Dynamic Trade-off Theory Research Articles

Dynamics of capital structure: evidence from Indian manufacturing firms

An optimal capital structure is the fundamental premise of dynamic trade-off theory. However, firms deviate from the optimal level and display adjustment behaviour. This mechanism is referred to as the speed of adjustment towards the point of optimality and implies an examination of the convergence process towards the optimal level. One of the key issues in manufacturing companies is their leverage ratios (Mukherjee and Mahakud, 2012); hence, we aim to investigate the capital structure dynamics of manufacturing firms in India. Included in this investigation is a sample of 55 Indian manufacturing firms listed on the NSE200 from 2009 to 2016. Based on the dynamic panel data model with system generalised method of moments (GMM) estimation, our findings indicate an adjustment speed for the sample firms of around 25%, with a half-life of nearly 2.4 years.

Determinants of Capital Structure and Speed of Adjustment: Evidence from Iran and Australia

This study investigated different companies’ capital structures using a comparative approach in a developing country (Iran) and a developed country (Australia). The purpose of this study was to identify the factors affecting the capital structure based on the company's characteristics in Iran and Australia. The main characteristics of the companies used in this research are mainly based on the variables used in Pecking order theory and the Trade-off theory namely tangibility, firm size, profitability, and business risk. Three other variables including liquidity, asset utilization ratio and speed of adjustment were also investigated. Two indicators of total debt ratio and long-term debt ratio have been used as corporate leverage index. The population of this study included 178 Iranian companies listed on Iran's stock exchange and 187 Australian companies listed on Australia’s stock exchange from 2009 to 2015. To test the hypotheses, Panel data and Eviews software were used. To ensure robustness of the results, the speed of adjustment was estimated using GMM and OLS (with fixed and random effects).The results of this study showed that dynamic trade-off theory could better explain the changes in capital structure in Iran and Australia. The results also revealed significant differences in factors affecting the capital structure in Iran and Australia.

Capital Structure Dynamics: Near vs. Off Target Firms in Sri Lanka

This research paper aims at examining the determinants of the Speed of Adjustment (SOA) towards the target capital structure of near and off target firms in Sri Lanka. Particularly, it analyses the impact of not only firm-specific factors but also corporate governance factors on target capital structure. The methodology utilizes the benefits of the partial (stock) adjustment model, viz, two step Generalised Method of Moments (GMM) to determine the SOA to target capital structure. The results indicate that there is discernible concrete evidence of dynamic behaviour of capital structure in Sri Lanka. This confirms the applicability of dynamic trade-off theory. The near or off target firms’ capital structure adjustment exhibits significant difference in SOA between the two types, implying that off target firms adapt swiftly vis-à-vis those at the doorstep of target firms, in each of the three models. There is a clear indication of both firm related factors and corporate governance factors swaying capital structure adjustment in at least one of the measures of leverage in both situations, very near to and far off from optimum level of debt.

混合所有制、股权激励与 融资决策中的防御行为——基于动态权衡理论的证据

文章基于动态权衡理论，以1999-2014年上市公司为样本，运用混合所有制改革这一“自然实验”条件，研究了高管股权激励对其融资决策中防御行为的影响，分离出激励和治理双重效应。研究发现：（1）股权激励有助于抑制高管融资决策中的防御行为，但这种效应只存在于民营企业中；（2）对于国有企业，只在股权分置改革后才观察到类似效果，而股改前高管在减少债务融资的同时，提高了股权激励水平，自我激励问题明显；（3）公司股权混合度越高，其在赋予高管股权激励上越谨慎，但在国有股比例较高的公司中，混合所有制改革显著提高了股权激励水平；（4）股权混合安排显著改进了股权激励契约在抑制高管防御行为方面的效率，这种效应在非国有股比例较高的公司中更强。

Leverage Persistence and Corporate Dynamic Tradeoff Behavior

We investigate the dynamics of observed and target leverage ratios and deviations from the targets. The cross-sectional persistence in observed leverage ratios is driven by highly persistent targets, whereas the time series variation is driven by transitory deviations from targets. Deviations are less persistent for firms that are overlevered and firms that are smaller, younger, focused, or have lower credit ratings. In recessions, excess leverage is less persistent for larger firms and is more persistent for smaller firms. Thus, consistent with dynamic trade-off theories, persistence is higher when the costs of deviating from targets are likely to be lower and when the costs of adjustment are likely to be higher.

