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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. [email protected]
Jay R. Ritter
Affiliation:
Warrington College of Business Administration, University of Florida, PO Box 117168, Gainesville, FL 32611. [email protected]
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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

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