Firm Characteristics, Economic Conditions and Capital Structure Adjustment

We use a dynamic framework and panel methodology to investigate the NEWLINE determinants of a firms’ time-varying capital structure. Our sample comprises NEWLINE 706 European firms from France, Germany, Italy and the U.K. over NEWLINE the period from 1983 to 2002. If capital structure adjustment is costly, firms NEWLINE may deviate temporarily from their target debt ratios. Therefore, we endogenize NEWLINE the adjustment process and analyze the impact of firm-specific NEWLINE characteristics as well as macroeconomic factors on the speed of adjustment NEWLINE towards target leverage. We find that larger and faster growing firms as well NEWLINE as firms that are further away from their targets adjust more readily. Additionally, NEWLINE we document interesting relations between well-known business NEWLINE cycle variables and the adjustment speed. In a nutshell, firms adjust faster in NEWLINE favorable macroeconomic conditions, e.g. if interest rates are low and the NEWLINE risk of disruptions in the global financial system are negligible. We also NEWLINE document that capital structure decision are largely determined by financial NEWLINE constraints. Finally, we shed new light on the interdependence between NEWLINE book value based and market value based measures of leverage as well as on NEWLINE capital structure rebalancing issues.