Taiwan Finance Association Conference

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Research Title: 
Timing Behavior Versus Adjustment Towards theTarget: What ‎Determines the Capital Structure Dynamics ‎
Timing Behavior Versus Adjustment Towards theTarget: What ‎Determines the Capital Structure Dynamics ‎309.85 KB
Research Abstract: 

The adjustment towards the target leverage and the timing of equity market are not necessarily two distinct behaviors as theoretically suggested. The firm choice to adjust towards the target  leverage depends on the costs of being away from the target and the cost of adjustment toward  that target. If the cost of deviation is high, adjustment becomes a first priority whatever the  market conditions of the firm are. Lower cost of deviation opens the door for other aspects,  especially timing the market, to be considered in the financing decision. Using GMM system  estimators with the Malaysian data for the period of 1992-2009, this study find that Malaysian  firms, on average, are adjusting their capital structure toward the target but at a slow rate. At the  same time, firms consider timing of the market conditions as an important factor when making  financing decisions. Comparing subgroups of firms that are likely to have different costs of  deviation reveal that the speed of adjustment is higher and the timing role is lower for firms with  high cost of deviation. Particularly, firms far above the target adjust at a high speed and do not  consider timing the market. Firms far below or close to the target adjust slowly and take market  valuation into account. Deviating from the target to the upper side is more costly because  bankruptcy costs and agency costs of debt will intensify quickly as the firm deviates more above  the target. Firms seem to be very sensitive to be significantly above the target. Once the firm is  not far above the target it becomes less sensitive to the cost of deviation and more likely to  consider other motives including timing the equity market. The finding of this study supports  that firms consider risk of distress and possible conflict with debtors as leading factors in the  financing decision. This result is consistent with both tradeoff and agency theories. Only when  the firm is not in the risky area, it may consider other factors as timing the market. Timing is  better seen as an additional factor in a broad tradeoff framework. A framework that interprets all  the empirical findings is still lacking.