The Impact of Internationalization of the Boardroom on Capital Structure
Round 1
Reviewer 1 Report
Many thanks for the opportunity to read and review the paper:
“The Impact of Internationalization of the Boardroom on Capital Structure”.
The topic is innovative and interesting. Moreover, I think that the paper is well structured and argued. Therefore, my suggestions are only minor revisions.
A) First, I also think it is useful to strengthen the academic references especially in key parts of the paper. For example, when authors state (page 2 of 15):
“We support this claim by arguing that foreign directors may improve board effectiveness by bringing new knowledge and experience, and hence improving the overall quality of corporate governance in general (add references). Additionally, foreign directors may prove capable of better coordinating a firm’s resources than domestic directors given their exposure to a wide array of global business practices and environments, and thus leading to overall improvements in productivity and performance (add references). Our research thus participates in an emerging field of study focusing on the precursors and impacts of international diversity on boards of directors”.
I think it is important to add the references in the red parts in order to confirm the considerations expressed by the authors, given their relevance in the formulation of the research hypothesis.
Idem for this part of the paper (page 6 of 15):
“Furthermore, we include several additional firm-specific control variables which previous studies (add references) have shown to play a role in capital structure decisions; these include firm size, profitability, tangibility, and growth opportunities”.
B) Moreover, I suggest explaining in the paper the motivations behind the choice of the sample. In other words:
b1) why the authors focus on a sample of American firms? In other words, why the research hypothesis is tested only on the American market? For what reasons is the American market more suitable to test the research hypothesis? Moreover, what implications can the structure of the American financial markets have on the research hypothesis formulated and tested by the Authors?
C) Finally, as an additional robustness test, I also suggest using one year's lagged independent variables.
Comments for author File: 
Comments.pdf
Author Response
Response to Reviewer’s Comments:
We thank the anonymous reviewers for their careful reading of our manuscript and their many insightful comments and suggestions. Below we respond to the comments in detail, with reviewer comments in black and our response in blue. We are also providing a revised manuscript that reflects their suggestions and comments. We believe that this has resulted in a stronger manuscript.
Reviewer(s)' and Associate Editor Comments to Author:
Reviewer: 1
Recommendation: Major Revision
Comments and Suggestions for Authors
Many thanks for the opportunity to read and review the paper: “The Impact of Internationalization of the Boardroom on Capital Structure”. The topic is innovative and interesting. Moreover, I think that the paper is well structured and argued. Therefore, my suggestions are only minor revisions.
Response: Thank you for this positive remark, which is greatly appreciated.
- A) First, I also think it is useful to strengthen the academic references especially in key parts of the paper. For example, when authors state (page 2 of 15):
“We support this claim by arguing that foreign directors may improve board effectiveness by bringing new knowledge and experience, and hence improving the overall quality of corporate governance in general (add references). Additionally, foreign directors may prove capable of better coordinating a firm’s resources than domestic directors given their exposure to a wide array of global business practices and environments, and thus leading to overall improvements in productivity and performance (add references). Our research thus participates in an emerging field of study focusing on the precursors and impacts of international diversity on boards of directors”.
I think it is important to add the references in the red parts in order to confirm the considerations expressed by the authors, given their relevance in the formulation of the research hypothesis.
Idem for this part of the paper (page 6 of 15):
“Furthermore, we include several additional firm-specific control variables which previous studies (add references) have shown to play a role in capital structure decisions; these include firm size, profitability, tangibility, and growth opportunities”.
Response: Thank you. We accept the reviewer’s suggestion, and we have added the most recent related references to support our arguments.
- B) Moreover, I suggest explaining in the paper the motivations behind the choice of the sample. In other words: b1) why the authors focus on a sample of American firms? In other words, why the research hypothesis is tested only on the American market? For what reasons is the American market more suitable to test the research hypothesis? Moreover, what implications can the structure of the American financial markets have on the research hypothesis formulated and tested by the Authors?
Response: Thanks for this suggestion. In the interdiction section, we have added a clear justification for country selection.
- C) Finally, as an additional robustness test, I also suggest using one year's lagged independent variables.
Response: Thanks for this comment. In the robustness section (section 6), we have added a new analysis (table 4) using GMM estimation in order to solve the endogeneity issue. To obtain robust results using the GMM, the lagged values of the independent variables are used as instruments.
Many thanks, once again, to you and the reviewers for the positive comments alongside the extremely helpful advice and suggestions for enhancing the manuscript. We hope and trust that the revised version meets expectations and look forward to your final decision.
Kind Regards,
The Authors
Author Response File: 
Author Response.docx
Reviewer 2 Report
The paper examines how internationalization of board impacts the firm’s capital structure (the ratio of debt to equity). The paper uses a sample of US non-financial firms and documents that board international diversity can reduce the debt ratio, after controlling some other variables , including both firm characteristics and other corporate governance variables (such as board size, gender diversity, and number of nonexecutive directors). The econometric analysis is based on OLS, fixed effect. and random effect models.
