Growth Opportunities, Capital Structure and Dividend Policies in Japan

Journal of Corporate Finance 5 1999.
141168
www.elsevier.comrlocatereconbase
Growth opportunities, capital structure and

dividend policies in Japan
Ferdinand A. Gul
Department of Accountancy, City Uniersity of Hong Kong, Tat Chee Aenue, Kowloon Tong,
Hong Kong, China
Received 1 August 1995; accepted 1 October 1998
Abstract
This paper, using 5308 observations of listed Japanese firms between the years 1988
1992, provides additional evidence on contracting theory arguments for the relation between
growth opportunities, capital structure and dividend policies. To avoid the problems of
using cross-sectional proxies for time-sequenced variables, this study uses 1. pooled
cross-sectional time-series analysis and 2. time-series analysis with a one-year lag for the
dependent variables. Results show significant negative relations between growth opportunities and levels of both debt financing and dividend yields after controlling for firm size,
profitability, firm keiretsu affiliations and industry regulation. The results are consistent
with contracting cost arguments for corporate finance and dividend policies and confirm the
importance of growth opportunities in corporate finance theory. q 1999 Elsevier Science
B.V. All rights reserved.
JEL classification: G32; G35
Keywords: Japan; Growth opportunities; Dividends; Debt; Keiretsu
1. Introduction
An important body of research on capital structure and dividend policies
attempts to validate the theory that differences in contracting costs may provide an
explanation for cross-sectional variations in these financial policies Jensen and
)
Tel.: q852-2788-7919; fax: q852-2788-7944; e-mail: acgul@cityu.edu.hk
0929-1199r99r$ - see front matter q 1999 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 9 - 1 1 9 9 9 9 . 0 0 0 0 3 - 6
142
F.A. Gul r Journal of Corporate Finance 5 (1999) 141168
Meckling, 1976; Rozeff, 1982; Easterbrook, 1984.. In particular, differences in

contracting costs that arise from a firms investment opportunity set IOS. are
expected to be related to corporate financing and dividend decisions. To date,
relatively few empirical studies have addressed this issue. The studies that have
been done have been conducted on US data, thus, providing a country-specific test
of the theory.
The objective of this paper is to investigate the relationship between IOS and
capital structure and dividend policy of listed Japanese firms. The interest in
studying Japan stems from three factors. First, unlike in the US, Japanese legal
and regulatory environment permit commercial banks and financial institutions to
own shares in corporations and exert more control Jensen, 1989; Prowse, 1991,
1992.. 1 Second, there exist differences between keiretsu or industrial groups
centered around affiliated banks and financial institutions and unaffiliated independent firms with weaker banking ties. The differences in institutional arrangements
between keiretsu and non-keiretsu firms may influence the behavior of shareholders as monitors Hoshi et al., 1991; Prowse, 1992.. Third, there is evidence to
suggest that monitoring functions of large shareholders of keiretsu firms are
different from that of US firms. Kester 1990. describes the corporate governance
system of keiretsu firms in terms of a complex interaction between shareholdings,
credit holding and long-term business relationship that exist between the firm and
its stake holders. Prowse 1990, 1992. suggests that the problems of wealth
transfers from debtholders to shareholders are unlikely to exist for keiretsu firms
because the large shareholders are also large debtholders. The concentration of
borrowing and the linkage between debt and equity reduces the cost of financial
distress because it reduces conflicts between investors when a firm is near default
Hoshi et al., 1991.. Thus, the unique Japanese institutional arrangements provide
an interesting backdrop to investigate whether contracting costs explanations for
debt and dividend policies still apply given these differences.
Much of the theoretical and empirical basis for this paper is drawn from two
related studies. Smith and Watts 1992. SW. report significant associations
between IOS and capital structure and dividend policy. They use the contracting
perspective to explain their findings. Gaver and Gaver 1993. extend the SW study
by conducting a cross-sectional analysis at the firm, rather than the industry level
and use an index of investment opportunities based on six proxies for growth
opportunities. 2 Gaver and Gavers GG. results are in general consistent with the
findings of Smith and Watts 1992. that firms with good growth opportunities
In the US, the GlassSteagall Act prohibits any equity ownership by banks.
The proxies are 1. the ratio of firm market value to the book value of assets, 2. the ratio of
market to book value of equity, 3. the ratio of R&D expenditures to the book value of assets, 4. the
earningsrprice ratio, 5. the variance of the total stock return of the firm, and 6. the frequency that the
firm is included in the holdings of growth-oriented mutual funds Gaver and Gaver, 1993..
2
143
have significantly lower debtrequity ratios and lower dividend yields than nongrowth firms.
This paper provides pooled cross-sectional time-series and lagged time-series
evidence on the relation between IOS and corporate finance policies for listed
Japanese firms using observations for the five-year period from 1988 to 1992
obtained from PACAP Pacific-Basin Capital Markets. files. The lagged timeseries is used to overcome the concern in the GG study of spurious correlation
between debtrequity ratio and dividend yield and the IOS because each of the
three proxies for the IOS market-to-book assets, market-to-book equity and
earningsrprice ratio. is also dependent on stock price Gaver and Gaver, 1993, p.
154..
The results show that high growth firms have significantly lower debtrequity
ratios and dividend yields compared to low growth firms, which support the
findings of SW and GG. In particular, the use of the lagged variable approach
provides a more robust test of the theory. In addition, the study found that keiretsu
firms are associated with higher debt, controlling for growth opportunities.
Section 2 provides an explanation for the relation between IOS and both capital
structure and dividend policy and the empirical proxies for the IOS and Section 3
provides a discussion of the sample selection process and characteristics of the
sample. Section 4 presents the results and a discussion and summary of the
findings are provided in Section 5.
2. The relation between IOS and corporate financial policies
2.1. Growth opportunities, capital structure and diidend policy
Following Myers 1977., growth opportunities are considered in terms of the
proportion of firm value accounted for by assets-in-place; the lower the fraction of
firm value represented by assets-in-place, the greater are the firms growth
opportunities or IOS. Mason and Merton 1985. point out that firms with growth
options are those that have relatively more capacity expansion projects, new
product lines, acquisition of other firms and maintenance and replacement of
existing assets. Three theories that might explain the association between IOS and
corporate finance policy are the tax, signaling and contracting arguments Smith
and Watts, 1992..
An important tax argument, for example, relies on the progressivity in taxes
which implies that expected tax liabilities are higher when there is greater
volatility in taxable income. Thus, firms with high growth options and high cash
flow volatility have incentives to reduce debt in their capital structure over the
range of progressivity Smith and Watts, 1992.. This tax effect suggest a negative
association between IOS and debt.
The signaling hypothesis is based on the impact of information asymmetries on
debt policies. For example, firms with high growth options face greater informa-
144
tion disparities and therefore are expected to have higher debt levels to signal
higher quality. This signaling effect predicts a positive association between IOS
and debt.
Following the contracting perspective, firms with more growth opportunities
are less likely to issue debt for two reasons. 3 First, the underinvestment problem
suggests that firms generally issue only risky debt that can be supported by
assets-in-place. If not, managers acting on behalf of shareholders may decide not
to undertake positive net present value investments to avoid the possibility of the
payoffs going to debtholders. This suggests that, other things being equal, the
lower the assets-in-place, the lower the financial leverage. Second, given that debt
has been issued, the asset-substitution problem occurs when managers acting on
behalf of shareholders opportunistically substitute higher variance assets for lower
variance assets. In this way, wealth is being transferred to the shareholders
provided the debt was issued and priced on the basis of low variance assets. Asset
substitution is less likely when there are more assets-in-place since it is relatively
easy for outsiders such as auditors to monitor the existence and value of these
assets such as land, building and plant. However, when a firm has more intangible
growth opportunities, asset substitution is more likely since outside monitoring of
these assets is more difficult. Thus, firms with more growth opportunities 4 are
less likely to issue debt other things being equal.
The costly contracting perspective 5 and the evidence obtained in prior studies
Long and Malitz, 1985; Smith and Watts, 1992; Gaver and Gaver, 1993; Goyal et
al., 1998. suggests the following hypothesis.
H1. Firms with lower levels of growth opportunities will have more debt.
A review of the literature suggests two explanations for the association between
growth opportunities and dividend policy. 6 The first explanation, which relies on
the signaling perspective, suggests that high quality firms may commit to larger
dividends in order to certify or signal. to the market their higher quality
Easterbrook, 1984.. This is also consistent with the views of Bhattacharya 1979.,
who argues that high quality firms pay higher dividends to reduce information
disparities between managers and investors of high growth firms. Thus, high
dividends may be associated with high investment opportunities.
The second explanation, which relies on contracting costs arguments, suggest
that dividends may serve incentive roles Jensen, 1986; Milgrom and Roberts,
3
See, also, arguments by Myers and Majluf 1984. and discussion by Titman and Wessels 1988..
Both the underinvestment and asset substitution problems are likely to be less severe for keiretsu
firms since the large shareholders in most keiretsu firms are also debtholders.
5
The lack of information on the specific tax status of the companies makes it difficult to conduct
tests of the tax hypothesis.
6
Smith and Watts 1992. point out that no tax analysis exists in the dividend literature to explain
cross-sectional variations in dividends.
4
145
1992.. Dividend payments remove resources from the firm and so help to mitigate
agency costs of free cash flows. 7 Milgrom and Roberts 1992, p. 507. point out
that this incentive effect argues for dividends being higher in slow-growth
industries than ones with good investment opportunities. This assumes that firms
without profitable investment opportunities will pay higher dividends than undertake negative net present value projects Smith and Warner, 1979.. On the other
hand, firms with high growth opportunities are likely to pay lower dividends since
they have lower free cash flows and less flexibility in their dividend policy. These
firms may also pay lower dividends to reduce their reliance on costly external
financing. This reasoning which has considerable support Gaver and Gaver, 1993.
is consistent with the interpretation by Rozeff 1982. and leads to H2.
H2. Firms with lower levels of growth opportunities have higher dividends.
2.2. IOS measure

