Dynamic Trade-off Theory Research Articles

Bank Fintech and firm leverage adjustment speed: Evidence from China

The recent development of Fintech has greatly changed the operation and loan management of commercial banks, which has had a significant impact on firm financing and governance. This paper analyzes the impact of the rising use of bank Fintech on leverage adjustment speed. The results show that bank Fintech accelerates firm leverage adjustment speed. This effect is more pronounced for under-leveraged firms, high-growth firms, non-state-owned firms and firms located in regions with more developed institutions. Transmission channel tests show that bank Fintech can accelerate leverage adjustment speed by alleviating firm-level financial constraints and agency problems. Finally, bank Fintech improves firm performance by accelerating leverage adjustment speed. Our work extends the literature on Fintech and dynamic trade-off theory and has implications for banking regulations and Fintech development.

The determinants of banks' capital structure in SAARC economies

The capital structure determinants for South Asian banks are required to be exposed. This investigation attempts to address the existing gap by examining the capital structure determinants for the South Asian Association for Regional Cooperation (SAARC) countries. To accomplish the main objective, the Panel Data of 52 banks is collected from the four main regional economies for the period starting from 2012 to 2022. The methodology is based on the estimation of constructed models by executing Static Panel Data analysis and Dynamic Panel Data analysis via the Generalized Method of Moments (GMM). The investigation discovered that tangibility, growth, profitability and non-performing loans have positive significant influences, whereas, liquidity and gross domestic products have negative significant impacts on the regional banks' capital structure. Also, the significant lagged variable and the presence of adjustment speed suggest the implementation of the Dynamic Trade-Off theory in the SAARC countries' banking sectors. The findings will help regulatory bodies develop a harmonization policy to enhance financial integration among SAARC economies via adopting identified capital structure determinants.

Cashflow Management Practices and Financial Performance of Small and Medium Business Enterprises in Kenya

This comprehensive review examines cash management and its impact on the financial performance of Small and Medium Enterprises (SMEs). The review covers theories, practices, and empirical evidence, providing insights into financial management strategies. Theoretical perspectives include the Dynamic Trade-Off Theory and the Free Cash Flow Theory, which shed light on the implications for SMEs' financial management strategies. Empirical evidence underscores the importance of cash accountability, internal controls, cash policy, cash budgeting, and financial performance metrics like profitability, liquidity, and solvency. Effective cash management is crucial for SMEs as it enables growth, optimizes investments, enhances profitability, and ensures financial stability. This synthesis offers valuable insights for policymakers, practitioners, and academics seeking to understand and enhance SMEs' financial performance through sound cash management practices.

What explain capital structure determinants choices of Shariah firms?

This study aims to discover key capital structure determinants for the entire Shariah firms operating in dissimilar contexts. Moreover, it also estimates the adjustment speed for these firms to maintain targeted capital structures at all times. For this purpose, 321 Shariah firms that are operational in Saudi Arabia, Pakistan, the UAE, and Indonesia are nominated. The empirical analysis is conducted using 11 years, i.e., 2011-2021, of balanced Panel Data. The debt-to-asset and debt-to-equity ratios are used as variables of interest, whereas the asset tangibility ratio, current ratio, return on equity, size, non-debt-tax shield, inflation, and gross domestic product are used as explanatory variables. The robust estimator, i.e., Generalized Method of Moments (GMM), is executed to perform the analysis. The results show that the most important factors for Shariah-tagged firms are inflation, the gross domestic product, the asset ratio, the return on equity, the non-debt tax shield, and the lagged dependent variables. The important role of asset tangibility, lagged variables, and the presence of adjustment speed postulate that Shariah-tagged firms are following the provided guidelines of Dynamic Trade-Off theory to preserve capital structure. The findings are a new contribution to the limited empirical inquiries of Shariah firms’ capital structure and a fresh addition to Islamic Finance literature. Besides, the outcomes are also helpful for policymakers and assist them in developing an optimal model of capital structure for Shariah-tagged firms that decreases overall capital costs and enhances these firms’ market value.

