'Hot' Debt Markets and Capital Structure

This paper examines the motives of debt issuance during hot-debt market periods and its impact on capital structure over the period 1970-2006. We find that perceived capital market conditions as favourable, an indication of market timing, and adverse selection costs of equity (i.e., information asymmetry) are important frictions that lead certain firms to issue more debt in hot- than cold-debt market periods. Using alternative hot-debt market issuance measures and controlling for other effects, such as structural shifts in the debt market, industry, book-to-market, price-to-earnings, size, tax rates, debt market conditions and adjustment costs based on debt credit ratings, we find that firms with high adverse selection costs issue substantially more (less) debt when market conditions are perceived as hot (cold). Moreover, the results indicate that there is a persistent hot-debt market effect on the capital structure of debt issuers; hot-debt market issuing firms do not actively rebalance their leverage to stay within an optimal capital structure range.