The data are taken from the combined quarterly research, full coverage, and industrial COMPUSTAT files for the years 1984 to 2001.26 We also extract return data from the Center for Research in Security Prices (CRSP) monthly stock price file. All regulated (SICs 4900–4999) and financial firms (SICs 6000–6999) are removed from the sample to avoid financial policy governed by regulatory requirements and maintain consistency with earlier studies (e.g., Fama and French (2002), Frank and Goyal (2003), and Korajczyk and Levy (2003)). Any observations with missing data for the book value of assets, stock issuances, stock repurchases, short-term debt, or long-term debt are deleted because these variables are required to determine whether an issuance or repurchase has occurred. Finally, since the emphasis of this study is on dynamic capital structure, we restrict our attention to firms with at least four years of contiguous observations.27 The final data set is an unbalanced panel containing 127,308 firm-quarter observations: 3,494 firms each with a time series of observations ranging in length from 16 to 71 quarters.28
A. Capital Structure Adjustments
To define when a change in capital structure has occurred, we follow the approach used by Hovakimian, Opler, and Titman (2001), Hovakimian (2004), and Korajczyk and Levy (2003). An issuance or repurchase is defined as having occurred in a given quarter if the net change in equity or debt, normalized by the book value of assets at the end of the previous period, is greater than 5%. For example, a firm is defined as having issued debt in quarter t when the change in the total value of debt from quarter t− 1 to t, divided by the book value of assets at the end of quarter t− 1, exceeds 5%. We define four basic types of financing “spikes”: equity issuances, equity repurchases, debt issuances, and debt retirements, each of which is represented mathematically by a binary variable indicating whether or not a spike has occurred for firm i in period t. With the exception of equity repurchases, all spike definitions use the 5% cutoff. Equity repurchases use a 1.25% cutoff to avoid missing the numerous smaller-sized repurchase programs in place.29
While there may be instances of misclassification using this scheme, such as when convertible debt is called or when an equity account is transferred from a subsidiary to a parent, Hovakimian, Opler, and Titman (2001) show that analysis carried out using new debt and equity issue data from SDC produces results similar to analysis using the 5% classification scheme. Korajczyk and Levy (2003) also confirm the accuracy of this classification scheme. We present additional accuracy checks below and note that Whited (2003) uses a similar approach to identify investment decisions. This classification also allows us to capture changes in total debt due to private debt net issuing activity that may not be tracked by the SDC database. As Houston and James (1996) and Bradley and Roberts (2003) show, the majority of corporate debt is comprised of private placements.
In addition to the four basic types of financing spikes, we examine two additional measures of capital structure adjustment that we refer to as leverage-increasing decisions and leverage-decreasing decisions (or, more succinctly, as leverage increase and leverage decrease). Since our focus is on corporate decisions that impact leverage, we require measures that can isolate the effect of financial decisions on leverage, while ignoring those financing decisions that have no impact. For example, a firm that issues debt and equity in proportions equal to the firm's previous debt–equity ratio does not affect its leverage, despite the fact that it has undertaken a large amount of net issuing activity. To isolate those decisions that impact leverage, we define a leverage increase as net debt issuance minus net equity issuance, divided by book assets, in excess of 5%. Similarly, we define a leverage decrease as net equity issuance minus net debt issuance, divided by book assets, in excess of 5%. As with the four financing spikes, the mathematical representation of each of these leverage adjustments is a binary variable.
As a robustness check, we also perform all of our analysis using 3% and 7% cutoffs in defining the various financing spikes (0.5% and 3% for equity repurchases). These changes have a negligible effect on our results.
Table III presents summary statistics for each type of adjustment. Perhaps the most striking result is that in 72% of the quarters in our sample no adjustment occurs. That is, a majority of the time firms are inactive with respect to their capital structures. However, since we are examining quarterly data, a 72% inactivity rate implies that firms adjust their capital structures approximately once a year, on average. Thus, financing activity is actually quite frequent but far from continuous. This inactivity is consistent with the presence of adjustment costs, but could also be consistent with the alternative hypothesis that firms are indifferent toward leverage, as market timing or inertia would predict. A more thorough examination of these alternatives is postponed until the formal modeling below.
