Dynamics of speed of leverage adjustment and financial distress in the Indian steel industry

Abstract

Business managers strive to attain the optimal capital structure (OCS), which allows them to raise capital at a minimal cost, thereby maximising their returns. Balancing risk and reward is crucial in determining the target capital structure. Therefore, understanding the optimal leverage ratio and the Speed at which leverage adjustments are made is vital to managers. This study examines the optimal leverage ratio, the speed of adjustment, and the factors contributing to achieving the target capital structure for select 208 steel firms, particularly in an emerging economy like the Indian steel industry. A partial adjustment model is utilised, employing the Generalised Method of Moments (GMM) technique. Additionally, the Altman Z-score is employed to evaluate the financial distress of these steel firms. Very few studies have specifically focused on determining the Speed of adjustment (SOA) using GMM of emerging economies like the Indian steel industry. The findings indicate that steel firms take approximately 2.13 years to reach their target leverage, supporting the existence of the dynamic trade-off theory. The results also highlight the relationship of selected variables (Profitability, Growth, Size, Tangibility, NDTS, Liquidity, and Financial Distress) with the Speed of leverage adjustment and the weak financial position of these businesses.