Dynamic adjustment towards target capital structure: evidence from Indian companies

Abstract

PurposeThe purpose of this paper is to study the dynamics of capital structure in the context of Indian manufacturing companies in a partial‐adjustment framework during the period 1993‐1994 to 2007‐2008.Design/methodology/approachThis paper specifies a partial‐adjustment model and uses the generalized method of moments technique to determine the variables which affect the target capital structure and to find out the factors affecting the adjustment speed to target capital structure.FindingsFirm‐specific variables like size, tangibility, profitability and market‐to‐book ratio were found to be the most important variables which determine the target capital structure across the book and market leverage and the factors like size of the company, growth opportunity and the distance between the target and observed leverage determine the speed of adjustment to target leverage for the Indian manufacturing companies.Research limitations/implicationsThe behavioural variables like managers' confidence and attitude towards raising the external finance have not been incorporated in the model to determine the target capital structure due to the data constraint.Practical implicationsThis paper has implications for corporate managers in India, for example, to consider the various adjustment costs while altering the financing decisions of the company with other variables like flexibility of the manager, direct cost of debt and equity.Originality/valueThis paper is first of its kind to study both the determination of target capital structure and the speed of adjustment to target capital structure in the context of Indian companies.

Emerging Markets and Financial Resilience

“…Rajan and Zingales (1995) add that the definition of leverage should depend on the objective of the analysis being carried out are employed in the studies. For example, Bevan and Danbolt (2002), Mukherjee and Mahakud (2010) and Caglayan (2010) have reported on different results derived from the use of different leverage definitions. Arguments put forward above show how highly important leverage definition is in determining and examining both the level of leverage (Rajan & Zingales, 1995;Bevan & Danbolt, 2001) and the determinants of leverage (Chittenden et al, 1996;Michaelas et al, 1999;Bevan & Danbolt, 2002) as different leverage definition used may yield different results thus leads to inconclusive findings in the capital structure studies.…”

Factors Affecting Speed of Adjustment to Target Leverage: Malaysia Evidence

“…Instead, we will focus on analyzing factors affecting speed of adjustment in Malaysia firms. This is a very new interest in capital structure studies nowadays and still very limited work has been done on this issue for example, Banerjee et al (2004), Loof (2004), , Mukherjee and Mahakud (2010) and Aybar-Arias et al (2011). We will look at how fast firms in Malaysia adjust to their target leverage and what are the factors influencing the adjustment speed.…”

“…According to Fama and French (2002) the target leverage ratio is not observable but it may be attributed from the other variables of the firms like debt-to-equity itself, size, growth opportunities and NDTS. In relation to the study on factors affecting speed of adjustment, among the most important studies in the related areas are the work done by Banerjee et al (2004), Loof (2004), , Mukherjee and Mahakud (2010) and AybarArias et al (2011). They argue that the adjustment speed varies across firms and time period because of the varying adjustment costs incurred by the firms.…”

“…They also add that the more distance firms from the target leverage the faster the adjustment process will be and despite the existence of adjustment costs firms still rebalance. Mukherjee and Mahakud (2010) studied the dynamic adjustment towards target capital structure of Indian manufacturing firms and conclude that firm-specific factors like size, tangibility, profitability and growth are found to be the most important factors determining target capital structure. Factors like size, growth opportunity and the distance between target and observed leverage determine the speed of adjustment for Indian manufacturing firms.…”

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

“…It logically follows that it is vital to translate the signs of the estimates of the relevant coefficients pertaining to the interaction terms suitably. When the interaction term is negative, speed of adjustment is high (or of positive affinity) and when the interaction term is positive, the speed of adjustment is low (or of negative affinity) (Drobetz & Wanzenried, 2006;Mukherjee & Mahakud, 2010). …”