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Required return on equity when capital structure is dynamic
Author(s) -
Dai Na,
Piccotti Louis R.
Publication year - 2019
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/fima.12266
Subject(s) - gearing ratio , return on equity , debt to equity ratio , return on capital , capital structure , monetary economics , bankruptcy , debt ratio , economics , debt , weighted average cost of capital , equity value , debt to capital ratio , equity ratio , cost of capital , debt to gdp ratio , equity (law) , external debt , business , finance , debt levels and flows , microeconomics , financial capital , profit (economics) , capital formation , population , law , sociology , stock exchange , political science , nonprobability sampling , demography
We link the firm's required return on equity to its target debt ratio. We find that a firm's expected return on equity is increasing in the product of the distance between its debt ratio and its target debt ratio, its speed of adjustment, and the spread of the tax benefits of its debt over its bankruptcy costs of debt. Our empirical tests validate the testable implications of our model.