The capital structure of firms is affected by economic conditions as indicated by the majority of recent researches that investigated the impact of the international financial crisis of 2007-2009 on the financial leverage of firms (Harisson & Widjaja, 2014; Demirguc- Kunt et al., 2015; Banerjee, 2017; Chatzinas & Papadopoulos, 2018). In the European Union, however, the international financial crisis was converted to debt crisis. Dealing with the consequences of the crisis led to the establishment of the European Financial Stability Facility (EFSF) and its successor, the European Stability Mechanism (ESM). These two mechanisms were aimed at providing financial support to country-members which were facing high fiscal deficits and high debt ratios. The support was accompanied by strict and painful austerity measures. So, the EFSF/ESM were understood as having resulted in a decrease of the country’s economic uncertainty due to the fact that the facility guaranteed the country’s financial needs and an increase in the tax burden in the context of a stricter fiscal policy. However, at least according to the present available knowledge, previous studies which examined the firms’ capital structure of the countries supported by these facilities, were in the same context with the rest of the firms which had been ignoring a possible facilities’ impact.

To address the above problem, the present study has focused on the impact of the EFSF/ESM support on the effect that firm-specific characteristics have on firms’ capital structure. To the best of our knowledge, this study is the first of its kind. More specifically, the present study has compared the effect of five firm-specific factors, namely growth, profitability, size, tangibility, non-debt tax shield that have driven capital structure between normal economic conditions and the economic conditions that were formed by the EFSF/ESM financial assistance programs. The determination of these effects should reveal useful information on the way that the EFSF/ESM changes a firm’s procedure on financing decisions, as well as whether the trade-off or pecking order theory drives a firm’s capital structure. The sample consisted of listed, non-financial and non-utilities firms operating in ten countries, members of the Eurozone (Austria, Cyprus, Estonia, France, Germany, Greece, Ireland, Italy, Portugal and Spain) for the period from 2003 to 2016. The results were quite interesting since they supported the view that a firm’s capital structure behavior was interpreted mostly by the pecking order, regardless of the occurrence of an economic crisis. Conversely, the EFSF/ESM financial assistance programs seemed to change the magnitude of the effect of firm- specific capital structure determinants in the following three cases: profitability, growth and Non-Debt Tax Shield (NDTS).

The remainder of the paper is organized as follows: In section II, the trade-off and pecking order theories will be briefly, but comprehensively presented. In line with the predictions of these theories, the research hypotheses of the present study were developed. The research methods (sample, data, variables, and statistical techniques) will be described in Section III, while Section IV presents the results of statistical analysis that will be discussed in Section V. Finally, Section VI sums up the conclusions and recommendations for future research. The section also includes a discussion of the limitations of the research.

Researchers and financial professionals have focused on a firm’s capital structure for at least 60 years. The impetus for the formation of modern capital structure theories is to be found in the theorems of Modigliani and Miller (1958; 1963). Based on these, various theories of capital structure have been proposed. The Trade-off and pecking order theory were the two main and competing ones (Mihalca & Antal,

2009). The Trade-off theory supported the existence of an optimal capital structure that minimized the cost of capital and maximized a firm’s value (Smart et al., 2004). Particularly, the value of a firm depended positively on the amount of its debt due to the tax savings it created (Modigliani & Miller, 1963). However, the level of debt tax saving would be affected by the tax rates of individuals (Miller, 1977), while it decreased in case the company already had levels of high non- debt tax shield (NDTS), such as depreciations (DeAngelo & Masulis, 1980). In addition, positive dependence was justified by the mitigation of costs arising from owners-managers conflicts (Jensen & Meckling, 1976), while negative dependence might be explained by an increase of financial distress costs (Wruck, 1990) and owners-lenders conflicts (Jensen & Meckling, 1976). On the other hand, no optimal capital structure would exist, according to the pecking order theory, which stated that a firm’s capital structure was the outcome of managers’ past financing decisions (Shyam-Sunder & Myers, 1999). Managers, in particular, preferred internal funds to external funds based on capital source costs, and when external funds were needed, managers tended to prefer debt to equity (Grinblatt & Titman, 2002). Besides cost, the pecking order hypothesis seemed to face a firm’s asymmetry information problems (Sergiescu & Vaidean, 2014). Many researchers have attempted to determine which of the two theories has been more explanatory and has a higher interpretation power regarding a firm’s capital structure behavior. The most recent researches have implied that the two theories were not mutually exclusive, but complemented each other (Chatzinas & Papadopoulos, 2018; Banga & Gupta, 2017; Mc Namara et al., 2017; Ohman & Yazdanfar, 2017; Serrasqueiro & Caetano, 2015; Burgstaller & Wagner, 2015).

