The Debt-Equity Choice: An Empirical Analysis

This paper compares U.S. firms which issued equity between 1976 and 1993 to those which issued debt. with an emphasis on determining the relative importance. Our results suggest that both the static tradeoff and pecking order explanations of capital structure choice theories are useful in explaining firm behavior. Consistent with the static-tradeoff story, we find that firms which have less debt than predicted by a cross-sectional predictive model of the debt ratio are the most likely to issue debt. Moreover, profitable firms which can enjoy significant gains from leverage are the most likely to issue debt. At the same time, we confirm previous studies which show that firms are much more likely to issue equity after experiencing a rise in their share price. This phenomenon can be rationalized with an asymmetric information/pecking order story. Because there are other potential explanations for the share price rise/equity issue relation, we stratify our analyses by proxies for asymmetry of information between insiders and outsiders including firm size, extent of analyst following and the level of dividend payout. Surprisingly, the impact of share prices rises on the incidence of equity issues is largest among firms with low informational asymmetry. This is not consistent with the informational asymmetry explanation of why firms issue equity. We thank Michael Barclay, Steve Kaplan, Craig Lewis, David Mauer, Bob McDonald, Stewart Myers and participants at the 1994 NBER Autumn Conference on Corporate Finance for helpful discussions and comments. The first author benefitted from research support from the Charles A. Dice Center for Financial Research of Ohio State University.