Determinants of Firms’ Capital Structure Choice, Their Credit Ratings and the Leverage-Rating Relation



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Both theory and practice seem to agree that firms adjust their capital structure to stay in close proximity to a target leverage ratio. However, this target leverage ratio is not accounted for as a determinant of leverage in existing empirical work. In the first chapter, I calculate the deviation of actual leverage from target leverage and use it as a determinant of firm’s leverage along with a set of other control variables that are traditionally used in the literature. I find that the addition of deviations from target leverage more than doubles the explanatory power compared to existing empirical specifications. Using standardized regression coefficients I show that the deviation from target leverage ratios is the most important determinant of firms’ capital structure.

In the second chapter, I study firms’ credit ratings. Capital structure choice as measured by firms’ leverage ratio is an essential parameter in rating models. The endogeneity of firms’ leverage in rating estimation has recently come to consideration but has not received the attention it should have. My study shows that the corrected impact of leverage is about ten times more than the other determinants.

In the final chapter, I study the endogeneity of leverage-rating relation. I estimate leverage-rating relation simultaneously using three-stage least squares. I find that change in rating is the most important factor for change in leverage (two to five times more than the control variables) and vice versa change in leverage is the most important factor for change in rating (three to nine times more than the control variables).



Target leverage, Capital structure, Credit rating, Rating changes, Leverage changes