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To Have a Target Debt Ratio or Not: What Difference Does it Make?

20 Pages Posted: 22 Oct 2007 Last revised: 29 Oct 2009

Abe de Jong

Rotterdam School of Management, Erasmus University

Patrick Verwijmeren

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: October 28, 2009

Abstract

The static tradeoff theory of capital structure predicts that firms aim to approach a target debt ratio. The theory provides several firm characteristics that determine this target ratio. In contrast, the pecking order model rejects a target debt ratio, because firms are expected to finance investments subsequently from (internal) equity, debt, and (external) equity. A fundamental problem in empirical studies is that having a target debt ratio or not is unobservable from public data. We use survey evidence from 235 CFOs to discriminate static tradeoff firms from pecking order firms and relate the responses to public data. For the two sets of firms we estimate standard capital structure models and find that pecking order firms contaminate static tradeoff theory-based estimations.

Keywords: pecking order theory, static tradeoff theory

JEL Classification: C42, G32

Suggested Citation

de Jong, Abe and Verwijmeren, Patrick, To Have a Target Debt Ratio or Not: What Difference Does it Make? (October 28, 2009). Applied Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1023581

Abe De Jong

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T08-25
Rotterdam, 3000 DR
Netherlands
+31 10 408 1022 (Phone)

HOME PAGE: http://https://www.rsm.nl/people/abe-de-jong/

Patrick Verwijmeren (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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