Dynamic capital structure adjustment: US MNCs & DCs

Abstract

This paper uses dynamic panel estimators to test whether there are differences in the speed of capital structure adjustment between US-based multinationals and domestic corporations, and why such differences may occur. Prior literature attributes the differences in leverage between MNCs and DCs to agency costs of debt financing and the theorized variance stabilization of overall cash flows from diversification. Related, specific speed factors of adjustment and the rebalancing of capital structure following an equity price shock are also investigated. The results using a dynamic partial adjustment model show that on average DCs adjust to target leverage faster than MNCs. This provides support for the market-timing, pecking order and dynamic trade-off theories of capital structure. Further the paper identifies and attributes the overall relatively faster capital structure adjustment speed of DCs to relatively higher equity returns for MNCs, relatively lower incidence of under-leverage for DCs and the relatively higher incidence of above-target leverage for DCs. Further tests show that agency costs, financial flexibility (i.e., cash flows) and capital investments have different effects on adjustment process for MNCs relative to DCs. The result partially supports prior evidence of inertia following equity price shock to capital structure rebalancing.