Dynamic Partial Adjustment Model Research Articles

Financing of state-owned entities: Can the Trade-off Theory explain the debt structure?

The purpose of this research is to determine if the financing behaviour of South African state-owned entities (SOEs) have a target capital structure which they adjust towards and if so, the speed of adjustment, a central tenet of the Trade-off Theory. An unbalanced panel data set from a sample of thirty-three commercial SOEs were studied using a dynamic partial adjustment model. The findings provide strong evidence that South African SOEs follow the trade-off theory based on the existence of a target capital structure and speed of adjustment of 21.5% per annum towards the target which is slower than other SOEs in developing economies. The findings also revealed that these SOEs take almost five years to close off two-thirds of the gap between the actual and optimal capital structures. The findings will be of interest to observers of the economy, as they measure the capacity of SOEs to play a leading role in investment and in improving the efficiency of the economy. They could also inform decision making and policy development on SOEs.

Capital Structure Adjustment Speed and Ownership Structure: A Research on BIST 100 Index Food Sector Firms

In this study, the capital structure adjustment speed of 19 food sector firms in the Borsa Istanbul (BIST) 100 index has been estimated between 2010 and 2021. The effect of ownership identity on the capital structure adjustment speed has been investigated within the scope of family and non-family firms. The seven firms have been classified as non-family firms (NFF) and twelve as family firms (FF). The capital structure adjustment speed for family and non-family firms has been composed of the classical dynamic partial adjustment model. The Generalized Moments Method (GMM) model has been used as the econometric model in estimating the models. The results obtained from the study revealed that there is no significant difference between the debt ratios of family companies and non-family firms. The adjustment speed of family firms has been determined as 68%, and the adjustment speed of non-family firms has been approximately 56%. The capital structure adjustment speed of family firms is higher than non-family firms. The results show that family firms are less exposed to financial constraints than other firms increasing their borrowing capability, thus enabling them to reach the target debt level faster. The findings suggest that ownership structure plays a vital role in capital adjustment behavior.

What determines the capital structure of farms? Empirical evidence from Poland

ABSTRACT The purpose of this paper is to analyse capital structure and its dynamics for farms in Poland, a leading European Union producer. The theoretical framework is based on the trade-off and pecking order theories of capital structure. We use data from the Farm Accountancy Data Network (FADN), which is representative of Polish professional farms during the period 2009–2018. We adopt a dynamic partial adjustment model using the generalized method of moments in order to explain the financing of farms through debt. The results show that Polish farms exhibit low target levels of debt, which they adjust dynamically, thus partially validating the trade-off theory. While size and growth opportunities positively influence the indebtedness of farms, profitability and land have the opposite effect. Polish farmers therefore use available internal funds, especially retained earnings, as a substitute for debt, in line with the pecking order theory.

Trade Credit and Capital Structure Adjustment Speed: Evidence From Chinese Listed Firms

This paper examines the impact of trade credit on the speed of capital structure adjustment toward target leverage using an integrated dynamic partial adjustment model. Trade credit is an important substitute for debt financing and gives firms a low-cost means of adjusting leverage toward the target capital structure in China. We measure trade credit by accounts payable. Using the public listed company data from 1998 to 2016, we find that trade credit accelerates capital structure adjustment. The asymmetric impacts on the capital structure adjustment speed in different situations are also evidenced. The positive impact of trade credit on the speed of capital structure adjustment is more pronounced for over-levered firms. The trade credit also accelerates the speed of capital structure adjustment more quickly for high market share firms. Our results imply that firms use trade credit to save cash flow and restore the leverage level to the target capital structure in China.

Corporate Real Estate Usage and Firm Valuation: Evidence from a Dynamic Partial Adjustment Model

The trade-off between the potential benefits and costs of using corporate real estate (CorRE) in the production process creates an optimal level of CorRE that varies over time and across firms. We document the importance of conditioning on a firm’s optimal CorRE usage when analyzing the influences of CorRE on firm valuations and stock returns. Using a dynamic partial adjustment model, we estimate differences in firms’ actual CorRE usage from optimal levels and the speed at which firms move toward their optimal CorRE usage. We find that investors tend to punish the valuation of companies that deviate from optimal CorRE usage, probably through the channel that large deviations from optimal CorRE usage hurt firm profitability. The positive stock return-CorRE relationship documented by previous studies mainly holds for firms with too little CorRE.

