Impact of risk on capital structure adjustments: Evidence from the African markets

• Published date: 01 October 2023
• Author: Lydie Myriam Marcelle Amelot,Ushad Subadar Agathee,Boopendrah Seetanah
• Date: 01 October 2023
• DOI: http://doi.org/10.1002/jcaf.22634

Received:  January  Revised:  April  Accepted:  April 

DOI: ./jcaf.

RESEARCH ARTICLE

Impact of risk on capital structure adjustments: Evidence

from the African markets

Lydie Myriam Marcelle Amelot Ushad Subadar Agathee Boopendrah Seetanah

Finance and Accounting Department,

University of Mauritius, Reduit, Mauritius

Correspondence

Ushad Subadar Agathee and Boopendrah

Seetanah, Finance and Accounting

Department, University of Mauritius,

Reduit, Mauritius.

Email: u.subadar@uom.ac.mu and

b.seetanah@uom.ac.mu

Abstract

Employing panel data analysis, the study investigated the impact of risk on speed

and costs of adjustments on target leverage on listed firms from the African

markets—a panel data set of  observations for  years spanning from 

to . Based on the results of the Unit root test and Granger causality test,

there are bidirectional relationships between risk and capital structure and vice

versa. Additionally, Panel DOLS and System GMM were applied for regression

and comparison analysis between the African markets and South Africa. The

estimates disclose that when companies experience lower risk, the costs of adjust-

ment toward the target are higher. Hence, companies can re-adjust their capital

structure more easily by issuing external capital over periods of stable economic

environments, thereby improving their market value. Considering the case of

South Africa, the first DOLS results outlined similar estimates compared to the

African market. Conversely, when measured with System GMM, the estimates

imply that firms incur difficulties in adjusting costs, thus reducing leverage due

to unfavorable macroeconomic indicators in line with the pecking order theory

stating that in African economies, companies spend more on expenses and adjust

their capital structure slowly to reach their optimal target position.

KEYWORDS

African markets, capital structure adjustments, risk

1 INTRODUCTION

Managers have difficulty calibrating companies’ capital

structures to attain optimal target leverage as asymmet-

ric information, adverse selection problems, and trade-

offs between expenses and advantages of stock financing

prevent them from doing so (Myers & Majluf, ).

Meanwhile, companies modify their capital structure by

maintaining the benefits and expenses of employing lever-

agewhichmightconstituteanelementofrisk.Riskisa

vital concept that should be heeded when examining the

effect of capital structure and capital structure adjustment.

According to Baum et al. (), when risk varies over

time, lenders fail to assess the creditworthiness of com-

panies. Subsequently, this contributes to external credit

funding, and managers rely on internal finance, namely

retained earnings or liquid assets, to solve their finan-

cial difficulties (Amelot & Agathee, ). When cash

flow risk is raised, credit risk is boosted, and the antici-

pated bankruptcy expenses are elevated. In other words,

when there is a rise in default risk, there is a decrease

in leverage (Borochin & Yang, ). It is noteworthy

that speed of adjustment is a crucial aspect that has to

be considered strictly toward target leverage (Hackbarth

et al., ). In addition, capital structure is regarded as

being inherently dynamic and under a dynamic capital

122 ©  Wiley Periodicals LLC. J Corp Account Finance. ;:–.wileyonlinelibrary.com/journal/jcaf

AMELOT  . 123

structure adjustment, companies often modify their lever-

age swiftly and frequently following normal economic

conditions (Hackbarth et al., ).

When high adjustment costs are considered, compa-

nies face difficulties in reaching their target leverage as

planned, thus taking more time to attain and maintain

their expected influence. An overwhelming amount of

the literature focused on attributes of capital structure

(see Abasali, ; Frank & Goyal, ,;Kyereboah-

Coleman, ; Riaz et al., ) while other researchers

studied the impact of risk on leverage on developed mar-

kets such as UK (Baum et al., ; Dierker et al., ;

Rashid, ; Rehman et al., ) and recently on emerg-

ing markets (for instance, Yinusa et al.,  in Nigeria

and Mbulawa et al.,  in Zimbabwe). However, the

influence of risk on capital structure adjustment has been

largely ignored in the literature. It is, therefore, one of the

main salient factors to be heeded in this study.

