Navigating The Debt-Equity Decisions Of Financial Services Firms: Some Evidence From South Africa

Abstract

Empirical studies on the impact of regulation on the financial policies of banks have documented that unconstrained forward-looking banks with sufficient franchise value build and actively maintain capital buffers. This financing behaviour thus relegates the regulatory intervention to non-binding and of secondary importance. This study used a sample of 29 financial services firms listed on the Johannesburg Stock Exchange (JSE) during the period 2003 to 2012 to test for the validity of the market timing, pecking order and the dynamic trade-off theories in explaining the financing behaviour of financial services firms. Consistent with the dynamic trade-off theory and contrary to the market timing and pecking order theories, the study documents that, leverage is positively correlated to firm profitability, size and asset tangibility. The firms’ true speed of adjustment is 56.80% for the market-to-debt ratio (MDR) and 71.31% for the book-to-debt ratio (BDR). The modified external finance-weighted average market-to-book has an insignificant positive and negative correlation with the MDR and the BDR respectively. Taken together, the JSE-listed financial services firms have target optimal capital structures which they actively adjusts towards. Their security issuance decisions are not driven by the stock market performance, share returns or the time-varying adverse selection costs.