Household and industrial electricity demand in Europe

This paper examines the electricity demand, and its determinants, in 29 European countries during the liberalization of the electricity market. Based on panel data for these countries for the years 1995–2015 and using a dynamic partial adjustment model, price elasticities are estimated for both residential and industrial electricity demand. These elasticities and effects of other variables on electricity consumption are estimated using both GMM (generalized method of moments) and ML (maximum likelihood) approaches. It is found that the price elasticities are very small, especially in the short run, while the income elasticities are relatively large, especially for households and in the long run.

Revisiting the residential electricity demand in the United States: A dynamic partial adjustment modelling approach

In recent years, price policies and price changes derived from environmental regulations have played a more important role to promote residential energy conservation. Using recent annual state-level panel data for 48 states, we estimate a dynamic partial adjustment model for electricity demand elasticities on price and income in the residential sector. Our analysis reveals that in the short run, one unit price increase will lead to 0.142 unit of reduction in electricity use after controlling for the endogeneity of electricity price. Thus, raising energy price in the short run will not give consumers much incentive to adjust their appliances to reduce electricity use. However, in the long run, one unit price increase will lead to almost one unit consumption reduction, ceteris paribus. In addition, we find new evidence that for states of higher per capita GDP, raising the electricity price may be more effective to ensure a cut in consumption.

Do Indonesian firms practice target capital structure? A dynamic approach

Purpose This study aims to investigate the dynamic aspects in the capital structure decisions of firms in Indonesia, offering an extension to the existing literature on Indonesia via a dynamic model, including the existence of target capital structure, the influencing factors, the speed of adjustments and the supporting theories to explain the findings. Design/methodology/approach This study uses a dynamic partial adjustment model estimated based on a generalized method of moments. Findings Indonesian firms do practice target capital structure and are influenced by firm-specific factors like profitability, business risk, firm size, liquidity and share price performance due to time-varying factors. A rapid adjustment toward target leverage is detected, thus supporting the existence of the dynamic trade-off theory (TOT). The pecking order theory (POT) also has significant influence, particularly after the new reformation of financing policy, where retained earnings are also preferred as a source of financing apart from merely external financing through bank loans. There are also traces of market timing influences where firms also seem to time their equity issuance. Research limitations/implications Despite relatively utilizing recent data and bigger sample firms compared to the previous limited studies on Indonesia, the results of this study, however, need to be cautiously interpreted. First, the sample chosen focused on listed firms, hence may not be generalized to all Indonesian firms, listed and unlisted. Second, the study does not separate firms by sectors and their leverage positions, that is under-levered and over-levered, so as to note that financial decisions may also be affected by the sector in which the firms operate and their leverage positions. These are to be considered in future research. Practical implications There is strong evidence that the corporate financing behavior of Indonesian firms is governed by the POT and TOT. Both are dealing with the function of debt. The financial sector reformation does have a positive impact on the banking sector, but not the local corporate bond market. Therefore, regulators and policymakers should bear in mind that banking as well as private bond market in Indonesia must be tailored in such a way that both could act as intermediaries of debt financing, as bond market represents an important component of a diversified financial sector. Originality/value This study fills the gap by providing an extension to the existing literature and a deeper insight of the capital structure of Indonesian firms using a more robust dynamic model.

The capital structure adjustment through debt financing based on various macroeconomic conditions in Korean market

We investigate the relationship between the capital structure and the economic conditions in Korean market. To find the adjustment behavior on capital structure depending on macroeconomic conditions, we use dynamic partial adjustment model to estimate adjustment speeds toward targets. As the data analyzed in the study, we use non-financial firms listed in the Korean stock exchange. Through the empirical test, we find evidence that is consistent with Hackbarth, Miao and Morellec (2006) and Cook and Tang (2010)’s arguments that firms tend to adjust faster their leverage toward target level in economic expansion. Thus, our findings support to the pecking order and market timing theories in terms of corporate finance theories on capital structure. In addition, our test results are re-confirmed with robust consistency even though we include year dummy variable in the empirical test model for controlling global financial crisis in contrast with Kim (2013).

Does Corporate Tax Avoidance Impair Earnings Informativeness?

