Do firms have target capital structures? Evidence from institutional monitoring

Abstract

This study lends support to the existence of target capital structures through the interplay between institutional monitoring and corporate debt policies. Specifically, using institutional ownership to proxy for institutional monitoring, we find that aggregate institutional ownership is negatively associated with deviations from hypothesized leverage targets and the negative relationship is driven by long-term institutions that are better positioned to influence corporate debt policies due to the nature of such efforts. We also find that our results are more evident in firms with low information asymmetry, which provide greater monitoring benefits due to perceived lower monitoring costs. These findings are consistent with monitoring institutions actively seeking to maintain a certain debt level and thus suggest its existence. We show that reductions in leverage deviation lead to better future firm performance, indicating institutional monitoring is effective in creating shareholder value. Our results are robust after controlling for measures of internal governance and invariant to alternative proxies for institutional monitoring.