IOS is measured in terms of three widely used proxies for growth opportunities
Goyal et al., 1998.. The first variable is the ratio of market value of assets to
book value of assets 8 French and Poterba, 1991. which is defined as follows:
MKTBKASs w Book assets y Total common equityq Shares outstanding
=Share closing price x % Book assets.
1.
This ratio is selected for two reasons. First, as argued by SW and GG, this ratio
is inversely related to the proportion of firm value accounted for by assets in place
and hence directly related to the proportion of firm value accounted for by its
investments opportunities. Second, Skinner 1993. used variations of this ratio of
the value of gross property, plant and equipment to firm value, and Tobins q,
defined as the ratio of market value of the firm to the replacement cost of the
assets. A number of recent research have used this proxy to examine the relation
between growth opportunities and debt, dividend policy and compensation contracts Morck et al., 1988; Barclay and Smith, 1995; Rajan and Zingales, 1995;
Goyal et al., 1998..
7
Free cash flows is defined as cash flow in excess of that required to fund all projects that have
positive net present values when discounted at the relevant cost of capital Jensen, 1986..
8
A possible limitation is that this measure contains potentially significant measurement errors for
firms with long-lived assets since book value is historical cost less depreciation. SW encountered the
same problem in their proxy for IOS. A redeeming factor, however, is that virtually all Japanese firms
use accelerated depreciation.
146
The second measure is the ratio of the market to book value of equity Chung
and Charoenwong, 1991. which is defined as follows:
MKTBKEQs w Shares outstanding= Share closing price x
% Total book value of common equity.
2.
Two reasons prompt the selection of this measure. First, the difference between
the market and book value of equity approximates the value of investment
opportunities facing the firm Collins and Kothari, 1989.. Second, future earnings
that the firm is expected to produce and the expected growth rate of both earnings
and cash flow are determined by the amount of growth opportunities Lewellen et
al., 1987..
The third empirical proxy for IOS selected is the earningsrprice EP. 9 ratio
Beaver and Morse, 1978. which is defined as follows:
EP s Primary EPS before extraordinary item % Share closing price.
3.
Chung and Charoenwong 1991. demonstrate that the EP ratio is inversely related
to growth opportunities; the larger the EP ratio, the larger the proportion of equity
value attributable to earnings from assets-in-place. 10 Chung and Charoenwong
1991, p. 26. also demonstrate that the EP ratio is more robust than the priceearnings ratio to possible distortion when a firm has earnings that is close to zero or
negative. 11
2.3. Dependent ariables identification
Financing policy is defined in terms of the following two versions of the
debtrequity ratio:
Book debtrequity ratio s Total book value of liabilities
% Total book value of common equity.
4.
Market debtrequitys Total book value of liabilities

% w Shares outstanding= Share closing price x .
5.
Similarly, dividend policy is defined in terms of the following two versions: the
9
A possible limitation with the use of this measure is that many firms may use unconsolidated
earnings for reported PrE ratios French and Poterba, 1991. and Japanese tax code allow firms to set
aside funds against future contingencies including payment of retirement benefits.. These factors could
reduce reported earnings and bias the EPS measure. To check for this, separate regressions are run
using only the EPS measure as a proxy for IOS and the results are qualitatively similar to the results
obtained using the IOS index.
10
It is assumed that current earnings is an appropriate proxy for cash flows generated from assets.
The ratio is only used for firms with non-negative earnings see Gaver and Gaver, 1993, p. 132..
11
See French and Poterba 1991. for a discussion on the reasons why Japanese firms have relatively
high PE low EP. ratios.
147
dividend payout ratio which is accounting-based and the dividend yield which is
market-based.
Dividend payouts Dividends per share
% Primary earnings per share before extraordinary item.
6.
Dividend yield s Dividends per share % Price per share.
7.
3. Data collection and description

3.1. Sample selection and characteristics
The sample consists of firms reported in PACAP files with no missing values
for the variables under investigation for the years 19881992. The pooled
cross-section time-series data is collected for five years in the vast majority of
cases. For some firms, complete data for a particular year is not available, in
which case no observations for that particular year is recorded. For the purpose of
the lagged analysis, firms that had complete data for the two relevant years are
selected. In other words, data for the independent variable in say, year 1988,
should be available for the same firms in the year 1989 to identify the dependent
variables. Publicly-traded firms with a March 31 year-end are selected since there
are twice as many firms that had this year-end than the December 31 year-end.
The March 31 year-end also coincides with the Japanese government fiscal year.
Unlike the GG study, no size requirement is imposed. The Japanese market
experienced a crash in 1990 and separate regressions are run for the cross-sectional time-series data without the 1990 data in order to evaluate the impact of the
crash.
The sampling frame consists of observations from PACAP files for publicly
traded firms with a March 31 fiscal year-end for which five complete years of data
are available. This provided 6531 observations. From this, firms without any one
of the three measures for IOS are screened leaving a total of 5308 observations
1988, n s 1040; 1989, n s 1092; 1990, n s 1104; 1991, n s 1092; 1992, n s
980.. Table 1 presents the descriptive statistics and correlations among the
measures of IOS. 12 As expected, MKTBKEQ is positively correlated with MKTBKAS and the magnitude of the correlation 0.612. is reasonably high. EP is also,
as expected, negatively correlated with MKTBKEQ and MKTBKAS but the
magnitudes of the negative correlations y0.273 and y0.128, respectively. are
relatively low. 13 In order to assess whether the three individual measures are
12
13
Observations with negative earnings for the EP ratio calculations are excluded.
The size of these correlations are similar to the correlations obtained by Gaver and Gaver 1993..
148
Table 1
Descriptive statistics for the ratio of market value of assets to the book value of assets MKTBKAS.,
the ratio of market to book value of equity MKTBKEQ. and the EP ratio and the correlations between
the three proxies ns 5308. a
MKTBKEQ
EP
Panel A: Descriptie statistics

