International Journal of Economics and Finance; Vol. 11, No. 5; 2019 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 103 Legal Origins and the Financial Conservatism of Private Firms Hongzhong Fan 1 , Mirza Nouman Ali Talib 1 & Pan Chen 1 1 School of Economics, Huazhong University of Science and Technology, Wuhan, P.R. China Correspondence: Mirza Nouman Ali Talib, School of Economics, Huazhong University of Science and Technology, Wuhan, P. R. China. E-mail: noumanmirza@hust.edu.cn Received: February 25, 2019 Accepted: March 15, 2019 Online Published: April 15, 2019 doi:10.5539/ijef.v11n5p103 URL: https://doi.org/10.5539/ijef.v11n5p103 Abstract Following the literature of corporate law and finance, our study emphasizes on differences of legal origins and their laws influencing the capital structures of the private firms following suboptimal conservative policies. The countries considered in each legal origin represents common law countries (UK, Australia, India, Pakistan and Thailand) and Roman backed civil law countries (Japan, South Korea, Germany) respectively. The time series considered for the study is 2000-2017. The findings provide that the conservative private firms are smaller in size with less investments but are positively related with profitability in both legal origins. However, the dividend payouts and non-debt tax shields have significant positive relation with conservative policies in civil law countries. It shows that the presence of minority shareholders’ protection law in civil law countries directs the firms to pay more dividends which may also help them in reducing agency costs. We further exhibit that, before financial crises of 2008, the conservative firms in both legal origins are less directed towards dividends, especially in common law countries. Nevertheless, private conservative firms of civil law countries are more inclined towards dividend payouts after financial crises. The study implicates that the difference of laws in legal origins affect the capital structures of the conservative private firms. It further provides that because of the less effective credit markets, private firms may also be forced to adopt conservative policies in civil law countries but may also have less agency problems due to high probability of having dividend payouts. Keywords: legal origins, financial conservatism, financial crises, dividends, tax shields 1. Introduction Legal environment of the country affects the financial decisions of the firms. With the difference in the laws, capital market structures, firms follow different strategic financial policies (Porta et al., 2000). Investor protection law in common law countries provides better atmosphere for future growth yet it may lead to agency problems if minority shareholders or debtors are ignored in taking financial decisions. Contrary to that, civil law countries protect the minority shareholders’(agents) rights whic h may reduce the agency problems but may hinder growth. Thus, difference in legal systems affects the financial decisions and structural policies of the firms. Bigelli, Martín-Ugedo and Sánchez-Vidal (2014) provides that private firms are constrained than public firms. Public firms are found to be large in size and private firms have limited assets and investments. The policies adopted influence the firms’ capital structures irrespective of their size. Progressive policies may highlight risk taking characteristics in contrast to the conservative policies leading to risk averse behaviors. One of the most important risk averse policies being highlighted in recent decades are the financially conservative policies. A number of scholars (Graham, 2000; Lemmon, Roberts, & Zender, 2008; Korteweg, 2010; Bigelli, Martín-Ugedo, & Sánchez-Vidal, 2014) have established a fact that firms do adopt risk averse policies to either believe in future growth or because of their financial distress. Conservative financial behavior has also been investigated by Bessler et al. (2013); Strebulaev and Yang (2013) focusing on zero-leverage firms. Bigelli (2014) by calculating net financial position presents that conservative private firms in Italy are smaller in size and are financially constrained. It is noteworthy that Italy belongs to the pool of roman backed civil law countries with narrow capital markets, less property rights, lower creditor’s protection characterizing the preferences of internal funds usage. On the other side, Bessler et al. (2013) also presents that despite of efficient capital markets and better bank credit access, firms exhibit the adoption of zero leverage policies. The existing literature on financial conservative policies describes conservatism in literature to the financial