Testing Theories of Capital Structure and Estimating the Speed of Adjustment
65 Pages Posted: 18 Oct 2006 Last revised: 29 Jun 2009
Date Written: May 21, 2009
This paper examines time series patterns of external financing decisions and shows that publicly traded U.S. firms fund a much larger proportion of their financing deficit with external equity when the cost of equity capital is low. The historical values of the cost of equity capital have long-lasting effects on firms' capital structures through their influence on firms' historical financing decisions. We also introduce a new econometric technique to deal with biases in estimates of the speed of adjustment towards target leverage. We find that firms adjust toward target leverage at a moderate speed, with a half-life of 3.7 years for book leverage, even after controlling for the traditional determinants of capital structure and firm fixed effects.
Keywords: capital structure, market timing, pecking order, static tradeoff, speed of adjustment, long difference
JEL Classification: G32
Suggested Citation: Suggested Citation