Trade-Off, Timing, and Capital Structure

38 Pages Posted: 15 Jun 2006

See all articles by Narasimhan Jegadeesh

Narasimhan Jegadeesh

Emory University - Department of Finance

T. Clifton Green

Emory University - Department of Finance

Date Written: June 2006

Abstract

The trade-off theory posits that firms seek to maintain a target capital structure and the market timing hypothesis suggests that managers are able to recognize and exploit stock misvaluation when they recapitalize. Jointly, these theories imply that deviations from target leverage reflect stock mispricing. Our results strongly support this view. We find that firms that are over-levered relative to their target outperform under-levered firms by roughly five percent per year over the next three to five years. The results hold for firms that issue debt or equity as well as for non-issuers. Our findings indicate that firms' capital structure choice is best understood using a combination of trade-off and market timing theories.

Keywords: capital structure, market timing, target debt ratio, trade-off

JEL Classification: G32

Suggested Citation

Jegadeesh, Narasimhan and Green, T. Clifton, Trade-Off, Timing, and Capital Structure (June 2006). Available at SSRN: https://ssrn.com/abstract=908467 or http://dx.doi.org/10.2139/ssrn.908467

Narasimhan Jegadeesh

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States

T. Clifton Green (Contact Author)

Emory University - Department of Finance ( email )

1300 Clifton Rd.
Atlanta, GA 30322-2710
United States
404-727-5167 (Phone)
404-727-5238 (Fax)

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