Decisions on Leverage Adjustment and Stock Price Crash Risk

Document Type : Research Paper

Authors

1 Assistant Prof., Department of Accounting, Payame Noor University, Tehran, Iran.

2 PhD., Department of Economics, Deputy of Economic of the Economic and Finance Administration of South Khorasan, Birjand, Iran.

Abstract

Objective
Existing theories of capital structure indicate that information asymmetry is an important factor in adjusting target leverage. The signaling theory of capital structure shows that the stock market reacts positively (negatively) to the announcement of debt (equity). Furthermore, the dynamic trade-off theory allows firms to weigh the benefits of maintaining a financial structure below the target leverage level against the costs of adjusting leverage. Accordingly, this theory suggests that firms with higher adjustment costs tend to adjust their leverage ratios toward their targets at a slower speed. In this article, we examine whether stock price crash risk can affect the decision-making process regarding financial leverage adjustment. Thus, it is expected that as stock price crash risk increases, firms’ tendency to adjust their leverage decreases.
 
Methods
The study population was selected from the Tehran Stock Exchange based on four criteria. Data from 143 companies were collected for the period from 2013 to 2024, and the research models were estimated using multivariate regression, controlling for year and industry fixed effects.
 
 
Results
Stock price crash risk has a negative effect on the speed of leverage adjustment, and a firm’s leverage level does not moderate this relationship.
 
Conclusion
Two interesting findings may shed light on how dynamic capital structure decisions are made. First, the empirical results show that firms more exposed to stock price crash risk adjust their leverage ratios more slowly toward their target leverage ratio. This result can be explained by the fact that firms facing higher stock price crash risk encounter greater transaction costs when adjusting their financial leverage. Recent evidence on stock price crash risk indicates its association with information asymmetry. Therefore, in line with dynamic trade-off theory, firms with higher adjustment costs show greater tolerance for operating below optimal leverage and adjust more slowly toward their target leverage. Second, the empirical results reveal that the effect of stock price crash risk on the speed of financial leverage adjustment does not depend on the actual level of financial leverage. According to capital structure signaling theory, stock prices are predicted to increase (decrease) following the announcement of debt (equity) issuance. Thus, in firms with lower leverage, an increase in stock price crash risk reduces the speed of leverage adjustment, as they typically need to issue equity. On the other hand, for firms with higher leverage, this effect is weaker because issuing debt can help conceal bad news. Consequently, the researchers’ expectations regarding the moderating role of firms’ financial leverage on the relationship between stock price crash risk and the speed of leverage adjustment were not confirmed. Possible reasons for this result include the weak efficiency of the Iranian capital market, the substantial trading volume of new investors entering the market, and the generally low level of financial leverage among the sample firms.

Keywords

Main Subjects

References

 
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Financial Research Journal
Volume 28, Issue 1
2026
Pages 161-186

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