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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.

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Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
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