Essays on the Dynamics of Capital Structure

Tests of the static trade-off theory that posits that firms movetowards the optimum capital structure necessitate a jointhypothesis test - whether firms adjust toward target leverage, andwhether the proxy used for target leverage is the true targetleverage. Prior studies use the time-series mean leverage for eachfirm, the industry median leverage, an estimated cross-sectionalleverage, and a tobit estimated leverage using the factorssuggested by the static trade-off theory as proxies for the targetleverage. In this dissertation, I examine whether these proxies areequivalent and test the consistency of the proxies with thetheorized behavior of the true target leverage. My results indicatethat the four proxies we examine have significantly differentdistributions and this holds across most industries. Further, theindustry median leverage is the proxy which best exhibitsbehavior consistent with the true target leverage. Firm value ishigher for firms closer to the industry median and lower for firmsaway from the industry median. A robustness check using Kmeanscluster analysis confirms the superiority of the industrymedian leverage over the other proxies of target leverage. Thisstudy complements the previous studies on the pecking ordertheory and the trade-off theory. The main purpose of this study isto investigate three issues that are not considered in the previousstudies. The adequacy of the specification and the assumptions ofthe models used in testing the trade-off and the pecking ordertheory. The second issue examined in this study is the validity toputting the pecking order and the trade-off theories in a horserace. The final issue examined in this study is the factors drivingfirms to issue (repurchase) debt or equity or combination of bothand simultaneously the factors affecting the size of issue(repurchase)