The dynamic adjustment towards target capital structures of firms in transition economies [EBRD - Working papers]

This paper studies the capital structure dynamics of central and eastern European firms to better understand the quantitative and qualitative development of financial systems in this region. The dynamic model used endogenises the target leverage as well as the adjustment speed towards these targets. It is applied to microeconomic data for 10 countries. We find that during the transition process firms generally increased their leverage, lowering the gap between actual and target leverage. Profitability and age of firms are the most robust determinants of their capital structure targets. Older firms attract more bank debt, whereas profitability decreases firms’ leverage targets. While banking system development has in general enabled firms to get closer to their leverage targets, information asymmetries between firms and banks are still important. As a result, firms prefer internal finance above bank debt (pecking order behaviour) and adjust leverage only slowly.