Understanding the Fundamental Persistence of Corporate Capital Structure

Abstract

When predicting future leverage ratios, the explanatory power of initial residual leverage falls quickly over time, while initial standard leverage determinants retain much of their explanatory power. To make sense of this fundamental persistence, we show that growth-type (identified by a two-way sort on firm initial market-to-book ratio and asset tangibility) can parsimoniously span significantly dispersed and persistently different leverage ratios. Different growth-types suggest persistently distinct investment styles (of tangible investments versus R&D or intangible investments). This gives rise to specific market imperfections and hence induces different financing behaviors. Therefore, growth-type plays a stable role in anchoring long-run capital structure.

Keywords: Capital Structure, Persistence, Initial Determination, Fair Market Timing, Growth Type Compatibility

JEL Classification: G14, G32, G34