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Capital Structure and Stock Returns: The European Evidence

Author

Listed:
  • Drobetz, Wolfgang
  • Pensa, Pascal

    () (University of Basel)

Abstract

Using a panel of 425 European firms over the period from 1990 to 2005, we revisit Welch's (2004) finding that stock returns are the primary determinant of capital structure changes and that corporate motives for net issuing activities are largely a mystery. We document that roughly half of the variation in leverage measures can be explained by stock return-induced effects on the capital structure over 1- and 5-year horizons. In contrast to the US evidence, corporate issuing activities are not as pronounced in our European sample, but they nevertheless seem to be sufficient for firms to follow target debt ratios in the long run. Our findings are consistent with recent evidence for dynamic rebalancing of the capital structure within a target range in the presence of adjustment costs (e.g. Leary and Roberts, 2005; Kayhan and Titman, 2007). In a horse race with stock returns, traditional capital structure variables are inferior in explaining corporate leverage ratios and readjustments in response to return-induced changes in the short run, but they retain a significant role in the long run.

Suggested Citation

  • Drobetz, Wolfgang & Pensa, Pascal, 2007. "Capital Structure and Stock Returns: The European Evidence," Working papers 2007/18, Faculty of Business and Economics - University of Basel.
  • Handle: RePEc:bsl:wpaper:2007/18
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    Cited by:

    1. Panayiotis Artikis & Georgia Nifora, 2012. "Capital Structure, Macroeconomic Variables & Stock Returns. Evidence from Greece," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 18(1), pages 87-101, February.

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