Capital Structure Policy in Central Europe and BRIC: Interaction of Internal Determinants and Macroeconomic Factors. Irina Ivashkovskaya Corporate Finance Center, National Research University Higher School of Economics Moscow, RUSSIA Alexey Kadurov Corporate Finance Center, National Research University Higher School of Economics Moscow, RUSSIA Maria Kokoreva Corporate Finance Center, National Research University Higher School of Economics Moscow, RUSSIA ABSTRACT Capital Structure policy puzzles researchers in developed and emerging markets. We contribute to the literature by examining capital structure policy in emerging markets. Our sample consists of 372 firms from BRIC, Central and Eastern European countries for 2002-2009 years. The dynamic model we develop enables to incorporate traditional fundamental determinants of capital structure, speed of adjustment and pecking order and market-timing hypotheses. The results obtained allowed to conclude that the macroeconomic factors, internal financial deficit and cost of debt influence the adjustment speed. The crisis played a crucial role in debt-to-equity choice by weakening the significance of target adjustment motive. JEL: G 32 Key words: capital structure, pecking order of financing, trade-off theory, emerging markets finance, Central and Eastern Europe, BRIC INTRODUCTION The choice of capital structure has always been one of the crucial elements of the financial architecture of any firm (Myers, 1999). As financial architecture includes debt –to–equity proportions, ownership structure, and internal corporate governance structures, capital structure becomes a key factor in a firm’s value. The capital structure is also vital for the appropriate development of relationships among the company’s stakehold ers (Opler et al, 1997; Titman et al., 1988). Many previous researchers have addressed the capital structure of companies in developed markets; however, few have investigated firms in emerging markets. The research done on capital structures in emerging markets that has recently appeared has mostly focused on factors that determine choices of debt-to-equity ratios. Most research about this group of countries has shown that debt-to-equity decisions depend on traditional factors: profitability (Seifert, 2008), tangibility of assets (Booth et al., 2001), taxes and growth opportunities (Ni, 2008), size (Ivashkovskaya et al., 2007). The analyses underscore differences among countries. For example, for firms in China (Bhabra et al., 2008), (Ni, 2008) the most influential factors of capital structure appear to be profitability, size of the company and growth, while in Hungary and Slovenia, financial leverage tends to depend more on the ownership structure and tangibility (Nivorozhkin, 2002; Crnigoj, 2009). The comparative analysis of several countries is more conclusive. Thus research conducted on data from 10 countries (Booth et al., 2001) and 23 countries (Seifert, 2008) generally reaches similar conclusions. While the traditional determinants influence financial leverage similarly in any country, previous research has presented systematic differences in the way debt ratios depend on such individual country factors as GDP growth rates, inflation rates, and the development of capital markets. Most of empirical studies on capital structure policy may be classified into two groups. One group of studies that we defined as normative studies is aimed to find out how capital structure policy affects firm value. In other words, the question is what CFO should do to increase value. The example is an analysis of market price reaction to equity issues, debt issues and exchange offers. Such research studies are generally based on event study method. An evident advantage of normative studies is a straightforward measuring of interaction between capital structure policy and firm value. However, normative studies are subject to implicit assumption of market efficiency and short-term nature of observed market reaction. Second group of studies that we defined as positive studies is aimed to observe actual policy of companies and to establish determinants and motives of capital structure choice. In such a way researchers reveal actual firm behavior but give no explicit answer what is optimal. Nevertheless assuming that managers are rational and have proper understanding of capital structure issues positive studies help to find out value maximizing policy. At least positive studies provide evidence of actual firm policy and reasons under management actions.