Oil price uncertainty and capital structure dynamics

Faisal Alnori and Abdullah Bugshan

Journal of Financial Economic Policy, 2025, vol. 17, issue 4, 639-659

Abstract: Purpose - The literature is remarkably silent on questions concerning the nexus between firms’ capital structure adjustment speed and the uncertainty of oil prices. This study aims to examine how oil price fluctuations affect a firm’s capital structure and adjustment speed. Design/methodology/approach - This research focuses on a set of corporations from the Gulf Cooperation Council spanning from 2011 to 2022. The methods applied are panel fixed effects and dynamic two-step system Generalized Method of Moments models. Findings - The findings indicate that changes in oil prices significantly impact corporate capital structure. Specifically, high oil price volatility leads to a reduction in both market leverage and book leverage. In addition, increased volatility in oil prices results in higher costs for leverage adjustment speed, which subsequently influences how quickly companies move toward their optimal leverage ratio. It is observed that when there is an increase in oil price volatility, firms adjust their leverage more slowly. At the same time, they do so more rapidly during phases of lower oil price volatility. Practical implications - The findings of this study hold significant implications for corporate managers, investors and lenders. The observed negative relationship between oil price uncertainty and leverage suggests that corporate managers may benefit from prioritizing equity financing over debt during periods of heightened oil price volatility. In addition, managers should integrate oil price uncertainty into their liquidity management strategies by maintaining sufficient cash reserves. This proactive approach can help mitigate the challenges posed by reduced access to external debt financing during volatile periods. Furthermore, understanding the influence of oil price fluctuations on firms’ cost of debt is crucial, as it directly impacts firms’ adjustment costs in achieving their optimal capital structures. Creditors, too, should consider the adverse effects of oil price volatility on corporate financing when designing credit policies, ensuring they remain responsive to the financial constraints faced by firms under such conditions. Originality/value - At best, this study presents new evidence that sheds light on the nexus between oil price volatility and the speed at which firms adjust their leverage toward the trade-off theory’s optimal target.

Keywords: Capital structure; Speed of adjustment; Oil price uncertainty; GCC (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-05-2024-0121

DOI: 10.1108/JFEP-05-2024-0121

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