Journal of Asset Management and Financing (Dec 2024)
Investigating the Effects of Debt Convergence of Companies on the Speed of Capital Structure Adjustment Considering the Time Horizon
Abstract
This study examined the capital structure adjustment speed between converged and non-converged companies in terms of financial leverage according to the timing of capital structure adjustment using data from companies listed on the Tehran Stock Exchange (TSE). The aim of the study was to investigate whether corporate debt convergence and timing of capital structure adjustment had a significant effect on the capital structure adjustment speed. This study was unique in that it investigated the effect of debt convergence on capital structure adjustment speed, comparing adjustment timing between converged and non-converged companies - an approach not previously explored in domestic research. The relevant data for companies listed on the TSE from 2015 to 2021 were collected. First, the converged and non-converged companies were identified using the Phillips and Sul’s (2007) method. Then, the estimation results were analyzed using the generalized method of moments regression. The results indicated that the capital structure adjustment speed was higher for the converged companies (in terms of leverage) compared to the non-converged companies. Additionally, the capital structure adjustment speed was lower in the earlier years of the adjustment period compared to the later years. There was a significant difference in the capital structure adjustment speed between the beginning and the end of the adjustment period for the converged versus non-converged companies.Keywords: Capital Structure Adjustment Speed, Debt Convergence, Capital Structure Adjustment Time, Converged Companies, Non-Converged Companies. IntroductionExtensive research has examined the speed at which companies adjust their financial leverage towards an optimal capital structure. The idea is that there exists an optimal debt-to-equity ratio that maximizes a company's value and when companies deviate from this optimal level, they will make adjustments to return to the target capital structure. The phenomenon of mean reversion in leverage was first highlighted by Chen and Zhao (2007), which complicates the assessment of adjustment speed. This mean reversion effect can create contradictions in financial policies and leverage changes - for instance, a company may have an explicit policy to increase debt, yet its debt ratio still decreases and vice versa. The fact that leverage ratios are bounded between 0 and 1 contributes to this mean reversion tendency. Studies on capital structure adjustment speed have generally found that companies adjust their leverage gradually over a long period of time. Specifically, the adjustment tends to start off at a slower pace in the beginning and then accelerate in the later years of the adjustment process. Given these considerations, we investigated whether the convergence of corporate debt levels affected the speed of capital structure adjustment and whether the adjustment speed varied over the course of the adjustment period. In other words, the study sought to examine if debt convergence impacted the dynamics of the capital structure adjustment process for companies listed on the Tehran Stock Exchange (TSE). Materials & MethodsThe study period spanned from 2016 to 2021. The first step was to distinguish between convergent and non-convergent companies using the Phillips and Sul’s (2007) method. Then, the generalized method of moments regression was employed to estimate the results. FindingsThis study examined debt convergence as a key factor influencing the capital structure speed of adjustment. The results supported the hypothesis that debt convergence affects the adjustment speed. The second hypothesis was also confirmed - the capital structure speed of adjustment was lower in the initial years of the adjustment period compared to the later years. This was likely because adjusting the capital structure incurred costs and given the significant gap between actual and target leverage in the early adjustment years, the companies tended to adjust their leverage more slowly during this phase. Finally, the third hypothesis was supported as well - the capital structure speed of adjustment differed between the convergent and non-convergent companies both in the early and later stages of the adjustment process. This suggested that the dynamics of the adjustment path varied depending on whether a company's debt level had converged towards an industry average or not. Discussion & ConclusionsNumerous domestic and international studies have examined the factors affecting the capital structure speed of adjustment. However, two factors that have received relatively less attention are the impacts of corporate debt convergence and timing of the adjustment process. This study aimed to investigate the influence of these two variables on the capital structure speed of adjustment with greater rigor and precision. The findings provided important insights; the results indicated that the speed of adjustment was higher for companies whose debt levels had converged compared to those that had not. Additionally, the adjustment speed was lower in the initial years of the process compared to the later stages. These insights could enhance our understanding of how companies selected their optimal capital structure mix of equity and debt. The results suggest that researchers should pay close attention to both factors of timing and debt convergence when examining companies' decisions on their optimal capital structure compositions. In fact, the optimal capital structure for a company cannot be assessed in isolation. It is essential to evaluate the optimal composition based on the convergence of a company's capital structure with its industry peers or other comparable companies in the same geographic region or country. This contextual perspective is crucial for accurately determining a company's optimal financing mix. In conclusion, this study contributes to the existing literature by shedding light on the dynamic and nuanced nature of the capital structure adjustment process, underscoring the importance of considering debt convergence and adjustment timing when investigating these decisions.
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