Differentiating Debt Target from Non-Target Firms: An Empirical Study on Corporate Capital Structure

Abstract

Surveys of Chief Financial Officers show that some managers claim to pursue a target adjustment model while others claim to follow alternative financing models. We therefore estimate a model for debt dynamics in which the target adjustment and short-run flow-of-funds coefficients may vary across companies. This allows us to, (i) distinguish between target and non-target firms; (ii) examine whether the two groups of companies differ with respect to key financial variables; and (iii) investigate whether short-run investment, acquisitions and profitability shocks impact differently on target and non-target companies. In general, we find that financing cost factors appear to be more important than the determinants of target capital structure. However, roughly 60% of our companies follow a debt target. These target companies tend to be smaller and less profitable, and have lower market-to-book ratios and cash holdings. Their debt levels are also significantly less sensitive to short-run shocks in investment and acquisitions expenditure. Overall, our work raises the interesting possibility that one financing model may not be descriptive for all firms. Different financing models may well be appropriate for different types of firms.

Keywords: capital structure, debt target

JEL Classification: G32