Targeting behavior and capital structure theories: An empirical analysis of gulf cooperation council countries

Abstract

This study examined the dynamic nature of capital structure decisions and the effectiveness of trade-off, pecking order, and market timing theories in explaining the changes in leverage ratios. A partial adjustment model was used to examine the practice of setting a target (optimal) leverage, estimate firms’ speeds of adjustment in reaching their target leverages, and identify the capital structure theories that best explain the changes in leverage levels of firms in the Gulf Cooperation Council countries. Firms in these countries reach their target leverages at estimated average speeds of adjustment of 59.8 %–72 % annually. These speeds of adjustment are sensitive to country- and firm-specific characteristics. The targeting behavior factor of the trade-off theory better explains the changes in capital structure compared with the pecking order or market timing theories.