Effects of Inflation Rate Risk and Firm-Specific Risk on A Firm Capital Structure Adjustment: GMM Approach

Abstract

One of the most important duties of a firm’s financial managers is to select an optimal capital structure for it. The research hypotheses are developed based on the effects of both internal (firm specific risk) and external (inflation rate risk) risks of a firm on the capital structure and the distance between real leverage and target leverage (capital structure adjustment speed), from the viewpoint of the dynamic balance theory. The generalized method-of-moments (GMM) dynamic panel estimator is used to estimate the models and test the hypotheses. The research data is collected from 121 firms listed in Tehran Stock Exchange from 2011 to 2018. The results of the first model indicate that the effect of both inflation rate risk and firm specific risk on the financial leverage of the company is significant. This effect on the financial leverage is negative for both variables. Meanwhile, the results of the second model indicate that the effects of both firm specific risk and inflation risk on the target leverage adjustment speed is significant. In other words, the influence of these two variables on the capital structure adjustment speed of firms is negative. Results also show that the speed of capital structure adjustment is 29% for firms, which decreases to %28 when a firm inflation rate risk occurs. Moreover, it drops to %25 during the periods a firm is exposed to a firm specific risk .Therefore, internal factors have a greater impact on the speed of capital structure adjustment of firms, as compared to external factors. ‌

Keywords

• inflation rate risk
• firm specific risk
• capital structure
• capital structure adjustment speed
• generalized method-of-moments (gmm) estimation