Hostname: page-component-78c5997874-4rdpn Total loading time: 0 Render date: 2024-11-15T04:39:29.476Z Has data issue: false hasContentIssue false
  • English
  • Français

Testing Theories of Capital Structure and Estimating the Speed of Adjustment

Published online by Cambridge University Press:  01 April 2009

Rongbing Huang  and
Jay R. Ritter
Rongbing Huang
Affiliation:
Coles School of Business, Kennesaw State University, 1000 Chastain Road NW, Kennesaw, GA 30144. rhuang1@kennesaw.edu
Jay R. Ritter
Affiliation:
Warrington College of Business Administration, University of Florida, PO Box 117168, Gainesville, FL 32611. jay.ritter@cba.ufl.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper examines time-series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms’ capital structures through their influence on firms’ historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment toward target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 2 , April 2009 , pp. 237 - 271
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Alti, A. “How Persistent Is the Impact of Market Timing on Capital Structure?” Journal of Finance, 61 (2006), 1681–1710.CrossRefGoogle Scholar
Anderson, T. W., and Hsiao, C.. “Estimation of Dynamic Models with Error Components.” Journal of the American Statistical Association, 76 (1981), 598–606.CrossRefGoogle Scholar
Antoniou, A.; Guney, Y.; and Paudyal, K.. “The Determinants of Capital Structure: Capital Market-Oriented versus Bank-Oriented Institutions.” Journal of Financial and Quantitative Analysis, 43 (2008), 59–92.CrossRefGoogle Scholar
Arellano, M., and Bond, S.. “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations.” Review of Economic Studies, 38 (1991), 277–297.CrossRefGoogle Scholar
Arellano, M., and Bover, O.. “Another Look at Instrumental Variable Estimation of Error-Components Models.” Journal of Econometrics, 68 (1995), 29–51.CrossRefGoogle Scholar
Baker, M.; Greenwood, R.; and Wurgler, J.. “The Maturity of Debt Issues and Predictable Variation in Bond Returns.” Journal of Financial Economics, 70 (2003), 261–291.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 1–32.CrossRefGoogle Scholar
Bayless, M., and Chaplinsky, S.. “Is There a Window of Opportunity for Seasoned Equity Issuance?” Journal of Finance, 51 (1996), 253–278.CrossRefGoogle Scholar
Blundell, R., and Bond, S.. “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87 (1998), 115–143.CrossRefGoogle Scholar
Brav, A.; Lehavy, R.; and Michaely, R.. “Using Expectations to Test Asset Pricing Models.” Financial Management, 34 (2005), 31–64.CrossRefGoogle Scholar
Chang, X., and Dasgupta, S.. “Target Behavior and Financing: How Conclusive Is the Evidence?” Journal of Finance, forthcoming (2009).CrossRefGoogle Scholar
Chen, L., and Zhao, X.. “Mechanical Mean Reversion of Leverage Ratios.” Economics Letters, 95 (2007), 223–229.CrossRefGoogle Scholar
Chirinko, R. S., and Singha, A. R.. “Testing Static Tradeoff against Pecking Order Models of Capital Structure: A Critical Comment.” Journal of Financial Economics, 58 (2000), 417–425.CrossRefGoogle Scholar
Choe, H.; Masulis, R. W.; and Nanda, V.. “Common Stock Offerings across the Business Cycle: Theory and Evidence.” Journal of Empirical Finance, 1 (1993), 3–31.CrossRefGoogle Scholar
Claus, J., and Thomas, J.. “Equity Premia as Low as Three Percent? Evidence from Analysts’ Earnings Forecasts for Domestic and International Stock Markets.” Journal of Finance, 56 (2001), 1629–1666.CrossRefGoogle Scholar
DeAngelo, H.; DeAngelo, L.; and Stulz, R. M.. “Seasoned Equity Offerings, Market Timing, and the Corporate Lifecycle.” Journal of Financial Economics, forthcoming (2009).Google Scholar
Elliott, W. B.; Koeter-Kant, J.; and Warr, R.. “A Valuation-Based Test of Market Timing.” Journal of Corporate Finance, 13 (2007), 112–128.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Testing Trade-Off and Pecking Order Predictions about Dividends and Debt.” Review of Financial Studies, 15 (2002), 1–33.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Financing Decisions: Who Issues Stock?” Journal of Financial Economics, 76 (2005), 549–582.CrossRefGoogle Scholar
Fischer, E. O.; Heinkel, R.; and Zechner, J.. “Dynamic Capital Structure Choice: Theory and Tests.” Journal of Finance, 44 (1989), 19–40.CrossRefGoogle Scholar
Flannery, M. J., and Rangan, K. P.. “Partial Adjustment Toward Target Capital Structures.” Journal of Financial Economics, 79 (2006), 469–506.CrossRefGoogle Scholar
Frank, M. Z., and Goyal, V. K.. “Testing the Pecking Order Theory of Capital Structure.” Journal of Financial Economics, 67 (2003), 217–248.CrossRefGoogle Scholar
Frank, M. Z., and Goyal, V. K.. “Trade-Off and Pecking Order Theories of Debt.” In Handbook of Empirical Corporate Finance: Vol. 2, Eckbo, B. E., ed. Amsterdam: Elsevier Science (2008), 135–202.CrossRefGoogle Scholar
