OECD and it is reported in column 1. Based on this measure, German and Japanese firms appear o be more highly levered than U.S. firms. However, if you look at column 2, where capital structure is measured by interest-bearing debt to total assets, it appears that German firms use less leverage than U.S. and Japanese firms. What explains this difference? Rajan and Zingales argue that much of this difference is explained by the way German firms account for pension liabilities (and their offsetting assets) on the balance  sheet, whereas firms in other countries (including the United States) generally “net out” pension assets and liabilities on their balance sheets. To see the importance of this difference, consider a firm with $10 million in liabilities (not including pension liabilities) and $20 million in assets (not including pension assets). Assume that the firm has $10 million in pension liabilities which are fully funded by $10 million in pension assets. Therefore, net pension liabilities are zero. if this firm were in the United States, it would report a ratio of total liabilities to total assets equal to 50 percent ($10 million $20 million). By contrast, if this firm operated in Germany, both its pension assets and liabilities would be reported on the balance sheet. The firm would have $20 million in liabilities and $20 million in assets or a 67 percent ($20 million/$30 million) ratio of total liabilities to total assets. Total debt is the sum of short-term debt and long-term debt and excludes other liabilities including pension liabilities. Therefore, the measure of total debt to total assets provides a more comparable measure of leverage across different countries.

Rajan and zingales also make a variety of adjustments which attempt to control for other differences in accounting practices. The effect of these adjustments are reported in Columns 3 and 4. overall, the evidence suggests that companies in Germany and the United Kingdom tend to have less leverage, whereas firms in Canada appear to have more leverage, relative to firms in the United States, France, Italy and Japan. This conclusive is supported by data in the final column, which shows the average times-interest-earned ratio for firms in a number of different countries. That the times-interest-earned ratio is the ratio of operating income (EBIT) to interest expense. This measure indicates how much cash the firm has available to service its interest expense. In general firms with more leverage have a lower times-interest-earned ratio. The data indicate that this ratio if highest in the United Kingdom and Germany and lowest in Canada.