Can EBIT-based structural models explain U.S. companies’ capital structure?

Abstract

This dissertation explores the EBIT-based structural model for capital structure developed by Goldstein, Ju and Leland (2001), along with a modified version that accounts for dividend taxation on debt issuance proceedings. Both models are applied to a cross-section of U.S. stocks from 2007 to 2019. The original model is implemented in its static version – that does not account for the option of issuing further debt in the future – and suggests optimal leverage ratios ranging from 72% to 80%. These results are broadly in line with what the literature has found for similar models. The values are nevertheless quite extreme, and in general very different from what is observed in reality. The introduction of dividend taxes results however in a marked reduction, aligning the predicted optimal coupon and leverage levels with the actual ones (on average). The framework’s ability to explain observed interest expenses and leverage ratios is then assessed by regressing the observed metrics against those suggested as optimal by the models. The resulting R-squared are relatively low, the highest value being 10.75%. The main identified reasons for such performance are the simplifying assumptions on which the model is based, together with the fact that observed capital structures do not necessarily correspond to the optimal ones, as firms might deviate from their gearing target.

Date of Award	16 Oct 2020
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Nuno Ricardo Raimundo Rodrigues Marques da Silva (Supervisor)