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Risk changes and external financing activities: Tests of the dynamic trade-off theory of capital structure

Author

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  • Dierker, Martin
  • Lee, Inmoo
  • Seo, Sung Won

Abstract

We provide new insight into the relevance of the dynamic trade-off theory of capital structure by examining firms’ external financing activities following risk changes. Consistent with the prediction of the dynamic trade-off theory but inconsistent with the pecking order theory, we find that firms issue equity following risk increases and debt after risk decreases, even when we narrowly focus on financially unconstrained firms. However, the results do not hold for firms with high market-to-book assets ratios, indicating that in this case, external financing activities are better captured by other factors than those explicitly considered in the trade-off theory, such as market timing. Our results are robust to a variety of risk measures including stock return volatility, default probability, implied asset volatility, and adjusted Ohlson (1980) scores.

Suggested Citation

  • Dierker, Martin & Lee, Inmoo & Seo, Sung Won, 2019. "Risk changes and external financing activities: Tests of the dynamic trade-off theory of capital structure," Journal of Empirical Finance, Elsevier, vol. 52(C), pages 178-200.
    • Handle: RePEc:eee:empfin:v:52:y:2019:i:c:p:178-200
    DOI: 10.1016/j.jempfin.2019.03.004
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    Citations

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    Cited by:

    1. Hossain, Mohammed Sawkat, 2021. "A revisit of capital structure puzzle: Global evidence and analysis," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 657-678.
    2. Karpuz, Ahmet & Kim, Kirak & Ozkan, Neslihan, 2020. "Does financial reporting regulation influence the value of cash holdings?," Journal of Empirical Finance, Elsevier, vol. 59(C), pages 52-67.
    3. Mundi, Hardeep Singh, 2022. "CEO social capital and capital structure complexity," Journal of Behavioral and Experimental Finance, Elsevier, vol. 35(C).
    4. Boasiako, Kwabena Antwi & Adasi Manu, Sylvester & Antwi-Darko, Nana Yaw, 2022. "Does financing influence the sensitivity of cash and investment to asset tangibility?," International Review of Financial Analysis, Elsevier, vol. 80(C).
    5. Rana Yassir Hussain Xuezhou Wen Rehan Sohail Butt Haroon Hussain Sikandar Ali Qalati Irfan Abbas, 2020. "Are Growth Led Financing Decisions Causing Insolvency in Listed Firms of Pakistan?," Zagreb International Review of Economics and Business, Faculty of Economics and Business, University of Zagreb, vol. 23(2), pages 89-115, November.
    6. Muhammd Istan, 2024. "Analysis of the Influence of Assets Structure, Earning Volatility, and Financial Flexibility on Capital Structure and Corporate Performance in Manufacturing Sector Companies on the IDX," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 1, pages 49-65.
    7. Jing Du & Hongyue Wu & Ruoyu Jin, 2019. "Capital Structure of Public–Private Partnership Projects: A Sustainability Perspective," Sustainability, MDPI, vol. 11(13), pages 1-25, June.
    8. Feng-Li Lin, 2020. "Do DJIA Firms Reflect Stationary Debt Ratios?," Economies, MDPI, vol. 8(4), pages 1-19, September.
    9. Guo, Jiaqi & Li, Changhong & Jiao, Wenting & Wang, Zhan, 2021. "Marketisation, information transparency and the cost of equity for family firms," Finance Research Letters, Elsevier, vol. 38(C).
    10. Mu-Jung Huang & Kuo-Chih Cheng & Ching-Ju Huang & Kun-Meng Lin & Huo-Ming Wang & Cheng-Kuo Chuang & Ming-Cheng Wu, 2021. "Establishing a Dynamic Capital Structure Model for Company Sustainability Performance Using Data Mining Techniques," Sustainability, MDPI, vol. 13(11), pages 1-15, May.
    11. Fan, Zhenjun & Zhang, Zongyi & Zhao, Yanfei, 2021. "Does oil price uncertainty affect corporate leverage? Evidence from China," Energy Economics, Elsevier, vol. 98(C).
    12. Han, Feng & Qin, Qi & Peabody, S. Drew, 2022. "Does incentive conflict between CEOs and CFOs benefit firms? Implications for corporate decision-making," Research in International Business and Finance, Elsevier, vol. 63(C).
    13. María T. Tascón & Paula Castro & Adrián Ferreras, 2021. "How does a firm's life cycle influence the relationship between carbon performance and financial debt?," Business Strategy and the Environment, Wiley Blackwell, vol. 30(4), pages 1879-1897, May.
    14. Yusuf Adeneye & Fathyah Hashim & Yusuf Babatunde Rahman & Normaizatul Akma Saidi, 2023. "COVID-19 Dynamics and Financing of Cash Flow Shortages: Evidence from Firm-Level Survey," Capital Markets Review, Malaysian Finance Association, vol. 31(2), pages 23-53.

    More about this item

    Keywords

    Capital structure theory; Dynamic trade-off; Pecking-order; Market timing; Risk change; External financing activities;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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