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Two Common Problems in Capital Structure Research: The Financial‐Debt‐To‐Asset Ratio and Issuing Activity Versus Leverage Changes
Author(s) -
WELCH IVO
Publication year - 2011
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2010.01125.x
Subject(s) - capital structure , debt to capital ratio , leverage (statistics) , debt , debt to equity ratio , mistake , debt ratio , capital adequacy ratio , business , equity (law) , cash flow , finance , economics , financial economics , monetary economics , equity ratio , equity capital markets , valuation (finance) , microeconomics , profit (economics) , mathematics , population , demography , sociology , political science , law , nonprobability sampling , statistics
This paper points out two common problems in capital structure research. First, although it is not clear whether non‐financial liabilities should be considered debt, they should never be considered as equity. Yet, the common financial‐debt‐to‐asset ratio (FD/AT) measure of leverage commits this mistake. Thus, research on increases in FD/AT explains, at least in part, decreases in non‐financial liabilities. Future research should avoid FD/AT altogether. The paper also quantifies the components of the balance sheet of large publicly traded corporations and discusses the role of cash in measuring leverage ratios. Second, equity‐issuing activity should not be viewed as equivalent to capital structure changes. Empirically, the correlation between the two is weak. The capital structure and capital issuing literature are distinct.