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Do Indonesian firms practice target capital structure? A dynamic approach

Razali Haron (IIUM Institute of Islamic Banking and Finance, International Islamic University, Kuala Lumpur, Malaysia, and Centre for Islamic Economics, International Islamic University, Kuala Lumpur, Malaysia)

Journal of Asia Business Studies

ISSN: 1558-7894

Article publication date: 1 August 2016




This study aims to investigate the dynamic aspects in the capital structure decisions of firms in Indonesia, offering an extension to the existing literature on Indonesia via a dynamic model, including the existence of target capital structure, the influencing factors, the speed of adjustments and the supporting theories to explain the findings.


This study uses a dynamic partial adjustment model estimated based on a generalized method of moments.


Indonesian firms do practice target capital structure and are influenced by firm-specific factors like profitability, business risk, firm size, liquidity and share price performance due to time-varying factors. A rapid adjustment toward target leverage is detected, thus supporting the existence of the dynamic trade-off theory (TOT). The pecking order theory (POT) also has significant influence, particularly after the new reformation of financing policy, where retained earnings are also preferred as a source of financing apart from merely external financing through bank loans. There are also traces of market timing influences where firms also seem to time their equity issuance.

Research limitations/implications

Despite relatively utilizing recent data and bigger sample firms compared to the previous limited studies on Indonesia, the results of this study, however, need to be cautiously interpreted. First, the sample chosen focused on listed firms, hence may not be generalized to all Indonesian firms, listed and unlisted. Second, the study does not separate firms by sectors and their leverage positions, that is under-levered and over-levered, so as to note that financial decisions may also be affected by the sector in which the firms operate and their leverage positions. These are to be considered in future research.

Practical implications

There is strong evidence that the corporate financing behavior of Indonesian firms is governed by the POT and TOT. Both are dealing with the function of debt. The financial sector reformation does have a positive impact on the banking sector, but not the local corporate bond market. Therefore, regulators and policymakers should bear in mind that banking as well as private bond market in Indonesia must be tailored in such a way that both could act as intermediaries of debt financing, as bond market represents an important component of a diversified financial sector.


This study fills the gap by providing an extension to the existing literature and a deeper insight of the capital structure of Indonesian firms using a more robust dynamic model.



Haron, R. (2016), "Do Indonesian firms practice target capital structure? A dynamic approach", Journal of Asia Business Studies, Vol. 10 No. 3, pp. 318-334.



Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

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