Using the ratio of total, long term, and short term debt to total equity in 1982 as the dependent variable, the OLS cross- section regression results for 387 firms are shown in Table 5.
In general, these findings are consistent with those of the
capital structure literature. For example, in column (1), using total debt to common equity (TD/CE) as the dependent variable, the emergence of a negative and statistically significant
coefficient for R&D/Sales is consistent with expectations and matches the findings of both Bradley, Jarrell and Kim (1984), and Titman and Wessels (1988). The negative and statistically
significant coefficient on OPM is consistent with the pecking order theory, as found by Titman and Wessels (1988). The
negative sign on the innovation coefficient is consistent with the corporate governance hypothesis of capital structure, using innovation as a proxy for asset specificity. The coefficient, however, is not significantly different from zero. This may be due to ambiguity resulting from a size relationship in the trade
off between tax and other leverage related effects.
When lagged D/CE is included in the equation, neither the sign nor significance of any of the other coefficients change
(i.e., column (2)). The lagged debt term is positive and
correlation of the error terms, yielding parameter estimates that are both consistent and efficient. Descriptive characteristics of the regression sample are included in Table 4.
24
statistically significant, implying that current capital
structure is closely related to its prior characteristics. This supports the hypothesis that the capital structure of the firm is stable over time, as advanced by Fischer, et.al. (1989). These results are robust for different specifications of capital
structure, as can be seen in columns (3)-(6).
Because of the potential size related ambiguity, the results of the debt/equity equations are re-estimated for the two
separate size classes. Results for the larger firms are
presented in Table 6. The important difference between these and the estimates for the uncut sample can be seen in column (1), where the innovation coefficient is negative and significant.
This is consistent with the hypothesis that the net investment related tax benefits are exceeded by leverage related costs as well as the governance approach to capital structure, in which specific assets are financed with equity. The positive and significant sign on the size coefficient is consistent with the hypothesis that larger firms are more diversified, and hence, use more debt. The sign and significance on the R&D/Sales and OPM coefficients are preserved.
When lagged D/CE is added to the equation, as in column (2), innovation becomes insignificant, indicating the presence of
collinearity or simultaneity between the two variables. The pattern for the long term ciebt equations in columns (3) and (4) is the same. Columns (5) and (6) imply that the most important determinant of short term debt for large firms is operating
Table 5
Sample Size 387 387 387 387 387 387
A d j . R-square 0.045 0.2417 0.113 0.408 0.118 0.4526 F-Statistic 4.719 21.084 11.048 44.281 11.568 53.808 Significant at the .05 level
26
— 2.036* -1.291 -2.168* -1.445 -0.858 -0.391 R&D/S -6.691 -3.801 -5.892 -3.287 -0.801 -0.588 -3.591* -2.612* -4.087* -2.895* -1.023 -0.809 Ln (Assets) 11.083 7.113 10.481 7.281 0.602 -0.056 2.928* 2.432* 3.582* 3.195* 0.378 -0.038
Sample Size 258 258 258 258 258 258
A d j . R-square 0.1277 0.482 0.146 0.489 0.028 0.162 F-Statistic 9.017 41.844 10.353 42.903 2.603 9.481 Significant at the .05 level
Table 7
Regression Results (OLS) for Short Term, Long Term and Total Debt to Common Equity Equations for Small Firms in 1982
(t-statistics below coefficients)
(1) (2) (3) (4) (5) (6)
Variable TD/CE TD/CE LTD/CE LTD/CE STD/CE STD/CE Intercept 185.955 124.981 104.01 77.902 81.945 50.246
3.587 2.637 2.431 1.913 4.116 2.953
INNOV 47.026 28.838 32.389 18.856 14.636 11.764
3.727* 2.461* 3.Ill* 1.808* 3.021* 2.941*
R&D/S -8.102 -5.645 -5.819 —4.207 -2.285 -1.646 -4.191* -3.177* -3.647* -2.701* -3.075* -2.671*
Ln (Assets) -14.331 -8.818 —2.109 -1.359 -12.222 -7.511 -1.272 -0.879 -0.227 -0.156 -2.814* -2.074*
OPM -4.555 -3.868 -3.771 -3.353 -0.784 -0.568
-4.828* -4.574* -4.842* -4.541* -2.166* -1.899*
STD/CE -5 0.336
6.709*
LTD/CE -5 0.293
3.688*
TD/CE -5 0.332
5.118*
Sample Size 129 129 129 129 129 129
A d j . R-square 0.291 0.444 0.242 0.334 0.201 0.4611 F-Statistic 10.715 16.182 8.596 10.548 6.954 17.255 Significant at the .05 level
28
profit margin, consistent with pecking order theory.
