Essays on capital structure

Abstract

This dissertation consists of two essays about capital structure. These two essays study how firms adjust their capital structure against changes in stock prices and changes in risk. The first essay investigates firms’ reactions to significant stock price drops in the capital structure perspectives. We present evidence that firms repurchase equity to boost stock prices following significant stock price drops, even though buybacks cause their capital structures to deviate further from the previous levels. Unless firms were significantly under-leveraged prior to the price drops, share repurchases would not be an optimal choice of managers who would like to maintain optimal capital structures. Our results also show that firms with precautionary financial policies (e.g. high cash holdings and under leverage) and those with managers whose compensation strongly depends on stock return performance are more likely to repurchase shares than others following significant stock price drops. These results indicate that managerial incentives and firms’ historical financial policies seem to play more important roles in determining how they react to significant stock price drops than managers’ desires to maintain optimal leverage.In the second essay, we provide a new insight on how changes in risk affect a firm’s capital structure decisions. Using an approach that alleviates potential problems caused by high capital structure adjustment costs, we test whether firms that experience a substantial increase in risk choose an external financing method that is consistent with the implications of dynamic trade-off theories of capital structure. We find that these firms indeed choose a financing method that lowers their leverage ratios. This finding is particularly pronounced for firms with a high level of risk or firms that raise a large amount of external capital, and is robust to a variety of risk measures such as stock return volatility, default probability and implied asset vola...