The international financial crisis gave a new impetus to the investigation of capital structure theories, since scholars had the opportunity to investigate how economic crises affected the claims of the theories (Harisson & Widjaja, 2014). Thus, after 2007, many studies focused on the impact of a financial crisis on a firm’s indebtness (Harisson & Widjaja, 2014; Banerjee, 2017; Chatzinas & Papadopoulos, 2018). Demirguc-Kunt et al. (2020) provided evidence that a financial crisis negatively affected debt on a firm’s balance sheets even in economies that did not suffer from the consequences of the international financial crisis. This impact was higher for small and medium enterprises (SMEs) and large non-listed companies. In the same context, D’Amato (2020) drew the same conclusion, but he claimed that short-term debt was affected more severely. On the other hand, Migliori et al. (2018) did not find evidence that the international financial crisis influenced the way managers made their financing decisions. Moreover, they concluded that neither capital structure theory had been able to interpret these decisions, regardless of the economic conditions. Similar conclusions were drawn by many other researches (Adair & Adaskou, 2017; Zhang & Mirza, 2015; Danso & Adomako, 2014).

In the European Union, the global financial crisis was transformed into a debt crisis that threatened the Eurozone’s stability. To face these consequences, four economies, namely Cyprus, Ireland, Greece, and Portugal became financially supported by programs developed, supported and monitored by the European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM). In all four cases, the financial support was accompanied by strict austerity measures and structural reforms (Singala & Kumar, 2012). In the pre-crisis period, each country’s firm capital structure had been investigated. In the case of Cypriot firms, the limited number of studies published, agreed that the trade-off theory was prevailing (Mokhova & Zinecker, 2013; Machielsen, 2012). On the other hand, Greek (Noulas & Genimakis, 2011; Daskalakis & Psillaki, 2008, 2009; Eriotis et al., 2007) and Portuguese (Nunes & Serrasqueiro, 2017; Pacheco, 2016) financing decisions of firms seemed to be mostly driven by the pecking order theory. Finally, there had been ambiguous evidence on Irish firm capital structure behavior, since some researchers had concluded that the trade-off theory was prevailing, while others disagreed with this conclusion (Mac an Bhaird & Lucey, 2010; Bancel & Mittoo, 2004).

As mentioned above, the international financial crisis gave a new impetus to the investigation of capital structure theories. Many researchers tried to approach the factors that could affect a firm’s financing decisions and the way a firm change during a crisis (Harisson & Widjaja, 2014; Banerjee, 2017; Chatzinas & Papadopoulos, 2018; Demirguc-Kunt et al., 2020; D’Amato, 2020; Migliori et al., 2018; Adair & Adaskou, 2017; Zhang & Mirza, 2015; Danso & Adomako, 2014). However, the case of a firm’s financing decision in Cyprus, Greece, Ireland and Portugal would be different because of the interacting effect that the EFSF/ESM financial supporting programs might have had.

As a result, the aim of the present study has been two-fold. First, the determinants of capital structure and their direct effect were investigated. Second, the moderating effect that the EFSF/ESM programs might impose on the above direct effects was also investigated. More specifically, the identified five firm-specific characteristics were used as determinants of capital structure, while two country-specific characteristics were used as control variables. The former were, on the one hand, growth, size, profitability, tangibility and NDTS. The latter control variables were, on the other hand, tax rates and country risk. The effect of each of these firm-characteristics, as well as the way that the EFSF/ESM programs were anticipated to influence the variables will be discussed below.

According to the trade-off theory, profitability, size, tangibility and tax rates will be positively correlated to debt level, while growth, NDTS and country risk will be negatively correlated. Higher profitability leads to higher taxes, thus motivating firms to increase their debt (Ebrahim et al., 2014; Rahim et al., 2020). Similarly, larger firms and firms with more tangible assets would face a lower level of financial distress risk due to the higher level of diversification and lower cost of information asymmetry, which in turn, would encourage them to expand their debt levels (Chen, 2004; Cortez & Susanto, 2012; Chin & Zakaria, 2018). Finally, as a result of the positive relationship between tax rates and debt tax shield, there would be a positive relationship between tax rates and financial leverage (Modigliani & Miller, 1963). On the other hand, growth opportunities and country risk might be interpreted as in a higher level of anticipated financial distress cost (Stulz, 1990; Demirguc-Kunt et al., 2015), as well as leading to a decrease in a firm’s financial leverage.

