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

Martin Dierker, Inmoo Lee and Sung Won Seo

Journal of Empirical Finance, 2019, vol. 52, issue C, 178-200

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.

Keywords: Capital structure theory; Dynamic trade-off; Pecking-order; Market timing; Risk change; External financing activities (search for similar items in EconPapers)
JEL-codes: G32 G33 G35 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:52:y:2019:i:c:p:178-200

DOI: 10.1016/j.jempfin.2019.03.004

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