Two Common Problems in Capital Structure Research: The Financial-Debt-To-Asset Ratio and Issuing Activity Versus Leverage Changes

17 Pages Posted: 9 Mar 2011

See all articles by Ivo Welch

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Abstract

This paper points out two common problems in capital structure research. First, although it is not clear whether non-financial liabilities should be considered debt, they should never be considered as equity. Yet, the common financial-debt-to-asset ratio (FD/AT) measure of leverage commits this mistake. Thus, research on increases in FD/AT explains, at least in part, decreases in non-financial liabilities. Future research should avoid FD/AT altogether. The paper also quantifies the components of the balance sheet of large publicly traded corporations and discusses the role of cash in measuring leverage ratios. Second, equity-issuing activity should not be viewed as equivalent to capital structure changes. Empirically, the correlation between the two is weak. The capital structure and capital issuing literature are distinct.

Suggested Citation

Welch, Ivo, Two Common Problems in Capital Structure Research: The Financial-Debt-To-Asset Ratio and Issuing Activity Versus Leverage Changes. International Review of Finance, Vol. 11, No. 1, pp. 1-17, 2011. Available at SSRN: https://ssrn.com/abstract=1781630 or http://dx.doi.org/10.1111/j.1468-2443.2010.01125.x

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