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Does the source of capital affect capital structure
| Venue: | Review of Financial Studies |
| Citations: | 189 - 12 self |
BibTeX
@ARTICLE{Faulkender_doesthe,
author = {Michael Faulkender and Mitchell A. Petersen},
title = {Does the source of capital affect capital structure},
journal = {Review of Financial Studies},
year = {},
pages = {45--79}
}
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Abstract
Prior work on leverage implicitly assumes capital availability depends solely on firm characteristics. However, market frictions that make capital structure relevant may also be associated with a firm’s source of capital. Examining this intuition, we find firms that have access to the public bond markets, as measured by having a debt rating, have significantly more leverage. Although firms with a rating are fundamen-tally different, these differences do not explain our findings. Even after controlling for firm characteristics that determine observed capital structure, and instrumenting for the possible endogeneity of having a rating, firms with access have 35 % more debt. Under the tradeoff theory of capital structure, firms determine their preferred leverage ratio by calculating the tax advantages, costs of financial distress, mispricing, and incentive effects of debt versus equity. The empirical literature has searched for evidence that firms choose their capital structure, as this theory predicts, by estimating firm leverage as a function of firm characteristics. Firms for whom the tax shields of debt are greater, the costs of financial distress lower, and the mispricing of debt relative to equity more favorable are expected to be more highly levered. When these firms discover that the net benefit of debt is positive, they will move toward their preferred capital structure by issuing additional debt and/or reducing their equity. The implicit assumption has been that a firm’s leverage is completely a function of a firm’s demand for debt. In
Keyphrases
capital structure firm characteristic capital affect capital structure firm leverage financial distress empirical literature implicit assumption preferred leverage ratio net benefit firm demand debt relative debt rating tradeoff theory debt versus equity capital availability capital structure relevant incentive effect public bond market preferred capital structure tax shield tax advantage possible endogeneity market friction additional debt prior work