We investigate a previously overlooked type of non-tax cost associated with tax avoidance: the potential loss of earnings informativeness. Expected benefits from corporate tax planning include positive effects on after-tax earnings and an increase in firm value. However, tax avoidance can entail opaqueness which clouds investors’ view on firm performance and reduce earnings informativeness. We run multiple tests on a large U.S. firm sample over the period 1993 to 2012. First, we find that tax avoidance is significantly negatively associated with earnings informativeness, as measured by the Earnings Response Coefficient (ERC) derived from a standard pricing model. Second, we introduce a dynamic partial adjustment model to study the overall firm information quality and show that firms may not be able to compensate for the tax-related loss in earnings informativeness, e.g. by providing other (non-earnings) information. Third, we extend our research design to better control for a number of factors known to affect the ERC, such as firm growth, risk, size, and leverage (Collins and Kothari [1989]). Beyond GAAP and Cash effective tax rates, we use a range of alternative tax avoidance proxies (e.g. Frank, Lynch and Rego’s [2009] DTAX measure, Wilson’s [2009] tax shelter probabilities) to further validate our findings. Results consistently suggest that higher levels of tax avoidance are associated with lower earnings informativeness and that this finding is likely not limited to particularly aggressive types of tax avoidance.

Factors Affecting Speed of Adjustment to Target Leverage: Malaysia Evidence

This study focuses on the dynamic aspect of capital structure which is a relatively new area in the finance literature. By employing panel data, 790 of non-financial listed firms in Malaysia are examined for the period 2000–2009. Conducted using the dynamic Partial Adjustment Model and estimated based on the Generalized Method of Moment, this study investigates the existence of target capital structure, speed of adjustment and factors affecting speed of adjustment. There are evidences of target capital structure and firms do adjust to be at their target from time to time with a considerably rapid speed of adjustment, in line with dynamic trade-off theory. Firms in Malaysia are found to be under-adjusted, being below the required adjustment to be at the target within a year. Study on factors affecting speed of adjustment is a new contribution to the literature as no work has been done regarding this issue in Malaysia. This study also analyzes firm-specific factors affecting speed of adjustment. There is strong evidence on the negative relationship between the speed of adjustment and distance from target leverage suggesting fast adjustment if not being far from target. Firm size and profitability significantly influence speed of adjustment for firms in Malaysia.

Partial adjustment toward target capital structure: Evidence from selected African countries

This paper investigates the firm-specific determinants of target capital structure and the speed of adjustment towards this target for industrial firms in four African countries. In addition to using a two-stage, dynamic partial adjustment model which sheds light on the dynamic nature of the adjustment process, various definitions of leverage are also used to check for robustness. The findings of the paper indicate that African firms adjust faster to short-term debt targets than they do to longterm debt targets. Furthermore, firms in Nigeria and South Africa adjust relatively faster to their target capital structures, whereas firms in Ghana and Kenya have slower speeds of adjustment, pointing to the existence of higher adjustment costs and less-developed capital markets in these countries. The speeds of adjustment obtained range from 17.9%-60.2% per year, consistent with international evidence regarding speeds of adjustment in other developing and emerging economies

Dynamic capital structure adjustment: US MNCs & DCs

This paper uses dynamic panel estimators to test whether there are differences in the speed of capital structure adjustment between US-based multinationals and domestic corporations, and why such differences may occur. Prior literature attributes the differences in leverage between MNCs and DCs to agency costs of debt financing and the theorized variance stabilization of overall cash flows from diversification. Related, specific speed factors of adjustment and the rebalancing of capital structure following an equity price shock are also investigated. The results using a dynamic partial adjustment model show that on average DCs adjust to target leverage faster than MNCs. This provides support for the market-timing, pecking order and dynamic trade-off theories of capital structure. Further the paper identifies and attributes the overall relatively faster capital structure adjustment speed of DCs to relatively higher equity returns for MNCs, relatively lower incidence of under-leverage for DCs and the relatively higher incidence of above-target leverage for DCs. Further tests show that agency costs, financial flexibility (i.e., cash flows) and capital investments have different effects on adjustment process for MNCs relative to DCs. The result partially supports prior evidence of inertia following equity price shock to capital structure rebalancing.

Response of residential electricity demand to price: The effect of measurement error

In this paper we present an empirical analysis of the residential demand for electricity using annual aggregate data at the state level for 48 US states from 1995 to 2007. Earlier literature has examined residential energy consumption at the state level using annual or monthly data, focusing on the variation in price elasticities of demand across states or regions, but has failed to recognize or address two major issues. The first is that, when fitting dynamic panel models, the lagged consumption term in the right-hand side of the demand equation is endogenous. This has resulted in potentially inconsistent estimates of the long-run price elasticity of demand. The second is that energy price is likely mismeasured. To address these issues, we estimate a dynamic partial adjustment model using the Kiviet corrected Least Square Dummy Variables (LSDV) (1995) and the Blundell–Bond (1998) estimators. We find that the long-term elasticities produced by the Blundell–Bond system GMM methods are largest, and that from the bias-corrected LSDV are greater than that from the conventional LSDV. From an energy policy point of view, the results obtained using the Blundell–Bond estimator where we instrument for price imply that a carbon tax or other price-based policy may be effective in discouraging residential electricity consumption and hence curbing greenhouse gas emissions in an electricity system mainly based on coal and gas power plants.