On the other hand, according to the pecking order assumption, growth, tangibility, tax rates and country risk were positively correlated to debt level, while profitability and size were negatively correlated. Moreover, it is worth mentioning that the NDTS has no anticipated impact on financial leverage (Noulas & Genimakis, 2011). Higher growth might be interpreted as higher anticipated future profitability that would motivate firms to increase the present levels of debt (Frank & Goyal, 2003). Similarly, tangibility would reduce the cost of informational asymmetry and assure the lenders in case of a bankruptcy, allowing debt to increase (Ebrahim et al., 2014). Finally, an increase in tax rates and in country risk could deteriorate the internally generated cash flows and lead to an increase in financial leverage (Cetorelli & Goldberg, 2011). On the other hand, profitability and size, due to the higher levels of cash flows, would decrease the need for external funds, thus reducing a firm’s debt (Jong et al., 2008; Myers, 2001). Table 1 summarizes the above direct effects of the examined firm- and country-specific characteristics on a firm’s leverage according to the trade-off and pecking order theories.

The objective of an ESM loan is “to assist ESM Members in significant need of financing and which have lost access to the market, either because they cannot find lenders or because the financing costs would adversely impact the sustainability of public finances”. As a result, a country that enters an ESM financial assistance program is a country that will face significant barriers in raising capital from the markets. In entering an ESM program, the country’s financial needs are immunized for a long-term period at the expense of strict austerity measures and structural reforms. As a result, EU-members accepting an ESM financial assistance program face two direct economic condition changes. The first one is a decrease of uncertainty; country risk decreases, since the ESM ensures the country’s financial needs. The second one is an increase in tax burden, in the context of a stricter fiscal policy. The resultant interacting/moderating effect of the EFSF/ESM programs will have a direct impact on the firm-specific determinants of capital structure and will be further discussed below. According to the trade-off theory, growth expresses anticipated levels of financial distress risk. As a result, the decreased levels of uncertainty are expected to mediate growth’s impact. On the other hand, the bigger the size and the higher the tangibility of firms are, the lower the levels of financial distress risk will be. So, a positive effect of the ESM programs on these determinants’ effect on leverage is expected, due to the decreased level of uncertainty, too. Simultaneously, the increase in tax rates increases the Non-Debt Tax Shield, resulting in the amplification of its effect, while the firms are expected to take advantage of the new tax conditions, and intensifying the positive relationship between profitability and tax rates. Consequently, in accordance with the trade-off theory, the following hypotheses were proposed for the present study:

TO-RH1:The negative effect of growth on a firm’s financial leverage decreases due to the lower level of uncertainty (Alternatively, a positive change in the negative effect of growth on a firm’s financial leverage is anticipated).

TO-RH2:The positive effect of profitability on a firm’s financial leverage increases due to the higher levels of tax rates (Alternatively, a positive change in the positive effect of profitability on a firm’s financial leverage is anticipated).

TO-RH3:The positive effect of size on a firm’s leverage increases due to the lower levels of uncertainty (Alternatively, a positive change in the positive effect of size on a firm’s financial leverage is anticipated).

TO-RH4: The positive effect of tangibility on a firm’s leverage increases due to the lower levels of uncertainty (Alternatively, a positive change in the positive effect of tangibility on a firm’s financial leverage is anticipated).

TO-RH5:The negative effect of NDTS on a firm’s financial leverage increases due to the higher levels of tax rates (Alternatively, a negative change in the negative effect of NDTS on a firm’s financial leverage is anticipated).

On the other hand, the pecking order theory postulated that growth has the potential for higher future profitability. The decrease in the level of uncertainty increases the probability of higher future growth, resulting in an amplification of growth’s direct impact. Moreover, the lower level of uncertainty negatively influences the level of informational asymmetry. So, tangibility’s direct impact on a firm’s financial leverage is anticipated to increase. Profitability and size reduce the external financial needs of the firms. However, the increase of tax levels is anticipated to increase the need for external financing, intensifying the impact of these two firm-specific factors. Finally, no impact of the NDTS on a firm’s leverage is anticipated in normal economic conditions. Consequently, in accordance with the pecking order hypothesis, the following hypotheses have been proposed for the present study:

PO-RH1:The positive effect of growth on a firm’s financial leverage increases due to the lower level of uncertainty (Alternatively, a positive change in the positive effect of growth on a firm’s financial leverage is anticipated).

PO-RH2:The negative effect of profitability on a firm’s financial leverage increases due to the higher level of tax rates (Alternatively, a negative change in the negative effect of profitability on a firm’s financial leverage is anticipated).

