Business shocks and corporate leverage

Kelvin Jui Keng Tan, Qing Zhou, Zheyao Pan and Robert Faff

Journal of Banking & Finance, 2021, vol. 131, issue C

Abstract: We examine whether and to what extent business shocks explain the puzzling instabilities of corporate leverage. We find that business shocks explain a large portion of the unexplained leverage deviation, cross-sectional leverage position migration, and evaporating leverage similarities in the cross-section of firms. The cross-sectional distribution of corporate leverage is relatively persistent when there are fewer and smaller business shocks but becomes unstable for firms with larger business shocks. Our findings suggest that business shocks lead to discontinuities in the corporate value creation process and investment, thereby affecting corporate financing decisions. Put simply, the lumpiness of investment creates a “lumpy need for external financing. Our analysis implies that the empirical modeling of capital structure adjustment and, indeed, the modeling of other corporate policies, should be conditioned on business shocks.

Keywords: Capital structure; Instability; Business shock; Leverage deviation (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:131:y:2021:i:c:s0378426621001679

DOI: 10.1016/j.jbankfin.2021.106208

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