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A New Test of Capital Structure

  • Colin Mayer
  • Oren Sussman

This paper reports a new test of capital structure theories. It uses a filtering technique to identify large investment spikes. We find that the spikes are predominantly financed with debt by large firms and with new equity by small firms. In the process of financing large projects, firms move significantly away from their previous capital structure, as predicted by the pecking order theory. Furthermore, consistent with the pecking order theory, new equity issues are primarily associated with small, loss-making firms. However, we also observe a tendency for firms to adjust back to previous levels of leverage, consistent with a trade-off theory. We conclude that a combination of the pecking order and trade-off theories provides a good description of short-run and longer run dynamics.

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Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2003fe16.

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Date of creation: 2003
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Handle: RePEc:sbs:wpsefe:2003fe16
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  1. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
  2. Malcolm Baker & Jeffrey Wurgler, 2002. "Market Timing and Capital Structure," Journal of Finance, American Finance Association, vol. 57(1), pages 1-32, 02.
  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. Jeremy C. Stein, 1992. "Convertible Bonds as "Back Door" Equity Financing," NBER Working Papers 4028, National Bureau of Economic Research, Inc.
  5. Raghuram G. Rajan & Luigi Zingales, 1994. "What Do We Know About Capital Structure? Some Evidence from International Data," NBER Working Papers 4875, National Bureau of Economic Research, Inc.
  6. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  7. Mayer, Colin, 1988. "New issues in corporate finance," European Economic Review, Elsevier, vol. 32(5), pages 1167-1183, June.
  8. Shyam-Sunder, Lakshmi & C. Myers, Stewart, 1999. "Testing static tradeoff against pecking order models of capital structure," Journal of Financial Economics, Elsevier, vol. 51(2), pages 219-244, February.
  9. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. Ivo Welch, 2002. "Columbus' Egg: The Real Determinant of Capital Structure," NBER Working Papers 8782, National Bureau of Economic Research, Inc.
  11. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
  12. Frank, Murray Z. & Goyal, Vidhan K., 2003. "Testing the pecking order theory of capital structure," Journal of Financial Economics, Elsevier, vol. 67(2), pages 217-248, February.
  13. Bradley, Michael & Jarrell, Gregg A & Kim, E Han, 1984. " On the Existence of an Optimal Capital Structure: Theory and Evidence," Journal of Finance, American Finance Association, vol. 39(3), pages 857-78, July.
  14. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  15. Corbett, Jenny & Jenkinson, Tim, 1997. "How Is Investment Financed? A Study of Germany, Japan, the United Kingdom and the United States," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(0), pages 69-93, Supplemen.
  16. 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.
  17. Chirinko, Robert S. & Singha, Anuja R., 2000. "Testing static tradeoff against pecking order models of capital structure: a critical comment," Journal of Financial Economics, Elsevier, vol. 58(3), pages 417-425, December.
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