Academic journal article IUP Journal of Applied Finance

Dynamics of Corporate Capital Structure Choices and Intervening Forces: Indian Evidence

Academic journal article IUP Journal of Applied Finance

Dynamics of Corporate Capital Structure Choices and Intervening Forces: Indian Evidence

Article excerpt

(ProQuest: ... denotes formulae omitted.)

The Tax-Shield (TS) theory, the Agency Cost (AC) theory, the Pecking Order (PO) theory, the Dynamic Trade-Off (DTO) theory, and the Market Timing (MT) theory have overstressed on the different views while the facets have their specific roles. The researchers ... have deviated far away and ... have explained a little. ... In a dynamic time frame model, firms' financing choice may neither completely in a STO nor a DTO phenomenon. It may neither completely be under the PO nor MT framework. Firms might have their independency (i.e., flexibility) of shifting their decisions from one framework to another.

- Sinha and Ghosh (2013a, p. 12).

Introduction

How do the firms revise their capital structure dynamics at stake? In corporate finance, the query is partially addressed in a few studies like De Fiore and Uhlig (2015) and Ariff et al. (2008). At its core, the dynamics of firms' capital structure choices spin at changes in their intervening forces. This theoretical proposition motivates us in studying intervening forces that derive dynamics in firms' capital structure decisions. The global financial crisis of 2008-09 has also moved the present author in exploring the effects of the intervening forces on dynamics of capital structure choices.

The dynamic "time-state-focus" as propagated in Sinha and Ghosh (2013a) has put forth a Unifying Theory of firms' joint determination of the capital structure choices. It proposes new developments amongst the existing capital structure theories, viz., the Static Trade-Off (STO) theory, Pecking Order (PO) theory, Dynamic Trade-Off (DTO) theory and market timing (MT) theory. The Unifying Theory suggests that firms' capital structure choices are reconciliatory in nature while its dynamic properties seek to use the said theories as specific strategic financing vehicles for their specific time-state-focus.

The dynamics of corporate capital structure choices depend on two endogenous decision variables-dynamic targets and adjustment speeds (Sinha and Ghosh, 2010). Firms' dynamic targets are set by their exogenous financing motives, while the adjustment speeds depend on adjustment costs. Financing motives include reduction of the costs for dynamic recapitalization, information asymmetry and failed MT efforts at capital issues. Firms logically respond to these motives by means of dynamic provisions towards their expected changes in the exogenous variables, and finally, by intervening into their adjustment speeds as required. Firms' intervening forces are different from the innovative forces in Sinha and Ghosh (2014). The former influences adjustment speeds, while the latter is the unexpected forces inducing shifts.

Interestingly, the time path of firms' leverage change is phenomenally complex. Over a feasible time for the assets' life cycle of firms, the time path of leverage change reflects firms' adjustments to shock realizations, sequential responses and intervening leverage adjustments (DeAngelo et al., 2011). Firms issue the debts as the transitory financing vehicles with provisional but careful drifts from their target capital structures. Their flexibility in both financing and investment decisions creates drifts, while its failing initiates the presence of adjustment cost (Lindstrom and Hesmati, 2004; and Chun-ai and Hai-ying, 2010). That is, firms' purposeful dynamic interventions could be plugged in much time before their actual bankruptcy has appeared and they could avoid their short-term financing problems like debt indebtedness. Hence, theoretically, firms are expected to set some ex ante adjustment costs. These may include factors like the direct and indirect bankruptcy costs, actual or opportunity costs for tax-shield benefits, agency costs and debt covenants, the market rate of return, the risk-free rate of return and transaction costs, etc.

Now, in the stated unifying theory of Sinha and Ghosh (2013a), the presence of an efficient capital market is neither a basic assumption nor it is essential empirically. …

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