Capital Structure Dynamics in the UK and Continental Europe

Abstract

This paper investigates empirically the effects of institutions and market characteristics on corporate capital structure dynamics. Based on the fact that firms may temporarily deviate from their optimal capital structure due to the existence of adjustment costs, a partial adjustment model is used that links these transaction costs to country-specific characteristics such as the development of the financial markets, legal system, and macroeconomic environment. The sample comprises data from 873 firms in France, Germany, Italy and the UK over the period from 1982 to 2002. The results support the hypotheses that more developed financial markets, greater efficiency of the legal system and better protection of shareholders all have a positive effect on the speed at which firms adjust their capital structure towards the target. Similarly, higher economic growth and a higher inflation rate positively affect the speed of adjustment to the optimal capital structure as well.