Testing Dynamic Tradeoff Theory: Evidence from Rebalancing Points.
Georgia Institute of Technology
Daniel A. Rettl
Vienna Graduate School of Finance (VGSF)
July 15, 2011
International Conference of the French Finance Association (AFFI), May 11-13, 2011
We develop a simple methodology to identify firms that are at or close to their optimal capital structure. Using this methodology we present cross-sectional and time series evidence in favor of dynamic tradeoff theory. In particular, at rebalancing points the relationship between profitability and leverage is positive, consistent with theoretical predictions. Also, the time series of market leverage, profitability, and equity payouts in the years prior to rebalancing events match the patterns obtained from simulated data. Our methodology is robust to recent critiques of empirical tests of dynamic tradeoff theory.
Number of Pages in PDF File: 38
Keywords: empirical corporate finance, capital structure, dynamic tradeoff theory
JEL Classification: G30, G32
Date posted: May 16, 2011 ; Last revised: December 20, 2012
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