A longitudinal study of borrowing by large American corporations

Administrative Science Quarterly,  March, 1994  by Mark S. Mizruchi,  Linda Brewster Stearns

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Pfeffer, Jeffrey, and Gerald R. Salancik 1978 The External Control of Organizations: A Resource Dependence Perspective. New York: Harper and Row.

Richardson, R. J. 1987 "Directorship interlocks and corporate profitability." Administrative Science Quarterly, 32: 367-386.

Roy, William G. 1983 "The unfolding of the interlocking directorate structure of the United States." American Sociological Review, 48: 248-257.

Corporate managers make strategic decisions on a wide range of issues, from mergers and acquisitions to research and development, and anticipated economic costs and benefits of a policy always figure into their decision making. Firm officials are concerned with improving such factors as the organization's growth, profitability, and market share, but the methods by which firms pursue these economic goals are by no means agreed upon. Company officials may disagree on a common measure of firm performance, and particular firms often rely on different measures under different circumstances (Meyer, 1993). Whether a firm engages in a vertical integration strategy or a diversification strategy may be a matter of considerable dispute among a firm's officials, and different firms may employ different strategies because of or regardless of their current financial conditions.

In recent years organizational researchers have devoted increasing attention to the determinants of these corporate strategies. We have seen a flurry of papers on topics such as mergers and acquisitions, adoption of the multidivisional form, make-or-buy decisions, takeover prevention strategies, research and development expenditures, chief executive officer compensation, and political and charitable contributions. Organizational researchers have found that firm strategies in these areas can be accounted for in part by noneconomic phenomena, including a firm's ownership structure, the actions of its peers, and the firm's social ties with other firms. But one crucial strategic decision has received very little attention.

Among the most important decisions that managers make are those involving the firm's financing and capital structure. As Barton and Gordon (1987: 67) noted, "The question of how to finance the firm . . . represents a fundamental functional (financial) decision which should support and be consistent with the long-term strategy of the firm." Yet, with the exception of two studies by Donaldson (1961, 1969), there has been virtually no work on this topic among organizational researchers. This may not be surprising, since financing decisions could be viewed as among the most purely economic decisions that a firm makes. But finance scholars, although they agree on what firms should do, have failed to reach a consensus on how borrowing decisions are actually made (Myers, 1977, 1984; Barton and Gordon, 1987; MacKie-Mason, 1990). The wide range of options open to firms as well as the many alternative ways of evaluating capital projects are two possible reasons for this lack of consensus. We believe that organizational theory may be able to contribute to understanding even this most economic of corporate strategies. In this paper, we draw on several currently prominent organizational models to investigate the role of economic, organizational, and institutional factors in corporate debt financing. Using a time-series model, we then test the ability of these models to account for the borrowing patterns of 22 large U.S. manufacturing corporations over a 28-year period.

Financial Dependence and Managerial Autonomy

The extent to which firms have actually depended on external financing over the years has been debated for decades. Business historians agree that in the early twentieth century, financiers such as J. P. Morgan wielded enormous power within the business community. Investment bankers played an important role in corporate formations and mergers because of their central position in the issuance and sale of new securities (Navin and Sears, 1955; Carosso, 1970; Mizruchi, 1982; Roy, 1983). As the major providers of capital in a period of intense competition and increasing concentration, investment banks appropriated a major share of the promoters' profits for themselves, appointed their own representatives to corporations' boards, and exerted influence over corporate policy (Sweezy, 1956; Chandler, 1977). This period is often referred to as the era of finance capital (Cochran and Miller, 1942).

After 1920, the relationship between investment banks and corporations changed (Sweezy, 1956; Berle and Means, 1968). According to Sweezy (1956), the specter of cutthroat competition ceased in most industrial sectors as large industrial monopolies came to dominate the market. Fewer combinations occurred and in some industries ceased altogether. Investment banks' power decreased correspondingly as issuing new securities, the basis of their power, became less important. Between the 1920s and the 1970s, theories of finance capital virtually disappeared from economic and business writings. Managerialism became the dominant theory of corporate control. According to managerialists, because corporations could successfully and regularly produce enough internal funds (Berle, 1954; Dahrendorf, 1959; Bell, 1961; Baran and Sweezy, 1966; Galbraith, 1967), they no longer had to depend on external capital sources. Oligopolistic market structures ensured adequate profits, and the state, as a major consumer, intervened to prevent economic crises (Baran and Sweezy, 1966; Galbraith, 1967). As a result, firms could finance their own investments and thereby escape dependence on financial institutions. According to Galbraith (1967: 92-93), "Few other developments can have more fundamentally altered the character of capitalism."