Abstract
This paper analyses the adjustment speed of the firm to achieve target leverage. The study further extends the empirical work to diagnose the factors that significantly impact its capital structure. The study consists of 132 Indian non-financial firms listed in the National Stock Exchange for the period 1998-2018. A static panel model and dynamic two-step GMM model has been used to make a comparative analysis and select the best model. The results of the study claim that the adjustment speed is 44 percent per annum, yielding a half-life of 1.18 years. Further, the study reveals that profitability, tangibility, and GDP growth are significantly related to leverage in the dynamic model. In the static model, besides profitability, tangibility, and GDP Growth, its uniqueness, growth, and age also significantly impact leverage. In the study, the R square appears to be 0.34, and the determinants, namely, profitability, growth uniqueness, and age, follow pecking order theory, and size, tangibility, liquidity, GDP Growth, and inflation follow trade-off theory. The comparative statement results reveal that the dynamic model is more realistic, considering the adjustment cost. This paper can be further improved by incorporating human resource factors and their impact on its leverage.
Highlights
Since a few decades, capital structure theory has been one of the most controversial issues in corporate finance
The study reveals that profitability, tangibility, and GDP growth are significantly related to leverage in the dynamic model
The financial managers have always aimed to maximise firm value, and in order to do so, it is important to identify an optimum ratio of debt and equity that would result in the maximisation of shareholders wealth
Summary
Capital structure theory has been one of the most controversial issues in corporate finance. The "Trade-off" theory later emerged and proposed that the firm's capital structure should constitute an optimum combination of debt and equity by balancing the cost and benefit of debt. Benefits are referred to the firm's interest tax shield due to debt financing and cost referred to as the bankruptcy cost. The firms need to maintain a trade-off in order to achieve the optimal capital structure. This optimal capital structure can be achieved by maintaining a balance
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