Abstract
In this research, we tested the heterogeneity of speed of adjustment toward target leverage among industries on the Indonesian stock exchange by using two-step partial adjustment model. The sample collected from 2007-2016 and consisted of firms in eight sectors, i.e. agriculture, mining, basic industries, miscellaneous, consumer goods, property and real estate, infrastructure, utilities and transportation as well as trade, services and investment sectors. Firms in the financial industry are excluded because the capital structure of firms in the financial industry reflects specific regulations and are not independent firms’ policies. The results showed that speed of adjustment ranged from 61% - 45% for book leverage and 67% - 43% for market leverage. This significant speed of adjustment is consistent with trade-off theory, which states that firms have target leverage and when firms are deviated from the target, firms will make financial decisions that will close the gap between previous year’s leverage and the target leverage of current period.
Highlights
One of the dominant and widely studied theories of capital structure is trade-off theory which states that firms have optimal leverage ratio that balances bankruptcy risk and tax benefits from debt financing
Significant corporate bankruptcy cost leads firms' debt-equity choices inversely related to earning variability (Bradley et al, 1984). They stated that there is a strong relationship between industry classification and average level of firms' ratio aiming at determining optimal capital structure under static trade-off theory
The results of this research indicate heterogeneity of speed of adjustment between firms produced by using both book leverage and market leverage
Summary
One of the dominant and widely studied theories of capital structure is trade-off theory which states that firms have optimal leverage ratio that balances bankruptcy risk and tax benefits from debt financing. Significant corporate bankruptcy cost leads firms' debt-equity choices inversely related to earning variability (Bradley et al, 1984) They stated that there is a strong relationship between industry classification and average level of firms' ratio aiming at determining optimal capital structure under static trade-off theory. Previous researches show that targeting behavior is not homogeneous between firms; there is no single speed of adjustment suitable for all firms (Lemmon et al, 2008; Clark et al, 2009; Flannery & Hankins, 2013; Dang et al, 2014; Lotfaliei, 2018) This difference in speed of adjustment was identified because of firm specific characteristics (firm specific factors) including profitability, firm size, asset tangibility, growth opportunities, financial constraints (Byoun, 2008), deviation distance from the target (Mukherjee & Wang, 2013), macroeconomic factors (Huang & Ritter, 2009) and business cycles (Korajczyk & Levy, 2003)
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