The results for the small firms are shown in Table 7. In column (1), the innovation coefficient is positive and
statistically significant. This result is inconsistent with the hypothesis of Williamson (1988), that innovative behavior is associated with greater levels of equity for all firms. The result is consistent, however, with the hypothesis that the net investment-related tax effect offsets other leverage related costs, leading to increased use of debt. The results remain robust when lagged debt/equity variables are included, and for different specifications of the dependent variable.
Table 8 presents the results of the 3SLS estimates of the innovation equation. The system is estimated separately for the small and large firm size classes using each of the three debt measures. In all six equations, the positive and statistically
significant coefficient for lagged R&D/S indicates that research and development is an important determinant of innovation. This is consistent with both theory and prior results (Acs and
Audretsch 1991; and Acs and Isberg, 1991). The positive and statistically significant coefficient for the log of assets in the large firm size class implies that innovation increases with firm size. This is also consistent with prior findings. The statistically insignificant coefficients on the log of assets for
*.
the small firms model indicates that innovation is not
differentiated by size for small firms. While the coefficient of lagged operating profit is positive and significant for small
3SLS Results for the Innovation Rate Equation for 1982 (t-statistics below coefficients)
Variable
Small Firms Large Firms
(1) (2) (3) (4) (5) (6)
Intercept -0.317 -0.439 0.074 -0.573 -0.673 -0.597 -0.601 -0.916 0.138 -1.662 -2.402 -1.636 R&D/S (77) 0.063 0.074 2.604 0.123 0.102 0.164 1.984* 2.263* 0.825 4.134* 3.723* 5.393*
OPM (77) 0.012 0.012 0.012 0.002 0.004 -0.002
2.097* 2.046* 2.107* 0.388 0.679 -0.265 Ln(Ass.) (77) 0.028 0.044 -0.012 0.164 0.180 0.141 0.258 0.447 -0.105 3.362* 3.806* 2.785*
TD/CE (77) 0.002 -0.003
3.861* -7.506*
LTD/CE (77) 0.004 -0.004
4.550* -7.837*
STD/CE (77) 0.004 -0.007
3 . Ill* -2.976*
Sample Size 129 129 129 258 258 258
S y s .W t .R - s q u . 0.304 0.259 0.278 0.301 0.301 0.160
Sys.Wt.MSE 1.307 1.192 1.313 1.540 1.687 1.083
Significant at the .05 level
Separate regressions estimated for each equation.
30
firms, it is insignificant for large firms. This suggests that internal cash is more important for small firm innovation than for large firm innovation, ceteris paribus.
The most important findings in the innovation equations regard the lagged D/E ratio. The statistically significant coefficients in both firm size classes suggest that the firm's investment and financing decisions are related. In the small- firm class, innovations are positively related to debt, while for large firms, however, the relationship between lagged D/E and innovation is negative.
These findings are further substantiated in the 3SLS
estimates of the D/E equations presented in Table 9. Examination of the innovation coefficients in the small firm equations, (1)-
(3), indicate the presence of a direct and significant
relationship between the debt/equity ratio and innovation. This confirms the suggestion that, ceteris paribus, small innovative firms use more, and not less, debt to finance firm specific assets. The results are again robust for different
specifications of the dependent variable. For large firms, the innovation coefficients are negative and statistically
significant when long term and total D/E ratios are dependents, but insignificant for the short term ratio.
