A New Test of Capital Structure
University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
University of Oxford - Said Business School; Ben-Gurion University of the Negev; University of London
October 6, 2004
AFA 2005 Philadelphia Meetings
We report results of a new test of the financing of large and indivisible projects - arguably the focus of most capital structure theory. We develop a filter that identifies investment spikes in a large population of firms. Consistent with the pecking-order theory we find that projects are predominantly financed with debt, particularly in large and profitable firms. However, we reject the hypothesis that internal finance plays a major role in funding investment. Consistent with the trade-off theory, firms show a strong tendency to revert back to their initial leverage. This pattern of "pecking order in the short run, trade-off in the long run" is consistent with equity adjustment being postponed until certain thresholds are reached. However, we do not find evidence that equity issues are lumpy or infrequent.
Number of Pages in PDF File: 47
Keywords: Capital structure, pecking order theory, trade-off theory
JEL Classification: G32working papers series
Date posted: January 5, 2005
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