Maximum
14.26
Third quartile
2.35
Median
1.89
First quartile
1.55
Minimum
0.98
Mean
2.06
MKTBKAS
244.91
16.46
10.9
7.12
0.95
13.82
0.434
0.031
0.022
0.013
0.000
0.024
Panel B: Correlations
MKTBKAS
MKTBKEQ
EP
1.000
y0.128UUU
1.000
1.00
0.612UUU
y0.273UUU
UUU
p- 0.001.
n is for the number of observations and it is possible that some firms very few. may have less than
five observations 19881992..
MKTBKASs AssetsyTotal Common EquityqShares Outstanding=Share Closing Price.rAssets.
MKTBKEQs Shares Outstanding=Share Closing Price.rTotal Common Equity.
EP s Primary EPS Before Extraordinary ItemsrShare Closing Price.
a
common to the measure of IOS employed in this study, common factor analysis is
used Harman, 1976; Gaver and Gaver, 1993..
Table 2 provides the results of the factor analysis of the 5308 observations.
Panel A reports the starting communalities 14 of the individual IOS proxies and
Panel B shows the eigenvalues 15 of the reduced correlation matrix. In Panel C,
the correlations between the common factor and the three proxies are given. The
significant correlations which are in the predicted direction strongly suggest that
the IOS common. factor captures the underlying construct that is common to the
three measures of the IOS. The descriptive statistics of the common factor are
provided in Panel D.
In order to provide a stronger test of the theory, the top and bottom quartile of
the 5308 observations are selected to represent high growth n s 1327. and low
growth n s 1327. firms. Table 3 compares a. asset size, b. profitability, c.
regulated vs. unregulated firms, and d. keiretsu affiliation 16 distributions for
14
Communalities are the squared multiple correlations obtained by regressing each of the proxies
with the other two proxies.
15
Cattrell 1966. and Harman 1976. suggest that if the first eigenvalue exceeds the sum of the three
communalities, this one common factor explains the intercorrelations among the individual measures.
16
The reason for the lower sample size in Panel D is because the classification for keiretsu is
obtained from Nakatani 1984. who provided information only for manufacturing companies.
149
Table 2
Selected statistics related to common factor analysis of the ratio of market value of assets to the book
value of assets, market value to book value of equity and the EP ratio to obtain the IOS factor scores
ns 5308.
Panel A: Estimated communality estimates
MKTBKASs 0.413
MKTBKEQs 0.375
EP s 0.077
Panel B: Eigenalues
MKTBKASs1.086
EP sy0.254
MKTBKEQs 0.0318
Panel C: Correlations between common factor and three IOS measures

MKTBKASs 0.919UUU
MKTBKEQs 0.856UUU
EP sy0.357UUU
Panel D: Descriptie statistics of the common factor (obserationss 5308)
Maximum
10.131
Third quartile
0.277
Median
y0.150
First quartile
y0.487
Minimum
y3.779
Mean
0.000
UUU
p- 0.0001.
Based on these factor scores, growth and non-growth firm were identified as follows: Growth Firms:
Top 25% of the distribution of factor scores ns1327.; Non-Growth Firms: Bottom 25% of the
distribution of factor scores ns1327..
MKTBKASs AssetsyTotal Common EquityqShares Outstanding=Share Closing Price.rAssets.
MKTBKEQs Shares Outstanding=Share Closing Price.rTotal Common Equity.
EP s Primary EPS Before Extraordinary ItemsrShare Closing Price.
firms in the sampling frame and the growth and non-growth categories. An
interesting aspect of Table 3 is that, unlike the GG study there is no predominance
of large firms in the growth sample and, in fact, the large firms are predominantly
in the non-growth sample. A chi-squared test shows that while there are no
significant differences in the size distribution between each of the growth and
non-growth firms and the sampling frame, there are significant differences p 0.05, one-tailed. between the growth and non-growth firms. Further, both a
Wilcoxon test and a t-test show that there are no differences in profitability 17
between the growth 2.545. and the non-growth 2.565. firms. This issue is taken
up later in the Section 5. Appendix A reports the industry representation of firms
in the sampling frame and firms in the growth and non-growth firms.
3.2. Descriptie statistics
Table 4 provides descriptive statistics for the dependent variables for both
growth and non-growth firms and keiretsu and non-keiretsu firms.
17
Profitability is measured as operating income for year t divided by the market value of the firm at
year-end market values total assets-book value of common equityqmarket value of common equity..
150
Table 3
Distributions of firms in the total sample ns 5308. and firms in the growth top quartile of IOS factor
scores. and non-growth bottom quartile of IOS factor scores. sample
Panel A (By quartiles of the book alue of asset size)
Quartiles of book value of assets
Y millions.
Total sample
ns 5308.
Growth firms
ns1327.
Non-growth firms
ns1327.
Less than 33.3

33.3- A- 70.6
70.6 - A- 205.5
More than 205.5
25%
25%
25%
25%
31.12%
24.64%
22.48%
21.85%
20.42%
21.33%
24.11%
34.14%
Panel B (By quartiles of profitability (operating incomer market alue of firm in the preious year))
Quartiles of profitability %.
Total sample
ns 5308.
Growth firms
ns1327.
Non-growth firms
ns1327.
Less than 1.56

1.56 - P - 2.37
2.37- P - 3.27
More than 3.27
25%
25%
25%
25%
26.78%
24.75%
21.70%
26.78%
25.87%
22.54%
26.26%
25.33%
Total sample
ns 5308.
Growth firms
ns1327.
Non-growth firms
ns1327.
343
4974
130
1197
88
1239
Panel C (By regulated s. unregulated firms) a
Regulated
Unregulated
Panel D (By keiretsu s. non-keiretsu firms. The lower sample size is because these are only
manufacturing firms as per Nakatani (1984))
Total sample
ns 5308.
Keiretsu
Non-keiretsu
836
207
Growth firms
ns1327.
223
62
Non-growth firms
ns1327.
149
30
Regulated firms are financial, land transport, shipping, air transport, communications and electricity
and gas source: Price Waterhouse, 1992..
As reported in Panel A of Table 4, growth firms have lower levels of debt in

their capital structure than non-growth firms. The Wilcoxon two-sample test and
the t-test for differences in means assuming unequal variances. show that the
book debtrequity ratio and the market debtrequity ratio for growth firms i.e.,
mean of 8.416 and 0.363, respectively. is significantly p - 0.01. lower than for
non-growth firms i.e., mean of 15.958 and 2.195, respectively.. These results are
consistent with contracting cost predictions. 18
18
It is worth noting that these test do not control for the role of bank ownership of keiretsu firms
which is likely to encourage higher levels of debt Nakatani, 1984..
151
Table 4
Descriptive statistics for book debtrequity ratio, market debtrequity ratio, dividend yield and dividend
payout
Panel A (By growth (top quartile of IOS factor scores) and non-growth (bottom quartile of IOS factor
scores) firms)
Policy variables
Book DebtrEquity Ratio

