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To have a target debt ratio or not: what difference does it make?

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  • Abe de Jong
  • Patrick Verwijmeren

Abstract

The static tradeoff theory of capital structure predicts that firms aim to approach a target debt ratio. The theory provides several firm characteristics that determine this target ratio. In contrast, the pecking order model rejects a target debt ratio, because firms are expected to finance investments subsequently from (internal) equity, debt and (external) equity. A fundamental problem in empirical studies is that having a target debt ratio or not is unobservable from public data. We use survey evidence from 235 Chief Financial Officers (CFOs) to discriminate static tradeoff firms from pecking order firms and relate the responses to public data. For the two sets of firms we estimate standard capital structure models and find that pecking order firms contaminate static tradeoff theory-based estimations.

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  • Abe de Jong & Patrick Verwijmeren, 2010. "To have a target debt ratio or not: what difference does it make?," Applied Financial Economics, Taylor & Francis Journals, vol. 20(3), pages 219-226.
    • Handle: RePEc:taf:apfiec:v:20:y:2010:i:3:p:219-226
    DOI: 10.1080/09603100903282671
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    References listed on IDEAS

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    Cited by:

    1. Daniel Arce & Douglas Cook & Robert Kieschnick, 2015. "On the evolution of corporate capital structures," Journal of Evolutionary Economics, Springer, vol. 25(3), pages 561-583, July.
    2. Brown, Stephen & Dutordoir, Marie & Veld, Chris & Veld-Merkoulova, Yulia, 2019. "What is the role of institutional investors in corporate capital structure decisions? A survey analysis," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 270-286.
    3. Lambert H. de Wet & Sean Joss Gossel, 2016. "South African Capital Structure Decisions: A Survey of Listed Companies," Journal of African Business, Taylor & Francis Journals, vol. 17(2), pages 167-187, May.
    4. Chauhan, Gaurav Singh & Huseynov, Fariz, 2018. "Corporate financing and target behavior: New tests and evidence," Journal of Corporate Finance, Elsevier, vol. 48(C), pages 840-856.
    5. Shab Hundal & Annika Sandstrom & Assel Uskumbayeva, 2018. "The Impact Of The Financial Crisis On Corporate Capital Structure Dynamics In The Nordic Countries," Eurasian Journal of Economics and Finance, Eurasian Publications, vol. 6(3), pages 34-51.
    6. Stefan Dierkes & Imke de Maeyer, 2020. "Valuation with mixed financing strategies," Business Research, Springer;German Academic Association for Business Research, vol. 13(3), pages 1317-1341, November.
    7. Ralf Diedrich & Stefan Dierkes & Hans-Christian Gröger, 2022. "A note on the cost of capital with fixed payout ratios," Review of Quantitative Finance and Accounting, Springer, vol. 59(4), pages 1559-1575, November.
    8. Unyong Pyo & Yong Shin & Howard Thompson, 2015. "Reducing agency conflicts with target debt ratios," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 39(3), pages 431-453, July.

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