Firm-specific stock return variation and capital structure decisions

Abstract

We evaluate the association between the pace of the adjustment toward target capital structure and the extent to which equity prices reflect firm-specific information. The evidence indicates that firm-specific stock return variation explains significantly the pace of the adjustment toward target capital structure. We also show that the financing decisions of most Taiwanese firms support trade off theory. Only the samples of high (low) firm-specific stock return variation support pecking order (market timing) theory. Our findings suggest that firm-specific stock return variation provides considerable insight to capital structure decisions. In other words, corporate financing decisions cannot divorce from the efficiency of capital markets.