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Tests of determinants of optimal capital structure Portman, Nicholas Francis


This paper provides an examination of the relationship between capital structure and a number of firm characteristics. A synopsis of the theory and evidence on capital structure to date is provided. A model is developed which posits that capital structure is positively related to liquidity, firm size, the relative amounts of subordinated and priorized debt, and negatively related to operating leverage, sales variability, and bankruptcy costs. Tests of the model were performed in a regression context, with the logarithm of the debt-to-equity ratio as the dependent variable. The characteristics used as independent variables were degree of operating leverage, variance of sales, industry class, firm size, the proportion of secured to unsecured debt, a liquidity measure (cash to total assets), and a number of proxies for operating leverage (accounts receivable, inventory and net plant, to total assets). Dummy variables were introduced to check for the influence of industry class, convertible debt and preferreds on capital structure. Capital structure was found to be significantly negatively related to liquidity, industry class, operating leverage, and significantly positively related to the ratio subordinated to other long term debt. Size and sales variability were found to have no influence on financial leverage. Firms which had issued preferred stock had higher debt ratios. Convertible debt tended to act like equity.

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