ALL-EQUITY FIRMS AND THE BALANCING THEORY OF CAPITAL STRUCTURE

Despite the benefits of leverage, many firms exist that at some point in their corporate history had no debt. This study provides evidence that the balancing theory of capital structure can predict the behavior of such firms. All-equity firms allow a more precise measurement of firm market value and risk, and provide a less ambiguous relationship between independent variables and dependent variables than the firms used in previous studies. Using a logit function to avoid spurious correlation between the dependent and independent variables, we find that for most years during 1964-88 all-equity firms listed in the Compustat industrial file exhibited a consistently significant negative relationship between the Myers growth option variable and the probability of borrowing. Positively significant but less consistent relationships exist between the risk measures and the nondebt tax shields, and the probability of borrowing. These results do not qualitatively change when the data are aggregated over twenty years or over five-year subperiods. The tests are also conducted by industry according to the one-digit Standard Industrial Classification (SIC) code. Significant relationships are found in the 2000 and 3000 SIC code manufacturing industries.