Reevaluating the Trade-off Theory of Capital Structure: Evidence from Zero-Leverage Firms

33 Pages Posted: 11 Nov 2019

See all articles by Babak Lotfaliei

Babak Lotfaliei

Finance Department, San Diego State University

Clark Lundberg

San Diego State University

Date Written: October 30, 2019

Abstract

We empirically evaluate extensions to the trade-off theory of capital structure featuring a real option on debt issuance in a zero-leverage environment. Controlling for alternative explanations of zero-leverage behavior, we find considerable evidence in support of the extended trade-off theory and no evidence against it. We validate our empirical approach via simulations under the real option mechanism and under an alternative financially constrained mechanism. The simulations show that our empirical findings are not consistent with zero-leverage behavior driven exclusively by financial constraints, but they are consistent with the real-option mechanism.

Keywords: zero leverage, capital structure, real option, trade-off theory

JEL Classification: G32

Suggested Citation

Lotfaliei, Babak and Lundberg, Clark, Reevaluating the Trade-off Theory of Capital Structure: Evidence from Zero-Leverage Firms (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3478159 or http://dx.doi.org/10.2139/ssrn.3478159

Babak Lotfaliei (Contact Author)

Finance Department, San Diego State University ( email )

5500 Campanile Drive
San Diego, CA 92182-8236
United States
+16195944790 (Phone)

HOME PAGE: http://cbaweb.sdsu.edu/faculty/profile/Babak-Lotfaliei

Clark Lundberg

San Diego State University ( email )

San Diego, CA 92182-0763
United States

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