The influence of cash flow on the speed of adjustment to the optimal capital structure

The aim of this paper is to examine the influence of cash flow on French SMEs' speed of adjustment (SOA) to their capital structure targets. Adjusting a firm's financial structure results in transaction costs, including information costs, bargaining costs, and monitoring costs. Transaction costs have a strong influence on the SOA of a company's financial structure to its target leverage (TL). Furthermore, transaction costs are considered higher for SMEs than for listed companies. In this context, studying cash flows is particularly relevant because cash flow is a resource that involves low transaction costs. We apply a two-step model to French panel data collected during the period 2005-2014. In the first step, the TL is estimated. We considered two leverages: a short-term leverage and a long-term leverage. In the second step, the target is used to estimate adjustment speeds by distinguishing between over-levered companies and under-levered companies. There are two main contributions of this study. This study's first contribution was that we found a significant difference in the SOA between over-levered and under-levered firms for short-term leverage but not for long-term leverage. This study's second contribution was to highlight SMEs' behaviour while adjusting their financial structure. For over-levered firms, the statistical results showed that the speed of firms with a positive cash flow is higher than the speed of firms with a negative cash flow. Contrary to findings related to listed companies, for under-levered firms, our results do not show that a negative cash flow implies a faster adjustment to TL.