Macroeconomic Conditions and Capital Structure Adjustment Speed

56 Pages Posted: 8 Mar 2008

See all articles by Douglas O. Cook

Douglas O. Cook

University of Alabama - Culverhouse College of Commerce & Business Administration

Tian Tang

University of Alabama

Date Written: March 3, 2008

Abstract

Studies show that capital structure choice varies over time and across firms and that macroeconomic conditions are important factors in analyzing firms' financing choices. However, studies have largely ignored the impact of macroeconomic conditions on the adjustment speed of capital structure toward targets. Hackbarth et al. (2006) develop a contingent model for analyzing the impact of macroeconomic conditions on dynamic capital structure choice. Allowing for dynamic capital structure adjustments, their model predicts that firms should adjust their capital structure faster in booms than in recessions. We employ U.S. data over a 30 year sample period to test the relationship between macroeconomic conditions and capital structure adjustment speed using both two-stage and integrated partial adjustment dynamic capital structure models. We find evidence supporting the prediction from Hackbarth et al's theoretical framework that firms adjust to target leverage faster in good states than in bad states, where states are defined by term spread, default spread, GDP growth rate, and market dividend yield. Our results also support the pecking order theory in that under-levered firms adjust faster than firms that are over-levered. We find evidence favoring the market timing theory implication that under-levered firms have less incentive to adjust toward target leverage when stock market performance is good, as measured by dividend yield on the market and price-output ratio. Robustness tests demonstrate that our speed of capital structure adjustment cannot be simply explained by firm size, the degree of deviation from target, or by the definition of debt ratio. Our results are also robust to potential boundary issues.

Keywords: Dynamic capital structure, speed of adjustment, macroeconomic conditions

JEL Classification: G11, G18, G23

Suggested Citation

Cook, Douglas O. and Tang, Tian, Macroeconomic Conditions and Capital Structure Adjustment Speed (March 3, 2008). Available at SSRN: https://ssrn.com/abstract=1101664 or http://dx.doi.org/10.2139/ssrn.1101664

Douglas O. Cook (Contact Author)

University of Alabama - Culverhouse College of Commerce & Business Administration ( email )

Culverhouse College of Business
Tuscaloosa, AL 35487-0223
United States
205-348-8971 (Phone)
205-348-0590 (Fax)

Tian Tang

University of Alabama ( email )

P.O. Box 870244
Tuscaloosa, AL 35487
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
1,146
Abstract Views
3,997
rank
17,518
PlumX Metrics