Do Firms Adjust Capital Structures to Manage Risk?

64 Pages Posted: 29 Nov 2013

See all articles by Martin Dierker

Martin Dierker

Korea Advanced Institute of Science and Technology (KAIST)

Jun-Koo Kang

Nanyang Technological University (NTU) - Nanyang Business School

Inmoo Lee

KAIST College of Business

Sung Won Seo

Korea Advanced Institute of Science and Technology (KAIST)

Date Written: October 1, 2013

Abstract

We provide a new insight on how changes in risk affect a firm’s capital structure decisions. Using an approach that alleviates potential problems caused by high capital structure adjustment costs, we test whether firms that experience a substantial increase in risk choose an external financing method that is consistent with the implications of dynamic trade-off theories of capital structure. We find that these firms indeed choose a financing method that lowers their leverage ratios. This finding is particularly pronounced for firms with a high level of risk or firms that raise a large amount of external capital, and is robust to a variety of risk measures such as stock return volatility, default probability and implied asset volatility based on the Merton (1974) model, and an adjusted Ohlson (1980) score.

Suggested Citation

Dierker, Martin and Kang, Jun-Koo and Lee, Inmoo and Seo, Sung Won, Do Firms Adjust Capital Structures to Manage Risk? (October 1, 2013). KAIST College of Business Working Paper Series No. 2013-031, Available at SSRN: https://ssrn.com/abstract=2360903 or http://dx.doi.org/10.2139/ssrn.2360903

Martin Dierker

Korea Advanced Institute of Science and Technology (KAIST) ( email )

85 Hoegi-ro
Seoul, 130-722
Korea

Jun-Koo Kang

Nanyang Technological University (NTU) - Nanyang Business School ( email )

Nanyang Avenue, Block S3-01b-54
Singapore, 639798
Singapore
(+65) 6790-5662 (Phone)
(+65) 6791-3697 (Fax)

HOME PAGE: http://www.nbs.ntu.edu.sg/nbs_corporate/divisions/bnf/index.asp

Inmoo Lee (Contact Author)

KAIST College of Business ( email )

85 Hoegiro Dongdaemun-Gu
Seoul 02455
Korea, Republic of (South Korea)

Sung Won Seo

Korea Advanced Institute of Science and Technology (KAIST) ( email )

Korea, Republic of (South Korea)

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