How do they adjust their capital structure along their life cycle? An empirical study about capital structure over life cycle of Pakistani firms

Abstract

Purpose The purpose of this study is to explain the adjustment rate made to target capital structures by listed non-financial firms in Pakistan during the courses of their life cycles and to determine what factors influence their adjustment rates. Design/methodology/approach The study used multivariate analysis to classify 39 years (1972-2010) of unbalanced panel data from listed non-financial Pakistani firms in terms of their growth, maturity and decline stages. Further, it used a fixed-effects panel data model to determine the factors that influence capital structure and adjustment rates during the life-cycle stages of firms. Findings The study observed a low–high–low leverage pattern during the growth, maturity and decline stages of businesses in line with tradeoff theory. Furthermore, the study observed an adjustment rate for growing firms of between 49.3-37.9 per cent, for mature firms of between 35.5-17.5 per cent and for declining firms of between 22.2-15.1 per cent toward their respective leverage targets. Furthermore, it was found that growing firms have higher leverage adjustment rates because, by having more investment opportunities, these firms can alter their capital structures easily by changing the composition of their new issues. Practical implications Erratic economic conditions in Pakistan have created an uncertain business environment. Therefore, even mature Pakistani firms remain skeptical about the sustainability of positive trends among current economic indicators. Furthermore, to avoid uncertainty, Pakistani firms grab short-term opportunities by using quickly available short-term debt as a main financing source. Government should introduce long-term policies that will stabilize the business environment and strengthen the financial, as well as the judicial, institutions of the country so that these firms may benefit from long-term investment opportunities and access more options for raising external financing. The results of this study will also help policymakers for other Asian economies where the capital markets are underdeveloped and where firms have higher leverage ratios, such as Thailand, Indonesia and Malaysia. Originality/value This is the first study in Pakistan that has used a multivariate approach to classify firms into their different life-cycle stages and to discover the leverage adjustment rates of firms during those life-cycle stages.

Dynamics of financial leverage across firm life cycle in Chinese firms: an empirical investigation using dynamic panel data model

“…Table 2 represents description of all the explanatory variables and their relationship with leverage and leverage adjustment rate. For dependent variable of leverage, this study uses financial leverage following the empirical studies of Delcoure (2007), Sheikh and Qureshi (2014), Ahsan et al (2016b), and Tian et al (2015). The study uses three proxies of leverage: short-term leverage (SL) which is the ratio of short-term loan to total assets, long-term leverage (LT) is the ratio of long term loan to assets, and total leverage (TL) is the ratio of total liabilities to total assets.…”

“…Our study further differs in sample size and sample period Tian et al (2015) reported a different adjustment rate for leverage across birth (68.52%) and decline (48.72%) stages of firm's life cycle. Our approach of multivariate firm life cycle measurement is in accordance with Ahsan et al (2016b). Ahsan et al (2016b) found different adjustment rate for growing, mature, and declining firms while analyzing a large data set of Pakistani nonfinancial firms.…”

“…Our approach of multivariate firm life cycle measurement is in accordance with Ahsan et al (2016b). Ahsan et al (2016b) found different adjustment rate for growing, mature, and declining firms while analyzing a large data set of Pakistani nonfinancial firms.…”

“…Notable studies in this regard include studies conducted by Ahsan et al (2016a), Getzmann et al (2014), Bradley et al (1984), and Bontempi and Golinelli (2001). Ahsan et al (2016b) and Bontempi and Golinelli (2001) used unit root testing to confirm that a percentage of firm follow a target capital structure while Getzmann et al (2014) used dynamic panel data model (GMM) to find that firm adjust their capital structure and estimated an adjustment rate for firms using generalized method of moment (GMM). More recently, Tian et al (2015) using a sample of public sector manufacturing Chinese firms and studied their leverage adjustment across firm life cycle.…”

“…For this purpose, this study follows Anthony and Ramesh (1992) and Ahsan et al (2016b) and employ a multivariate approach in measurement of firm life cycle to an unbalanced data of 15,005 firm level observations (1996)(1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006)(2007)(2008)(2009)(2010)(2011)(2012)(2013)(2014) and categorize firms into three categories, i.e., growing firms, mature firms, and declining firms. Further, the study uses dynamic panel data model to estimate adjustment rate in these three life stages of firms and also examines various multilevel determinants of leverage (firm-level, industry-level, and country-level determinants).…”