How Do Commercial and Non-commercial Banks Adjust Capitalization Ratio: Evidence from Tanzania

This study examines the dynamic balanced panel data to explore the level of capitalization adjustment process for commercial and non-commercial banks in Tanzania for a period of 10 years from 2012 to 2021 in a two-step system GMM estimator. The findings of the research reveal that the cost of adjustment towards the required bank capitalization ratio is lower for commercial and non-commercial banks operating in Tanzania. The results are significant to the instantaneous adjustment process of a capitalization ratio measured in terms of the ratio of bank total equity to total assets. This finding is consistent with the dynamic trade-off theory of capitalization ratio using the coefficient value of the lagged response variable. The result reveals further that return on assets reduces the cost of the target bank capitalization ratio which means it eliminates the financial distress because return on assets is easier to be valued by investors. Therefore, it can be used as an indicator of the good performance of banks that can increase the easy availability of external capital from prospective and existing investors. The negative and significant sign of the bank size coefficient (-0.710) implies that the sample of banks in this study in terms of equity to assets ratio causes the capitalization ratio to deviate from the target level. This is consistent with the too-big to fail hypothesis. Abdulhamid et al. (2019) hold that an inverse association between bank size and capitalization ratio would happen because large banks have comparative advantages in non-traditional banking activities (interest) since they can operate with a fixed cost. The findings of this study have significant policy implications for economic and financial sector growth.

Corporate Governance and Cash Holdings among Non-Financial Companies Listed in the Nigerian Exchange Group

The exogenous shocks that necessitate firm deviation from a target cash holding vary across firms and institutional environments, hence the need for the study. This study examines the relationship between corporate governance (CG) and cash holdings among non-financial companies in the Nigerian Exchange Group between 2011 and 2020. The number of populations is 133 non-financial firms. As not all firms disclosed publicly comprehensive annual reports the number of final samples is 88 firms. Generalized Method of Moments (GMM) and the quantile techniques were adopted. With a speed of adjustment (SOA) of 0.75 and a time frame of one year, three months, and four days (1/0.749 = 1.34), the result reveals a partial dynamic adjustment to target cash holdings. The quantile estimation generally reveals low cash holdings and high SOA dynamics, and it is significant at 5% level. With exception of board gender diversity and institutional ownership, variables such as board independence, size, and chief executive officer equity ownership exhibit a significant inverse impact on cash holdings at a 5% level. Relying on the dynamic trade-off and agency theories, the results conform to a prior expectation. This study recommends that a manager should formulate strategic financial policy based on a firm’s specific SOA.

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

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.

Customer–supplier relationships and non-linear financial policy response

We investigate whether changes in the capital structure of major customers play an important role in determining the firm’s financial policy. Following (Leary and Roberts, 2014) and using average customer idiosyncratic equity return shocks, we find that a firm’s leverage ratio is negatively and nonlinearly affected by the leverage ratio of its major customers. This “customer effect” occurs only when the idiosyncratic equity shock to the customer firms is negative. Consistent with the prediction of the modified pecking order theory that firms are more concerned about excessively high leverage ratios than excessively low leverage ratios, supplier firms tend to significantly reduce their long-term debt in response to increases in the leverage ratios of their major customers but are insensitive to the inverse change. Finally, consistent with the stakeholder theory and the dynamic trade-off theory, we find that this capital structure correlation is more pronounced for firms producing specialized or unique products, firms with lower profitability, firms with weaker operational capabilities, firms that take more risks, firms whose customers operate in more competitive industries, and firms whose customers are more financially vulnerable. Our results contribute to identifying the dynamics and determinants of corporate capital structures.

