This paper examines the relative importance of many factors in the capital structure decisions of publicly traded American firms from 1950 to 2003. The most reliable factors for explaining market leverage are: median industry leverage (+ effect on leverage), market-to-book assets ratio (−), tangibility (+), profits (−), log of assets (+), and expected inflation (+). In addition, we find that dividend-paying firms tend to have lower leverage. When considering book leverage, somewhat similar effects are found. However, for book leverage, the impact of firm size, the market-to-book ratio, and the effect of inflation are not reliable. The empirical evidence seems reasonably consistent with some versions of the trade-off theory of capital structure.

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Capital Structure Decisions: Which Factors Are Reliably Important?

The literature provides conflicting assessments about how firms choose their capital structures, with the "tradeoff", pecking order, and market timing hypotheses all receiving some empirical support. Distinguishing among these theories requires that we know whether firms have long-run leverage targets and (if so) how quickly they adjust toward them. Yet many previous researchers have relied on empirical specifications that fail to recognize the potential impact of adjustment costs on a firm's observed leverage. Likewise, few researchers have incorporated the effect of share price changes on market-valued leverage. We estimate a relatively general, partial-adjustment model of firm leverage decisions, and conclude that firms do have target capital structures. The typical firm closes more than half the gap between its actual and its target debt ratios within two years. 'Targeting' behavior as opposed to market timing or pecking order considerations explains a majority of the observed changes in capital structure.

Partial Adjustment Toward Target Capital Structures

This chapter discusses how applied researchers in corporate finance can address endogeneity concerns. We begin by reviewing the sources of endogeneity—omitted variables, simultaneity, and measurement error—and their implications for inference. We then discuss in detail a number of econometric techniques aimed at addressing endogeneity problems, including instrumental variables, difference-in-differences estimators, regression discontinuity design, matching methods, panel data methods, and higher order moments estimators. The unifying themes of our discussion are the emphasis on intuition and the applications to corporate finance.

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Endogeneity in Empirical Corporate Finance1

http://lib.cufe.edu.cn/upload_files/other/4_20140512105606_12.pdf

Partial adjustment toward target capital structures

We find that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: High (low) levered firms tend to remain as such for over two decades. This feature of leverage is largely unexplained by previously identified determinants, is robust to firm exit, and is present prior to the IPO, suggesting that variation in capital structures is primarily determined by factors that remain stable for long periods of time. We then show that these results have important implications for empirical analysis attempting to understand capital structure heterogeneity.

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Back to the Beginning: Persistence and the Cross‐Section of Corporate Capital Structure

We empirically examine whether firms engage in dynamic rebalancing of their capital structures, while allowing for costly adjustment. We begin by showing that the presence of adjustment costs has significant implications for the dynamic behavior of corporate financial policy and the interpretation of previous empirical results. Then, after confirming that financing behavior is consistent with the presence of adjustment costs, we use a dynamic duration model to show that firms behave as though adhering to a financial policy in which they actively rebalance their leverage to stay within an optimal range. We find that firms respond to changes in their equity value, due to price shocks or equity issuances, by adjusting their leverage over the two to four years following the change. The presence of adjustment costs, however, often prevents this response from occurring immediately, resulting in shocks to leverage that have a persistent effect. Our evidence suggests that this persistence is more likely a result of optimizing behavior in the presence of adjustment costs, as opposed to indifference towards capital structure.

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Do Firms Rebalance Their Capital Structures

We empirically examine whether firms engage in a dynamic rebalancing of their capital structures while allowing for costly adjustment. We begin by showing that the presence of adjustment costs has significant implications for corporate financial policy and the interpretation of previous empirical results. After confirming that financing behavior is consistent with the presence of adjustment costs, we find that firms actively rebalance their leverage to stay within an optimal range. Our evidence suggests that the persistent effect of shocks on leverage observed in previous studies is more likely due to adjustment costs than indifference toward capital structure. A TRADITIONAL VIEW IN CORPORATE FINANCE is that firms strive to maintain an optimal capital structure that balances the costs and benefits associated with varying degrees of financial leverage. When firms are perturbed from this optimum, this view argues that companies respond by rebalancing their leverage back to the optimal level. However, recent empirical evidence has led researchers to question whether firms actually engage in such a dynamic rebalancing of their capital structures. Fama and French (2002), among others, note that firms’ debt ratios adjust slowly toward their targets. That is, firms appear to take a long time to return their leverage to its long-run mean or, loosely speaking, optimal level. Moreover, Baker and Wurgler (2002) document that historical efforts to time equity issuances with high market valuations have a persistent impact on corporate capital structures. This fact leads them to conclude that capital structures are the cumulative outcome of historical market timing efforts, rather than the result of a dynamic optimizing strategy. Finally, Welch (2004) finds that equity price shocks have a long-lasting effect on corporate capital structures as well. He concludes that stock returns are the primary determinant of capital structure changes and that corporate motives for net issuing activity are largely a

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We show that peer firms play an important role in determining corporate capital structures and financial policies In large part, firms' financing decisions are responses to the financing decisions and, to a lesser extent, the characteristics of peer firms These peer effects are more important for capital structure determination than most previously identified determinants Furthermore, smaller, less successful firms are highly sensitive to their larger, more successful peers, but not vice versa We also quantify the externalities generated by peer effects, which can amplify the impact of changes in exogenous determinants on leverage by over 70%

Do Peer Firms Affect Corporate Financial Policy

http://w4.stern.nyu.edu/finance/docs/pdfs/Seminars/091w-roberts.pdf

The pecking order, debt capacity, and information asymmetry.

This paper explores the relevance of capital market supply frictions for corporate capital structure decisions. To identify this relationship, I study the effect on firms' financial structures of two changes in bank funding constraints: the 1961 emergence of the market for CDs, and the 1966 credit crunch. Following an expansion (contraction) in the availability of bank loans, leverage ratios of bank-dependent firms significantly increase (decrease) relative to firms with bond market access. Concurrent changes in the composition of financing sources lend further support to the role of credit supply and debt market segmentation in capital structure choice.

Mark T. Leary

Papers

Do Firms Rebalance Their Capital Structures

Do Firms Rebalance Their Capital Structures

Do Peer Firms Affect Corporate Financial Policy

The pecking order, debt capacity, and information asymmetry.

Bank Loan Supply, Lender Choice, and Corporate Capital Structure