Empirical Tests for Market Timing Theory of Capital Structure on the Indonesian Stock Exchange

Abstract

This study has aim to examine the validity of Market Timing Theory (MTT) from Baker and Wurgler (2002) in the Indonesian context. The essence of MTT is when the market price overvalued, the firms will take debt financing and otherwise for undervalued condition. MTT is actually the development of Pecking Order Theory (POT) and Static Trade-Off Theory (STT). The motivations of this study are to test the dispute level of pro and cons empirical studies about MTT such as Alti (2003) and Wagner (2007) and to check the consistency result of empirical studies of MTT in Indonesian from Dahlan (2004), Kusumawati and Danny (2006), Susilawati (2008) and Saad (2010).

In order to realize the objective, this study will reuse the empirical model OLS from Baker and Wurgler (2002) with adaptation in Indonesian context. The empirical model OLS from Baker and Wurgler (2002) has a specific uniqueness i.e. the negative relation between leverage and market to book ratio. That negative relation is controlled by several factors such as EAT, Total Asset and Fixed Asset. The other specific uniqueness is empirical models of MTT are generally applied for IPO-firms.

The result of this study supports the hypothesis of MTT from Baker and Wurgler (2002) in Indonesian Stock Exchange (IDX) with the main finding i.e. market to book ratio has the negative impact to market leverage. While the relevant factor for supporting the hypothesis of MTT is EAT. The implication is when firm achieve the earnings growth due to increasing of EAT; the stock price will be overvalued as an impact from investor positive sentiment. This situation suggests the firm in IDX should conduct the debt financing

Keywords: market timing theory, IPO, market to book ratio, book leverage, market leverage, optimal leverage

JEL Classification: G3, G31, G32