Do Indonesian firms practice target capital structure? A dynamic approach

Abstract

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.

Ownership and Debt Financing: Indonesia Evidence

“…This is perhaps, according to [25], due to the effects of the financial deregulations taken place where internal financing is also significantly preferred in financing investments and projects, not merely bank loans as previously discussed. An indication of market timing theory at work is also traced where firms seem to time their equity issuance.…”

“…Ameer [42] and De Jong et al [43] support this trade-off theory explanation on the relationship between firm size and debt financing. However, [25] depicts significant negative relationship between size and debt financing. Perhaps according to [25], the negative relationship is due to the effects of Indonesian financial market deregulation activities where the control over initial offering prices and the daily movement of stock prices were lifted and thus encouraged large firms to issue equity over debt.…”

“…However, [25] depicts significant negative relationship between size and debt financing. Perhaps according to [25], the negative relationship is due to the effects of Indonesian financial market deregulation activities where the control over initial offering prices and the daily movement of stock prices were lifted and thus encouraged large firms to issue equity over debt. Firm size is represented by natural logarithm of total asset [25].…”

“…Very recently, Haron [25] investigates 365 listed companies using a panel data from year 2000 to 2011 and concludes that POT has significant influence on the capital structure of firms in Indonesia, with several determinants affecting the financing decisions. This is perhaps, according to [25], due to the effects of the financial deregulations taken place where internal financing is also significantly preferred in financing investments and projects, not merely bank loans as previously discussed.…”

“…All listed firms in IDX should comply with corporate governance regulations [24]. After several financial reformations, trading activities in Indonesia were then started to improve and market capitalization grew alongside the development of Indonesia's financial markets and private sector highlighted by a major bull run in 1990 [25]. At present after several financial reformations and severe experiences during several financial crises, [26] predicts in the long-term perspective of 2016-2020 that Indonesia's average real growth rate is predicted to remain high at 5.5% per year, higher than the average real growth rate of 5.2% of ASEAN (10 countries) compared to China and India of 6.0 and 7.3%, respectively.…”