Firms' Dynamic Adjustment to Target Capital Structures in Transition Economies

We study the capital structure dynamics of Central and Eastern European firms in order to get a better understanding of the quantitative and qualitative development of the financial systems in this region. The dynamic model we use endogenizes the target leverage as well as the adjustment speed and is applied to microeconomic data for ten countries. We find that during the transition process firms generally increased their leverage, lowering the gap between actual and target leverage. Profitability and age are the most robust determinants of 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.