Skip to main content
    • Aa
    • Aa

Testing Theories of Capital Structure and Estimating the Speed of Adjustment

  • Rongbing Huang (a1) and Jay R. Ritter (a2)

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.

Linked references
Hide All

This list contains references from the content that can be linked to their source. For a full set of references and notes please see the PDF or HTML where available.

A Alti . “How Persistent Is the Impact of Market Timing on Capital Structure?Journal of Finance, 61 (2006), 16811710.

T. W. Anderson , and C. Hsiao . “Estimation of Dynamic Models with Error Components.” Journal of the American Statistical Association, 76 (1981), 598606.

M. Arellano , and O. Bover . “Another Look at Instrumental Variable Estimation of Error-Components Models.” Journal of Econometrics, 68 (1995), 2951.

M. Baker ; R. Greenwood ; and J. Wurgler . “The Maturity of Debt Issues and Predictable Variation in Bond Returns.” Journal of Financial Economics, 70 (2003), 261291.

M. Baker , and J. Wurgler . “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 132.

M. Bayless , and S. Chaplinsky . “Is There a Window of Opportunity for Seasoned Equity Issuance?Journal of Finance, 51 (1996), 253278.

R. Blundell , and S. Bond . “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87 (1998), 115143.

A. Brav ; R. Lehavy ; and R. Michaely . “Using Expectations to Test Asset Pricing Models.” Financial Management, 34 (2005), 3164.

X. Chang , and S. Dasgupta . “Target Behavior and Financing: How Conclusive Is the Evidence?Journal of Finance, forthcoming (2009).

L. Chen , and X. Zhao . “Mechanical Mean Reversion of Leverage Ratios.” Economics Letters, 95 (2007), 223229.

R. S. Chirinko , and A. R. Singha . “Testing Static Tradeoff against Pecking Order Models of Capital Structure: A Critical Comment.” Journal of Financial Economics, 58 (2000), 417425.

H. Choe ; R. W. Masulis ; and V. Nanda . “Common Stock Offerings across the Business Cycle: Theory and Evidence.” Journal of Empirical Finance, 1 (1993), 331.

J. Claus , and J. Thomas . “Equity Premia as Low as Three Percent? Evidence from Analysts’ Earnings Forecasts for Domestic and International Stock Markets.” Journal of Finance, 56 (2001), 16291666.

W. B. Elliott ; J. Koeter-Kant ; and R. Warr . “A Valuation-Based Test of Market Timing.” Journal of Corporate Finance, 13 (2007), 112128.

E. F. Fama , and K. R. French . “Testing Trade-Off and Pecking Order Predictions about Dividends and Debt.” Review of Financial Studies, 15 (2002), 133.

E. F. Fama , and K. R. French . “Financing Decisions: Who Issues Stock?Journal of Financial Economics, 76 (2005), 549582.

E. O. Fischer ; R. Heinkel ; and J. Zechner . “Dynamic Capital Structure Choice: Theory and Tests.” Journal of Finance, 44 (1989), 1940.

M. J. Flannery , and K. P. Rangan . “Partial Adjustment Toward Target Capital Structures.” Journal of Financial Economics, 79 (2006), 469506.

M. Z. Frank , and V. K. Goyal . “Testing the Pecking Order Theory of Capital Structure.” Journal of Financial Economics, 67 (2003), 217248.

M. Z. Frank , and V. K. Goyal . “Trade-Off and Pecking Order Theories of Debt.” In Handbook of Empirical Corporate Finance: Vol. 2, B. E. Eckbo , ed. Amsterdam: Elsevier Science (2008), 135202.

W. Gebhardt ; C. M. C. Lee ; and B. Swaminathan . “Toward an Implied Cost of Capital.” Journal of Accounting Research, 39 (2001), 135176.

J. R Graham . “Taxes and Corporate Finance: A Review.” Review of Financial Studies, 16 (2003), 10751129.

J. Hahn ; J. Hausman ; and G. Kuersteiner . “Long Difference Instrumental Variables Estimation for Dynamic Panel Models with Fixed Effects.” Journal of Econometrics, 140 (2007), 574617.

C. A. Hennessy , and T. Whited . “Debt Dynamics.” Journal of Finance, 60 (2005), 11291165.

A Hovakimian . “The Role of Target Leverage in Security Issues and Repurchases.” Journal of Business, 77 (2004), 10411071.

A. Hovakimian ; G. Hovakimian ; and H. Tehranian . “Determinants of Target Capital Structure: The Case of Dual Debt and Equity Issuers.” Journal of Financial Economics, 71 (2004), 517540.

K. Jung ; Y. Kim ; and R. Stulz . “Timing, Investment Opportunities, Managerial Discretion, and the Security Issuing Decision.” Journal of Financial Economics, 42 (1996), 159185.

J. R. Kale ; T. H. Noe ; and G. G. Ramirez . “The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence.” Journal of Finance, 46 (1991), 16931715.

A. Kayhan , and S. Titman . “Firms’ Histories and Their Capital Structures.” Journal of Financial Economics, 83 (2007), 132.

R. A. Korajczyk , and A. Levy . “Capital Structure Choice: Macroeconomic Conditions and Financial Constraints.” Journal of Financial Economics, 68 (2003), 75109.

M. T. Leary , and M. R. Roberts . “Do Firms Rebalance Their Capital Structure?Journal of Finance, 60 (2005), 25752619.

M. L. Lemmon ; M. R. Roberts ; and J. F. Zender . “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structure.” Journal of Finance, 63 (2008), 15751608.

J. K Mackie-Mason . “Do Taxes Affect Corporate Financing Decisions?Journal of Finance, 45 (1990), 14711493.

S. C Myers . “The Capital Structure Puzzle.” Journal of Finance, 39 (1984), 575592.

S. J Nickell . “Biases in Dynamic Models with Fixed Effects.” Econometrica, 49 (1981), 14171426.

M. A Petersen . “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435480.

J. R. Ritter , and R. S. Warr . “The Decline of Inflation and the Bull Market of 1982–1999.” Journal of Financial and Quantitative Analysis, 37 (2002), 2961.

L. Shyam-Sunder , and S. Myers . “Testing Static Tradeoff Against Pecking Order Models of Capital Structure.” Journal of Financial Economics, 51 (1999), 219244.

J. C Stein . “Rational Capital Budgeting in an Irrational World.” Journal of Business, 69 (1996), 429455.

I. A Strebulaev . “Do Tests of Capital Structure Theory Mean What They Say?Journal of Finance, 62 (2007), 17471787.

I Welch . “Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106131.

H White . “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test of Heteroskedasticity.” Econometrica, 48 (1980), 817838.

Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *


Full text views

Total number of HTML views: 0
Total number of PDF views: 225 *
Loading metrics...

Abstract views

Total abstract views: 1153 *
Loading metrics...

* Views captured on Cambridge Core between September 2016 - 23rd June 2017. This data will be updated every 24 hours.