This paper provides new evidence of how macroeconomic conditions affect capital structure choice. We model firms ’ target capital structures as a function of macroeconomic conditions and firm-specific variables. We split our sample based on a measure of financial constraints. We find that target leverage is counter-cyclical for the relativelyunconstrained sample, but pro-cyclical for the relativelyconstrained sample. The choice of what type of security to issue/repurchase is significantly related to deviations from the target capital structure, particularly for the constrained sample. Macroeconomic conditions are significant for issue choice for unconstrained firms but less so for constrained firms. Our results support the hypothesis that unconstrained firms are able to time their issue choice to periods when macroeconomic conditions are favorable, while constrained firms take what they can get.

This paper examines the ability of the risk-shifting hypothesis and the backdoor equity hypothesis to explain firms ’ decisions to issue convertible debt. Using a security choice model that incorporates pre-offer issue, issuer, and macroeconomic information, we document significant variation in the market reaction to new convertible debt issues depending on whether investors expect the motivation for issuance to be asset substitution or asymmetric information. Our results suggest that both motives explain the use and design of convertible debt. Some firms issue convertible debt instead of straight debt to mitigate the costs of bondholder/stockholder agency conflicts. Other issuers use convertible debt instead of common equity to reduce the costs of adverse selection. Thus, in contrast to standard securities like straight debt or common equity, which solve some financing problems but exacerbate others, hybrid securities such as convertible debt are seen as providing a more flexible funding choice that can solve conflicting financing problems. Financial economists study the security issue decision to understand more fully why firms choose to issue a particular security and how investors in financial markets react to that choice. The research documents several results about investor reaction to the announcement of

I would like to thank seminar participants at Baruch College and SUNY Binghamton for helpful comments. Are Observed Capital Structures Determined by Equity Market Timing? Contrary to Baker and Wurgler (2002), we find that the importance of historical average market-to-book in leverage regressions is not due to past equity market timing. We find that though equity transactions may be timed to equity market conditions, they do not have significant long-lasting effects on capital structure. Debt transactions exhibit timing patterns that are unlikely to induce a negative relation between market-to-book and leverage. We also find that historical average market-to-book has a significant effect on current financing and investment decisions, implying that it contains information about Traditional theories of corporate financing explain firms ’ financing choices as either the result of the fundamental trade-offs between various costs and benefits of debt and equity

Debt initial public offerings ~IPOs! represent a major shift in a firm’s financing policy by both extending debt maturity and altering the public-private debt mix. In contrast to findings for seasoned debt offerings, we document a significantly negative stock price response to debt IPO announcements. This result is consistent with debt maturity and debt ownership structure theories. The equity wealth effect is negatively related to the offer’s maturity, and positively related to the degree of bank monitoring. We find that firms with less information asymmetry and firms with higher growth opportunities experience a less adverse stock price response. The decision to access the public debt market for the first time represents a major change in a firm’s financing policy. An initial public debt offer alters the firm’s debt structure in two significant ways. Not only does this policy choice affect the firm’s debt ownership structure, by altering its mix of public relative to private debt, but it also extends the average debt maturity of the firm substantially. This study provides empirical evidence on the validity of some important debt structure theories by focusing on the information content of initial public debt offers ~debt IPOs!. Two major strands of theories have evolved in the literature. The debt ownership choice theories model corporate choice of private and public debt mix ~see, e.g., Fama ~1985!, Diamond ~1991a!, and Rajan ~1992!!, while the other set of theories models corporate debt maturity choice ~Easterbrook ~1984!, Flannery ~1986!, and Kale and Noe ~1990!!. A number of recent studies empirically test some of the predictions of these models ~Barclay and

for helpful comments and suggestions. The paper has also benefitted from comments of participants at the

This paper provides new evidence of how macroeconomic conditions affect capital structure choice. We model firms' target capital structures as a function of macroeconomic conditions and firm-specific variables. We split our sample based on a measure of financial constraints. We find that target leverage is counter-cyclical for the relatively unconstrained sample, but pro-cyclical for the relatively constrained sample. The choice of what type of security to issue/repurchase is significantly related to deviations from the target capital structure, particularly for the constrained sample. Macroeconomic conditions are significant for issue choice for unconstrained firms but less so for constrained firms. Our results support the hypothesis that unconstrained firms are able to time their issue choice to periods when macroeconomic conditions are favorable, while constrained firms take what they can get. JEL Classification: G32, G1 Keywords: Capital Structure; Business Cycles; Financial Constraints Specifically, Choe, Masulis, and Nanda (1993) document that aggregate seasoned primary equity issues are pro-cyclical and debt issues are counter-cyclical. Korajczyk, Lucas, and McDonald (1990) document that aggregate equity issues are positively related with equity market performance. Gertler and Gilchrist (1993) document that aggregate net debt issues (public and private) increases for large firms but remains flat for small firms following recessions associated with a monetary contraction. Gertler and Gilchrist (1994) document that aggregate net shortterm debt is more stable over the business cycle for small firms.

The literature provides conflicting assessments about firms ’ leverage decisions. We argue that econometric mis-specifications have influenced many past conclusions, because the estimated regression models implicitly impose strong, but unwarranted, assumptions on the data. This study estimates a partial-adjustment model for a firm’s leverage decision. Our model recognizes that a firm’s target capital structure can change over time and that (unanticipated) share price changes also have on effect on observed leverage. Our results indicate that firms do have specific target capital structures, and that they adjust quickly toward those targets when a gap arises. We estimate that the typical firm closes more than half the gap between its actual and its target debt ratios within two years.

anonymous referee for valuable comments. Determinants of Target Capital Structure:

Number of pages 43

This paper studies the capital structure choice of firms in a dynamic setting and the intertemporal patterns in security issuance. The model examines the impact of information spillovers from public securities on the capital structure and long run financing costs of a firm. The empirical work provides evidence that the borrowing costs of firms are decreasing in measures of information production in stock markets. In the model, I show that firms use bank borrowing initially to minimize the lemons cost. Subsequently, when they meet the feasibility conditions for sustaining a market for their securities, they issue public equity (IPO) and then use either bank borrowing or bonds for subsequent financing rounds. This sequence of securities is optimally chosen to maximize the gains from information spillovers from public equity. Firms trade off the initial lemons cost of information sensitive public equity against the gains from having more informative stock prices arising from endogenous information production in financial markets. The information spillover gains occur through a reduction in (i) bank monitoring costs and (ii) adverse selection costs of future financing. This effect has implications for the sequencing of securities over the life of the firm, and in particular the decision to go public.