Heterogeneity in Speed of Adjustment Toward Target Leverage:Evidence from China

Abstract

This paper estimates the speed of adjustment toward target leverage using the standard partial adjustment model. We use data of China’s publicly listed firms in both Shanghai Stock Exchange and Shenzhen Stock Exchange from 1999-2010. In the previous literature, the speed of adjustment is assumed to be the same across firms in all years. We modify the baseline specification by allowing heterogeneity in the speed of adjustment and estimate the adjustment speed semi-nonparametrically. We control the potential endogeneity bias in the dynamic panel-data model by including the correlated (random) effect. Comparing the estimation performance across different specifications, we find that our semi-nonparametric model is preferred in terms of flexibility, consistency and practical application. We find evidence to prove the existence of target leverage in China’s publicly listed firms. We also find that the firms in China tend to adjust their capital structure toward target at a slower pace than the listed firms in developed countries. The adjustment speeds in China vary plausibly with firm’s ownership structure, CEO’s ability and managerial incentives. In particular, the state ownership is negatively related with the adjustment speed while the top executives’ salary and managerial shareholding are positively related with the adjustment speed. Finally, we reveal the effectiveness of the adjustment speed on corporate performances. Our results indicated that compared with firms with adjustment speed in the bottom 10th percentile, firms with adjustment speed in the top 90th percentile have 13% higher Tobin’s Q, 1% higher earnings, 30% lower financial fees, 40% lower non-business expenditure, 28% higher investment and 62% higher institutional ownership. The industry of transportation and warehousing has the highest average adjustment speed while the industry of utilities has the lowest average adjustment speed.