Reevaluating the Trade-off Theory of Capital Structure: Evidence from Zero-Leverage Firms
33 Pages Posted: 11 Nov 2019
Date Written: October 30, 2019
Abstract
We empirically evaluate extensions to the trade-off theory of capital structure featuring a real option on debt issuance in a zero-leverage environment. Controlling for alternative explanations of zero-leverage behavior, we find considerable evidence in support of the extended trade-off theory and no evidence against it. We validate our empirical approach via simulations under the real option mechanism and under an alternative financially constrained mechanism. The simulations show that our empirical findings are not consistent with zero-leverage behavior driven exclusively by financial constraints, but they are consistent with the real-option mechanism.
Keywords: zero leverage, capital structure, real option, trade-off theory
JEL Classification: G32
Suggested Citation: Suggested Citation