43 Pages Posted: 15 Mar 2011 Last revised: 20 Feb 2013
Date Written: February 15, 2013
This paper develops a dynamic model of capital structure. It uses the model to determine whether shifts in the demand for capital or shifts in the supply of capital is the key driving force behind capital structure variation over time. Simulations of the model show that adjusting capital structure in response to variation in the supply of capital results in persistence of dividend and market leverage that is lower than the observed persistence in the data. When variation in the supply of capital is shut down, the persistence of dividend and market leverage of simulated firms is reasonably close to that in the data. The results suggest that shifts in the demand for capital are likely the key driving force behind capital structure variation over time.
Keywords: Corporate Capital Structure, Capital Market Driven Corporate Finance, Structural Models of Capital Structure
JEL Classification: G32
Suggested Citation: Suggested Citation