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Co-determination of capital structure and stock returns--A LISREL approach: An empirical test of Taiwan stock markets

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  • Yang, Chau-Chen
  • Lee, Cheng-few
  • Gu, Yan-Xiang
  • Lee, Yen-Wen
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    Abstract

    Titman and Wessels (1988) utilize a structural-equations model (LISREL) to find out the latent determinants of capital structure. Maddala and Nimalendran (1996) indicate that the problematic model specification causes the poor results in Titman and Wessels' research. Chang, Lee, & Lee (2009) apply a Multiple Indicators and Multiple Causes (MIMIC) model to re-examine the same issue as Titman and Wessels did but found more convincing results. We extend Titman and Wessels' research from using a single-equation approach to a multi-equations approach. In addition to the determinants of firms' capital structure, those of stock returns are determined simultaneously. Literature indicates that a firm's capital structure may affect its stock returns (Bhandari, 1988), and the reverse is true too ([Baker and Wurgler, 2002], [Lucas and McDonald, 1990] and [Welch, 2004]). Hence, a firm's determinants of its capital structure and those of its stock returns should be decided simultaneously, rather than independently. By solving the simultaneous equations, we examine the empirical relationship between the two endogenous variables: capital structure and stock returns and find out their common determinants as well. Our results show that stock returns, expected growth, uniqueness, asset structure, profitability, and industry classification are the main factors of capital structure, while the primary determinants of stock returns are leverage, expected growth, profitability, value and liquidity. The level of debt ratios and stock returns are mutually determined by the aforementioned factors and themselves.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 50 (2010)
    Issue (Month): 2 (May)
    Pages: 222-233

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    Handle: RePEc:eee:quaeco:v:50:y:2010:i:2:p:222-233

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    Web page: http://www.elsevier.com/locate/inca/620167

    Related research

    Keywords: Capital structure Stock returns Simultaneous equations Latent variables LISREL;

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    Cited by:
    1. Hamid Ahmad & Bashir A. Fida & Muhammad Zakaria, 2013. "The Co-determinants of Capital Structure and Stock Returns: Evidence from the Karachi Stock Exchange," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 18(1), pages 81-92, Jan-June.
    2. Rubina Shaheen & Attiya Yasmin Javid, 2014. "Effect of Credit Rating on Firm Performance and Stock Return; Evidence form KSE Listed Firms," PIDE-Working Papers 2014:104, Pakistan Institute of Development Economics.
    3. Arosa, Clara Maria Verduch & Richie, Nivine & Schuhmann, Peter W., 2014. "The impact of culture on market timing in capital structure choices," Research in International Business and Finance, Elsevier, vol. 31(C), pages 178-192.

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