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Do Tests of Capital Structure Theory Mean What They Say?

  • Ilya A. Strebulaev

In the presence of frictions, firms adjust their capital structure infrequently. As a consequence, in a dynamic economy the leverage of most firms is likely to differ from the "optimum" leverage at the time of readjustment. This paper explores the empirical implications of this observation. I use a calibrated dynamic trade-off model to simulate firms' capital structure paths. The results of standard cross-sectional tests on these data are consistent with those reported in the empirical literature. In particular, the standard interpretation of some test results leads to the rejection of the underlying model. Taken together, the results suggest a rethinking of the way capital structure tests are conducted. Copyright 2007 by The American Finance Association.

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 646.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:646
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