On the Relation Between the Market-to-Book Ratio, Growth Opportunity, and Leverage Ratio

Abstract:     
The negative relation between the market-to-book ratio and leverage ratio is one of the most widely documented empirical regularities in the capital structure literature. Most related studies take this negative relation as given and debate about its economic interpretation. We show that firms with higher market-to-book ratios face lower debt financing costs and borrow more. The relation between the market-to-book ratio and leverage ratio is not monotonic and is positive for most firms (more than 88% of COMPUSTAT firms and more than 95% of total market capitalization). The previously documented negative relation is driven by a subset of firms with high market-to-book ratios.

Number of Pages in PDF File: 19

Keywords: Capital structure, target leverage ratio, pecking order theory, market timing hypothesis, market-to-book ratio, growth opportunity

JEL Classification: G32

working papers series