Dynamic adjustment towards target capital structure: evidence from Indian companies

Abstract

Purpose The purpose of this paper is to study the dynamics of capital structure in the context of Indian manufacturing companies in a partial‐adjustment framework during the period 1993‐1994 to 2007‐2008. Design/methodology/approach This paper specifies a partial‐adjustment model and uses the generalized method of moments technique to determine the variables which affect the target capital structure and to find out the factors affecting the adjustment speed to target capital structure. Findings Firm‐specific variables like size, tangibility, profitability and market‐to‐book ratio were found to be the most important variables which determine the target capital structure across the book and market leverage and the factors like size of the company, growth opportunity and the distance between the target and observed leverage determine the speed of adjustment to target leverage for the Indian manufacturing companies. Research limitations/implications The behavioural variables like managers' confidence and attitude towards raising the external finance have not been incorporated in the model to determine the target capital structure due to the data constraint. Practical implications This paper has implications for corporate managers in India, for example, to consider the various adjustment costs while altering the financing decisions of the company with other variables like flexibility of the manager, direct cost of debt and equity. Originality/value This paper is first of its kind to study both the determination of target capital structure and the speed of adjustment to target capital structure in the context of Indian companies.

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