Since Modigliani/Miller’s famous theorem (1958) that capital structure is irrelevant for firm valuation, firms’ capital structure choice has been one of the most significant subjects in the modern finance theory. The subsequent theoretical literature has found evidence to negate the irrelevance theorem. Most empirical studies applied a static framework and are capable to explain differences in the optimal leverage ratios across firms, using observed leverage ratios as proxies for the optimal target leverage, but do not explain observed differences in firms’ leverage ratios itself. One broadly accepted reason for a firm’s deviation from their target leverage ratio is the existence of adjustment costs. In the presence of adjustment costs, firms may deviate from their target leverage and find it not cost effective to adjust their leverage ratio frequently or fully within one period, even if they recognize that their existing capital structure is not optimal. This shows the need for developing and using a dynamic approach in order to examine firms’ capital structure.
The paper is organized as follows. Section 2 provides a brief overview of the three main theories of capital structure. Section 3 specifies the dynamic partial-adjustment model and describes the variables that may affect the target capital structure as well as the adjustment speed. Section 4 reports the empirical results and Section 5 concludes the paper
Table of Contents:
List of Abbreviations
List of Symbols
List of Appendices
1. Introduction
2. Theories on capital structure
2.1. Trade-off theory
2.2. Other theories on capital structure
3. The dynamic framework
3.1. The two-stage dynamic partial-adjustment capital structure model
3.2. Definitions of leverage
3.3. Determinants of the target leverage
3.4. Determinants of the speed of adjustment
4. Empirical analysis
4.1. Data description
4.2. Descriptive statistics of observed leverage ratios
4.3. Determinants of the target leverage
4.4. Determinants of the speed of adjustment
5. Conclusion
Appendix
List of Cited Literature
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