PO-RH3: The negative effect of size on a firm’s leverage increases due to the lower levels of uncertainty (Alternatively, a negative change in the negative effect of size on a firm’s financial leverage is anticipated).

PO-RH4:The positive effect of tangibility on a firm’s leverage increases due to the lower levels of uncertainty (Alternatively, a positive change in the positive effect of tangibility on a firm’s financial leverage is anticipated).

Table 2 summarizes the above changes of direct effects of the examined firm -specific characteristics under the EFSF/ESM financial assistance programs, on a firm’s leverage according to the trade-off and pecking order theories.

Bloomberg’s database was used and accounting data on Cypriot, Irish, Greek, and Portuguese firms was retrieved from 2003 to 2016. To distinguish between the effect of the EFSF/ESM programs and the effect of the international financial crisis, data from French, German, Italian and Spanish firms were collected. In order to mitigate the potential bias due to country size, Estonian and Austrian firms were then added. Finally, firms of the financial sector and utility firms were excluded from the sample. The final sample consisted of 2,086 firms and was winsorized at the 1 percent level.

Table 3 presents the variables used in the analysis carried out in the present study. These variables have already been discussed above, except for two cases. In particular, these two variables refer to the two dummy variables that were formed to distinguish between the effects of a general economic crisis and the economic conditions that might be attributed to the EFSF/ESM financial support.

leverage ratios increased during the EFSF/ESM financial supporting period, while the same change was observed for tangibility and country risk. On the other hand, growth, profitability and tax rates decreased.

Note. FL1 Long-term Debt to total asset, FL2 Total debt to total assets, Gr Growth, Pr Profitability, Si Size, Ta Tangibility, NDTS Non-Debt Tax Shield, Cr Country Risk, Tr Tax rates.

Table 5 presents the estimated three regressions using long-term debt to total assets ratio as the dependent variable. In cases of all models, tangibility (a4>0, p<0.01) and growth (a1>0, p<0.01) positively influenced leverage, while profitability exerted a negative impact (a2<0, p<0.01). Out of the country-characteristics, the impact of the tax rates (a7>0, p<0.01) was positive. The estimation of model (2) shows that the EFSF/ESM support increased the effect of profitability on a firm’s leverage (b2>0, p<0.10) when no other crisis was taken into account; while model (3) indicates that there was no interaction of the EFSF/ESM and firm-specific characteristics when crises were taken into account. Regarding the country-specific characteristics, the impact of country risk decreased (b7<0, p<0.10) and the tax rates increased (b6>0, p<0.10), in both model (2) and model (3).

Note. 1. FL1 Long-term debt to total asset, Gr Growth, Pr Profitability, Si Size, Ta Tangibility, NDTS Non-debt tax shield, Cr Country’s risk, TR Tax Rates, D dummy variable for years of EFSF/ESM financial support, Difs dummy variable for years of other type of economic crisis. Note 2. The estimated impact of Lags of the Dependent Variable is omitted.

Note. 1. FL2 Total debt to total asset, Gr Growth, Pr Profitability, Si Size, Ta Tangibility, NDTS Non-debt tax shield, Cr Country’s risk, TR Tax Rates, D dummy variable for years of EFSF/ESM financial support, Difs dummy variable for years of other type of economic crisis. Note. 2. The estimated impact of Lags of the Dependent Variable is omitted.

Table 6 shows the estimations of the regression with total debt to total assets ratio as the dependent variable. The results were similar to those presented in Table 5 with the following differences. Firstly, firm size seemed to influence negatively the leverage ratio of total debt to total assets (b3<0, p<0.05). Secondly, considering the EFSF/ESM period and/or crisis period, the country risk had influenced a firm’s leverage in a positive way in the normal economic conditions period (a6>0, p<0.05). Third, there was a positive impact on the NDTS during the EFSF/ESM financial assistance period [b5>0, p<0.10]. Fourth, the effect of profitability during the EFSF/ESM period seemed to become more negative (b2<0.20, p<0.10).

