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Columbus' Egg: The Real Determinant of Capital Structure

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  • Ivo Welch

Abstract

This paper shows that managers fail to readjust their capital structure in response to external stock returns. Thus, the typical firm's capital structure is not caused by attempts to time the market, by attempts to minimize taxes or bankruptcy costs, or by any other attempts at firm-value maximization. Instead, capital structure is almost entirely determined by lagged stock returns (which, when applied to ancient equity values, predict current equity value and with it debt equity ratios). Consequently, one should conclude that capital structure is determined primarily by external stock market influences, and not by internal corporate optimizing decisions.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8782.

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Date of creation: Feb 2002
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Publication status: published as Welch, Ivo. "Capital Structure and Stock Returns." Journal of Political Economy 112-1 (February 2004): 106-131.
Handle: RePEc:nbr:nberwo:8782

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  1. Malcolm Baker & Jeffrey Wurgler, 2002. "Market Timing and Capital Structure," Journal of Finance, American Finance Association, vol. 57(1), pages 1-32, 02.
  2. Shlomo Benartzi & Roni Michaely & Richard Thaler, 1997. "Do Changes in Dividends Signal the Future or the Past?," CRSP working papers 455, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
  4. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
  5. Rajan, Raghuram G & Zingales, Luigi, 1995. " What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-60, December.
  6. David Hirshleifer & Ivo Welch, 2002. "An Economic Approach to the Psychology of Change: Amnesia, Inertia, and Impulsiveness," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 11(3), pages 379-421, 09.
  7. Michael J. Barclay & Clifford W. Smith & Ross L. Watts, 1995. "The Determinants Of Corporate Leverage And Dividend Policies," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 4-19.
  8. Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
  9. John R. Graham & Michael L. Lemmon & James S. Schallheim, 1998. "Debt, Leases, Taxes, and the Endogeneity of Corporate Tax Status," Journal of Finance, American Finance Association, vol. 53(1), pages 131-162, 02.
  10. Schwartz, Alan & Watson, Joel, 2000. "Economic and Legal Aspects of Costly Recontracting," University of California at San Diego, Economics Working Paper Series qt4jr3g3h7, Department of Economics, UC San Diego.
  11. Samuelson, William & Zeckhauser, Richard, 1988. " Status Quo Bias in Decision Making," Journal of Risk and Uncertainty, Springer, vol. 1(1), pages 7-59, March.
  12. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-170, Summer.
  13. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
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Cited by:
  1. Anderson, Ronald W & Carverhill, Andrew, 2005. "A Model of Corporate Liquidity," CEPR Discussion Papers 4994, C.E.P.R. Discussion Papers.
  2. Peter MacKay & Gordon M. Phillips, 2002. "Is There an Optimal Industry Financial Structure?," NBER Working Papers 9032, National Bureau of Economic Research, Inc.
  3. Colin Mayer & Oren Sussman, 2003. "A New Test of Capital Structure," OFRC Working Papers Series 2003fe16, Oxford Financial Research Centre.
  4. Gabrielle Wanzenried, 2003. "Capital Structure Inertia and CEO Compensation," Diskussionsschriften dp0305, Universitaet Bern, Departement Volkswirtschaft.
  5. Ehrhardt, David & Irwin Timothy, 2004. "Avoiding customer and taxpayer bailouts in private infrastructure projects : Policy toward leverage, risk allocation, and bankruptcy," Policy Research Working Paper Series 3274, The World Bank.
  6. Peter Gibbard & Ibrahim Stevens, 2006. "Corporate debt and financial balance sheet adjustment: a comparison of the United States, the United Kingdom, France and Germany," Bank of England working papers 317, Bank of England.
  7. Balla, Andrea, 2006. "Tőkeszerkezeti döntések - empirikus elemzés a magyar feldolgozóipari vállalatokról 1992-2001 között
    [Decisions affecting capital structure - an empirical analysis of Hungarian manufacturin
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 681-700.

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