Market DebtrEquity Ratio
Dividend Yield %.
Dividend Payout
Growth firms ns1327.
Non-growth firms ns1327.
Mean
First
decile
Median
Ninth
decile
Mean
First
decile
Median
Ninth
decile
8.416
0.363
1.840
1.40
2.190
0.120
0.184
0.098
6.050
0.307
0.530
0.317
17.353
0.658
5.225
3.082
15.958
2.195
1.920
1.042
2.894
0.509
0.451
0.136
8.055
1.232
0.962
0.40
30.747
4.170
2.326
1.938
Panel B (By keiretsu s. non-keiretsu firms. The lower sample size is because these are only
manufacturing firms as per Nakatani (1984))
Policy variables
Book DebtrEquity Ratio

Market DebtrEquity Ratio
Dividend Yield %.
Dividend Payout
Keiretsu firms ns836.
Non-keiretsu firms ns 207.
Mean
First
decile
Median
Ninth
decile
7.869
0.708
1.251
1.308
3.585
0.263
0.337
0.167
6.828
0.586
0.765
0.378
12.914
1.294
1.575
1.290
Mean
6.855
0.622
1.561
0.942
First
decile
Median
Ninth
decile
2.095
0.184
0.423
0.186
5.563
0.465
0.843
0.368
12.240
1.192
2.427
1.441
Book DebtrEquity s Total LiabilitiesrTotal Common Equity.

Market DebtrEquity Ratios Total LiabilitiesrShares Outstanding=Share Closing Price..
Dividend Yield %. s Dividends Per SharerPrimary Earnings Per Share Before Extraordinary Items.
Dividend Payouts Dividends Per SharerPrice Per Share.
Similarly, there is some evidence that dividend policy is different between

growth and non-growth firms. While the t-test did not reveal significant differences in means, the Wilcoxon test shows that the dividend yield ratio is significantly p - 0.001. lower for growth firms mean of 1.840, median of 0.530. than
for non-growth firms mean of 1.920, median of 0.962.. No significant differences
are found in the payout ratio.
Panel B of Table 4 provides descriptive statistics for the policy variables for the
keiretsu vs. non-keiretsu subsample of firms. Both the Wilcoxon two-sample test
and t-test for differences in means show that the book debtrequity ratio and
market debtrequity ratio are significantly p - 0.01. higher for keiretsu i.e.,
mean of 7.869 and 0.708. than for non-keiretsu firms i.e., mean of 6.855 and
0.622.. These results are consistent with the finding of Nakatani 1984.. There is
no difference in payout ratios between keiretsu and non-keiretsu firms but some
differences are found in the dividend yield ratios. The Wilcoxon two-sample test
shows that keiretsu firms are significantly p - 0.01. associated with lower
dividend yields than non-keiretsu firms. The results using the t-test are similar but
152
Table 5
Coefficients for policy variables regressed on a growth dummy growdum. w0 s non-growth firms bottom quartile of IOS factor scores. and 1s high growth
firms top quartile of IOS factor scores.x, firm size, profitability and dummy variable for regulation 0s unregulated and 1s regulated.
Growdum
Lassets
ROM
Regul
Adj. R 2
F-value
y43.278
y5.191
1.502
y0.012
y5.692UUU
y1.605UUU
0.274
y0.0002
3.239UUU
0.412UUU
y0.010
0.001U
y1.173UUU
y0.193UUU
y0.113
0.003UUU
21.519UUU
2.245UUU
y0.188
y0.005
0.2158
0.2869
y0.00001
0.0196
177.885UUU
259.656UUU
0.981
13.843UUU
Panel B: Using year-end prices excluding 1990 data because of the market crash
DebtrEquity Book.
2035
y43.802
y5.482UUU
3.257UUU
UUU
.
DebtrEquity Market
2034
y5.584
y1.671
0.438UUU
Dividend Payout
2034
1.938
0.066
y0.029
Dividend Yield
2034
y0.009
y0.003
0.001
y1.102UUU
y0.186UUU
y0.124
0.003UUU
21.176UUU
2.241UUU
y0.005
y0.001
0.2103
0.2836
y0.0008
0.021
136.385UUU
202.28UUU
0.574
11.914UUU
Panel A: Using year-end prices

DebtrEquity Book.
2572
DebtrEquity Market.
2572
Dividend Payout
2571
Dividend Yield
2572
p- 0.05.
p- 0.01.
UUU
p- 0.001.
Growdum s Dummy Variable, 0 s Low Growth, 1s High Growth.
Lassetss Log of Total Assets.
ROMsOperating IncomerMarket Value Of The Firm In The Previous Year.
Reguls Dummy Variable, 0 s Non-Regulated, 1sRegulated.
UU
Intercept
Dependent variable
Table 6
Coefficients for policy variables regressed on the investment opportunity set factor scores, firm size, profitability and dummy variable for regulation
0 s unregulated and 1s regulated.
Factor
Lassets
ROM
Regul
Adj. R 2
F-value
y32.607
y4.184
1.902
y0.023
y1.782UUU
y0.622UUU
0.195
0.001
2.397UUU
0.296UUU
y0.026
0.002UUU
y0.541UUU
y0.118UUU
y0.114U
0.004UUU
13.842UUU
1.451UUU
y0.098
y0.005U
0.125
0.194
0.001
0.027
185.031UUU
310.532UUU
2.271U
37.311UUU
Panel B: Using year-end prices excluding 1990 data because of the market crash
DebtrEquity Book.
4075
y32.27
y1.813UUU
2.381UUU
DebtrEquity Market.
4075
y4.305
y0.656UUU
0.306UUU
Dividend Payout
4073
1.777
0.137
y0.018
Dividend Yield
4075
y0.021
y0.0006
0.002UUU
y0.522UUU
y0.119UUU
y0.129U
0.004UUU
13.416UUU
1.421UUU
0.034
y0.003
0.122
0.192
0.0006
0.026
142.636UUU
243.581UUU
1.627
27.841UUU

