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The theory of Long-term international capital flows and Canadian Corporate debt issues in the United States Stroetmann, Karl Antonius

Abstract

This study presents a new attempt to gain a better understanding of those forces that lead to the movement of funds from one country to another. Attention is restricted to the international market for long-term debt capital. The empirical analysis focuses on capital flows between Canada and the United States, particularly on Canadian corporate borrowing in the United States during the period from i960 through May 1973. A model of the international term structure of interest rates is developed. Differences in time preferences between nations, exchange rate expectations and exchange risk, and transaction costs are shown to determine interest rate differentials and to influence international capital flows. The inflow of long-term debt capital into Canada is almost exclusively due to the sale of new bond issues abroad by borrowers other than the federal government. Activities of international investors in secondary markets are of only minor importance. Therefore we have to rely on an indirect test of the basic features of our theory. We concentrate on an analysis of decisions by Canadian corporations to float U.S.-pay bonds. An examination of macro-economic data indicates that Canadians have a markedly higher demand for funds than Americans. An analysis of bond markets in the two countries suggests that Canadian lenders prefer comparatively marketable securities. To further test for such differences in time preferences, it is hypothesized that the availability of a well-functioning private placement market, of long-term forward commitments, and of longer maturities should be factors attracting Canadian corporations to the U.S. bond market. Both discriminant analysis results and interviews with managers, underwriters, and life insurance officers provide strong support for our assertions, except that longer terms to maturity available in the U.S. are of lesser interest to Canadian firms. An analysis of exchange risk suggests that long terms to maturity and evenly distributed sinking fund payments should be preferred. Firms active in export markets should regard foreign borrowing as a means to sell income denominated in a foreign currency forward. Only weak statistical support for the asserted corporate behaviour is found. Interviews revealed that exchange risk influences foreign borrowing, but its management is not well understood. Slightly lower nominal interest costs seem to be all the protection against exchange risk firms require. Factors other than lower borrowing costs have become increasingly important for the choice between Canadian-pay and U.S.-pay bonds. In our model it is assumed that information and transaction costs are higher when two investors from different nations deal with each other than for purely domestic transactions. Causes of such differences and their impact on capital flows are analyzed. Whereas the typical American private placement is small in size and issued by a smaller, less financially secure firm, Canadian U.S.-pay bonds are large in size and sold by larger corporations or those with international connections. Continuing relationships with American lenders have also proven very beneficial. Finally, the individual results are drawn together. It is shown that the hypotheses derived from our model lead to the identification of variables that allow an almost perfect discrimination between Canadian-pay and U.S.-pay bonds issued by Canadian corporations.

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