Abstract
Trade-off models commonly invoke financial transaction costs in order to explain observed leverage fluctuations. This paper offers an alternative explanation based on real options. The model is frictionless on the financing side but incorporates irreversibility and fixed costs of investment. Results obtained from simulating the model are broadly consistent with observed financing patterns. Market leverage ratios are negatively related to profitability, mean-reverting, and depend on past stock returns. The gradual and lumpy leverage adjustments can occur in the absence of financial transaction costs. This evidence shows that incorporating real frictions into structural models increases their explanatory power.
Original language | English (US) |
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Pages (from-to) | 232-252 |
Number of pages | 21 |
Journal | Journal of Financial Economics |
Volume | 89 |
Issue number | 2 |
DOIs | |
State | Published - Aug 2008 |
Externally published | Yes |
Keywords
- Capital structure
- Corporate tax
- Real options
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics
- Strategy and Management