Business cycles, financial cycles and capital structure

We perform peridogram based cycle analysis of firm capital structure and find evidence that firms’ leverage is both persistent and cyclical. The cyclicality of leverage is supported by the trade-off, pecking order and market timing capital structure theories (Korajczyk and Levy in J Financ Econ 68:75–109, 2003; Bhamra et al. in Rev Financ Stud 23:645–703, 2010). Although market timing theory research supports persistence, previous literature dictates that the trade-off and pecking order theories may predict either persistent or mean reverting leverage. Our tests reject mean reversion in favor of persistent and cyclical leverage. We corroborate pecking order theory literature that predicts leverage is persistent. In these models, when firms’ investment spending is below earnings, leverage decreases. In addition, we examine whether firms change their capital structure as a result of business and financial cycles. Since financial cycles last longer than business cycles, financial cycles should have a long term effect on leverage. Our findings confirm the persistent leverage business cycle models that suggest firms change their capital structure due to financial and credit cycles (Jermann and Quadrini in Am Econ Rev 102:238–271, 2012; Azariadis et al. in Rev Econ Stud 83:1364–1405, 2016). We conclude that leverage is persistent due to the cyclicality of the financing decision.