Growth status and persistence in the cross-section of corporate capital structure

Abstract

This thesis examines the relationship between growth status and the cross-section of corporate capital structure. First, I propose initial growth status, a concept based on a two-way sort on firms’ market-to-book and asset tangibility in early years after IPO, not only captures the cross-sectional variations in leverage ratios, but also reveals the time in-variant evolutions in capital structure. That is, high (low) growth status firms tend to have stable low (high) leverage over long periods of time. Second, the notion that growth firms can rationally benefit from new equity issues under improved market conditions is consistent with the generalized Myers and Majluf model in the literature. I suggest growth status can rationally determine financing costs through both tangibility and growth opportunities. Third, the fact that leverage ratios are determined in the initial years immediately casts doubts on the market-timing theory of capital structure. Unlike year-by-year market-to-book ratios, whose variations can give rise to corporate market-timing, the initially identified measures have little to do with future market-timing. Firms in the three growth status (high, mixed, and low) groups have persistently distinct characteristics. While market-timing may affect year-by-year debt and equity issues, it fails to change the general course of leverage. In a horse race, growth status determined variable completely overtakes the Baker and Wurgler (2002) market-timing variable in determining long-term capital structure at the firm level. I conclude that growth status gives rise to fair market-timing and ultimately dictates capital structure. Keywords: Capital Structure, Initial Growth Status, Persistence, Market Timing JEL Classification Code: G14, G32, G34