This research analyzes the determinants of capital structure across 37 countries. Institutional arrangements matter for capital structure decisions; however, firm-level covariates drive two-thirds of the variation in capital structure across countries, while the country-level covariates explain the remaining one-third. The observed relationships between the country-level determinants and leverage provide strong support to the predictions of both the trade-off and the pecking-order theories. Country-level determinants serve as substitute mechanisms for the firm-level, industry-level, and macroeconomic determinants by moderating their marginal impact on leverage.

Using a broad range of uncertainty measures, we show that uncertainty dramatically slows down firms’ adjustments toward their optimal capital structure. At the upper bound, the estimated speed of leverage adjustments almost halves when uncertainty is high. High quality institutions (common law legal origin, more disclosure to congress and/or to the public, and higher public sector ethics) and presidential political systems offset some of the adverse effects of uncertainty on leverage adjustments. The financial crisis has altered the relationships among uncertainty, adjustment speeds, and a country's institutions; more so for countries with weak institutions and parliamentary systems.

Political environment is an important determinant of financial intermediation costs, which eventually affects the external financing patterns of firms. Political gyrations create policy uncertainty, which increases the information risk, weakens the investor demand, and reduces the offer size. This raises the securities' placement costs for the financial intermediaries, who pass on these costs to the issuing firms in the form of higher underwriter spreads. The issuance costs for new equity and debt capital increase, leading to lower leverage. Simultaneous equation analysis of financing, investment, and cash policies reveals that this channel is distinct from previously documented effects of policy uncertainty on corporate outcomes.