This study investigates the capital structure behavior of nonfinancial firms in Jordan and Palestine, with a focus on the validity of the trade-off theory under institutional fragility, particularly the role of political instability in shaping financing decisions.
Drawing on an unbalanced panel of 166 non-financial firms (1,609 firm-year observations) from 2011 to 2021, the study examines the effects of firm-level factors (size, profitability, tangibility, growth, liquidity and non-debt tax shields) and country-level factors (GDP growth, inflation and political instability) on leverage. Both static and dynamic panel estimations are employed, including fixed effects and system GMM models, alongside robustness checks using two-stage least squares (2SLS) and sub-period analysis.
The results support the trade-off theory, showing that firms gradually adjust toward target leverage ratios. Political instability significantly reduces leverage, particularly long-term debt, highlighting the institutional constraints in fragile environments. However, the negative effect of profitability and the relatively slow speed of adjustment point to a dual influence of trade-off and pecking order theories in politically volatile contexts.
The geographic scope may limit generalizability. Future research should include a broader set of politically unstable emerging economies and consider meta-analytic or mixed-method approaches to deepen understanding of capital structure behavior under institutional fragility.
The findings offer practical guidance for financial managers, investors and regulators operating in fragile institutional contexts. By revealing how political instability drives firms toward short-term debt and hampers capital structure optimization, the study emphasizes the importance of improving institutional stability to foster long-term financing and investment. These insights are particularly relevant for policymakers aiming to enhance financial resilience and investment capacity in politically unstable economies.
By linking political conditions to corporate financing behavior, the study underscores how institutional stability can reduce borrowing costs, enhance capital formation and support sustainable economic development through greater private sector participation and job creation.
This study contributes to the literature by integrating political instability into capital structure modeling under static and dynamic versions of tradeoff theory, offering novel empirical insights from under-researched fragile emerging markets. By comparing two politically divergent but institutionally similar economies, it offers novel insights into how instability alters leverage behavior and highlights the importance of contextualizing traditional theories in environments characterized by political risk and institutional volatility.
