What is the effect of portfolio capital flows on corporate financing decisions of firms in emerging markets? How do these flows affect on the real economy? These are fundamental questions of significant importance to central banks as they deal with the effect of flows on financial and economic stability.

There are two prominent channels through which advanced economy monetary policies can affect financing of firms in emerging markets. One is the effect that monetary policy has on the portfolio rebalancing of investors, with easy monetary policy encouraging investors to reach for yield and seek higher returns by investing in overseas assets. The increased capital flows into emerging markets in turn result in lower risk premia, lower costs of financing and greater debt issuances by emerging market firms. Another channel is the issuance of U.S. dollar-denominated bonds by non-U.S. firms, which can increase in times of easy monetary policy to take advantage of relatively low US dollar rates; the local currencies tend to appreciate during these periods of US easing which diminishes the burden of US dollar debt as well.

The key questions are: Do firms in emerging markets respond to easier financing conditions and lower risk premia in advanced economies by issuing large amounts of corporate debt? How much of the debt build-up in emerging markets could be attributed to unconventional monetary policies in the advanced economies? The answers to these questions are not obvious as various asset markets are affected. The policies of the U.S. Federal Reserve could affect both debt and equity markets, and result in portfolio rebalancing across assets in both markets across all regions.

In recent research, Frank Packer of BIS and I find that the more accommodative monetary policies in the U.S. since the global financial crisis has resulted in greater use of debt financing in countries with stronger institutions. Capital seeking higher return flows into the debt of firms in countries with better quality institutions. Foreign investors prefer to invest in better governed firms since they are at an informational disadvantage relative to local investors. The more accommodative monetary policies in the U.S. have also resulted in higher capital expenditures by firms in countries with stronger institutions. Furthermore, global liquidity relaxes the financing constraints of firms. In other words, the legal environment and quality of institutions has an important influence on how global flows affect the capital structure of Asian firms.


This research is built on earlier tests of capital structure theories with Murray Frank (Minnesota, Carlson). The research tested competing theories of capital structure, identified robust factors that drive leverage, and showed how a proper consideration of adjustment costs could reconcile the trade-off theory with empirical evidence. In [R1], we examined the broad applicability of the pecking order theory and showed that the net equity issues track financing deficits more closely than do net debt issues. Subsequent work [R2] explored the relative importance of many factors in the capital structure of firms' financing decisions and established the most reliable factors for explaining market leverage as: median industry leverage (+ effect on leverage), market-to-book assets ratio (-), tangibility (+), profits (-), log of assets (+) and expected inflation (+). In a survey article in the Handbook of Empirical Corporate Finance [R3], we further reviewed the empirical evidence on capital structure decisions of firms and concluded that direct transactions costs and indirect bankruptcy costs play an important role in a firm's choice of debt, while the relative importance of the other factors is open to debate. More recently, we revisited the profits-leverage puzzle and showed that the inverse relation between leverage and profitability is not a defect of the tradeoff theory but of the use of a leverage ratio [R4]. They showed that the usual interpretation of the evidence is wrong and that researchers ought to focus on a proper consideration of adjustment costs in interpreting empirical evidence. References to the Research [R1] Frank, M.Z. and Goyal, V.K. (2003), “Testing the pecking order theory of capital structure”, Journal of Financial Economics 67, 217-248. Google Scholar citations: 2,878. [R2] Frank, M.Z. and Goyal, V.K. (2009), “Capital structure decisions: Which factors are reliably important?” Financial Management 38, 1-37. Google Scholar citations: 2,298. [R3] Frank, M.Z. and Goyal. V.K. (2008) “Trade-off and pecking order theories of debt”. In Espen Eckbo (ed.) The Handbook of Empirical Corporate Finance, Elsevier Science, Chapter 12, 135-19. Google Scholar citations: 1,006. [R4] Frank, M.Z. and Goyal, V.K. (2015) “The Profits-Leverage Puzzle Revisited” Review of Finance 19, 1415-1453. Google Scholar citations: 94. Links:

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