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Timing Behavior Versus Adjustment Towards theTarget: What Determines the Capital Structure Dynamics | 309.85 KB |
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.