Abstract
A firm’s capital structure decisions constitute an essential research topic academically and practically. In this study, the author uses the data of US listed firms to test the traditional trade-off theory of capital structure, which posits that firms should balance the benefit of tax shields and costs of financial distress to purse an optimal debt ratio. Therefore, to determine the complex relationship between firm value and debt ratio and avoid the problem of model misspecification, the author adopts the non-parametric fixed effect model and semi-parametric (partially linear) fixed effect model. Our empirical results reveal that a nonlinear and asymmetric relationship exists between firm value and market debt ratio, thus, considerably supporting trade-off theory. Moreover, the use of different definitions of key variables and various kernel functions engenders robust results. Overall, the author suggests that firm managers should employ financial leverages appropriately to maximize firm value.
Highlights
The author uses the data of US listed firms to test the traditional trade-off theory of capital structure, which posits that firms should balance the benefit of tax shields and costs of financial distress to purse an optimal debt ratio
A firm’s capital structure decisions, including the choice of debt financing or equity financing, the pursuit or maintenance of an optimal debt ratio, and the various determinants of financing factors have consistently constituted an essential topic in academic research
They can be summarized into two major capital structure theories depending on the existence of an optimal debt ratio: trade-off theory and pecking-order theory
Summary
According to the procedure presented by the method of Ullah and Roy (1998), we apply the local linear estimation approach involved in non-parametric estimation techniques to remove the constant term Įi and, yield the local fixed effect estimator of Ȗ(MDRi,t-1) by minimizing the following expression:. According to Ullah and Roy (1998), we can obtain the estimator of the marginal effect (i.e., the derivative term) of the MDR on FirmValue as follows: vNFE MDR. Once ESFEL is obtained, we apply the approach of Ullah and Roy (1998) to reformulate the function as an alternative of the NFE model, which is expressed as follows: FVi ,t FVi,t FmV i,t Di m MDRi,t1 Hi,t (8). We can obtain the SFE estimator of the derivative of m(MDR), Ȗ(MDR), by using identical procedures to those in the preceding section, which can be expressed as follows:
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