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Julija Tamulyte
The determinants of capital structure in the Baltic States and Russia
Electronic Publications of Pan-European Institute 1/2012

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Financing decisions are vital for the firm’s financial welfare and capital structure policy is assumed to be a way of creating company’s value. A bad decision about capital structure may lead to financial distress and eventually bankruptcy. Management of a firm in developed countries set its capital structure in a way that firm’s value is maximized. However, what should the leverage ratio to assure effective company’s assets and projects’ financing and company’s performance be? What are the main factors influencing management decision on capital structure?

Although many researchers have been trying to solve the problem of capital structure, none can determine the optimal capital structure or to formulate any rules or guidelines for it. However, some characteristics have been noticed during the time. Capital structure depends on a firm’s, industry and country characteristics and is dynamic in the long-term.

In this research I focus on the similarities and differences of capital structure and factors influencing it between The Baltic States and Russia, the countries that has just gone through a period of transition. These countries were chosen for comparison because their development of democracy and market economy started at the same time and were closely related as they were a part of The Soviet Union. However, differences in the size of the countries and their markets, political and economical directions, banking and stock markets development exist and influence business environment and firms’ capital structure. The aim of this paper is to define the determinants influencing capital structure in Russian, Estonian, Latvian and Lithuanian firms at both country- and firm-specific levels.2


Our analysis covered country-level, financial and firm-level determinants of capital structure in Estonia, Latvia, Lithuania and Russia, all economies which recently went through a transition process from a planned to a market economy. Even though the transition process started in 1990s, countries’ economies improved a lot. The growth of the economy was empowered by collaboration with Western countries, their expertise and investments, foreign trade and open market in the European Union for The Baltic States. Privatization and legislation played important roles in the countries development as well and influenced further growth of these economies.

An average of Total leverage in The Baltic States and Russia was similar during the period of 2002 – 2008 at between 15.8% in Estonia and 22.2% in Latvia and Lithuania with a Russian average of Total leverage was 19.6%. These leverages are still lower than in most of Western European countries, but will be presumably similar with European countries leverages assuming continued strengthening business relations and partnerships.

Trade Credit was the most important source of finance for all countries in our analysis, making about one third of Total Liabilities in all countries. Trade Credit is found to be important in other developing countries, analysed by other researchers, as well, as it is the least risky source of finance and is available at the lowest borrowing costs, if any occurs. Long term debt and Short term debt made about the same proportion of Total Liabilities, with Long term debt taking more significant part in Lithuanian and Russian Total Liabilities portfolio. Long term debt was so important in Lithuania and Russia because they had the biggest part of Tangible Assets, and this type of assets needs to be renovated and modernised periodically.

Credit market development (Domestic credit and Number of banks) played the most important role in our analysed countries when forming capital structure. The more the credit market developed, the more debt was taken. An increased number of banks created more tough competition and forced banks to provide better lending conditions. Stock market development had a significant influence on leverage level in Russia because there the Stock market is much bigger and has more investors in Russia. The higher Stock market capitalization was, the less debt companies took. Market Timing Theory can explain this balancing of Russian companies between the choice of debt and equity issue depending on the situation in both credit and equity markets. GDP growth encouraged Estonian and Lithuanian companies to finance most of their financial needs by their presumably increased profit and easier available Trade Credit (because of optimistic future forecasts).

Tangibility was the only significant determinant in firm-related models, especially Long term leverage models, uniting countries in this investigation. The importance of collateral in the credit market and the need for investments into Tangible Assets stipulates it. Liquidity was an important determinant in all Baltic States, especially in Short term leverage and Trade Credit/Total Assets models. It suggests that less liquid firms tend not to increase their debt and to take less risk by taking more Short term debt or (and) Trade Credit. Besides, Short term debt and Trade Credit are less expensive than Long term debt. Russian companies, on the contrary, tend to take more debt, especially Long term debt, when the company has higher business risk. This might be influenced by strict regulations in the Stock Exchange market, which prevents investors from equity issues of risky companies or current shareholders do not allow management to issue more stocks (Agency Costs Theory).

Therefore, these companies are forced to take Long term debt (even at the high costs) to finance their needs. Profitability is an important determinant in Lithuanian and Russian companies, signalling about the existent Pecking Order Theory, when companies tend to finance their needs using their own internal funds first. Age was an important determinant in Latvian and Lithuanian companies, where younger companies tend to take more debt. It was probably due to the lack of internal funds and inability to issue equity in Stock Exchange.

Age is statistically significant in Latvian Short term leverage formula specifying that younger companies tend to have more Short term debt – either because they want to avoid higher borrowing costs or because banks do not want to give them Long term debt due to the fact that they are newly established, less experienced and more risky firms. Assymetric Information factor might have some influence here as well.

To sum up, the level of leverage of The Baltic States and Russia were quite similar during the period of 2002 - 2008. Even though joining the European Union sped up the development of The Baltic States economies, but it did not have any significant influence on their capital structure.

Determinants of capital structure were similar in The Baltic States and Russia as well: Credit market development and Tangibility had the biggest influence when making financing decisions. However, the Russian capital structure was influenced by Stock market development as well. An important difference was noticed in risk acceptance perspective: risky Russian companies were more willing to take more debt, especially Long term debt. It might be due to larger size of companies in Russian sample, compared with the samples of the Baltic States, and their expectation to be “too big to fail”.

Finally, all companies have their own specific business models, financial needs and management which make capital structure decisions. These decisions may depend on both objective and subjective factors. Some of them can be measured, while others cannot. Therefore, the results of this research should be treated with caution as it only provides the statistic and econometric analysis of the factors that allegedly influenced the capital structure of the companies in our samples. However, business environment, credit and stock market development and conditions, and, most importantly, managers and banks’ risk perception and attitude towards debt (which was influenced by uncertainty in the economy and Soviet thinking) had key importance during our analysed period. Therefore, further research of the choice of capital structure could be extended into analysis of managers decision making procedure and analysis of the impact the choice of capital structure has to company’s performance.

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