Dynamic Capital Structure with Heterogeneous Beliefs and Market Timing

Abstract:     
This paper builds a dynamic trade-off model of corporate financing with differences in belief between the insider manager and outside investors. The optimal leverage depends on differences of opinion and can differ significantly from that in standard trade-off models. The manager's market timing behavior leads to several stylized facts, such as the low average debt ratios of firms in the cross section, the substantial presence of zero-debt firms that pay larger dividends and keep higher cash balances than other firms, and negative long-run abnormal returns following stock issuance. Market timing behavior leads to substantial losses of firm value through excessive financing activities. Market timing and debt conservatism depend negatively on shareholder control of the firm.

Number of Pages in PDF File: 53

Keywords: capital structure, heterogeneous beliefs, market timing, zero-debt firms, debt conservatism

JEL Classification: G31, G32, G34, G35

working papers series