Firm Characteristics and Dynamic Capital Structure Adjustment

Abstract

We use a dynamic framework and panel methodology to investigate the determinants of a time-varying corporate capital structure. Our sample comprises 706 European firms from France, Germany, Italy and the U.K. over the period from 1983 to 2002. If capital structure adjustment is costly, firms may deviate temporarily from their target debt ratios. Therefore, we investigate the adjustment process and analyze the impact of well-known firm characteristic variables on the speed of adjustment towards a endogenously specified target debt ratio. We find that larger and faster growing firms adjust their capital structure more readily. Furthermore, large deviations from target debt ratios lead to faster readjustment. Additionally, we shed new light on capital structure rebalancing arguments. We document that large swings in market values of leverage lead to readjustment in the corresponding book values of leverage in the following periods. Finally, we find that capital structure adjustments are largely determined by financial constraints, i.e., firms in unfavourable financial conditions show only little or no adjustment behavior at all.

Keywords: Capital structure, dynamic analysis, panel data

JEL Classification: G32, C61, C23