Determination of capital structure in India: a partial adjustment approach

We investigate the role of adjustment costs and other firm-specific variables like tangibility, growth opportunity, size of the company, profitability, volatility, nondebt tax shields and uniqueness of the company in the determination of capital structure in the case of 793 Indian manufacturing companies for the period 1995–1996 to 2006–2007. A dynamic partial adjustment model, more specifically the Generalised Method of Moments (GMM) technique, is used to test the dynamics of capital structure. The results indicate that firms do have a target capital structure. The adjustment speed towards the target capital structure is reasonably high and it varies with the definition of leverage ratio. All these results are consistent with the tradeoff theory of corporate capital structure.

The Impact of Financial Flexibility on Capital Structure Decisions: Some Empirical Evidence

I empirically test the impact of financial flexibility on capital structure decisions on a large sample of publically traded U.S. firms from 1971 to 2006. I find that accounting for the marginal value of financial flexibility in capital structure models sheds light on several important capital structure questions. First, I show that when the marginal value of financial flexibility is high, variables traditionally shown to impact leverage (e.g., profitability, depreciation and amortization expense, fixed assets, etc.) become less important and explain less of the observed variation in leverage. This is consistent with the notion that financial flexibility is of first-order importance when firms make capital structure decisions. Second, consistent with the predictions of DeAngelo, DeAngelo, and Whited (2010), the results show that firms that have a high marginal value of financial flexibility tend to preserve debt capacity in the current period but are significantly more likely to embark on intentional, but temporary, deviations from their target leverage ratios in the near future. Further, firms which have a high marginal value of financial flexibility that do raise large amounts of financing in the current period are significantly more likely to issue equity than transitory debt in order to preserve debt capacity. This result helps to explain why young, high-growth firms tend to have lower debt ratios than the pecking order or traditional tradeoff models predict. Finally, I show that once the marginal value of financial flexibility is included in a dynamic partial adjustment model, it explains the asymmetric adjustment speeds reported by Byoun (2009). That is, I show that it is only the firms with the highest marginal value of financial flexibility that tend to be reluctant to lever up when they have below their target leverage. Overall, my results highlight the need to account for the marginal value of financial flexibility in empirical tests of capital structure theory.

International Demand Equations for Forest Products: A Comparison of Methods

The objective of this study was to compare different methods of estimating the demand equations of global forest sector models. Past applications have shown that model projections depend critically on the elasticity of demand with respect to income and prices. To measure the elasticity coefficients, nine groups of products were examined, ranging from fuelwood to paper and paperboard, in 64 countries. The analysis was done with panel data on consumption, price and income, from 1973 to 1997. Two alternative forms were hypothesized: a static demand model, and a dynamic partial adjustment model. The demand equations were estimated first with classical panel methods: ordinary least squares pooling of country data, least squares with country dummy variables, between group pooling and error-component models. However, rejection of the hypothesis of homogeneity of elasticities across countries led to the investigation of two shrinkage estimators: the Stein rule and the iterative empirical Bayes estimator. Within-sample predictions were carried out to compare the accuracy of each estimator. The Stein rule estimator, based on the static model, gave the smallest root mean square error. Nevertheless, because the Stein-rule estimates often had theoretically wrong signs and large variances, other estimators, although biased, were deemed preferable for policy analysis. In conclusion, pooling by ordinary least squares with country dummy variables was one of the most useful methods to obtain demand equations applicable to many countries. Furthermore, static models predicted demand better than dynamic models, conditional on price and national income.

Residential energy demand in the United States: A regional econometric analysis

A static equilibrium and a dynamic partial adjustment model of residential demand for electricity and natural gas are presented and estimated for the United States over a recent period characterized by sharply increasing energy prices. The static model is estimated using Ordinary Least Squares while the instrumental variables method is used for the dynamic partial adjustment model. The estimates of long-run elasticities suggest the residential demand for electricity and natural gas are price and income elastic. Intercept and slope dummies used in the models identify significant regional differences in demand functions.