RDP 9313: The Determinants of Corporate Leverage: A Panel Data Analysis Appendix 3: Split Sample Results

Financial deregulation might be expected to have far reaching implications for firms' gearing decisions. Prior to the deregulation of financial markets, firms were credit rationed because of interest rate controls and restrictions on credit creation. This constraint may have forced firms to access relatively more expensive equity funds to finance investment opportunities. Thus, firms' leverage decisions over the 1970s may have been driven by fund availability considerations rather than fund cost considerations.

However, the analysis in the main body of our paper has not explicitly allowed for the easing of financial controls that occurred in the early 1980s. In an effort to allow the effects of financial deregulation to be reflected in our findings, we have estimated the static version of our fixed firm effects model over two sample periods: the first running from 1975 to 1981 and the second running from 1982 to 1990. The results are reported in Table A2 below.

Table A2: Split Sample Results for the Fixed Firm Effects Model
Variables Fixed Firm Effects
1974–1981 1982–1990
Constant −18.16 13.89
Cash Flow −0.02
Firm Growth −0.003
Real Tangible Assets 0.004
Firm Size 8.72
Potential Debt Tax Shield 0.11
Tax Exhaustion 6.09
Real Asset Prices −1.49
CPI Inflation 0.25
Fund Cost Differential 0.03
1. Numbers in parentheses are robust standard errors.

We tested the importance of the structural break between the period of regulation and the period during which financial markets were deregulated using a test described in Chow (1960). The test comfortably rejected the null hypothesis of no structural break at the 5 per cent level.[25]

Two points stand out from these split sample results.

  1. The coefficient on the real asset price index changes sign between the two sub-samples. Between 1975 and 1981, the sign on real asset prices is negative, although insignificantly different from zero. In comparison, from 1982 to 1990, the coefficient on the real asset price index is positive and highly significant. This switch suggests that the response of managers to increased investment opportunities underwent a fundamental change with the introduction of financial deregulation. After financial deregulation, managers were able to access debt funds rather than being forced to rely on equity finance to take advantage of higher returns from assets. This point is consistent with Lowe and Rohling (1993).
  2. Firm size has a much greater role in explaining variation in leverage during the pre-deregulation period. This may be because larger firms were able to find access to credit markets despite regulation. Deregulation opened up many credit markets to smaller firms, reducing the financing advantages of the larger players. The other variables provide little explanatory power in the pre-deregulation period.


The test statistic is 8.69. It is distributed according to an F114,1557 distribution which implies a 5 per cent critical value of 1.25. [25]