Debt, Stability, Capital Structure, Ireland
A previous study of financial policies and practices of Irish companies shows that the capital structures of Irish companies are generally consistent with the pecking order hypothesis (Kester & Robbins, 2010). In that study financial executives indicate a preference for following a financing hierarchy rather than adhering to a target capital structure. The fact that Irish firms appear not to target a specific leverage level suggests that their capital structures are not stable. In this paper, we test this proposition. To test this proposition, we source a list of 56 firms trading at some time on the Irish Stock Exchange over the period from 1981 to 2007. We use a series of simple statistical and econometric tests which establish that Irish corporate capital structures are not stable. We find that leverage stability tends to be the exception and not the rule. Leverage tends to be stable, that is, operate within a narrow range, over very short periods of time. For example, if we define this range as 0.100, the median firm’s maximum stable debt regime is just 7 years. We find that short-term debt tends to be more stable than long-term debt, where periods of debt stability tend to be longer. Our findings are consistent with the survey evidence of Kester & Robbins (2010). Irish firms do not appear to target a specific capital structure, at least in the sense that leverage ratios tend to mean-revert around a largely stationary target. We believe that this paper is the first to explore the time-series properties of Irish corporate capital structures. The findings serve to reinforce the evidence presented in Kester and Robbins (2010) that the pecking order, and not the static-trade off model serves to best explain corporate financing behaviour. Also, and in line with others (see DeAngelo and Roll, 2012) we find that firm-fixed effects (unobserved heterogeneity), which change over time (which we show using firm-decade interactions), explain most of the variation that exists in corporate capital structures. In contrast, observable firm-fundamentals i.e. size, growth opportunities, asset tangibility, and profitability, explain much less.