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On the Relation Between the Market-to-Book Ratio, Growth Opportunity, and Leverage Ratio

19 Pages Posted: 5 Mar 2004  

Long Chen

Cheung Kong Graduate School of Business

Xinlei Shelly Zhao

Government of the United States of America - Office of the Currency Comptroller - Risk Analysis Division

Date Written: June 2006

Abstract

The negative relation between the market-to-book ratio and leverage ratio is one of the most widely documented empirical regularities in the capital structure literature. Most related studies take this negative relation as given and debate about its economic interpretation. We show that firms with higher market-to-book ratios face lower debt financing costs and borrow more. The relation between the market-to-book ratio and leverage ratio is not monotonic and is positive for most firms (more than 88% of COMPUSTAT firms and more than 95% of total market capitalization). The previously documented negative relation is driven by a subset of firms with high market-to-book ratios.

Keywords: Capital structure, target leverage ratio, pecking order theory, market timing hypothesis, market-to-book ratio, growth opportunity

JEL Classification: G32

Suggested Citation

Chen, Long and Zhao, Xinlei Shelly, On the Relation Between the Market-to-Book Ratio, Growth Opportunity, and Leverage Ratio (June 2006). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=666845 or http://dx.doi.org/10.2139/ssrn.666845

Long Chen (Contact Author)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Xinlei Zhao

Government of the United States of America - Office of the Currency Comptroller - Risk Analysis Division ( email )

250 E Street, SW
Washington, DC 20219
United States

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