Theories of capital structure--an empirical study

The purpose of this study has been to investigate empirically the relevance of agency cost theories developed recently in the domain of capital structure decision making. There are three types of agency costs that have been identified in the finance literature. They are (1) agency costs arising out of growth opportunities for a firm, (2) agency costs arising out of the ownership structure of a firm, and (3) agency costs arising out of information asymmetry between managers and investors. This study considers the agency costs of the first two categories.

The methodology used for this study is cross-sectional regression analysis using diagnostics to check for multicollinearity and influential data points. The dependent variable is the financial leverage ratio. Two ratios, one using the book value of debt and another using the market value of debt, were calculated. Seven independent variables were used as proxy for the agency costs mentioned above. The data sample for this study consisted of data for 283 firms which were collected from (1) the COMPUSTAT industrial and research files, (2) Moody's Industrial Manuals, and (3) Investment Dealers Digest.

The results indicate that the debt ratios and the agency costs are related in an inverse way. The agency costs can explain the cross-sectional differences in the use of debt by the firm better than the bankruptcy costs.

This study has been compared with recent empirical studies done in the area of capital structure decision making. This comparison indicates that this study is an improvement over the other studies both in the methods used and results obtained.