DebtrEquity Book.
5152
DebtrEquity Market.
5152
Dividend Payout
5150
Dividend Yield
5152
p- 0.05.
p- 0.01.
UUU
p- 0.001.
Factor sComposite Factor Score of MKTBKAS, MKTBKEQ and EP.
UU
Intercept
Dependent variable
153
154
marginally significant p - 0.10.. The lower dividends for keiretsu firms is also
consistent with the finding of Nakatani 1984.. 19
4. Empirical results
The regression analyses 20 are conducted in three stages. The first stage uses
the pooled cross-sectional time-series data and regresses each of the dependent
variables on the dummy variable growth opportunities Growdum.. Firm size,
ROM and a dummy for industry regulation 0 s unregulated industries, and
1 s regulated industries. are used as control variables. 21 Firm size is measured in
terms of the logarithm of total asset Lassets. and profitability is defined as in
footnote 12. Table 5 presents the results for the four regression models.
The results in Panel A of Table 5 show a significant negative relation between
debt financing and growth opportunities. Firm size is also significantly positively
related to debt financing. As expected, firms that are regulated have higher levels
of debt Smith and Watts, 1992.. The results for both dividend yield and payout
are insignificant. Similar results are reported in Panel B of Table 5 which excludes
1990, thus, suggesting that the 1990 crash had no significant impact on the results.
19
For a discussion of the results, see later part under the Section 5.
The small discrepancy in the number of observations between Table 3 and the observations in the
remaining tables is because there were missing values for the control variable profitability ROM..
21
Ideally, keiretsu affiliation should have been included as a control variable but the classification by
Nakatani 1984., which is adopted in this study, is only for manufacturing companies N s 317. and
inclusion of this variable in the regressions would not only reduce the sample size but also exclude
firms in other industries. Additional regressions are conducted later to evaluate the impact of keiretsu
affiliations.
20
Notes to Table 7:
I. s independent variables.
D. sdependent variables.
U
p- 0.05.
UU
p- 0.01.
UUU
p- 0.001.
Table 7
Coefficients for one-year lagged policy variables regressed on a growth dummy growdum. w0 s non-growth firms bottom quartile of IOS factor scores. and
1s high growth firms top quartile of IOS factor scores.x, firm size, profitability and dummy variable for regulation 0 s unregulated and 1s regulated. for
the years 1988I. 1989D., 1989I. 1990D., 1990I. 1991D. and 1991I. 1992D.
N
Intercept
Growdum
Lassets
ROM
Regul
Adj. R 2
F-value
Panel A: 1988(I) 1989(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
483
483
483
483
y42.284
y6.567
1.680
y0.027
y7.443UUU
y1.080UUU
y0.312
y0.011UU
3.354UUU
0.445UUU
y0.015
0.003U
y1.533UUU
y0.079UU
y0.021
0.001
17.892UUU
1.766UUU
0.759
y0.006
0.225
0.312
y0.0001
0.028
36.059UUU
55.545UUU
0.991
4.457UUU
Panel B: 1989(I) 1990(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
513
513
513
513
y37.32
y3.911UUU
y0.275
y0.023
y2.373
y0.911UUU
0.452
0.0001
2.977UUU
0.324UUU
0.051
0.001
y2.232UUU
y0.254UUU
0.126
0.008UUU
18.109UUU
1.484UUU
y0.468
y0.016U
0.214
0.299
0.0034
0.058
35.749UUU
55.806UUU
1.437
8.814UUU
Panel C: 1990(I) 1991(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
511
511
511
511
y29.902
y3.537
1.095
0.006
y5.659UUU
y1.770UUU
y0.227UU
y0.004UUU
2.470UUU
0.349UUU
y0.014
0.0003UU
y1.124U
y0.266UUU
y0.096UUU
y0.00002
19.607UUU
2.110UUU
y0.049
y0.003UUU
0.188
0.282
0.029
0.360
30.589UUU
51.114UUU
4.911UUU
72.837UUU
Panel D: 1991(I) 1992(D)

DebtrEquity Book.
455
DebtrEquity Market.
455
Dividend Payout
455
Dividend Yield
455
y43.033
y7.464
1.896
0.009
y6.336UUU
y2.532UUU
y0.199
y0.005UUU
3.088UUU
0.591UUU
y0.029
0.0002
y0.473
y0.236U
y0.223UUU
0.0005UUU
20.165UUU
3.176UUU
y0.281
y0.001
0.209
0.286
0.02
0.308
31.104UUU
46.420UUU
3.328UU
51.39UUU
Dependent variable
155
156
The second stage of the analysis substitutes the actual factor score for growdum
and includes all the observations. The results presented in Table 6 are consistent
with the earlier findings.
To address the potential problem of spurious correlation, because the underlying variables are dependent on stock price measured on the same date, the market
debtrequity and dividend yield were recomputed using the average monthly
closing stock price for each year excluding the year end price. The result for
market debtrequity is significant in the predicted direction for both the growth
dummy variable and the factor scores. No significant result is obtained for the
dividend yield. These outcomes are similar to the earlier results using year-end
closing stock prices.
Finally, the results for regressions using lagged dependent variables for the
years 1988 to 1992 are reported in Tables 7 and 8. As noted, these results are far
more meaningful given the lag between the identification of growth opportunities
and the dependent variables.
The results show that dividend yield becomes significant and in the predicted
direction. in three of the four panels in Tables 7 and 8. In particular, the high
adjusted R 2 in Panels C and D of Tables 7 and 8 for the dividend yield regression
should be noted. Similar analysis is carried out using average prices for the
following year for the dependent variables market debtrequity ratios and dividend
yields. The results are consistent with the findings reported in Tables 7 and 8.
Dividend payout is generally insignificant except in Panel C of Table 7 where a
significant result in the right direction is found.
4.1. Additional analysis for keiretsu firms
Further tests are conducted to examine the role of keiretsu vs. non-keiretsu
firms in corporate finance and dividend policy. For this purpose, the classification
Notes to Table 8:
U
p- 0.05.
UU
p- 0.01.
UUU
p- 0.001.
Table 8
Coefficients for one-year lagged policy variables regressed on the investment opportunity set factor scores, firm size, profitability and dummy variable for
regulation 0 s unregulated and 1s regulated. for the years 1988I. 1989D., 1989I. 1990D., 1990I. 1991D. and 1991I. 1992D.
Dependent variable
Intercept
Factor
Lassets
ROM
Regul
Adj. R 2
F-value
962
962
962
962
y27.838
y4.319UUU
1.674
y0.025
y2.868UUU
y0.461UUU
y0.181
y0.004U
2.252UUU
0.285UUU
y0.023
0.002
y1.216UUU
y0.069UUU
y0.005
0.002UUU
13.699UUU
1.281UUU
0.746
y0.008
0.158
0.234
0.0011
0.019
46.134UUU
74.362UUU
1.259
5.664
Panel B: 1989(I) 1990(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
1026
1026
1026
1026
y25.628UUU
y2.931UUU
1.021
y0.047
y1.100
y0.443UUU
0.272
0.004U
2.142UUU
0.225UUU
y0.037
0.003UU
y1.375UUU
y0.138UUU
0.299UU
0.008UUU
13.013UUU
1.092UUU
y0.313
y0.013UU
0.134
0.225
0.009
0.081
40.745UUU
75.516UUU
3.21UU
23.436UUU
Panel C: 1990(I) 1991(D)

DebtrEquity Book.
1015
DebtrEquity Market.
1015
Dividend Payout
1014
Dividend Yield
1015
y28.242UUU
y3.797
2.755
0.003U
y1.181U
y0.651UUU
y0.295
y0.002UUU
2.109UUU
0.287UUU
y0.090
0.0003UUU
y0.342
y0.120UU
y0.146
0.00008
11.699UUU
1.150UUU
y0.196
y0.003UUU
0.0972
0.167
y0.003
0.203
28.282UUU
51.863UUU
0.357
65.554UUU
Panel D: 1991(I) 1992(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
y33.812
y6.077
6.462
0.005UU
y1.645UU
y0.929UUU
y0.209
y0.002UUU
2.337UUU
0.422UUU
y0.233
0.0003UU
0.179
y0.117
y0.474UU
0.0003UU
12.833UUU
2.078UUU
y0.420
y0.001UU
0.11
0.181
0.008
0.187
29.557
51.73
2.925
53.867UUU
922
922
922
922
Panel A: 1988(I) 1989(D)

