Dynamic Capital Structure Choice: Theory and Tests.

This paper develops a model of dynamic capital structure choice in the presence of recapitalization costs. The theory provides the optimal dynamic recapitalization policy as a function of firm-specific characteristics. The authors find that even small recapitalization costs lead to wide swings in a firm's debt ratio over time. Rather than static leverage measures, they use the observed debt ratio range of a firm as an empirical measure of capital structure relevance. The results of empirical tests relating firms' debt ratio range to firm-specific features strongly support the theoretical model of relevant capital structure choice in a dynamic setting. Copyright 1989 by American Finance Association.