Firm Specific Determinants of Capital Structure - Is Firm's Leverage Determined as a Residual of other Financial Decisions?

Abstract: This thesis empirically investigates the question if US firm’s capital structures are stable over longer periods of time and which firm characteristics drive optimal leverage. The analysis is based on a Compustat panel data sample consisting of 2,900 US firms between 1985 and 2016. After analyzing the stability of firm’s capital structure via a “narrow band” and a “relative bucket approach” an error correction model is used to measure the speed of adjustment towards a moving optimal target of leverage. The thesis finds that firms capital structures are far away from being stable. Furthermore, trade-off theory and pecking order hypothesis are not able to fully explain the evolution of leverage in the data sample. The remarkable finding is that leverage seems to be mainly determined as a residual of other financial decisions (investment and payout) as long as leverage is in an acceptable target zone around its optimum. Outside this range, the speed of adjustment significantly increases pushing leverage back to its optimal level. Another notable finding is, that credit rating downgrades work well to specify an upper border of firm’s leverage target zones encouraging the assumption that managers target credit ratings instead of optimal leverage ratios.