Gebhardt, W.; Lee, C. M. C.; and Swaminathan, B.. “Toward an Implied Cost of Capital.” Journal of Accounting Research, 39 (2001), 135–176.CrossRefGoogle Scholar
Gomes, A. R., and Phillips, G. M.. “Private and Public Security Issuance by Public Firms: The Role of Asymmetric Information.” Working Paper, University of Maryland (2007).Google Scholar
Graham, J. R. “Taxes and Corporate Finance: A Review.” Review of Financial Studies, 16 (2003), 1075–1129.CrossRefGoogle Scholar
Greene, W. H. Econometric Analysis, 5th ed.Upper Saddle River, NJ: Prentice-Hall (2003).Google Scholar
Hahn, J.; Hausman, J.; and Kuersteiner, G.. “Long Difference Instrumental Variables Estimation for Dynamic Panel Models with Fixed Effects.” Journal of Econometrics, 140 (2007), 574–617.CrossRefGoogle Scholar
Hennessy, C. A., and Whited, T.. “Debt Dynamics.” Journal of Finance, 60 (2005), 1129–1165.CrossRefGoogle Scholar
Hovakimian, A. “The Role of Target Leverage in Security Issues and Repurchases.” Journal of Business, 77 (2004), 1041–1071.CrossRefGoogle Scholar
Hovakimian, A. “Are Observed Capital Structures Determined by Equity Market Timing?” Journal of Financial and Quantitative Analysis, 41 (2006), 221–243.CrossRefGoogle Scholar
Hovakimian, A.; Hovakimian, G.; and Tehranian, H.. “Determinants of Target Capital Structure: The Case of Dual Debt and Equity Issuers.” Journal of Financial Economics, 71 (2004), 517–540.CrossRefGoogle Scholar
Hsiao, C. Analysis of Panel Data, 2nd ed.Cambridge: Cambridge University Press (2003).CrossRefGoogle Scholar
Ju, N.; Parrino, R.; Poteshman, A. M.; and Weisbach, M. S.. “Horses and Rabbits? Trade-Off Theory and Optimal Capital Structure.” Journal of Financial and Quantitative Analysis, 40 (2005), 259–281.CrossRefGoogle Scholar
Jung, K.; Kim, Y.; and Stulz, R.. “Timing, Investment Opportunities, Managerial Discretion, and the Security Issuing Decision.” Journal of Financial Economics, 42 (1996), 159–185.CrossRefGoogle Scholar
Kale, J. R.; Noe, T. H.; and Ramirez, G. G.. “The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence.” Journal of Finance, 46 (1991), 1693–1715.CrossRefGoogle Scholar
Kayhan, A., and Titman, S.. “Firms’ Histories and Their Capital Structures.” Journal of Financial Economics, 83 (2007), 1–32.CrossRefGoogle Scholar
Korajczyk, R. A., and Levy, A.. “Capital Structure Choice: Macroeconomic Conditions and Financial Constraints.” Journal of Financial Economics, 68 (2003), 75–109.CrossRefGoogle Scholar
Korajczyk, R. A.; Lucas, D.; and McDonald, R.. “Understanding Stock Price Behavior around the Time of Equity Issues.” In Asymmetric Information, Corporate Finance, and Investment, Hubbard, R. G., ed. Chicago, IL: University of Chicago Press (1990).Google Scholar
Leary, M. T., and Roberts, M. R.. “Do Firms Rebalance Their Capital Structure?” Journal of Finance, 60 (2005), 2575–2619.CrossRefGoogle Scholar
Lemmon, M. L.; Roberts, M. R.; and Zender, J. F.. “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structure.” Journal of Finance, 63 (2008), 1575–1608.CrossRefGoogle Scholar
Mackie-Mason, J. K. “Do Taxes Affect Corporate Financing Decisions?” Journal of Finance, 45 (1990), 1471–1493.CrossRefGoogle Scholar
Myers, S. C. “The Capital Structure Puzzle.” Journal of Finance, 39 (1984), 575–592.CrossRefGoogle Scholar
Nickell, S. J. “Biases in Dynamic Models with Fixed Effects.” Econometrica, 49 (1981), 1417–1426.CrossRefGoogle Scholar
Petersen, M. A. “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435–480.CrossRefGoogle Scholar
Ritter, J. R., and Warr, R. S.. “The Decline of Inflation and the Bull Market of 1982–1999.” Journal of Financial and Quantitative Analysis, 37 (2002), 29–61.CrossRefGoogle Scholar
Rogers, W. “Regression Standard Errors in Clustered Samples.” Stata Technical Bulletin, 13 (1993), 19–23.Google Scholar
Roodman, D. “How to Do Xtabond2: An Introduction to Difference and System GMM in Stata.” Stata Journal, 9 (2009), 86–136.CrossRefGoogle Scholar
Shyam-Sunder, L., and Myers, S.. “Testing Static Tradeoff Against Pecking Order Models of Capital Structure.” Journal of Financial Economics, 51 (1999), 219–244.CrossRefGoogle Scholar
Stein, J. C. “Rational Capital Budgeting in an Irrational World.” Journal of Business, 69 (1996), 429–455.CrossRefGoogle Scholar
Strebulaev, I. A. “Do Tests of Capital Structure Theory Mean What They Say?” Journal of Finance, 62 (2007), 1747–1787.CrossRefGoogle Scholar
Welch, I. “Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106–131.CrossRefGoogle Scholar
Welch, I. “A Correction for Flannery-Rangan, JFE 2006.” Working Paper, Brown University (2007).Google Scholar
White, H. “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test of Heteroskedasticity.” Econometrica, 48 (1980), 817–838.CrossRefGoogle Scholar