Capital Structure Choices

We examine three pairs of cross-section regressions that test predictions of the tradeoff model, the pecking order model, and models that center on market conditions. The regressions examine (i) the split of new outside financing between share issues and debt, (ii) the split of new debt financing between short-term and long-term, and (iii) the split of new equity financing between share issues and retained earnings. The pecking order does well until the early 1980s, when the share issues that are its bane become common. The adjustment of leverage to target predicted by the tradeoff model and the response of equity financing to market valuations predicted by the market conditions model have statistically detectable but rather second-order effects on the split of new outside financing between share issues and debt. Targets for shortterm debt seem to influence the mix of short-term versus long-term debt choices of smaller firms, but this targeting effect is weak to non-existent for large firms. Sticky dividends plague the predictions of the pecking order and market conditions models about the split of equity financing between share issues and retained earnings.