The dynamic trade-off theory of capital structure: evidence from a panel of US industrial companies

PurposeThis paper aims to test the empirical validity of the dynamic trade-off theory in its symmetric and asymmetric versions in explaining the capital structure of a panel of publicly listed US industrial firms over the period from 2013 to 2019. It analyzes the existence of an adjustment of leverage toward its target level and whether the speed of this adjustment is influenced by the debt measure, the model specification or/and the fact that the actual debt ratio is higher or lower than its long-term target level.Design/methodology/approachThis paper uses a quantitative research methodology using panel data analysis under the partial adjustment model and the error correction model using the generalized moment method in first differences and in systems to explore the dynamic nature of firms’ capital structure behavior.FindingsThe results show that the effects of the conventional determinants of leverage are globally consistent with the trade-off theory predictions. The dynamic versions confirm that firms exhibit leverage-targeting behavior. Although this speed of adjustment (SOA) depends on the debt and model specifications, it is around 60% on average. The estimated SOA is higher for the market leverage measure compared to the book leverage. The asymmetric adjustment model reveals that firms are more sensitive to reducing leverage than increasing it when they are away from their target; overleveraged firms exhibit approximately 5% faster adjustment than underleveraged firms when book leverage is used.Originality/valueThe originality of this research paper lies in its development and test of an asymmetric model to allow the leverage adjustment speed to vary depending on whether the firm’s debt ratio is above or below its target level and the methodological approach as well as the different model specifications used and the insights generated through the application of rigorous econometric techniques.

FINANCING AND CAPITAL STRUCTURE

The capital structure denotes the composite blend of debt and equity utilized by a business entity.In the past, the concept of capital structure was commonly categorized as a highly specialized and technical aspect of corporate management that pertained to a limited number of individuals within an organization.In the perspective of a conventional business individual, the likelihood of this vicinity to produce ample profits was rather low.The generation of considerable revenue is observed to be comparatively pronounced in certain financial domains, such as appropriately identified investment initiatives, when juxtaposed with other areas of financial pursuits.In recent times, there has been a substantial transformation in the prevailing circumstance.The area of capital structure has garnered significant attention and interest within academic discourse.The present discourse concerns both the theoretical and practical aspects of finance.The utilization of said funds may be extended towards facilitating the comprehensive functioning of the enterprise and executing investment operations. The various forms of capital structure commonly recognized include equity share capital, debt financing, preference share capital, and vendor financing.The present study aims to examine various aspects related to capital structure, including the challenges associated with the precise measurement of capital structure. Additionally, individual authors suggest that there exist numerous intriguing areas for future exploration in this domain.Anticipated outcomes encompass factors such as the provision of capital from the supply side, the correlations between capital structure and labor agreements, financial contracting, the dynamic trade-off theory, and the rate of capital structure adjustments. The aforementioned concepts will be subjected to scrutiny to evaluate their potential applicability as findings for research purposes.Some emphasis is also placed on the issue of asymmetric information and moral hazard that may arise between the parties involved in a given scenarioThe role of investors and issuers of diverse securities is fundamental in the financial domain.In the following, we also examine the three fundamental principles underlying the concept of capital structure in the realm of finance. The concept of capital structure irrelevance, the significance of the debt tax shield, and the interrelationship between the financing decisions and firm value represent essential themes in the field of finance.Attention is also focused on the expected financial costs associated with insolvency and their impact on determining the optimal capital structure.These ideas try to figure out if a firm can make more money by changing how it gets its money. Each idea has a unique answer, which means capital structure is a complex but interesting subject.

