Geographic Diversification and Agency Costs of Debt of Multinational Firms

Abstract

This paper examines the agency conflicts between shareholders and bondholders of multinational and nonmultinational firms and provides an explanation for the puzzle that multinational firms use less long-term debt but more short-term debt than domestic firms. Using a sample of 6,951 firm-year observations for multinational and domestic firms over the 1988-1994 period, we find that alternative measures of agency costs have statistically significant negative effects on firm long-term leverage. The results, however, also show that the negative effects of agency costs of debt on long-term leverage are significantly greater for multinational than non-multinational firms. It is documented that the effect of the agency costs of debt on leverage are increased by the firm’s degree of foreign involvement. The evidence shows that firm’s increasing foreign involvement exacerbates agency costs of debt leading to lower (greater) use of long-term (short-term) debt financing. This result is also confirmed using alternative measures of foreign involvement. The evidence is consistent with the view that multinational corporations are susceptible to higher agency costs of debt than domestic corporations because geographic diversity renders active monitoring more difficult and expensive in comparison to domestic firms. The results fail to support the view that MNCs’ lower long-term debt ratios are due to the advantages of the internal capital markets.