Macroeconomic conditions and capital structure: evidence from publicly listed companies in the U.K.

This research investigates whether and to what extent macroeconomic variables, namely, business cycle, financial market risk, credit supply and stock market performance, affect capital structure of publicly listed U.K. firms. Specifically, by using fixed effects, random effects, tobit, and GLS regression models and GMM methods (SGMM and DGMM), this research tests if the macroeconomic variables affect capital structure in a manner that is consistent with the pecking order, trade-off and market timing theories. Without considering the effect of 2008 financial crisis, I find that, first, the results from static models and dynamic models of capital structures indicate that leverage is negatively associated with the business cycle. This is consistent with the prediction of pecking order theory. Second, the results from static models report that leverage is positively associated with credit supply which is consistent with either prediction of pecking order or trade-off theories. However, the dynamic models’ results show that leverage is negatively associated with credit supply which is consistent with prediction of market timing theory. Third, the results from static models report that leverage is negatively associated with financial market risk which is consistent with the predictions of trade-off theory. However, leverage is associated significantly and positively with financial market risk based on the dynamic model results which is consistent with the predictions of pecking order theory. Fourth, the results from static models report that leverage is positively associated with stock market performance which is consistent with predictions of pecking order theory. However, the dynamic models’ results show that stock market performance does not have an explanatory power on capital structure. Moreover, considering the effect of 2008 financial crisis, I find that, the results are the same and consistent with both the static and dynamic results with the exception of financial market risk’s result which is only consistent with the static model’s results. The above results are robust to the stated estimation strategies and indicate that macroeconomic condition has explanatory power on capital structure. In addition, this research, despite the strong empirical evidence supporting effect of macroeconomic conditions on capital structure does not have overwhelming evidence in support of any of the three stated theories. Furthermore, the empirical findings indicate that the effect of macroeconomic condition was more balanced after the crisis, suggesting that during crises due to the uncertain level of financial market risk, the effect is undetermined, and a trade-off rises for economic policy. Therefore, this research contributes to the literature, by using the four chosen macroeconomic variables, static and dynamic estimation strategies and U.K. data and by establishing the hypotheses to predict how the four stated macroeconomic variables affect capital structure under the pecking order, trade-off and market timing theories