Examining Capital Structure Determinants for ASEAN Energy Firms

Increasing energy insufficiency is the main trench for the South East Asian countries. Though, there are rare empirical inquiries in relation to the energy firms’ capital structure determinants for the firms functioning in the Association of Southeast Asian Nations (ASEAN). Therefore, this study is an attempt to discover the capital structure determinants of energy firms that are functioning in the six key economies of ASEAN region which are Malaysia, Indonesia, Thailand, Philippines, Cambodia and Vietnam. In this setting, a total of 144 energy firms’ yearly Panel Data is involved over 14 years period from 2007 to 2020. The seven core determinants of capital structure, namely tangibility, return on equity, current ratio, non-debt tax shield, inflation and annual gross domestic product are inspected in relation to capital structure which is measured by ratio of debt to total asset. Employing both Panel Data models that are Static and Dynamic models via using robust estimator i.e. Generalized Method of Moments (GMM), the results reveal that tangibility and profitability are the most prominent determinants among all others. Evidently, the two newly introduced capital structure determinants that are inflation and energy consumption for ASEAN region energy firms are also reported significant by dissimilar estimators. The significant character of tangibility, profitability and lagged dependent variable directly infers the relevance of Dynamic Trade-Off theory. The findings provide new ways for policy makers to construct parallel strategies which will not only help out to overcome the energy scarcity issues but also to enhance regional level integration.

The firms’ debt reversibility trend: An application to a large sample of industrial SMEs

The corporate debt reversibility analysis can be carried out not only from the owner/manager’s active intervention perspective but also from the perspective of a mechanical reversion, independent of owner/managers’ deliberations. Our study aims to discover how and which theoretical perspective underlying reversibility has the most significant impact on the capital structure of Portuguese industrial small and medium-sized enterprises (SMEs). The present paper proposes a new approach linking the measures commonly used to determine the target leverage level to the specific assumptions of theories addressing debt dynamics. Our results show that the perspective with the stronger impact on capital structure materialises in the dynamic trade-off theory assumptions. However, owners/managers also strongly consider the industry references to which firms belong. The perspective of mechanical debt reversion also contributes, at its level, to the firms’ debt permanent reversibility in the sense of possible long-term stationarity.

Discovering Capital Structure Determinants for SAARC Energy Firms

Energy scarcity is the core drain for the South Asian economies. However, there is a lack of studies in relation to the capital structure determinants in the context of South Asian Association for Regional Cooperation (SAARC). Thus, this study is an attempt to explore the capital structure determinants of energy sector firms which are operating in the four large economies of the SAARC region that are Pakistan, India, Bangladesh and Sri Lanka. In this context, a total of 34 energy sector firms’ Panel Data is entailed over the period of 2007-2020. The six key capital structure determinants, namely asset tangibility, current ratio, return on equity, non-debt tax shield, annual gross domestic product are examined in relation to debt to total asset ratio. Deploying Panel Data Static models and Dynamic model via Generalized Method of Moments (GMM), the outcomes reveal that asset tangibility and current ratio are the most prominent determinants among all others. The significant role of profitability and tangibility through different estimators directly infers the relevance of Dynamic Trade-Off theory. The findings provide new ways for policy makers to construct parallel strategies which not only help out in overcoming the energy scarcity issues but also enhance regional level integration.

Capital Structure Adjustment Speed in Indonesia: Does Sharia Compliance Matter?

Leverage Speed of Adjustment (henceforth SOA) has previously been studied by researchers; however, the examination of its connection with sharia law has been overlooked. The majority of the literature currently in circulation comes from the Middle East and North Africa (MENA) region and Malaysian markets, so its implications for businesses in Indonesia may not be applicable given local regulations and cultural norms. This study investigates the distinction in the debt levels and the SOA of firms in Indonesia based on compliance to sharia law. The Two-step Generalized Method of Moment (GMM) model was used to calculate the SOA in the leverage model. We discover that sharia compliance plays a role in stimulating the Indonesian firm’s level of debt and leverage SOA. To put it more precisely, sharia firms use less debt and have a slower SOA than conventional firms. Overall, Indonesian firms implement the dynamic trade-off theory in their leverage framework. Instead of relying on conventional debt, which is only available at certain levels, sharia firms must issue Islamic debt instruments to accelerate the speed of adjustment. Even after a robustness test using various sharia compliance approaches, our results remained consistent.