It is noteworthy that continuously rising public debt

leads to increased interest rates, lower credit ratings, and

increases the odds of a country defaulting on its debt. In the

African region, debt has become more expensive to service

because interest rates are very high. Hence, a large amount

of revenue is channeled toward servicing the debt instead

of investing in critical areas of the economy, leading to

poor long-term economic performance. African countries

employ domestic and regional public leverage manage-

ment strategies, ensuring that public debt does not become

a fiscal burden (Political Economy, ). Financial lever-

age is usually considered a proxy of risk derived from a

company’s financial data, representing the financial deci-

sion outcome and a domain with distinctive determinants.

Meanwhile, beta is perceived as a proxy of idiosyncratic

risk coming from the market, representing macroeco-

nomic frictions (Mbulawa et al., ). Unfortunately,

most researchers have not yet sought tointensively explore

the variables that affect the cross-sectionally beta-and-

financial leverage adjustments relationship in a synergetic

way. Understanding adjustment costs is crucial, in our

context, concentrating on the expected augmentation in

investment opportunities as the Southern African coun-

tries experience market conditions modifications. More

so, the speed of adjustment and the determinants thereof

vary from what has been provided in past studies in devel-

oped countries (US, UK), namely (Baum et al., ,

; Borochin & Yang, ; Byoun, ; Dierker et al.,

; Flannery & Ranghan, ; Hatzinikola et al., ;

Rashid, ) analyzed the effect of risk conditions on

firms’ leverage and capital structure adjustments.

Existing related literature has tended to focus mainly on

developed countries’ panel sets (Hackbarth et al.,  for

the case of the United States; for the case of Korea; for a

sample of European countries and Ripamonti,  for the

US case) while also ignoring the dynamic nature of the

risk-capital structure adjustment nexus. To the best of the

authors’ knowledge, few studies, namely Callaghy (),

Stein and Nissanke (), and Chipeta and Deressa (),

have explored the impact of idiosyncratic and macroeco-

nomic risk on capital structure adjustments in the African

markets and even then, they, in addition, to include a

limited number of observations, ignored the potential

dynamism in the hypothesized link. Hence, the main con-

tribution of the study will be involved in terms of the

contextual aspect of the African capital market. Further,

the uniqueness of this study originates from its topological

analysis, which considers the dynamic nature of the link.

To fill up this research gap, the objective of this study will

be to investigate the impact of idiosyncratic and macroe-

conomic risk on capital structure adjustments in mainly

African countries. This will enable us to enhance under-

standing of the behavior of companies in Africa and gain

insights into how best they decide their capital structure

adjustment mix in the distinct challenging institutional

environments they operate. The study will also examine

the relation’s sensitivity cross-sectionally and temporally

between financial leverage adjustments and idiosyncratic

risk and test whether the link between financial leverage

and systematic risk is inter-temporally unidirectional or

bidirectional.

African countries provide an excellent case to study as

they are all developing economies on the low rung of the

development ladder. However, the environment in which

companies in Africa operate is different from that in which

firms in developed countries operate, mainly due to differ-

ences in institutional infrastructures. For example, capital

markets in the developing economies of Africa are inef-

ficient, small, and thinly traded. Further, governments in

these countries have high propensities to intervene in mar-

kets. Conversely, capital markets in developed economies

are characterized by well-functioning stock markets and

efficient and large credit markets. Such efficient capital

markets facilitate the transfer of funds from surplus to

deficit units, develop the transmission mechanism of mon-

etary policy, and engender appropriate environments for

robust economic activity (Gwatidzo & Kalu Ojah, ).

Apart from the contextual value added of this research,

the uniqueness of this study also emanates its method-

ological treatment, which considers the dynamic nature

of the link. The study also provides information on the

costs and benefits of adjustment to aid in decision-making

by firm managers, financial researchers, and stakehold-

ers involved in the African capital market. Firstly, it

will guide company managers in identifying the opti-

mal financing mix. From an investor’s point of view,

knowledge about the optimal financing mix and speed

of adjustment assists in identifying funds in high-quality