The foregoing results are consistent with the governance
*■ , > , ,
approach for large firms, but not for small firms. This is not surprising given institutional economists' focus on theories regarding large firms (FitzRoy and Acs, 1991). Governance
3SLS Results for Total, Long Term, and Short Term Debt Equations for 1982 (t-statistics below coefficients)
Variable
Small Firms Large Firms
(1) TD/CE
(2) LTD/CE
(3) STD/CE
(4) TD/CE
(5) LTD/CE
(6) STD/CE Intercept 137.255 77.194 45.600 -18.859 -43.151 11.497
1.839 1.487 1.244 -0.416 -1.203 0.693 INNOV (82) 185.695 106.046 109.828 -76.020 -67.025 -16.286 3.788* 3.289* 3.580* -3.190* —3.153* -1.622 R&D/S (82) -9.668 -6.172 -3.406 63.375 0.229 0.849 -2.875* -2.626* -1.969* 0.190 0.093 0.575 OPM (82) -6.150 -4.281 -2.552 -1.138 -0.596 -0.611 -2.762* -2.850* -1.876* -1.800* -1.281 —2.173*
L n (Ass.) (82) -9.209 -0.676 -6.765 18.673 18.602 2.185 -0.554 -0.059 -0.810 2.724* 3.347* 0.877*
Sample Size 129 129 129 258 258 258
Sys.Wt.R-squ. 0.304 0.259 0.278 0.301 0.301 0.160
Sys.W t .MSE 1.307 1.192 1.313 1.540 1.687 1.083
Significant at the .05 level
Separate regressions estimated for each equation
32
patterns for small firms are different because they tend to be more closely held, and therefore, subject to greater proprietary control. Given that there are generally fewer participants in the governance mechanism of small firms, structural differences in governance costs may explain why the governance model does not fit well for small firms.
In regard to leverage trade-offs, the foregoing results for small firms are consistent with the hypothesis that net
investment related to tax effects is exceed the sum of all other leverage related costs, leading to the greater use of debt by innovating firms. Conversely, for large firms, the 3SLS results are consistent with the net tax effects that are not sufficient to offset the combined costs of agency and information asymmetry, calling for the use of more equity by innovating firms. This apparent size-related net leverage effect can be explained by the presence of decreasing economies of scale, as previously
illustrated. This result may also indicate, however, that leverage costs as well as tax effects are size related.
One can argue that the cost of information asymmetry is related to both innovation and firm size. Jensen and Meckling
(1976), contend that small entrepreneurial firms will seek debt and not equity for several three reasons: First, small firms are more closely held and management is less willing to give up
equity control of the firm*. Second, small firms do not have a track record for paying dividends. Three, the entrepreneur may have a greater ability to raise debt in the informal rather than
the formal capital market (Gaston, 1989). Given this third point, small firms may have an advantage over large firms in
reducing the cost of information asymmetry because they seek debt in different capital market sectors. The costs of revealing
information in the informal market, where transactions are private and involve fewer parties, is lower than that of
revealing the same information in the public debt markets. In this case, information regarding an innovation provides tangible security for debt financing. Hence, it is not surprising to see a positive relationship between debt and small firm innovation.
Large firms, on the other hand, turn to the larger, formal, public debt markets for capital, where the arguments of Ross
(1977) and Myers and Majluf (1984) are more applicable.
The impact of risk-related agency costs on optimal capital structure may also be a function of firm size. For small firms seeking capital in less formal debt markets, it is easier to reduce and/or eliminate agency costs via contracting between the borrower and lender. Since fewer parties are involved in the financing process, covenants can be established and monitored with greater flexibility and at lower cost. For large firms involved in the formal debt markets, it is more costly to establish and provide for monitoring of such contracts. As a result, one can argue that the negative impact of risk-related agency costs is lower for femall firms. The remainder of the results of the debt/equity equations are consistent with finance theory.
34