The main issue concerns this paper is the underpinning theory and the hypothesis. The paper uses the pecking order theory as the underpinning theory and argues that internationalised board can lower information asymmetry, hence the firm will use more equity financing rather than debt financing. The paper claims that this is what the pecking order theory predicts. However, what the pecking order theory says is not what the paper argues. The pecking order theory jointly considers cost of debt financing (including bank loans) and cost of equity financing. This theory predicts that a firm facing information asymmetry, internal founds is the cheapest, then it is safe debt, then it is risky debt, and in the last resort the firm will use equity financing. The pecking order theory does not predict that for the same firm, if the firm’s governance improves and information symmetry becomes lower, then equity financing will become cheaper than debt financing. On this ground, the underlying theory of the central hypothesis of this paper cannot be the pecking order theory. The paper documents that board international diversity is negatively associated with the debt ratio, this may be the case, but it cannot be explained by the pecking order theory. It may be explained by other theorise, such as entrenched managers. When corporate governance is improved, managers are monitored more effectively, hence the free cash flow and overinvestment problems become less severe, hence there is less need for the firm to use debt financing as a monitoring mechanism to contain entrenched managers. In addition, there are other possible explanations as well. For example, it could also be the case that in a better governed firm, the interest of shareholders is more closely aligned with the firm, hence shareholders would use more equity financing to support the firm’s growth.
The empirical analysis of the paper also contains some issues:
- How did the paper select the sample to reach 3,773 non-financial USA firms?
- What are the summary statistics for the variables used in the empirical analysis?
- In the empirical models, observations of both the dependent variable and independent variables are taken from the current period (t), which means that these models contain serious multicollinearity problems.
- In the result tables, there is no statistics to reflect the overall model performance.
- It is not clear why the robustness test has to be ‘xtgls’ rather than others.
Author Response
Response to Reviewer’s Comments:
We thank the anonymous reviewers for their careful reading of our manuscript and their many insightful comments and suggestions. Below we respond to the comments in detail, with reviewer comments in black and our response in blue. We are also providing a revised manuscript that reflects their suggestions and comments. We believe that this has resulted in a stronger manuscript.
Reviewer(s)' and Associate Editor Comments to Author:
Reviewer: 2
Comments and Suggestions for Authors:
The paper examines how internationalization of board impacts the firm’s capital structure (the ratio of debt to equity). The paper uses a sample of US non-financial firms and documents that board international diversity can reduce the debt ratio, after controlling some other variables , including both firm characteristics and other corporate governance variables (such as board size, gender diversity, and number of nonexecutive directors). The econometric analysis is based on OLS, fixed effect. and random effect models.
The main issue concerns this paper is the underpinning theory and the hypothesis. The paper uses the pecking order theory as the underpinning theory and argues that internationalised board can lower information asymmetry, hence the firm will use more equity financing rather than debt financing. The paper claims that this is what the pecking order theory predicts. However, what the pecking order theory says is not what the paper argues. The pecking order theory jointly considers cost of debt financing (including bank loans) and cost of equity financing. This theory predicts that a firm facing information asymmetry, internal founds is the cheapest, then it is safe debt, then it is risky debt, and in the last resort the firm will use equity financing. The pecking order theory does not predict that for the same firm, if the firm’s governance improves and information symmetry becomes lower, then equity financing will become cheaper than debt financing. On this ground, the underlying theory of the central hypothesis of this paper cannot be the pecking order theory. The paper documents that board international diversity is negatively associated with the debt ratio, this may be the case, but it cannot be explained by the pecking order theory. It may be explained by other theorise, such as entrenched managers. When corporate governance is improved, managers are monitored more effectively, hence the free cash flow and overinvestment problems become less severe, hence there is less need for the firm to use debt financing as a monitoring mechanism to contain entrenched managers. In addition, there are other possible explanations as well. For example, it could also be the case that in a better governed firm, the interest of shareholders is more closely aligned with the firm, hence shareholders would use more equity financing to support the firm’s growth.
The empirical analysis of the paper also contains some issues:
How did the paper select the sample to reach 3,773 non-financial USA firms?
What are the summary statistics for the variables used in the empirical analysis?
In the empirical models, observations of both the dependent variable and independent variables are taken from the current period (t), which means that these models contain serious multicollinearity problems.
In the result tables, there is no statistics to reflect the overall model performance.
It is not clear why the robustness test has to be ‘xtgls’ rather than others.
Response:
Thanks for your suggestions. We have tried to cover some of the reviewers’ comments, for example, we have added a clear justification for country selection. Moreover, we have added a new analysis (table 4) using GMM estimation in order to solve the endogeneity issue. To obtain robust results using the GMM, the lagged values of the independent variables are used as instruments.
