Capital Structure Dynamics: Near vs. Off Target Firms in Sri Lanka

Abstract

This research paper aims at examining the determinants of the Speed of Adjustment (SOA) towards the target capital structure of near and off target firms in Sri Lanka. Particularly, it analyses the impact of not only firm-specific factors but also corporate governance factors on target capital structure. The methodology utilizes the benefits of the partial (stock) adjustment model, viz, two step Generalised Method of Moments (GMM) to determine the SOA to target capital structure. The results indicate that there is discernible concrete evidence of dynamic behaviour of capital structure in Sri Lanka. This confirms the applicability of dynamic trade-off theory. The near or off target firms’ capital structure adjustment exhibits significant difference in SOA between the two types, implying that off target firms adapt swiftly vis-à-vis those at the doorstep of target firms, in each of the three models. There is a clear indication of both firm related factors and corporate governance factors swaying capital structure adjustment in at least one of the measures of leverage in both situations, very near to and far off from optimum level of debt.