Does dynamic trade-off theory explain Portuguese SME capital structure decisions?

PurposeThe purpose of this paper is to analyse if capital structure decisions of small- and medium-sized Portuguese firms are in accordance with the predictions of dynamic trade-off theory, more precisely, the speed of adjustment of short-term debt (STD) and long-term debt (LTD) towards the respective target debt ratios.Design/methodology/approachBased on two samples of Portuguese firms, 1,377 small-sized firms and 811 medium-sized firms, dynamic estimators were used for the treatment of data obtained from the Amadeus database for the period 2007-2011.FindingsThe results indicate that small- and medium-sized firms adjust their STD and LTD ratios towards the respective target ratios. Small- and medium-sized firms present a high-speed adjustment towards the target STD ratio, suggesting that both types of firm face costs of deviating from the target capital structure, which are, probably, greater than the costs of adjustment associated with STD. However, considering the distance from the target ratio as a determinant of the adjustment speed, the results show the predominance of the negative effect of the costs of adjustment on capital structure adjustment speeds.Originality/valueThe results obtained for the speed of adjustment of STD and LTD, in a recession context, show that for small firms and medium-sized firms, mainly for the former, the costs of external market transactions are prohibitively high, slowing the speed of adjustment towards the target capital structure.

STRUKTUR MODAL OPTIMAL DAN KECEPATAN PENYESUAIAN: STUDI EMPIRIS DI BURSA EFEK INDONESIA

The research investigate whether non-financial firms listed on the Indonesian Stock Exchange made capital structure adjustment towards optimal capital structure and the determinants of adjustment speed in context of trade-off theory for 2009-2014 period. Existence of tax benefit that generates by debt interest payment causing firms arranged their capital structure in order to maximize debt utilizing. Debt utilizing would be make default problem and bankruptcy if it excess firm’s capacity that determine by some firm’s characteristic. Because of optimal capital structure unobservable, so they will be estimate by using some variable which are influencing in capital structure arrangement such tangibility. profitability, size and growth opportunities. The results indicate that non-financial firms in Indonesia follows dynamic trade-off theory with make capital structure adjustment towards optimal capital structure but still underleveraged and need 2,45 years to adjust their capital structure. Distance between actual capital structure and optimal capital structure and financial surplus/deficit are influenced speed of adjustments, while current liabilities is not influenced speed of adjustment. Thus, the practical implication is the companies must be consider and compare their actual capital structure and their optimal capital structure in order to get the benefit from the adjustment by not adding the posibility of bankruptcy due to these adjustment. Capital structure decision also related with various external policy, for instance, accesability to external funding such as creditors, investor and government which influence their adjustment. This research has some limitation, proxies are used in determining the target leverage was only four variables and this study did not addres macroeconomic variables that may affect the adjustment and adjustment speed.

Testing dynamic trade-off theory of capital structure: an empirical study for the textiles industry in India and China

The prime objective of the current study is to compare the dynamic behaviour of capital structure across firms operating in the textile industry in India and China. The study has been conducted by analysing 92 publicly listed textiles firms in India and 33 publicly listed textiles firms in China. The time period from 2005 to 2016 for Indian firms and from 2004 to 2015 for the Chinese firms has been considered. The Arellano and Bond (1991) and Blundell and Bond (1998) based dynamic panel estimation techniques have been deployed to generate the results. The empirical results confirm the applicability of the dynamic trade-off theory for the textile industry in India and China. Further, the results show that the speed of adjustment towards the targeted debt level is very low for the Indian textile companies as compared to that of the Chinese textile companies. The results strongly convey that Indian firms bear significant costs while moving from their observed leverage to their target leverage. The overall results support partial applicability of dynamic trade-off theory for the Indian firms and strong applicability of the theory for the Chinese firms.

