Dynamic Adjustment of Corporate Leverage: Is there a lesson to learn from the Recent Asian Crisis?

Much of the macro literature on the recent Asian crisis argues that a major cause was over borrowing and over investment encouraged by poor supervision and the resulting moral hazard problem. Surprisingly however there is little firm-level evidence to corroborate this. The present paper examines the extent to which firms in these countries had deviated from their optimal levels of leverage and also the determinants of their ability to adjust their capital structure. Results obtained using the Worldscope firm-level panel data for the four of the worst affected countries suggest that higher quality firms had lower optimal leverage while firms with excess capital stock had higher optimal leverage required to finance this capital expenditire. Further, there are signs of corporate inertia in the worst affected countries exhibiting very slow adjustment processes in their capital structure. This result holds even for those firms potentially better placed to control their levels of leverage. These results seem to strengthen the moral hazard argument of bad loans in poorly regulated and supervised East Asian economies.