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http://ssrn.com/abstract=960238
 
 

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Target Behavior and Financing: How Conclusive is the Evidence?


Xin (Simba) Chang


Nanyang Business School

Sudipto Dasgupta


Hong Kong University of Science & Technology - Department of Finance

January 2007


Abstract:     
The notion that firms have a debt ratio target and that this is a primary determinant of financing behavior is influential in finance. Yet, how definitive is the available evidence? We examine this question by benchmarking the dynamics of actual debt ratios and the pattern of financing after major leverage-changing events against what is observed in samples generated through simulations where no target behavior is assumed. We find that the collective evidence that has been interpreted as indicative of target behavior is much weaker than is generally recognized. Specifically, the simulated data show similar reversal of the debt ratio and patterns of debt and equity issuance after major leverage-changing events as in the actual data. We attribute the former to a mechanical reversal that exists on average, even with random financing, if the debt ratios are above or below a cut-off, and the latter to persistence of the financing deficit around major issuance activities. Some of the evidence in the actual data, however, can only be replicated if the simulation samples are modified to accommodate a specific type of "market timing" behavior. On the whole, our results indicate that there is not much to be learnt from the behavior of the debt ratios as to firms' motives for different types of financing. While models of issuance or repurchase that address the debt versus equity choice are in principle better, our simulations raise some concerns about the interpretation of existing results.

Number of Pages in PDF File: 61

Keywords: Capital Structure, Trade-off theory

JEL Classification: G32

working papers series


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Date posted: February 8, 2007  

Suggested Citation

Chang, Xin (Simba) and Dasgupta, Sudipto, Target Behavior and Financing: How Conclusive is the Evidence? (January 2007). Available at SSRN: http://ssrn.com/abstract=960238 or http://dx.doi.org/10.2139/ssrn.960238

Contact Information

Xin Chang
Nanyang Business School ( email )
S3-B1B-76 Nanyang Avenue
Singapore, 639798
Singapore
HOME PAGE: http://www.ntu.edu.sg/home/changxin
Sudipto Dasgupta (Contact Author)
Hong Kong University of Science & Technology - Department of Finance ( email )
Clear Water Bay, Kowloon
Hong Kong
852-2358-7666 (Phone)
852-2358-1749 (Fax)
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