Testing dynamic trade-off theory of capital structure: an empirical study for the textiles industry in India and China

The prime objective of the current study is to compare the dynamic behaviour of capital structure across firms operating in the textile industry in India and China. The study has been conducted by analysing 92 publicly listed textiles firms in India and 33 publicly listed textiles firms in China. The time period from 2005 to 2016 for Indian firms and from 2004 to 2015 for the Chinese firms has been considered. The Arellano and Bond (1991) and Blundell and Bond (1998) based dynamic panel estimation techniques have been deployed to generate the results. The empirical results confirm the applicability of the dynamic trade-off theory for the textile industry in India and China. Further, the results show that the speed of adjustment towards the targeted debt level is very low for the Indian textile companies as compared to that of the Chinese textile companies. The results strongly convey that Indian firms bear significant costs while moving from their observed leverage to their target leverage. The overall results support partial applicability of dynamic trade-off theory for the Indian firms and strong applicability of the theory for the Chinese firms.

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.

Navigating The Debt-Equity Decisions Of Financial Services Firms: Some Evidence From South Africa

Empirical studies on the impact of regulation on the financial policies of banks have documented that unconstrained forward-looking banks with sufficient franchise value build and actively maintain capital buffers. This financing behaviour thus relegates the regulatory intervention to non-binding and of secondary importance. This study used a sample of 29 financial services firms listed on the Johannesburg Stock Exchange (JSE) during the period 2003 to 2012 to test for the validity of the market timing, pecking order and the dynamic trade-off theories in explaining the financing behaviour of financial services firms. Consistent with the dynamic trade-off theory and contrary to the market timing and pecking order theories, the study documents that, leverage is positively correlated to firm profitability, size and asset tangibility. The firms’ true speed of adjustment is 56.80% for the market-to-debt ratio (MDR) and 71.31% for the book-to-debt ratio (BDR). The modified external finance-weighted average market-to-book has an insignificant positive and negative correlation with the MDR and the BDR respectively. Taken together, the JSE-listed financial services firms have target optimal capital structures which they actively adjusts towards. Their security issuance decisions are not driven by the stock market performance, share returns or the time-varying adverse selection costs.

What Drives Security Issuance Decisions Of Firms Listed On The Johannesburg Stock Exchange: Market Timing Or Dynamic Trade-Off Theory Or Both?

This study used the random effects Tobit model to investigate the validity of the market timing, trade-off and pecking order hypotheses of capital structure in 143 non-financial firms listed on the Johannesburg Stock Exchange. The results show that leverage is positively correlated to the modified external finance weighted average market-to-book ratio (EFWAMB). Firm profitability and growth rate are negatively correlated to leverage whilst firm size and asset tangibility are positively correlated to leverage. The firms also have target leverage ratios towards which they actively adjust at an unbiased speed of 41.80% for the market-to-debt ratio and 52.82% for the book-to-debt ratio. EFWAMB has a negligible effect on the firms’ speeds of adjustment towards target leverage. The results are robust. These results reject the market timing hypothesis in support of the dynamic trade-off and pecking order hypotheses. They further confirm the fact that these two theories of capital structure are not mutual exclusive.

Growth options effect on leverage: Evidence from China

Using the market-to-book assets (MB) ratio and its inverse exponential transformation as proxies for growth options, we find that the growth options effect on leverage is negative and highly convex in China, consistent with the U.S. evidence from Ogden and Wu (2013). Of particular importance, using a nonlinear transformed rather than a linear MB ratio yields stronger explanatory power for the growth options effect on leverage in tests of both static and dynamic trade-off theories. Moreover, we show that the growth options effect on leverage is stronger among firms characterized by wider divergence between control rights and cash-flow rights of the largest ultimate owner and firms that face more severe financial constraints.

Firm crash risk, information environment, and speed of leverage adjustment

This paper examines the effect of a firm's crash-risk exposure on its speed of leverage adjustment (SOA), and how this effect is influenced by the information environment of the country in which the firm is located. We employ a panel of 19,247 firms across 41 countries from 1989 to 2013, and we find that firms with a higher crash-risk exposure tend to adjust their financial leverages more slowly toward their targets. This evidence supports the dynamic trade-off theory that firms with larger transaction costs adjust their capital structures less often. Equally important, we document that the negative link between crash-risk exposure and SOA is less pronounced in countries with a more transparent information environment.

