Capital Structure Policy: Evidence From Taiwan

Capital structure literature shows that, in static tradeoff theory, a firm’s target leverage is related to its size and profitability. However, it remains unclear as to whether target leverage even exists. Assuming that it does, two key questions arise. First, how does the company adjust to the target? Second, is there a contradiction between pecking order theory and static tradeoff theory? This study classifies a sample of companies listed on the Taiwan Stock Exchange into four quadrant clusters by the average method based. The classification is based on factors related to firm size and profitability to determine whether firms in these clusters engage in different financing policies. This study explores whether pecking order or static tradeoff theory are conducted through independent and conventional four-factor joint testing. Results show the target-adjustment model is more efficient than the pecking order model. In addition, I conduct robustness checks by the quartile method. The results show the large firms with low profitability and no financing gaps adhere to both the pecking order and target-adjustment models. These results provide support for the hypothesis that financing policies employed by companies listed on the Taiwan stock market vary as a function of the quadrant in which they are classified