Profitability and Capital Structure: Evidence from Import Penetration

Abstract:     
I find that firms experiencing increases in import competition significantly reduce their leverage ratios by issuing equity and selling assets to repay debt. Using import tariffs and foreign exchange rates as instrumental variables for import penetration, I show that these results are not manifestations of endogenous relations between import competition and leverage. The results are consistent with traditional tradeoff models of capital structure that predict a positive relation between book leverage and future expected profitability. Further evidence suggests that import competition affects leverage through changes in the tradeoff between the tax benefits of debt and the costs of financial distress.

Number of Pages in PDF File: 58

Keywords: expected profitability, leverage, import competition

JEL Classification: D43, F12, G32, G33

Accepted Paper Series