The role of target leverage on firms' financial decision : empirical evidence in Australia, Singapore and Thailand

Abstract

This study investigates the role of target leverage on financing decisions of firms listed in the stock exchange in Australia, Singapore and Thailand between the periods of 1996-2006. These countries offer different environments for firms to raise external fund ranging from market-based to bank-based. The role of target leverage is examined in two aspects. The first aspect is, given that firms want to raise external fund, how would they decide between debt and equity. We test whether firms will select the source of fund that makes their leverage ratio closer to the target level. The second aspect is to test whether, when firms deviate from the target leverage ratio, they will try to adjust their leverage ratio back to the target level. Univariate and Binary logit regressions are applied in this study. The first aspect is tested by comparing between debt issuer and equity issuer. Consistent with the tradeoff theory, the results show that firms tend to select the source of fund that minimize the gap between actual leverage and the target leverage ratios. These results are consistent across countries used in the samples. The second aspect is tested by comparing between firms that involve in financing transactions and firms that do not involve in such transactions. The results show that firms in 3 countries when deviate from the target leverage ratio will adjust back to the target leverage ratio. Overleveraged firms tend to reduce their existing debt while underleveraged firms tend to issue debt