Optimal Capital Structure and Speed of Adjustment under Hyperinflation and Dollarization

Abstract

Economic challenges in Zimbabwe have resulted in firms being pushed out of their optimal leverage. Firms are faced with the need to move back to the optimal level of financing to improve their value. They tend to adjust quickly to the optimal level whenever failing to do so is costlier. This study employs a dynamic capital structure model to examine the determinants of optimal leverage and the speed of adjustment under a hyperinflation and dollarization period (2000–2016). The study shows that firms have an optimal leverage and there are costs of adjusting to this level of capital. Findings are consistent with theoretical predictions of the static trade-off theory (STT) and agency theory. The adjustment factors for all the models were found to be at least 0.475 and are higher under hyperinflation than under dollarization. Both firm and macroeconomic factors explain the optimal capital structure while the former also explains the speed of adjustment. Policies focusing on improving access to and reducing costs for finance will assist firms to maximize value as they adjust to the desired financing mix. The policies adopted may vary in response to the economic environment.

Impact of risk on capital structure adjustments: Evidence from the African markets

“…The empirical results are similar to that of Faulkender et al (2012) and Dierker et al (2019). They adjust quickly to the optimal level whenever failing to do so is costlier, in line with the static trade-off theory (Mbulawa et al 2020). Secondly, the estimates with the System GMM topology measure showed similar results as the DOLS measure, thus confirming robustness in the previous DOLS analysis.…”

“…Subsequent work from Kim (2015) postulated that companies listed on the stock exchange of Korea adjusted leverage faster toward the target level in the economic expansion situation, consistent with the pecking order and market timing theories. More recently, Mbulawa et al (2020) confirmed that companies have optimal leverage, and there are costs of adjusting to this level of capital. Consistent with the STT and agency theory, all models' adjustment factors are higher under hyperinflation than under dollarization.…”

“…The capital structure literature has already established that firms have target debt ratios where the value of a firm is maximized, and when deviated from these targets, they make periodic adjustments to move back to the optimum debt ratios (Flannery & Rangan, 2006;Frank & Goyal, 2009;DeAngelo & Roll, 2015;Huang & Ritter, 2009;Leary & Roberts, 2005;Lemmon et al, 2008;Mbulawa et al, 2020).This leverage rebalancing is focused on non-trivial transaction costs (Fischer et al, 1989;Leary & Roberts, 2005). Contrarily, the adjustment of firm capital structure is unclear from the perspectives of trade-off theory, pecking order theory, market timing theory, and other theories since the research findings contract each other.…”

“…When high adjustment costs are considered, companies face difficulties in reaching their target leverage as planned, thus taking more time to attain and maintain their expected influence. An overwhelming amount of the literature focused on attributes of capital structure (see Abasali, 2012; Frank & Goyal, 2003, 2009; Kyereboah‐Coleman, 2007; Riaz et al., 2014) while other researchers studied the impact of risk on leverage on developed markets such as UK (Baum et al., 2016; Dierker et al., 2019; Rashid, 2012; Rehman et al., 2016) and recently on emerging markets (for instance, Yinusa et al., 2017 in Nigeria and Mbulawa et al., 2020 in Zimbabwe). However, the influence of risk on capital structure adjustment has been largely ignored in the literature.…”

“…Financial leverage is usually considered a proxy of risk derived from a company's financial data, representing the financial decision outcome and a domain with distinctive determinants. Meanwhile, beta is perceived as a proxy of idiosyncratic risk coming from the market, representing macroeconomic frictions (Mbulawa et al., 2020). Unfortunately, most researchers have not yet sought to intensively explore the variables that affect the cross‐sectionally beta‐and‐financial leverage adjustments relationship in a synergetic way.…”