The Impact of Macroeconomic Conditions, Economic Development and Government Industrial Policy on Capital Structure of Firms: Evidence from Taiwan

Abstract

The thesis examines the impact of macroeconomic conditions, economic development and government industrial policy on capital structure. These three macro-level factors have been neglected by most of the voluminous studies on capital structure that have emerged since Modigliani and Miller’s irrelevance propositions in 1958. Very few studies have examined the impact of macroeconomic conditions and economic development on capital structure. In the case of macroeconomic conditions, a few studies on capital structure have analysed this variable in the context of default risk or investor protections while, in regards to economic development, a handful of studies have found that the impact of economic development on capital structure varies amongst countries. No study on capital structure decisions has examined the impact of government industrial policy. Thus, the effect of these three important variables on capital structure is not yet clearly established in the literature. The thesis therefore addresses this knowledge gap.

The investigation of these three factors is conducted based on the Partial Adjustment Model, i.e. PAM, of Capital Structure that the thesis reformulates. The thesis considers two important situations that have not been addressed by previous studies based on PAM – when firms are under financial constraint of either over-leverage or under-leverage relative to their target capital structure. Unlike previous studies, the thesis investigates macroeconomic conditions, economic development and government industrial policy guided by the agency theory of capital structure and with consideration given to growth opportunities. The thesis research is undertaken in the context of Taiwan – a country that has recently joined the ranks of developed countries after successfully transforming itself from being a Third World country, and with industries that are widely recognised worldwide. The period of study is from 1983 to 1995. This period has been chosen due to the limited availability of data for the electronics industry before 1980 and to control for the potential impact of intervening factors such as the Asian Financial Crisis in 1997, Taiwan’s implementation of a new tax policy in 1998 and both the bubble economy and the dot-com problem in the early 2000s. The sample used in the thesis includes the listed firms in the textile, plastics and electronics industries that were financially supported by the Taiwanese government’s industrial policy during the periods of the 1960s, the 1970s to the mid-1980s and the mid-1980s to the mid-1990s...