A Growth Type Explanation for Capital Structure Persistence

62 Pages Posted: 12 Feb 2009 Last revised: 9 Mar 2009

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: February 11, 2009

Abstract

Recent research has revealed a persistent cross-sectional pattern in leverage ratios but found it difficult to explain. We show that growth-type (largely revealed early on) can parsimoniously explain the persistent dispersion in leverage. Using a two-way independent sort on firm initial market-to-book ratio and asset tangibility in early IPO years, we classify firms into three growth-types (low, mixed and high). We find that on average, low-growth firms have significantly higher leverage, high-growth firms have significantly lower leverage, and mixed-growth firms are in the middle. Growth-type is persistent and characterizes firms in profound ways. For example, throughout the years, low-growth firms focus on more tangible investments while high-growth firms tilt overwhelmingly towards R&D investments. Interestingly, while heavy issues of new equity by high-growth firms push their low leverage ratios even lower, it is the huge decreases in retained earnings - due to the expensing or amortizing of relentless R&D or intangible investments that pay off slowly - instead of issues of new debt that pull the leverage ratios back and help sustain leverage persistence. As the growth-type story suggests, we find that growth-type predetermines firms' persistent pecking order preference in external finance. We are able to show that it is growth-type rather than market timing that best explains leverage persistence.

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

JEL Classification: G14, G32, G34

Suggested Citation

Wu, Xueping and Au Yeung, Chau Kin, A Growth Type Explanation for Capital Structure Persistence (February 11, 2009). Available at SSRN: https://ssrn.com/abstract=1341400 or http://dx.doi.org/10.2139/ssrn.1341400

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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