Capital structure and business cycles

Abstract

This study investigates the relationship between business cycles and capital structure. Specifically, it extends the work of Lemmon (2008), by incorporating the effect of four different stages of the business cycle - peak, contraction, trough and expansion - on the relative importance of the unobserved permanent component of the capital structure. Results indicate that business cycles play an important role in explaining the unobserved permanent component of leverage ratios after controlling for firm fixed effects. In particular, the model becomes much stronger in explaining the variation in leverage ratios after accounting for business cycle phases. © 2011 AFAANZ.