Dynamic Model of Optimal Capital Structure: Evidence from Nigerian Listed Firms

Abstract

Examination of optimal capital structure in financial markets with imperfections suggests that when deviations from optimal capital structure occur, adjustment costs may prevent firms from moving towards target capital structure. However, previous studies on the capital structure of non-financial firms in Nigeria did not consider these imperfections and adjustment costs. It is against this background that this study investigates the dynamic adjustment to target capital structure by non-financial firms listed on the Nigerian Stock Exchange. By utilizing a framework that provides for the determination of adjustment costs, the results reveal the existence of dynamic adjustment to optimal capital structure suggesting attempts made by the sampled firms to maximize shareholders wealth. A comparison of the adjustment costs with those of firms in more developed economies shows that Nigerian firms have higher costs of adjustment indicating that the level of development of the market is important in lowering transaction costs. In addition, tangibility of assets, non-debt tax shield, growth opportunity, firm size, profitability and inflation significantly influence Nigerian firms’ optimal capital structure.