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
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.
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