The Speed of Adjustment towards Optimal Capital Structure: A Test of Dynamic Trade-off Model

Abstract

Capital structure remains to be a highly debated topic and the number of researches on the dynamic version of capital structure in Indonesia is very small. Besides, the inclusion of macroeconomic factors is even harder to locate. This paper analyzes the financing behaviour of non-financial firms in Indonesia. The objective is to measure the adjustment speed of the firms toward the optimal capital structure. Partial Adjustment Model (PAM) was used to analyzed the data. It is expected that non-financial firms in Indonesia possess a target leverage and make partial adjustments toward the target over time. The empirical findings from 250-panel data observation revealed that tangibility and firm's size had a positive and significant relationship with target leverage. In addition, macroeconomic variables (GDP growth and inflation rate) were found to be negatively correlated with the firm's speed of adjustment. Finally, the result shows that non-financial firms in Indonesia readjusted toward their target leverage at a speed rate of approximately 57.44% a year. These evidences conclude that the financing behaviour of non-financial firms in Indonesia tended to follow the dynamic trade-off theory.

Speed of Adjustment of Capital Structure (Empirical Study on the Aviation Industry in Indonesia and Malaysia)

“…This shows that the growth of assets owned by the company does not become a basis for the company to immediately adjust its capital structure (leverage) during abnormal conditions even though the asset growth structure is experiencing an increase or decrease in aviation industry companies in Indonesia and Malaysia, because asset growth in This research is not based on illiquid fixed assets. The results of this research are in line with research (Wendy & Salim, 2019, G. Oka Warmana et al, 2020, which states that growth assets do not have a significant effect on target leverage.…”

“…By using GDP growth as a measure of macroeconomic conditions. The research is in line with research (Mukherjee & Mahakud, 2010, Cook & Tang, 2010, Chipeta & Mbululu, 2013, Wang, 2013, (Lemma & Negash, 2014, De Jonghe & Öztekin, 2015, Wendy & Salim, 2019, G. Oka Warmana et al, 2020.…”

“…Meanwhile (G. Oka Warmana et al, 2020) found an adjustment speed of 64.75% in their research. Nosita (2016) concluded that companies in Indonesia have an adjustment speed of 40.15% and (Wendy & Salim, 2019) concluded that companies in Indonesia have an adjustment speed of 57.44%.The difference in the adjustment speed of this study with previous studies may be caused by the first sampling period. G. Oka Warmana et al ( 2020) used a sample of manufacturing companies from 2012 to 2016).…”

“…Wetty (2013) believes that the average SOA in Indonesia is 83% per year or almost double that of (Darminto., 2008). Carrying out similar research in Indonesia, namely (Wendy & Salim, 2019) found that the adjustment to the capital structure SOA was 57.44% and (G. Oka Warmana et al, 2020) found that the adjustment to the capital structure SOA was 64.73% per year. Researchers are still asking how big the SOA of the capital structure is and what factors determine the SOA of the capital structure in aviation industry companies in Indonesia and Malaysia.…”

“…As a result, optimal capital structure plays an important role for aviation industry companies. Studies on target capital structure include, Wendy & Salim, (2019) conducted research in Indonesia whose objects were non-financial companies listed on the Kompas 100 index using the predictor variables profitability, asset tangibility, size, growth opportunities, non debt tax shield, growth DPG and inflation. Warmana.…”