Do Korean Firms have Changed their Financing Patterns and Capital Structures after the Asian Financial Crisis?

We investigate Korean firms’ financing patterns, including debt and equity issuances and capital structure adjustment speed between 1989 and 2008. We test the most adequate capital structure theory that explains firms' actual debt ratio changing patterns for Korean firms. According to the trade-off theory, firms need to change their capital structures to maximize their values by achieving their optimal capital structures. In the pecking order theory, firms issue debt first when they need external funds. Our results show that firms have changed(or adjusted) their capital structures over a twenty year span, and they mainly use equity issuance. These results deny the pecking order theory, but support the trade-off theory. Our results, a negative association between stock return(SR) and debt ratios, indicate that high (or overvalued) stock price reduces debt ratio by either issuing overvalued stocks or increasing the magnitude of total asset. We use Frank and Goyal’s(2003) method and a dynamic partial adjustment process to test whether firms use debts for their financial needs and change their capital structures in order to close their optimal capital structures, respectively. Furthermore, we use a two-step System GMM estimator to improve the reliability of our estimated results for capital structure adjustment speeds as we use a panel data set that likely has an endogeneity problem. We also use both book and market based debt ratios as there is no clear criteria of right debt ratio for a capital structure study.