Free Cash Flow, Capital Structure Adjustment Cost And Adjustment Speed

This paper use the magnitude of free cash flow as a standard to assort the samples into three subgroups, and then research the relationship between free cash flow and capital structure adjustment speed. Besides the baseline regression, this paper also tests the robustness of our finding through changing the method of free cash flow classification.According to the research and investigation of capital structure adjustment cost, this paper finds that the speed of capital structure adjustment is largely decided by adjustment cost. The author also finds that free cash flow is a proper yardstick to measure adjustment cost. So the amount of free cash flow is highly correlated with capital structure adjustment speed.This paper finds that groups with the highest and lowest free cash flow have lower capital adjustment cost, thus they can adjust their capital structure faster, on the other side, firms who is in the middle of the free cash flow distribution has higher adjustment cost and lower adjustment speed. In the four robustness tests of the baseline regression, three tests are consistent with the hypothesis, and one test doesn't fit for the assumption. Those three tests are: add the cash position in year t into year t+1 free cash flow, and redo the classification; sort firms into financial constrained and unconstrained groups; distinguish the distance between actual capital structure and target capital structure. The one which doesn't fit for the assumption is use lagged free cash flow as measurement to classify firm-years, this might suggest that free cash flow that is generated during the fiscal year may be endogenous and therefore affect the measurement of capital adjustment speed.