DebtrEquity Book.
DebtrEquity Market.
Dividend Payout
Dividend Yield
157
158
Table 9
Coefficients for policy variables regressed on a growth dummy growdum. w0 s non-growth firms bottom quartile of IOS factor scores. and 1s high growth
firms top quartile of IOS factor scores.x, firm size, profitability, dummy variables for regulation 0 s unregulated and 1s regulated. and keiretsu
0 s non-keiretsu and 1s keiretsu.
n

DebtrEquity Book.
454
DebtrEquity Market.
454
Dividend Payout
454
Dividend Yield
454
Intercept
Growdum
Lassets
ROM
Regul
Keiretsu
Adj. R 2
F-value
2.211
0.865UU
13.725
y0.028
0.037
y0.670UUU
y0.457
0.0005
0.084
0.009
y0.497
0.002
0.594UU
y0.033U
y1.097U
0.004UUU
9.678UUU
0.689UUU
y1.716
y0.007
2.577UUU
0.103U
0.413
0.001
0.0812
0.5099
0.0025
0.0476
9.010UUU
95.254UUU
1.226
5.533UUU
0.594UU
y0.036U
y1.255
0.003UU
8.864UU
0.706UU
y2.175
y0.007
2.506UUU
0.102U
0.969
0.001
0.0658
0.5013
0.0028
0.0160
5.997UUU
72.380UUU
1.198
2.151
Panel B: Using year-end prices excluding 1990 data because of market crash
DebtrEquity Book.
356
0.787
0.049
0.161
DebtrEquity Market.
356
0.834U
y0.706UUU
0.012
Dividend Payout
356
18.031
y0.847
y0.707
Dividend Yield
356
y0.009
y0.002
0.001
U
p- 0.05.
p- 0.01.
UUU
p- 0.001.
Market DebtrEquity Ratios Total LiabilitiesrShares Outstanding=Share Closing Price.
Keiretsus Dummy Variable, 0 s Non-Keiretsu, 1s Keiretsu.
UU
Dependent variable
Table 10
Coefficients for policy variables regressed on the investment opportunity set factor scores, firm size, profitability, dummy variables for regulation
0 s unregulated and 1s regulated. and keiretsu 0 s non-keiretsu and 1s keiretsu.
Factor
Lassets
ROM
Regul
Keiretsu
Adj. R 2
F-value
1.603
0.183
7.664
y0.018
0.312
y0.392UUU
0.454
0.001
0.193
0.027UU
y0.279
0.001
0.478UUU
y0.031UU
y0.583U
0.004UUU
11.796UUU
0.785UUU
y0.267
0.005
1.398UUU
0.089UU
0.209
y0.002
0.0954
0.3299
0.0035
0.0471
22.576UUU
101.747UUU
1.719
11.121UUU
Panel B: Using year-end prices excluding 1990 data because of market crash
DebtrEquity Book.
813
0.935
0.262
0.233
DebtrEquity Market.
813
0.151
y0.401UUU
0.031UU
Dividend Payout
813
9.602U
0.374
y0.379
Dividend Yield
813
y0.005
y0.002
0.001
0.472UUU
y0.037UUU
y0.652U
0.003UUU
11.187UUU
0.765UUU
y0.306
0.005
1.321
0.089U
0.487
y0.002
0.0886
0.3272
0.0032
0.0383
16.787UUU
79.978UUU
1.521
7.460UUU

DebtrEquity Book.
1024
DebtrEquity Market.
1024
Dividend Payout
1024
Dividend Yield
1024
p- 0.05.
p- 0.01.
UUU
p- 0.001.
UU
Intercept
Dependent variable
159
160
Table 11
Coefficients for one-year lagged policy variables regressed on the investment opportunity set factor scores, firm size, profitability, dummy variables for
regulation 0 s unregulated and 1s regulated. and keiretsu 0 s non-keiretsu and 1s keiretsu. for the years 1988I. 1989D., 1989I. 1990D., 1990I.
1991D. and 1991I. 1992D.
Factor
Lassets
ROM
Regul
Keiretsu
Adj. R 2
F-value
Panel A: 1988(I) 1989(D)

DebtrEquity Book.
204
DebtrEquity Market.
204
Dividend Payout
204
Dividend Yield
204
1.070
y0.693UU
5.625
y0.002
y0.096
y0.218UUU
y0.252
0.003
0.299
0.062UUU
y0.234
0.0003
y0.095
0.005
y0.107
0.006UUU
12.684UUU
0.790UUU
y0.338
y0.013
1.149
0.058
0.143
y0.004
0.0735
0.3575
y0.0146
0.0777
4.223UU
23.590UUU
0.415
3.337UU
Panel B: 1989(I) 1990(D)

DebtrEquity Book.
208
DebtrEquity Market.
208
Dividend Payout
208
Dividend Yield
208
5.408
0.616
y3.647
y0.073UU
0.371
y0.260UUU
1.112UUU
0.007U
0.036
y0.001
0.287
0.004UU
0.071
y0.028
y0.131
0.004UUU
14.901UUU
0.835UUU
y0.410
0.001
1.598U
0.100U
y0.814
y0.0001
0.0923
0.3306
0.0645
0.0876
5.210UUU
21.445UUU
3.854UU
4.976UUU
Panel C: 1990(I) 1991(D)

DebtrEquity Book.
203
DebtrEquity Market.
203
Dividend Payout
203
Dividend Yield
203
2.202
0.716
19.368
y0.001
0.549
y0.508UUU
y2.097
y0.003UUU
0.142
0.001
y0.999
0.001UUU
0.490
0.005
y0.046
0.00001
13.254UUU
1.112UUU
y0.749
0.002
1.768U
0.157U
1.445
y0.001
0.0894
0.3339
y0.0170
0.3427
4.964UUU
21.254UUU
0.325
22.067UUU
Panel D: 1991(I) 1992(D)

DebtrEquity Book.
180
DebtrEquity Market.
180
Dividend Payout
180
Dividend Yield
180
0.582
0.014
1.279
0.002
y0.270
y0.640UUU
y0.325
y0.003UUU
0.193
0.039
y0.020
0.001UU
0.703U
0.051
y0.052
y0.00006
14.192UUU
1.086UU
y0.434
0.005
1.615U
0.148
0.020
y0.001
0.1099
0.3775
0.0013
0.2586
5.418UUU
22.711UUU
1.048
13.486UUU
Intercept
Dependent variable
161
by Nakatani 1984. which is for 317 manufacturing companies is adopted. For the
period 19881992, PACAP files carried 836 observations for keiretsu firms 170
for 1988; 175 for 1989; 171 for 1990; 171 for 1991; 149 for 1992. and 207
non-keiretsu firms 43 for each of the years 1988 and 1989; 42 for 1990; 41 for
1991; 38 for 1992.. As in the earlier case, three sets of regressions are run; using
the growdum variable, using the factor scores and using the lagged relationships.
The results 22 are reported in Tables 911. The results, in general, show that
keiretsu firms have higher debt ratios than non-keiretsu firms. No significant
results are obtained for dividend ratios though the signs for the dividend yield are
consistently negative in Tables 10 and 11. The results for the association between
growth opportunities and market debt equity and dividend yield are in general
similar to the earlier results. Some of the adjusted R 2 are relatively high, thus,
suggesting that these models which controlled for the keiretsu variable are more
robust.
5. Discussion and summary