As certain as debt and taxes: Estimating the tax sensitivity of leverage from state tax changes

Using staggered corporate income tax changes across U.S. states, we show that taxes have a first-order effect on capital structure. Firms increase leverage by around 40 basis points for every percentage-point tax increase. Consistent with dynamic tradeoff theory, the effect is asymmetric: leverage does not respond to tax cuts. This is true even within-firm: tax increases that are later reversed nonetheless lead to permanent leverage increases. The treatment effects are heterogeneous and confirm the tax channel: tax sensitivity is greater among profitable and investment-grade firms which respectively have a greater marginal tax benefit and lower marginal cost of issuing debt.

A macroeconomic approach to corporate capital structure

The cross-sectional distribution of corporate capital structure and its macroeconomic implications are underexplored research areas. This paper embeds a dynamic trade-off theory of firm financing into a general equilibrium model with firm dynamics. I find that the stationary equilibrium replicates fairly well the distribution of leverage as well as the relationship between leverage, size and profitability. The counterfactual experiment points out relatively small effects of tax benefits on corporate capital structure. It also implies that the effects of the default cost on macroeconomic variables are almost negligible under endogenous capital structure choice.

Debt, Taxes, and Liquidity

We analyze a model of optimal capital structure and liquidity choice based on a dynamic tradeoff theory for financially constrained firms. In addition to the classical tradeoff between the expected tax advantages of and bankruptcy costs, we introduce a cost of external financing for the firm, which generates a precautionary demand for liquidity and an optimal liquidity management policy for the firm. An important new cost of financing in this context is an endogenous servicing cost: payments drain the firm's valuable liquidity reserves and thus impose higher expected external financing costs on the firm. The precautionary demand for liquidity also means that realized earnings are separated in time from payouts to shareholders, implying that the classical Miller-formula for the net tax benefits of no longer holds. Our model offers a novel perspective for the debt conservatism puzzle by showing that financially constrained firms choose to limit usages in order to preserve their liquidity. In some cases, they may not even exhaust their risk-free capacity.

Key Factors Influencing Target Capital Structure of Property Firms in Malaysia

Very limited studies have been done on the capital structure of property firms in Malaysia emphasizing on the presence of target capital structure and the affecting determinants and also the speed of adjustment to target leverage. Thus, this study aims to investigate these issues among the property firms in Malaysia by using a dynamic model. This study finds that these property firms do practice target capital structure which is influenced by certain firm characteristics like non-debt tax shield, asset structure, profitability, firm size, growth opportunity and liquidity in their capital structure and they also time their security issuance. Being deviated from target from time to time these property firms partially adjust indicating a support for the dynamic trade-off theory. There are also influences of the pecking order and the market timing theories in the capital structure decisions of these property firms. This study contributes to the literature by offering insights of the capital structure practice and the adjustment speed to target capital structure of property firms in Malaysia and fills the gap in the literature.

Reassessing the effect of growth options on leverage

Results of empirical studies of the trade-off theory of capital structure indicate that an important, stable factor is missing from traditional leverage regression models. Our review of theory leads us to the hypothesis that the missing factor is related to profitable growth options (GOs). Specifically, the relationship between optimal leverage and the market-to-book assets ratio (MB), a measure of GOs, is negative and highly convex. In tests of static trade-off theory, we find that a convex (inverse exponential) transformation of MB substantially increases adjusted R2 in leverage regressions, and partially subsumes the explanatory power of median industry leverage. Using the transformed MB variable also yields stronger results in tests of dynamic trade-off theory, including analyses of leverage evolution, speed of adjustment, and external financing activity.

Firm Crash Risk, Information Environments, and Speed of Leverage Adjustment

This paper examines the effect of firm crash-risk exposure on the speed of leverage adjustment (SOA), and how this effect is influenced by information environments, by employing a large panel of 19,254 firms across 39 countries spanning the years 1989 to 2009. We find that firms exposed to a higher crash risk tend to adjust their financial leverage toward their targets more slowly. This relation is more pronounced for over-leveraged firms. The empirical evidence supports the pecking order theory and the dynamic trade-off theory. We also find that, among the over-leveraged firms, the documented negative association between crash-risk exposure and leverage adjustment is attenuated by strong information environments at country level.