Trade-off Theory of Optimal Capital Structure and Adjustment to Long-run Target: Evidence from Dynamic Panel Data

Abstract

Abstract: The main objective of this paper is to test the trade-off theory of capital structure in South Africa. Using dynamic panel model and Generalized Method of Moments (GMM) estimation technique, the results show that fixed asset has a significant positive relation with total debt. with long-term debt. Similarly, fixed asset has a significant positive relation with total debt. Moreover, the study reveals that South African firms have long-run target debt, but the rate of adjustment to the long-run target debt is slow. Based on the findings, the study suggests that fixed asset is required as collateral to obtain long-term debt capital needed to finance profitable investment projects. Besides, the study suggests that costs of deviating finance profitable investment projects. Besides, the study suggests that costs of deviating from the optimal target debt ratio could be insignificant for South African firms. The paper contributes to capital structure research by testing trade-off theory in South Africa. In addition, the paper uses a better estimation technique, the Generalized Method of Moments.