Capital Structure Choice and Firm Value: New Empirical Evidence from Asymmetric Causality Test

Kartal Demirgunes

doi:10.5430/ijfr.v8n2p75

Abstract

This study aims to analyze the possible asymmetric causal relationship between capital structure and firm value by employing the asymmetric causality test of Hatemi-J (2012), on a time series data of Turkish manufacturing industry (consisting of Borsa Istanbul listed manufacturing firms) for the period of 1990.Q1-2015.Q4. Test results point out a unidirectional asymmetric causal relationship between capital structure and firm value, indicating that capital structure Granger-cause firm value when shocks are negative, but not when shocks are positive. More explicitly, a decrease in total debt ratio leads to a decrease in the market-to-book value ratio. Considering the effect of only negative shock, this empirical finding also supports partial evidence to the validity of trade-off theory which predicts a positive relationship between debt level and firm value.

Highlights

Before the late 1950s, the conventional finance theory defended that a moderate debt financing increases firm value, as it is less costly compared to equity financing, imply ing U-shaped cost of capital function of leverage
This study aims to find out the possible effect of capital structure on firm value v ia various empirical analyses including the unit root test with two structural breaks developed by Narayan and Popp (2010) and the asymmetric causality test of Hatemi-J (2012)
One of the unit root tests with structural breaks which was recently introduced into the literature developed by Narayan and Popp (2010) is performed to test whether a time series variable is non -stationary and possesses a unit root

Summary

Introduction

Before the late 1950s, the conventional finance theory defended that a moderate debt financing increases firm value, as it is less costly compared to equity financing, imply ing U-shaped cost of capital function of leverage. Many theories with their extensions (models) have been proposed on capital structure relevancy focusing on optimal use of debt, as point of origin These widely accepted theories may broadly be categorized into trade-off [proposed by Modigliani and Miller, 1963; Kraus and Lit zenberger, 1973; Jensen and Meckling, 1976; Scott, 1976; Miller, 1977; Kim, 1978; DeAngelo and Masulis, 1980; Grossman and Hart , 1982; Bradley et al, 1984; Jensen, 1986; Diamond, 1989; Harris and Raviv, 1990; Stulz, 1990; Chang, 1999]; and the pecking order [Myers, 1984; Myers and Majluf, 1984] theories. According to Tit man and Wessels (1988), one possible reason why empirical studies in this area have lagged behind the theories is because variables related to firm attributes embedded in research models are expressed by fuzzy and not directly observable concepts. Deesomsak et al (2004), Beattie et al (2006), and Al-Najjar and Taylor (2008) provide supportive emp irical evidence on the incomp leteness and inconclusiveness of understanding capital structure theories

Objectives

Results

Conclusion