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A New Test of Capital Structure

Colin Mayer

Peter Moores Professor of Management Studies, Sad Business School, University of Oxford

Oren Sussman

Sad Business School, University of Oxford


This paper reports a new test of capital structure theories.  It uses a filtering technique to identify large investment spikes.  We find that the spikes are predominantly financed with debt by large firms and with new equity by small firms.  In the process of financing large projects, firms move significantly away from their previous capital structure, as predicted by the pecking order theory.  Furthermore, consistent with the pecking order theory, new equity issues are primarily associated with small, loss-making firms.  However, we also observe a tendency for firms to adjust back to previous levels of leverage, consistent with a trade-off theory.   We conclude that a combination of the pecking order and trade-off theories provides a good description of short-run and longer run dynamics.

Key words: Capital structure, corporate finance, pecking order theory, trade-off theory

JEL classification:  G32


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