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Testing Target-Adjustment and Pecking Order Models of Capital Structure and Estimating Speed of Adjustment: Evidence from Borsa Istanbul (BIST)

Testing Target-Adjustment and Pecking Order Models of Capital Structure and Estimating Speed of Adjustment: Evidence from Borsa Istanbul (BIST)

Levent Ataünal (Istanbul Aydin University, Istanbul, Turkey) and Aslı Aybars (Marmara University, Istanbul, Turkey)
Copyright: © 2017 |Pages: 15
DOI: 10.4018/IJCFA.2017010101
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Abstract

This article examines the explanation power of the pecking order and target adjustment models on 148 Borsa Istanbul (BIST) firms' capital structure over the period of 2005 to 2015. The article also estimates the speed of adjustment (SOA) to the targeted leverage level. Although a firm's capital structure is jointly determined by both theories, target adjustment model appear to have relatively higher power in explaining capital structures of BIST firms. Estimates of the adjustment speeds suggests that firms move toward their target debt ratios at a fast pace. Adjustment speeds estimated with market leverage were significantly higher (44% - 83%). Share price volatility was found to have a rather short-term impact on market leverage. Firms rapidly revert back to their targets and offset these fluctuations within few years. Adjustment speed estimates vary with the estimation method. System generalized methods of moment estimator (GMM-SYS) provided the slowest SOA estimation whereas firm-fixed effects estimators imparted the fastest adjustment speed.
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2. Literature Review

When the probability of financial distress is low, we expect firms to prefer higher leverage because of tax advantage. Conversely, in some industries many profitable companies are found to be operating at low debt ratios (i.e. pharmaceutical companies). It is also observed that profitable companies tend to borrow least (Rajan and Zingales 1995). Some studies found no evidence of a bankruptcy cost effect, which seemed to be inconsistent with the predictions of trade-off theory (Masulis, 1980). Thus, classical trade-off theory does not fully explain the correlation between high profitability and low debt ratios. As Myers (1984) puts it “The static trade-off story works to some extent, but it seems to have an unacceptably low R2”.

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