Institutional Environment and Corporate Leverage in Latin America
This study of 729 Latin American firms from 2014 to 2024 finds that greater financial freedom is significantly associated with lower corporate leverage, whereas corruption control shows no statistically significant relationship, though the financial freedom effect is sensitive to the inclusion of Argentina.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
Every business needs money to grow, and companies generally have two main ways to get it: they can borrow it, or they can sell a piece of the company to investors. The mix of borrowed money versus investor money is a fundamental choice for any organization, often called its capital structure. For decades, economists have debated what drives this choice. Some theories suggest that companies borrow more when they are profitable or when they have valuable physical assets to use as security. Others argue that the rules of the game played by the country where a company lives matter just as much. If a country has strong laws that prevent officials from taking bribes, or if its banks are free to lend without heavy government interference, companies might feel safer borrowing. But it is also possible that these same strong conditions make it easier to sell shares to investors, which would actually lead companies to borrow less. Understanding which of these forces wins out is crucial for investors, business leaders, and policymakers trying to navigate the complex economies of Latin America.
A team of researchers set out to untangle this relationship by looking at nearly 730 listed companies across six major Latin American nations: Argentina, Brazil, Chile, Colombia, Mexico, and Peru. They examined a decade of financial records, from 2014 through 2024, a period that included the global economic shock of the pandemic. Their goal was to see how two specific aspects of a country's environment influenced how much debt these companies carried. The first aspect was corruption control, which measures how well a government protects public power from being captured by private interests. The second was financial freedom, a score that reflects how little the government interferes in the banking system and how efficiently money can move between lenders and borrowers. The researchers used advanced statistical methods to track changes within each company over time, ensuring that the results reflected the influence of the country's environment rather than just the specific nature of the business itself.
The study produced a clear and somewhat surprising result regarding financial freedom. The data showed that as a country's financial freedom score increased, the amount of debt companies carried relative to their total assets actually went down. Specifically, for every ten-point increase in a country's financial freedom score, the debt-to-assets ratio for these firms dropped by nearly three percentage points. This finding challenges the simple idea that a freer financial system simply means more loans are available. Instead, the researchers suggest that when a financial system is open and competitive, it offers companies a wider menu of options. With better access to equity markets and other financial instruments, companies may choose to rely less on borrowing and more on selling shares or using other forms of financing. In essence, a freer system does not just make debt cheaper; it gives companies the ability to diversify their funding sources, reducing their dependence on loans.
In contrast, the study found no clear, consistent link between corruption control and how much debt companies took on. While the data showed a slight positive trend—suggesting that better corruption control might be associated with slightly more debt—the result was not strong enough to be considered statistically significant. The researchers noted that corruption control is a factor that changes very slowly within a country, making it difficult to detect its specific impact using this type of analysis. More importantly, the results varied wildly depending on which country was included in the mix. When the researchers removed Argentina from the dataset, the entire pattern for financial freedom flipped, suggesting that the unique economic turmoil and specific conditions in Argentina were heavily influencing the regional average. This indicates that a single regional score cannot predict how a company in one specific country will behave, as local economic realities can override broader trends.
The analysis also looked at how the pandemic era changed things. The data confirmed that companies in the region carried more debt during and after the pandemic years compared to the period before 2020. This likely reflects a need for extra cash to survive the crisis or to refinance existing loans. Interestingly, the negative relationship between financial freedom and debt became weaker after 2019. This suggests that during times of extreme economic stress, the usual rules of financing may bend, and the benefits of a free financial system might not immediately translate into lower debt levels. The researchers emphasize that these are observations of what happened, not a proof of exactly why it happened, as many other economic factors shifted during those years.
Ultimately, the study offers a nuanced view of how institutions shape corporate finance in Latin America. It suggests that improving financial freedom does not necessarily lead to a debt-fueled boom; rather, it may encourage companies to use a broader range of financial tools, potentially making them less reliant on borrowing. However, the findings also serve as a warning against applying broad regional rules to individual nations. The experience of one country, like Argentina, can skew the data for the entire region, reminding us that local economic conditions, inflation, and government policies play a decisive role in how businesses choose to fund their future. For managers and investors, the lesson is that understanding the specific financial landscape of a country is just as important as knowing the general health of the economy.
Drowning in papers in your field?
Get daily digests of the most novel papers matching your research keywords — with technical summaries, in your language.