Do Firms Adjust Toward Target Capital Structures? Some International Evidence

Abstract

In a sample of 26,395 firms from 40 countries, we find evidence in support of the dynamic trade-off theory for capital structure. Firms in every country of our sample partially adjust toward target capital structures. We show that legal, institutional, and other country-level factors explain about 16 percent of the variation in adjustment speed for the full sample and about one-third for developing countries. These factors, however, have significantly different effects for developing and developed countries. Strong creditor and shareholder rights are both associated with faster adjustment speed in developing nations while they have no explanatory power in developed nations. Financial market development and higher tax rates are also positively associated with adjustment speed in developing countries, but have the opposite effect in developed countries.

Keywords: capital structure, international, financial leverage, partial adjustment, legal institutions, developing markets

JEL Classification: G20, G32