Capital Structure Inertia and Product Market Competition

von Prof. Dr. Gabrielle Wanzenried
Forschungsleiterin und Dozentin am Institut für Finanzdienstleistungen Zug IFZ

Based on a sample of US non-financial and non-utility firms over fiscal years from 1990 to 2010, this paper empirically examines how capital structure inertia differs across industries and to what extend such differences can be explained by product market competition. We find that firms in more competitive industries tend to be more inert with their capital structure decisions. This result could be explained by the disciplinary effect of debt, which serves as a substitute to product market competition.

When product market competition is low, managers are more active with regard to capital structure decisions, especially debt use to constrain the free cash
flow problem. In addition, we explore the explanatory power of transaction costs, which is a common explanation for capital structure inertia. Our results show that large firms are more inert than small firms. This provides evidence that transaction costs, at least, do not play a critical role in explaining capital structure inertia.

Read more in the IFZ Working Paper No. 0025/2014 – click here to download