Market Timing And Capital Structure

According to the classic MM theory, a company's choice of a capital structure does not affect its value given certain assumptions. Although the Pecking Order theory and Static Trade-off theory have modified the MM theory by relaxing some of the assumptions, they have not given up the assumption of Efficient Market. However, Behavior Finance theory suggests that as the irrational investors and the limit of arbitrage, equity market is inefficient. Under this frame, Market timing theory of capital structure is developed and tested by Baker and Wurgler (2002). They believed that market timing not only affects capital structure in the short run, but also in the long term. So they suggested that capital structure is the cumulative outcome of past attempts to time the equity market. It provides a new way to understand the capital structure.This dissertation includes five parts. The first one is an introduction, mainly giving the research backgrounds and objective, introducing the existed theories about the capital structure, and listing the structure of this paper.The second part is the theory foundation of this paper. I introduce the Behavior Finance theory and its important challenges to conventional Finance theory: irrational investors, pricing errors, and limited arbitrage. Just because of these challenges, some researchers suggested the market timing exists in practice and rational managers will attempt to seize the timing to arrange their financial decisions such as repurchasing the stocks when price is undervalued. Baker and Wurgler even proposed that kind of timing attempts would cause the capital structure changed in the long term.Remaining parts are the empirically test, I use the method of Alti (2002), isolate timing attempts in a single major financing event, the initial public offering, by identifying market timers as firms that go public in hot issue markets. I find that hot-market IPO firms issue substantially more equity, and lower their leverage ratios by more, than cold-market firms do. The market timing finance behavior exists in Chinese equity market. However, the timing attempts only effect the capital structure in a short time, in long terms there is a target leverage determined by the factors such as size and profitability, which are proposed by conventional theories. By the empirically study, we safely come to our conclusion that in the practical management of leverage, the traditional factors together with the behavior factors affect the capital structure policy.