What drives security issuance decisions of firms listed on the Johannesburg stock exchange: Market timing or dynamic trade-off theory or both?

Abstract

This study used panel datasets from 143 Johannesburg Stock Exchange-listed non-financial firms and four variants of the partial adjustment model fitted with the random effects Tobit estimator to investigate the validity of the market timing, trade-off and pecking order hypotheses of capital structure. The study documents that leverage is positively correlated to the modified external finance weighted average market-to-book ratio (EFWAMB). Firm profitability and growth rate are negatively correlated to leverage whilst firm size and asset tangibility are positively correlated to leverage. The firms also have target leverage ratios towards which they actively adjust at an unbiased speed of 41.80% for the market-to-debt ratio and 52.82% for the book-to-debt ratio. EFWAMB has a negligible effect on the firms’ speeds of adjustment towards target leverage. The results are robust. These results reject the market timing hypothesis in support of the dynamic trade-off and pecking order hypotheses. They further confirm the fact that these two theories of capital structure are not mutually-exclusive.