The most common form of adjustments is debt issuance, which accounts for over 40% of all capital structure adjustments.30 This is followed by debt retirements (28%), stock issuances (17%), and stock repurchases (14%). On a per firm basis, we see a similar pattern. The average firm has approximately 36 quarters' worth of data and experiences 4.2 debt issuances, 2.8 debt retirements, 1.9 equity issuances, and 2.8 equity repurchases. We also note that there are a significant number (2,219) of joint stock issuance and debt retirement observations, which are captured by the leverage decrease measure but not explicitly reported in the table.
Table III also presents summary information on financing spell durations. The median duration of each type of spell ranges from three quarters for debt issuances to five quarters for equity issuances. However, we refrain from drawing any conclusions from these durations, as they represent unconditional estimates from a heterogeneous sample containing censored durations and are likely quite biased. Because the sample ends in 2001 and some firms drop out of the sample prior to 2001 (e.g., bankruptcy), there are a number of right-censored spells. Right censoring occurs when a spell is still ongoing at the end of a firm's data series. For example, a firm that issues debt in the first quarter of 2000 and then does not issue debt again before the end of the sample period has a right-censored debt issuance spell with a duration of seven quarters. For right-censored spells, we can only place a lower bound on the duration of the spell. The consequence of right censoring is a downward bias in the unconditional duration estimates, which we address in the formal modeling. Because the first spell is measured with respect to the first observed financing spike, there is no left censoring, as well as no IPOs.31
The bottom two rows of Table III present summary information concerning leverage adjustments. Firms tend to increase their leverage more often than they decrease it (12.9% compared to 11.9%). If, on average, firms experience a positive drift in their equity values, then leverage has a natural tendency to decline. To counteract this tendency, firms will lever up more often than down if they are rebalancing their debt ratios. Thus, this preliminary evidence suggests that firms counteract the natural tendency of equity values to rise over time.
Table IV presents summary statistics on the magnitude of the different types of adjustments. All dollar values are inflation adjusted to 2001 dollars using the All Urban CPI. We focus our discussion of these results on medians because of the large skew in each measure's distribution. Debt issuances and retirements are comparable in magnitude, with median sizes of $7.8 million and $6.6 million, respectively. Median equity issuances are quite small ($3.6 million), while equity repurchases represent the largest adjustment ($11.2 million). Though equity issuances (repurchases) represent the smallest (largest) adjustment in terms of dollar magnitude, they represent the largest (smallest) adjustment in terms of magnitude relative to total assets. Additionally, because of the large number of small firms in our sample, the average and median issuance and retirement figures appear quite small. However, when we look at the subsample of our firms that meet the sample selection criteria of Altinkilic and Hansen (2000), the average and median size of equity issuances, for example, are comparable.
Table IV. Capital Structure Adjustment Magnitudes The sample consists of quarterly COMPUSTAT data from 1984 to 2001 and is restricted to firms with at least four years of contiguous data and no missing values for equity issuances, equity repurchases, long-term debt, short-term debt, or book assets. Financial firms (SICs 6000–6999) and utilities (SICs 4900–4999) are excluded. The table presents summary information on the magnitude of four basic financing spikes: Debt Issue, Debt Retirement, Equity Issue, and Equity Repurchase, each defined as a net security issuance or repurchase of at least 5% of book assets. All dollar values are in millions and inflation adjusted to 2001 dollars using the all urban CPI. The top one percentile of each variable's distribution is trimmed.
| ||Median||Mean||Std Dev|
|Debt issue||Issue size|| 7.81|| 54.48|| 147.66|
|Book assets|| 76.33|| 504.03||1491.57|
|Issue size/Book assets|| 0.10|| 0.16|| 0.17|
|Issue size/Market capitalization|| 0.12|| 0.23|| 0.33|
|Debt retirement||Retirement size|| 6.62|| 44.42|| 120.06|
|Book assets|| 66.12|| 498.93||1534.71|
|Retirement size/book assets|| 0.09|| 0.13|| 0.12|
|Retirement size/Market capitalization|| 0.15|| 0.40|| 0.83|
|Equity issue||Issue size|| 3.55|| 19.93|| 42.42|
|Book assets|| 15.14|| 154.03|| 597.65|
|Issue size/Book assets|| 0.20|| 0.41|| 0.58|
|Issue size/Market capitalization|| 0.09|| 0.14|| 0.17|
|Equity repurchase||Repurchase size|| 11.20|| 55.90|| 112.46|
|Repurchase size/Book assets|| 0.03|| 0.04|| 0.03|
|Repurchase size/Market capitalization|| 0.02|| 0.03|| 0.04|