Finally, Table 7 shows the results of Wald tests on the statistical significance of the coefficients. According to Table 7, after the acceptance of an EFSF/ESM financial assistance program, profitability had a negative impact on the long-term leverage, but its effect on the total debt leverage nullifies. In addition, the impact of profitability was intensified (became more negative) regarding total debt to total assets ratio, but weakened (became more positive) in the case of long- term debt to total assets ratio. The negative effect of size appeared only in the case of total debt ratio, which remained strong during the EFSF/ESM support period. Tangibility positively influenced both the leverage ratios regardless of economic conditions. Regarding total debt to total assets ratio, the positive effect of growth lost its statistical significance and the impact of the NDTS became positive during the period of EFSF/ESM financial assistance. With regard to country-specific characteristics, country risk had no effect on the long- term leverage, but there was a positive effect on the total debt ratio. However, during the EFSF/ESM support, the effect of country risk on long-term leverage transforms to negative and its effect on total debt ratio was nullified. The impact of tax rates remained positive regardless of the referring leverage ratio, or the referring economic conditions. Finally, it is worth mentioning that only one difference was noticed when normal economic conditions were compared to the crisis period; the positive impact of growth on long-term leverage ratio was diminished.

The statistical analysis presented in the foregoing section seemed to suggest that the pecking order theoretical framework has a significantly higher interpretation power than the trade-off perspective of things, when it comes down to explaining a firm’s financing decisions. However, there were also findings that neither theory could explain (Wong, 2018), such as the positive impact of the NDTS during the EFSF/ESM support period, and findings that only Trade-off predicts, such as the positive change of the effect of profitability. So, it was considered safe to conclude that financial leverage could not be interpreted exclusively by the trade-off or pecking order theory, but both theories were necessary (Chatzinas & Papadopoulos, 2018; Banga & Gupta, 2017; Mc Namara et al., 2017; Ohman & Yazdanfar, 2017; Serrasqueiro & Caetano, 2015; Burgstaller & Wagner, 2015). More specifically, it was found that growth and tangibility positively influenced the financial leverage of firms, but the impact from profitability and size had proved to be negative. However, the present study has provided evidence that the debt level would increase when the growth prospects increased (Frank & Goyal, 2003) and when the tangibility increased due to the lower levels of financial distress costs

(Frank & Goyal, 2003; Ebrahim et al., 2014). On the other hand, the financial leverage would decrease when the profitability increased due to the higher amounts of available internal funds (Myers, 2001), and when the size of a firm would increase due to the lower levels of risk (Gaud et al., 2007).

The above impacts have also been observed in periods of crisis, with only one exception; the effect of growth on the long-term leverage would be nullified during a period of crisis. On the other hand, some effects would be diminished or strengthened in the case of EFSF/ESM support periods. What could be the reasons for this result? During a crisis, an increase of uncertainty was observed, resulting in a rise of the cost of both debt and equity (Cetorelli & Goldberg, 2011). However, an EFSF/ESM program would reduce uncertainty, as it would see the implementation of strict fiscal policy measures (increase of taxes and/ or government spending cuts).

As a result, the factors that inhibited the above effects should be sought as a result of these changes. A probable reason could be a firm’s need for reorganization. An EFSF/ESM program would incorporate measures that could affect a variety of macro and micro economic variables through the implementation of structural reforms. Except for interest rates and tax rates, other parameters such as the disposable income, consumption and consumption habits, investment procedures, and savings were also influenced by government policies. In this rapidly changing environment, the management of a firm would be responsible for the firm’s survival. Appropriate adjustments in prices, costs, wages and expenses should be decided and implemented. As a result, the managers would have to reorganize many aspects of the firm’s function.

The present study examined five firm-specific capital structure determinants, namely growth, profitability, size, tangibility and tax deductibility in ten Eurozone-member countries in order to study the impact of the EFSF/ESM financial supporting programs on a firm’s financial leverage. The results showed that the pecking order theory prevails. However, a detailed examination of the evidence indicates that despite the pecking order’s prevalence, trade-off is also necessary for a full comprehension of a firm’s financing decisions.

A crisis in general, changes the magnitude, but not the sign of the effect that a firm’s characteristics have on its financial leverage. On the other hand, when the EFSF/ESM support programs were implemented, changes in effects of three firm-characteristics were observed. During the period of the EFSF/ESM assistance, the negative effect of profitability on long-term leverage disappeared, and on total debt leverage strengthened, the positive impact of growth on total debt ratio diminished and the NDTS had a positive influence on the total debt ratio. These changes might be explained by the fact that the firms were motivated to proceed to re-organization due to the following three environmental factors: increased levels of tax rates, decreased levels of uncertainty, and the reluctance of lenders to provide new funds.

The above analysis was based on data from the stock exchange of listed European firms. As a result, the study has focused on large firms. A similar study for small and medium sized enterprises would be interesting and worthwhile. Finally, an interesting practice can be recommended for policy makers. To the best of our knowledge, it is the first time that the effect of financial distress has been distinguished from the effect of tax rates. As a result, policy makers should make every effort to provide low tax rates in the event of rising interest rates.