Investigating the capital structure determinants of energy firms

The ongoing energy crisis has turned into a major bottleneck for economic growth and has had a long-lasting impact on the performance of energy firms. However, recognizing capital structure determinants helps these firms construct an ideal capital structure and attain their target of profitability. Thus, this study is an attempt to identify capital structure determinants for whole energy firms that are operating in dissimilar regions and countries. The 14-year balance panel data of 281 energy firms, i.e., 2007–2020, is used to perform the analysis. The debt-to-asset ratio is nominated as a dependent, whereas sales, current ratio, asset tangibility, non-debt tax shield, return on equity, inflation, gross domestic product, and energy consumption are selected as independent variables. The Panel Data Static models and Dynamic models via the Generalized Method of Moments (GMM) are executed to perform the inquiry. The results indicate that lagged dependent variables, sales, tangibility, return on equity, inflation, gross domestic products, and energy consumption are the main capital structure determinants of energy firms. The significant lagged dependent variable, tangibility, sales, and the existence of speed of adjustment point towards the practice of the Dynamic Trade-off theory by energy firms to maintain capital structure at all times. The results obtained by this empirical analysis are a new addition to the financial literature and will help policymakers develop similar policies regarding the capital structure-maintaining practices of energy firms that will enhance energy-related ties among countries.

Labor protection and dynamic leverage adjustments in the OECD countries

We study the link between employment protection laws (EPLs) and the speed of corporate leverage adjustments, emphasizing the role of the country's legal enforcement. Using comprehensive data from 19 OECD founding countries/members, we explore that firms operating in more stringent EPLs adjust slower to their target leverage ratios. These relationships are significant and robust for several tests addressing the endogeneity concern of a battery of robustness checks including an alternative measure of EPLs, an alternative measure of leverage, and alternative subsamples. We further demonstrate that the negative association between the stringency of EPLs and leverage SOA is more pronounced in countries with effective legal enforcement. Overall, our results are consistent with the dynamic trade-off theory of capital structure.

Target capital structure for managerial decision making: Dynamics and determinants

The study examines the dynamics and determinants of target capital structures among manufacturing firms listed on the Nigeria Stock Exchange during the period from 2012 to 2021. The study is motivated by the disparity in the Speed of Adjustment (SOA) to target leverage, which is influenced by firm-specific attributes largely dependent on macroeconomic indices. Therefore, understanding the determinants of SOA to target leverage is germane because no two macro-economic environments are the same. A longitudinal research design is used with a population of 75 manufacturing firms. The sample consists of 42 firms, drawn using a simple random technique. Secondary data is sourced from the annual report. Generalized Method of Moments is the estimation technique. The result shows that manufacturing firms adjust to a target capital structure with a high speed of 72%. This confirms the application of dynamic trade-off theory among listed manufacturing firms in Nigeria. Profitability, firm size, and asset tangibility are significant determinants of SOA to a target capital structure, confirming pecking order, agency, and static trade-off theories, respectively. Tax shelter and growth were not significant determinants. The study concludes that there is evidence of dynamic adjustment to the optimal capital structure of listed manufacturing firms in Nigeria. Governments and policymakers in firms should make effective policies that aid speedy access to long-term funds by these firms to increase their SOA to target capital structure.

Capital Structure Adjustment Speed: Evidence From Indonesian Property, Real Estate, and Construction Building Firms

This study examines the capital structure based on dynamic trade-off theory in property, real estate, and construction building companies in Indonesia. We have used a data panel from 17 companies over the years 2018 to 2021. There are two stages of testing in this study. First, we estimate the target leverage using Random Effect Model and then find the capital structure adjustment speed using Fixed Effect Model. The results of this study prove that profitability has a negative and significant effect on the company's capital structure, firm size has a positive and significant effect on the company's capital structure, while growth does not influence it. This study also revealed that property, real estate, and construction building companies in Indonesia adjusted their capital structure toward optimal capital structure, where the adjustment speed was 25% per year or took 4 years to achieve their optimal capital structure. This study suggests government policies encouraging people's purchasing power to support economic recovery.