The empirical results support H1 and confirm the association between IOS and
debt financing. Both the dummy variable for growth see Table 5. and the factor
variable for growth see Table 6. have significant relations with both market and
book debtrequity. The results provide evidence in favor of the contracting
argument rather than the signaling argument since in the signaling argument, high
growth firms issue more debt to signal their funding needs to finance growth
22
The lower number of observations for the various regressions is because of missing values for one
or more of the variables in the regressions. There are inadequate observations for some variables to run
the lagged relationships with the growth dummy.
Notes to Table 11:

U
p- 0.05.
UU
p- 0.01.
UUU
p- 0.001.
162
opportunities. 23 It is also worth noting that the results are inconsistent with the
non-debt tax shields NDTS. argument which predicts that growth firms which
have less NDTS e.g., depreciation, depletion and investment tax credits. should
have more debt Smith and Watts, 1992..
Firm size is also significantly related to these two ratios. Regulated firms are
associated with higher levels of debt which is consistent with prior studies and the
argument that regulation controls incentive problems between shareholders and
debtholders Smith and Watts, 1992; Gaver and Gaver, 1993.. However, cross-sectional time-series data show that the relation between IOS and dividend policy
variables are not significant and in some cases not in the predicted direction. This
is inconsistent with the results obtained by GG who find a significant relation
between growth dummy variable and factor scores. and dividend yields. Like
their study, no relation is found between these independent variables and dividend
payout.
However, the relation between IOS, firm size and dividend policies are
different when the lagged analysis is conducted. In particular, dividend yield is
shown to be significantly related to growth opportunities in three of the four 24
panels in each of the Tables 7 and 8, thus, also providing support for H2 and the
contracting argument. This suggests that the use of the lagged approach perhaps
captured the relationship more effectively than cross-sectional or cross-sectional
time-series analysis.
The reason for the lack of significant results for the dividend payout ratio
variable for this and the GG study may be due to an omitted variables problem
andror incorrect specification of the model. For example, Agrawal and Jayaraman
1994. find that in all equity firms, firms with lower managerial ownership pay
larger dividends than those with higher ownership. Dempsey and Laber 1992.
find that, apart from growth rates and ownership, the estimated beta coefficient
and the number of common stockholders affect the dividend payout ratio. These
results suggest that future studies should re-examine the effects of a wider range of
agency and transaction costs variables on dividend payout ratios.
The finding that growth firms are smaller than non-growth firms overcomes a
concern raised by Baker 1993. regarding the GG study p. 164.:
The predictions from the theory are perfectly valid and highly intuitive, but are
nonetheless based on intuitive and qualitative definitions of what characterizes
23
It is not possible to completely rule out the tax argument since no test was conducted to test the
hypothesis because of the lack of data on the tax status of companies.
24
The loosening up of financial and regulatory restrictions in the late 1980s through to 1990s see
note 10 earlier. should not be discounted in considering the strong results for dividend yields in Panels
C and D of Tables 9 and 10.
163
growth options. This is the reason that a selection criterion that divides firms
into growth and non-growth samples and ends up with the counter-intuitive
finding that growth firms are larger and more profitable than the non-growth
firms is troubling.
This study, which shows that non-growth firms are larger but not more
profitable. than growth firms, is therefore intuitively more appealing and consistent with predictions. It is also worth noting that large firms are more highly
leveraged which is consistent with the bankruptcy costs evidence obtained by
Warner 1977. and Ang et al. 1982.. Similarly, the findings that profitability is in
most cases negatively related to leverage are consistent with findings by Titman
and Wessels 1988, p. 14. that increases in the market value of equity, due to an
increase in operating income, are not completely offset by an increase in the firms
borrowing and the observation of Myers 1984. regarding the pecking order
theory that firms prefer internal to external financing.
The additional keiretsu analysis using a subsample of firms shows that keiretsu
firms are associated with higher levels of debt. 25 The results are consistent with
the finding of Nakatani 1984. who suggests that the higher debt ratios is because
of the smaller risk of bankruptcy for keiretsu firms since banks are the principal
shareholders of these firms. The negative signs for the dividend yield is consistent
with the expectation that keiretsu firms pay lower dividends because intercorporate
shareholdings are financed through borrowings and receiving dividends limits the
right of the firm to using tax-deductibility of interest payments Nakatani, 1984, p.
239.. 26
This study is subject to a number of caveats. First, as suggested by Baker
1993., the relation between a firms policies and IOS are interdependent and IOS
could also be affected by a firms debt and dividend policy. In addition, there is a
view that a firms debt financing has a negative influence on the amount of
dividends paid Higgins, 1972; McCabe, 1979.. The complexity of this problem
and the relation suggest some caution in interpreting the results. Second, any tests
of the contracting-cost hypothesis is complicated by the difficulty of measuring
IOS. An attempt is made to overcome this difficulty by conducting factor analysis
on three common proxies and inferring the unobservable IOS from the results. The
high and significant correlations between the three measures suggest that the
25
These results should be evaluated in the light of recent evidence which suggest that new rules
governing stock issues, increase in foreign ownership and loosening of other restrictions may cause a
breaking down of the differences between keiretsu and non-keiretsu firms Suzuki and Wright, 1985;
Prowse, 1992..
26
Nakatani 1984. also suggests that the lower dividends may be explained in terms of the fact that
keiretsu firms have less incentive to use dividends as a signal. Abegglen 1984, p. 77. notes that for
keiretsu, firms especially good profits are not generally recognized in dividend payments but rather
are recognized in terms of higher payments of bonuses to employees. See also Aoki 1987..
Fishery
Mining
Construction
Foods
Textiles
Pulp and
paper
Chemicals
Petroleum
Rubber
Glass and
ceramics
Iron and steel
Non-ferrous
metals
Metal products
Machinery
Electric
machinery
Transportation
equipment
1989
1990
1991
1992
0.0%
0.4%
8.8%
7.7%
3.1%
1.5%
11.9%
0.8%
1.9%
3.8%
5.8%
3.8%
1.5%
10.8%
12.3%
5.8%
0.4%
0.6%
9.4%
5.1%
3.9%
2.0%
10.8%
0.9%
1.1%
3.4%
3.6%
3.0%
2.1%
9.1%
12.8%
7.8%
8.8%
2.3%
5.0%
12.7%
1.9%
1.5%
6.2%
0.4%
0.4%
2.3%
0.0%
0.8%
10.0%
0.8%
1.9%
3.1%
7.8%
2.2%
9.4%
12.5%
3.7%
2.7%
11.3%
0.7%
1.1%
3.1%
0.2%
0.5%
9.5%
4.8%
3.8%
1.9%
5.1%
3.7%
13.2%
16.8%
1.1%
1.5%
12.8%
0.4%
1.8%
2.6%
0.4%
0.4%
6.2%
5.5%
4.8%
0.4%
10.3%
0.0%
2.6%
4.8%
6.2%
2.9%
14.7%
0.7%
0.4%
2.9%
0.0%
0.4%
8.1%
1.8%
3.7%
5.1%
7.3%
2.4%
9.4%
12.5%
3.6%
2.4%
11.2%
0.7%
1.1%
3.0%
0.1%
0.5%
10.0%
5.1%
3.8%
1.7%
10.1%
0.7%
5.1%
6.2%
4.7%
2.2%
13.4%
1.1%
1.1%
2.2%
0.0%
0.4%
13.4%
1.8%
1.8%
4.0%
4.0%
3.6%
11.6%
15.2%
1.1%
0.7%
11.6%
0.4%
0.7%
2.5%
0.4%
0.4%
6.2%
7.6%
4.7%
0.0%
7.3%
2.4%
9.7%
11.7%
3.6%
2.5%
11.0%
0.7%
1.0%
3.0%
0.2%
0.3%
10.1%
5.3%
3.9%
1.6%
12.1%
1.1%
7.0%
9.9%
6.6%
1.5%
10.3%
1.1%
1.1%
2.6%
0.0%
0.0%
10.3%
0.7%
2.6%
2.6%
3.3%
2.6%
9.5%
11.0%
1.8%
0.0%
11.0%
0.7%
0.7%
3.3%
0.4%
0.4%
7.3%
10.3%
3.7%
0.0%
7.8%
2.5%
8.4%
10.3%
3.4%
2.1%
11.2%
0.9%
1.0%
3.0%
0.2%
0.3%
11.3%
5.6%
3.7%
1.7%
11.0%
0.8%
4.5%
7.8%
6.9%
2.0%
11.0%
1.2%
1.6%
1.2%
0.0%
0.4%
14.7%
0.8%
1.6%
3.3%
3.3%
3.3%
9.4%
11.4%
2.4%
0.0%
13.1%
0.8%
0.8%
2.4%
0.0%
0.4%
9.8%
11.4%
3.7%
0.0%
Sampling Growth Non-growth Sampling Growth Non-growth Sampling Growth Non-growth Sampling Growth Non-growth Sampling Growth Non-growth
frame
firms
firms
frame
firms
firms
frame
firms
firms
frame
firms
firms
frame
firms
firms
n s 1040 . n s 260 . n s 260 .
n s 1092 . n s 273 . n s 273 .
n s 1104 . n s 276 . n s 276 .
n s 1092 . n s 273 . n s 273 .
n s 980 . n s 245 . n s 245 .
1988
Appendix A
Percentage industry distribution for each year 1988, 1989, 1990, 1991 and 1992 by total sample of firms and by growth top quartile of IOS factor scores. and non-growth bottom quartile of IOS
factor scores . firms
164
Precision
equipment
Other manufacturing
Wholesales
Retail
Financial
Real estate
Land transportation
Shipping
Air transportation
Warehousing
and wharfing
Communications
Electric
power
and gas
Services
2.3%
1.9%
0.4%
1.2%
0.0%
1.5%
3.8%
0.8%
1.2%
1.9%
0.8%
0.4%
3.8%
2.3%
2.3%
6.2%
1.5%
0.8%
1.4%
2.8%
1.6%
0.4%
1.5%
0.2%
1.3%
1.7%
0.8%
3.8%
0.0%
0.8%
3.8%
0.4%
16.9%
2.7%
2.7%
2.7%
3.5%
1.5%
2.3%
2.0%
1.3%
0.2%
1.6%
1.6%
0.4%
6.1%
1.6%
0.8%
1.5%
2.7%
2.7%
2.3%
2.2%
0.7%
0.7%
1.5%
2.6%
0.4%
2.6%
1.8%
0.0%
1.5%
5.1%
2.6%
1.8%
2.6%
2.9%
0.0%
1.5%
1.8%
0.4%
14.3%
2.6%
3.3%
2.6%
2.2%
1.1%
0.4%
2.2%
1.3%
0.2%
1.4%
1.4%
0.4%
6.0%
1.9%
1.0%
1.6%
2.7%
2.7%
2.4%
0.0%
3.3%
0.0%
0.4%
0.4%
0.4%
14.9%
2.5%
3.6%
2.5%
0.4%
1.4%
2.2%
5.8%
0.7%
0.7%
3.3%
5.1%
0.7%
1.4%
2.2%
0.0%
1.8%
4.3%
2.9%
0.4%
2.4%
1.3%
0.2%
1.5%
1.4%
0.3%
6.7%
1.8%
0.7%
1.6%
2.7%
3.0%
2.2%
0.0%
2.9%
0.0%
0.4%
0.0%
0.0%
16.8%
2.9%
2.2%
1.5%
0.0%
2.2%
1.8%
8.1%
1.5%
0.7%
3.7%
5.1%
0.4%
1.5%
1.8%
0.4%
1.5%
5.9%
3.3%
0.4%
2.2%
1.5%
0.2%
1.5%
1.5%
0.3%
7.1%
2.0%
0.7%
1.4%
3.3%
3.0%
1.7%
1.2%
3.7%
0.0%
0.4%
0.4%
0.8%
15.9%
2.4%
2.4%
2.0%
0.0%
1.6%
0.0%
4.9%
0.8%
0.8%
2.9%
1.6%
0.4%
2.4%
2.0%
0.0%
2.0%
4.1%
4.1%
1.6%

