On the determinants of firm leverage: evidence from a structural estimation

Abstract

Purpose – The purpose of this paper is to investigate the phenomena of convergence and stability of leverage reported by Lemmon et al. (2008). Design/methodology/approach – A dynamic trade-off model of the firm was used to simulate investment, leverage, and payout decisions for different types of firms. From an econometric standpoint, the Efficient Method of Moments was used to recover the structural parameters. Findings – The structural model generates a leverage ratio that oscillates around a long-run, time-invariant level and consistently reproduces the convergence and stability of leverage reported by Lemmon et al. (2008). The model also suggests the causes of those observed properties of the data. That is, convergence is due to the mean-reversion of profits while stability is due to the different fundamental characteristics (e.g. capital elasticity, volatility of profits, etc.) of the firm. Practical implications – Determining the optimal capital structure of a firm is a complex problem that has challenged academics and practitioners for a long time. Understanding leverage decisions is of great importance not only for financial managers, but also for investors, such as banks, debt-holders, equity-holders, and other capital providers, who need to understand how firms make capital structure decisions in order to achieve an efficient allocation of funds. Originality/value – The author shows that the firm-specific fixed effects in leverage regressions are not related to the usual determinants (e.g. profitability, market-to-book ratio), but to the primitive characteristics of the firm (e.g. elasticity of capital in the production function, the volatility of profits, the capital depreciation rate, the income tax rate, etc.)

Detecting Determinants of Capital Structure

“…Menichini argues that different fundamental characteristics such as capital elasticity and the volatility of profits cause the stability. With this finding Menichini (2015) adds to the list of time-varying capital struc-ture determinants which may be difficult to support empirically. Hanousek and Shamshur (2011) also support leverage stability.…”

Credit rating process

“…Ownership structure has major impacts on the choice of corporate capital structures (Ganguli, 2013; Chadha and Sharma, 2015). In this case, Titman and Wessels (1998) already mentioned that the leverage ratio is significantly associated to firm size, profitability and the uniqueness of a firm’s corporate governance (Titman and Wessels, 1998; Menichini, 2015). Therefore, previous empirical studies from Chen et al (2014), Croci et al (2011), Ellul (2010), Anderson et al (2003) indicated that family firms are reluctant in using equity financing because they are according to their behavior not willing to dilute their power and undermine the shareholders’ control position.…”

Determinants Analysis of Manufacturing Companies Values Listed On the Indonesia Stock Exchange

“…Leverage atau yang sering dikenal dengan rasio solvabilitas merupakan seberapa besar kemampuan perusahaan dalam memenuhi kewajiban jangka panjangnya (hutang). Menurut Menichini (2015) rasio solvabilitas ini sangatlah penting bagi investor. Untuk mengetahui seberapa besar kemampuan perusahaan dalam memenuhi kewajiban jangka panjang dapat diketahui menggunakan rumus:…”