Determinants and dynamics of capital structure in the UK : a methodological comparison approach
Despite considerable theoretical progress, the understanding of the determinants of a firm's capital structure remains incomplete and there are still numerous empirical issues to be resolved. The number of determinants of capital structure identified by theoretical reasoning keeps increasing, and as a result their analysis has become more and more complex. The primary contribution of this thesis is to provide some empirical tests of hypotheses suggested by theoretical models and reasoning. In the search for the most important determinants of capital-structure. This study uses a panel of 651 listed UK firms (9,486 firm-year observations) to compare structural equation, modelling (SME) and OLS-regression methodologies in both its cross-sectional and dynamic analyses. In addition, the study uses a set of implied gearing ratios to disentangle the impact of equity market timing behaviour from that of stock returns on capital structure. The evidence shows that, following an increase in stock returns, managers of UK firms issue more equity despite the fall in the debt-equity ratio and the consequent increase in debt carrying capacity. This practice has a statistically significant impact on capital structure, as UK firms do not appear to re-adjust their gearing thereafter. The study reveals that stock returns are the most important capital structure determinant. Though the effects of other firm-specific characteristics and equity market timing are persistent and statistically significant, compared to the stock returns effect, their economic role is negligible. Stock returns drive gearing mechanistically for a longtime, up to ten years. The findings imply that managers do not strive to adjust their capital structure towards some optimal debt ratio. This casts doubt on theories that advocate a degree of optimisation like the static trade-off theory of capital structure.