Firm Growth Type and Capital Structure Persistence

Abstract

We find that growth type (identified by a two-way sort on firm initial market-to-book ratio and asset tangibility) can parsimoniously predict significantly dispersed and persistently distinct future leverage ratios. Growth type is persistent; growth-type-sorted cross-sections of corporate fundamental variables such as tangible versus intangible investment style also meaningfully persist. With an increase in market-to-book ratios, low growth type firms are keener to issue new debt than equity, whereas high growth type firms are least likely to issue debt and keenest to issue new equity. These findings demonstrate that firms rationally invest and seek financing in a manner compatible with their growth type. Consistent with a generalized Myers-Majluf framework, growth type compatibility enables distinct growth types and hence specifications of market imperfection or informational environments to persist. Growth type is apparently a fundamental factor for capital structure persistence.

Keywords: capital structure, persistence, growth type, compatibility, investment style, financing behavior

JEL Classification: G14, G32, G34