Debt-Equity Ratio, CEO Power and Financial Performance of Listed Companies at the Nairobi Securities Exchange, Kenya

Firm financial performance is essential for corporate survival and prosperity. Financial leverage may be used to enhance corporate financial performance, but it can also occasion financial distress and bankruptcy if not carefully managed. At the Nairobi Securities Exchange, a number of firms face poor financial performance, financial distress, and weak corporate governance, commonly associated with excessive leverage and bankruptcy. Recent corporate finance research shows increasing importance of variables, omitted in prior corporate finance studies, with more practical significance to practicing managers such as debt slack and corporate governance. The purpose of this study was to determine the moderating effect of Chief Executive Officer Power on the relationship between financial leverage and financial performance of listed companies at the Nairobi Securities Exchange. The specific objective was to determine the conditional effect of Chief Executive Officer Power on the relationship between Debt-Equity ratio and firm financial performance. The study was grounded on dynamic trade-off, pecking order, agency, and upper echelon theories. Positivist research paradigm with a descriptive research design using a linear regression model on Panel data obtained from a survey of 38 listed companies at Nairobi Securities Exchange over the period 2010 to 2019 was used. The data was mined from financial statements filed at the Nairobi Securities Exchange. Controlling for Firm size, Sales growth and operational efficiency, the study found Chief Executive Officer Power to significantly moderate the relationship between Debt/Equity ratio and Return on Equity (∆R2 = +0.1314;ꞵ = 0.1019455, p=0.000), with scope for lower levels enhancing Return on Equity while higher levels dampening. The study recommended a low Chief Executive Officer Power configuration mandate. The study contributes to theory development by establishing executive power contingency to theories relating financial leverage to firm financial performance; to knowledge by developing a tool for measurement of Executive power; and to policy by providing empirical evidence for regulation of executive power. The study scope was limited to structural and shared ownership sources of Chief Executive Officer Power and recommends further research incorporating personal sources of power.

Debt-Equity Ratio and Financial Performance of Listed Companies at the Nairobi Securities Exchange, Kenya

Firm financial performance is essential for corporate survival and prosperity. Financial leverage may be used to enhance corporate financial performance, but it can also occasion financial distress and bankruptcy if not carefully managed. At the Nairobi Securities Exchange, a number of firms face poor financial performance, and financial distress, commonly associated with excessive leverage and bankruptcy. The purpose of this study was to determine the effect of debt-Equity ratio on financial performance of listed companies at Nairobi Securities Exchange. The study was grounded on dynamic tradeoff and pecking order theories. Positivist research paradigm with explanatory design using linear regression model on panel data obtained from a survey of 38 listed companies at Nairobi Securities Exchange over the period 2010 to 2019 was used. The data was mined from financial statements filed at the Nairobi Securities Exchange. Controlling for Firm size, Sales growth and operational efficiency, the study found Debt Equity ratio (ꞵ= -.1633009 p= 0.000) negatively related to Return on Equity and statistically significant at 0.05. The study recommended reduction in long-term or short-term debt or both or increase in equity finance for overall reduction in debt-equity ratio to enhance Return on Equity. Further, the study recommends deepening of Kenya’s capital market to permit optimal capital structure adoption by firms. The study contributes to knowledge by establishing the state of financial leverage at Nairobi Securities Exchange, to policy by establishing the need for deepening of capital market at NSE and to theory by confirming the relevance of dynamic tradeoff and pecking order theories at the bourse. The study scope was limited to firms listed at NSE. A similar study covering East Africa capital market is recommended. Further, a study to explore the limiting factors in Kenya’s capital market is recommended.