A Reinterpretation of the Relation between Market-to-book ratio and Corporate Borrowing

This paper develops an alternative interpretation of the observed inverse relation between market-to-book ratio and long term indebtedness based on the market timing theory of capital structure and provides empirical evidence to substantiate the same. Our findings suggest that in the presence of equity returns as an independent variable, market-to book ratio looses statistical significance in explaining incremental borrowing by the firm. Results in this paper reveal that long-term indebtedness is inversely related to market to book ratio in expansionary as well as contractionary phases of an economy. Consequently, the use of market-to-book ratio as an estimate of firm growth in regression models appears contestable.