Testing Theories of Capital Structure and Estimating the Speed of Adjustment

Posted: 25 Mar 2008

See all articles by Rongbing Huang

Rongbing Huang

Kennesaw State University - Michael J. Coles College of Business

Jay R. Ritter

University of Florida - Department of Finance, Insurance and Real Estate

Multiple version iconThere are 2 versions of this paper

Abstract

This paper examines time series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms' capital structures through their influence on firms' historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment towards target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.

Keywords: capital structure, market timing, static tradeoff, speed of adjustment

JEL Classification: G32

Suggested Citation

Huang, Rongbing and Ritter, Jay R., Testing Theories of Capital Structure and Estimating the Speed of Adjustment. Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1112327

Rongbing Huang

Kennesaw State University - Michael J. Coles College of Business ( email )

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Kennesaw, GA 30144
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Jay R. Ritter (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
(352) 846-2837 (Phone)
(352) 392-0301 (Fax)

HOME PAGE: http://https://site.warrington.ufl.edu/ritter

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