Effect of the 2008−2009 Financial Crisis on Firm Capital Structure

Abstract

Purpose of this study is to find out whether and how the financial crisis of 2008−2009 affected firms’ capital structure. The study also aims to explain how the crisis affected firms of different sizes.

Motivation for the study arises from the vast literature regarding capital structure. Despite numerous efforts attempting to explain changes in firms’ capital structure, consensus for the effects of different determinants is yet to be discovered. The competing theories of capital structure are reviewed in the beginning of the thesis. The theories introduced are the irrelevance theory by Modigliani and Miller, both static and dynamic trade-off theory, pecking order theory, theories of information asymmetry and market-timing, and lastly, the agency theory. The determinants of capital structure are examined next in the study.

In the study, a firm’s debt-to-equity ratio is used to represent its capital structure. In addition, lagged control variables are used to control for any firm-specific effects on capital structure. The sample used in the study consist of publicly listed firms in the US. A fixed-effects panel regression is run on four sample groups separately. These sample groups are Standard & Poor’s 400, 500, 600, and 1500 indices. The different indices represent firms of different sizes.

The results show that the crisis had a small, but statistically significant negative effect on firms’ debt-to-equity ratio. The effect was strongest for small firms. These finding are consistent with previous studies. Based on the results leverage did not revert back to its original levels after the crisis and stayed significantly lower compared to the years before the crisis. However, the study does not denote whether the decrease was due to lower levels of debt, higher levels of equity, or both. Examining this is one option for future research.