How do firms' capital structure decisions vary between monetary easing and tightening, and what drives these differences in response to interest rate changes

Nijat Jamilzada (Student)

Student thesis: Master's Thesis

Abstract

This dissertation investigates variations in corporate capital structure decisions during periods of monetary easing and tightening and analyses the factors reflecting these changes in response to interest rate changes. Using a comprehensive dataset covering all available US firms from 2000 to 2022, this dissertation employs Fixed Effects (FE), Pooled Ordinary Least Squares (POLS), and Random Effects (RE) models to investigate the impact of monetary policy changes on firms’ capital structure, more specifically, debt to equity ratios. The results shows that a Risk-Free rate increase significantly influences the leverage of firms, leading to the leverage decrease. Conversely, the Spread rate shows a positive correlation with debt to equity. This counterintuitive finding suggests that firms might expect the further growth of interest rate and increases the level of debt to guarantee the lower rates. Additionally, the paper analyses the impact of specific factors such as industry classification, firm size, profitability, volatility, and other related financial metrics in making capital structure decisions, showing statistically significant, varying impacts on leverage. This dissertation enhances the practical and theoretical understanding of how macroeconomic policies reflect corporate capital structure strategies, giving additional insights for investors, financial managers, and policymakers.