Testing capital structure theories using error correction models: Evidence from China, India, and South Africa

The objective of this study is to empirically examine the capital structure theories that can explain the capital structure choice made by the firms that are operating in China, India, and South Africa. The study tests the capital structure theories as a stand-alone basis as well as an integrated framework of nested models using advanced dynamic panel data methods with a data-set of 1,183 firms with 12,187 firm-year observations spanning the period 1999-2016. Findings suggest that the firms adjust toward target leverage very quickly and trade-off theory explains the firms' capital structure choice better than pecking order theory in the stand-alone model as well as the model nesting these two theories. This study contributes to the empirical literature of capital structure in the following way. First, this study uses error correction framework as a general specification of the widely used partial adjustment model. Second, the study uses advanced panel data estimators to estimate partial adjustment model and error correction model. Finally, the different specifications are tested using a large data-set of firms in China, India, and South Africa that has not been done so far.