Initial Growth Type and the Persistence of Corporate Capital Structure

57 Pages Posted: 27 Mar 2008

See all articles by Xueping Wu

Xueping Wu

City University of Hong Kong (CityU) - Department of Economics & Finance

Chau Kin Au Yeung

The Chinese University of Hong Kong (CUHK)

Date Written: March 2008

Abstract

Recent research has revealed a persistent cross-sectional pattern for leverage ratios. This paper argues that growth type captures important differences in market imperfections across firms. We show that growth type, largely revealed early on, parsimoniously explains the persistent dispersion in leverage. Using a two-way independent sort on firm market-to-book ratio and asset tangibility in early IPO years, we classify firms into three growth-types (low, mixed, and high growth). We find that low-growth-type firms have persistently high leverage and high-growth-type firms have persistently low leverage. The growth-types appear stable, and differ significantly and persistently in their new equity issues and changes in retained earnings. Interestingly, high-growth firms can maintain leverage persistence because huge decreases in retained earnings (instead of net debt issues as often suggested by the literature) neutralize heavy new equity issues. We further show that market timing is actually growth-type driven. In a horse race to determine long-run capital structure, our initial-growth-type-based variable completely overtakes the Baker and Wurgler (2002) market-timing factor. We conclude it is growth type, rather than market timing, that best explains leverage persistence.

Keywords: Capital Structure, Initial Growth Type, Persistence, Market Timing

JEL Classification: G14, G32, G34

Suggested Citation

Wu, Xueping and Au Yeung, Chau Kin, Initial Growth Type and the Persistence of Corporate Capital Structure (March 2008). Available at SSRN: https://ssrn.com/abstract=1107302 or http://dx.doi.org/10.2139/ssrn.1107302

Xueping Wu (Contact Author)

City University of Hong Kong (CityU) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+852 3442 7577 (Phone)
+852 3442 0195 (Fax)

HOME PAGE: http://personal.cityu.edu.hk/~efxpwu/

Chau Kin Au Yeung

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

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