Abstract
The adjustment for the firm capital structure is unclear from perspectives of trade-off theory, pecking order theory, life cycle theory, market timing theory, and free cash flow theory, since many research findings contradict each other. Adjustments for the capital structure are complex, since the conditions for each firm are different. The objective of this study is to provide empirical evidence of how firms adjust capital structure in relationship with maturity in context of trade-off, pecking order, free cash flow, and market timing theory. In terms of hypotheses testing, this study conducts logistic regression analysis with 138 Indonesian public firms as the sample in the observed period from 2010 to 2015. To distinguish the results, this study controls the sample by size and age based on the median. The study reports that preferences for the source of funds based on the cost of capital, internal conflict, and firm maturity indicate adjustments for the firm capital structure. Based on Indonesian firms, the form of capital structure in developing countries can refer to a single model or a combination of the trade-off model and pecking order model, as well as market timing.
Highlights
The studies of Myers (1984) about the puzzle of the firm capital structure are remaining until now, especially in the field of corporate finance, as many research findings contradict each other in the context of firm preferences for equity and debt
The firms seem to adopt the pecking order model, and firm size is calculated by the natural logarithm of they have, reached the mature level, as total assets and cut off by the median in a term to reflected by their retained earnings to total assets get larger firms and smaller firms
Adjustments to firm capital structure depend on firm conditions and can be explained in the context of trade-off theory, pecking order theory, free cash flow theory, and market timing theory
Summary
The studies of Myers (1984) about the puzzle of the firm capital structure are remaining until now, especially in the field of corporate finance, as many research findings contradict each other in the context of firm preferences for equity and debt. Capital structure is flexible depending on the conditions of a firm; theories such as tradeoff, pecking order, and free cash flow are applied conditionally (Myers, 2001). Sunder and Myers (1999) find that firms and in particular mature firms should prefer the pecking order model for their capital structure rather than the trade-off model; in other words, firms should finance their investments by internal funding or retained earnings first, followed by debt. Jensen (1986) proves that free cash flow theory contributes in establishing the firm capital structure in a trade-off model, in particular when shareholders have a conflict of interest with managers in the allocation of free cash and considering the use of debt as a control device for managers in spending the funds. Baker, and Wurgler (2002), Hovakimian, Hovakimian, and Tehranian (2004), and Elliott, Kant, and Warr (2008) show that market prices have a role in establishing the firm capital structure, which refers to market timing and at once triggers the pecking order model
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