However, regarding the comment related to the underpinning theory and the hypothesis. The reviewer mentioned that “The paper uses the pecking order theory as the underpinning theory and argues that internationalised board can lower information asymmetry, hence the firm will use more equity financing rather than debt financing. The paper claims that this is what the pecking order theory predicts. However, what the pecking order theory says is not what the paper argues. The pecking order theory jointly considers cost of debt financing (including bank loans) and cost of equity financing. This theory predicts that a firm facing information asymmetry, internal founds is the cheapest, then it is safe debt, then it is risky debt, and in the last resort the firm will use equity financing. The pecking order theory does not predict that for the same firm, if the firm’s governance improves and information symmetry becomes lower, then equity financing will become cheaper than debt financing.”
We disagree with the reviewer argument. Under their pecking order theory, equity capital is the most information-sensitive security whereas debt capital is much less sensitive to the adverse selection problem. Therefore, reducing the information symmetry could make the equity financing cheaper than debt financing. For example, Petacchi (2015, P2-3) argued that “Since the regulation has little impact on the debt market, firms with improved information environments in the equity market may find equity financing relatively cheaper than debt financing and rely more on the equity market to raise capital. In contrast, firms with worsened information environments in the equity market may have incentives to turn to the debt market, where private disclosure is still available.”
Petacchi, R. (2015). Information asymmetry and capital structure: Evidence from regulation FD. Journal of Accounting and Economics, 59(2-3), 143-162.
Many thanks, once again, to you and the reviewers for the positive comments alongside the extremely helpful advice and suggestions for enhancing the manuscript. We hope and trust that the revised version meets expectations and look forward to your final decision.
Kind Regards,
The Authors
Author Response File: Author Response.docx
Reviewer 3 Report
This paper deals with topics of potential interest to readers of this journal. It also presents some empirically interesting results.
However, I have some reservations which are given below.
(1)The definition of a foreign director is unclear. Is it based on director’s citizenships? Or the locations of residency, etc.
(2)Under normal circumstances facing the company management, directors are chosen to increase profitability, ROA, etc. If so, the foreign director variable may be correlated with growth, ROA, and possibly the equation error term. This might imply the presence of endogeneity. If so, this issue might also cause serious bias in the estimation results, and hence need the authors’ attention.
(3)Given these potential problems, the paper’s conclusion might not be well substantiated. What the paper finds may be a reasonable empirical regularity, but the interpretation of such empirical regularity may require further work along the lines noted above.
Author Response
Response to Reviewer’s Comments:
We thank the anonymous reviewers for their careful reading of our manuscript and their many insightful comments and suggestions. Below we respond to the comments in detail, with reviewer comments in black and our response in blue. We are also providing a revised manuscript that reflects their suggestions and comments. We believe that this has resulted in a stronger manuscript.
Reviewer(s)' and Associate Editor Comments to Author:
Reviewer: 3
Comments and Suggestions for Authors:
This paper deals with topics of potential interest to readers of this journal. It also presents some empirically interesting results.
Response: Thank you for this positive remark, which is greatly appreciated.
However, I have some reservations which are given below.
(1) The definition of a foreign director is unclear. Is it based on director’s citizenships? Or the locations of residency, etc.
Response: Thank you for this suggestion. In the data and methodology section (section 4), we have added a clear definition for the foreign director based on the BoardEx database, which has been used for data collection.
(2) Under normal circumstances facing the company management, directors are chosen to increase profitability, ROA, etc. If so, the foreign director variable may be correlated with growth, ROA, and possibly the equation error term. This might imply the presence of endogeneity. If so, this issue might also cause serious bias in the estimation results, and hence need the authors’ attention.
(3) Given these potential problems, the paper’s conclusion might not be well substantiated. What the paper finds may be a reasonable empirical regularity, but the interpretation of such empirical regularity may require further work along the lines noted above.
Response: Thanks for this comment. We accept the reviewer’s suggestion and have now re-estimated the results based on the GMM estimation in the robustness section (section 6) in order to solve the endogeneity issue. To obtain robust results using the GMM, the lagged values of the independent variables are used as instruments. The results are robust after accounting for endogeneity as the results of all regressions confirm the internationalization effect.
Many thanks, once again, to you and the reviewers for the positive comments alongside the extremely helpful advice and suggestions for enhancing the manuscript. We hope and trust that the revised version meets expectations and look forward to your final decision.
Kind Regards,
The Authors
Author Response File: Author Response.docx
Round 2
Reviewer 2 Report
The revised paper is much clearer in terms of both the underlying theories and the empirical part.
Although in their response to my previous comments on the theory, the authors said that they disagree on what I said regarding the pecking order theory, in fact I can see that they have followed my suggestions in revising the paper on the theories. They have made other relevant theories explicit in this revised version. That is fine with me.
Reviewer 3 Report
The revision has responded adequately to my comments.