165
166
variables are adequate for this sample. Third, the March 31 fiscal year requirement
means that firms a smaller proportion. which had a December 31 fiscal year were
excluded and to this extent could have biased the results. Finally, this study does
not specifically test the tax hypothesis for corporate finance and dividend policies
and this suggests a possible avenue for future research.
Overall, this study increases our understanding of the relation between IOS and
corporate financial policies and it supplements the evidence of the SW and GG
studies in four ways. First, it provides evidence consistent with contracting theory
predictions in a legal and regulatory environment that is different from that in the
US. Second, it uses cross-sectional time-series data and a lagged variable
analysis, which may be more effective in capturing the dynamics of the relations.
The lagged analysis mitigates the problem of spurious correlations and provides
some basis for causal inferences. Third, this paper does not exclude small firms
and therefore provides a broader test of the theory. Finally, the finding that there is
a higher incidence of larger firms in the non-growth category provides some
albeit indirect. evidence that the three measures used in this study adequately
captured the IOS.
Acknowledgements
The comments of an anonymous reviewer, the Editor, Ken Lehn, Bikki Jaggi,
Raymond Chiang, Larry Lang, Paul Nevell and Judy Tsui are gratefully acknowledged.
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Journal of Corporate Finance 5 1999.

Growth opportunities, capital structure and

Tel.: q852-2788-7919; fax: q852-2788-7944; e-mail: acgul@cityu.edu.hk

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Meckling, 1976; Rozeff, 1982; Easterbrook, 1984.. In particular, differences in

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

2.2. IOS measure

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Market debtrequitys Total book value of liabilities

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

3. Data collection and description

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: Descriptie statistics

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel C: Correlations between common factor and three IOS measures

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Less than 33.3

Less than 1.56

Panel C (By regulated s. unregulated firms) a

As reported in Panel A of Table 4, growth firms have lower levels of debt in

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Book DebtrEquity Ratio

Growth firms ns1327.

Non-growth firms ns1327.

Book DebtrEquity Ratio

Keiretsu firms ns836.

Non-keiretsu firms ns 207.

Book DebtrEquity s Total LiabilitiesrTotal Common Equity.

Similarly, there is some evidence that dividend policy is different between

Panel A: Using year-end prices

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: Using year-end prices

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: 1988(I) 1989(D)

Panel B: 1989(I) 1990(D)

Panel C: 1990(I) 1991(D)

Panel D: 1991(I) 1992(D)

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel B: 1989(I) 1990(D)

Panel C: 1990(I) 1991(D)

Panel D: 1991(I) 1992(D)

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: 1988(I) 1989(D)

Panel A: Using year-end prices

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: Using year-end prices

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

Panel A: 1988(I) 1989(D)

Panel B: 1989(I) 1990(D)

Panel C: 1990(I) 1991(D)

Panel D: 1991(I) 1992(D)

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

5. Discussion and summary

Notes to Table 11:

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168

F.A. Gul r Journal of Corporate Finance 5 (1999) 141168