Disentangling Sentiment from Cyclicality in Firm Capital Structure

This study examines the relationship between capital structure choices and investor and managerial sentiment, finding that periods of positive sentiment are associated with reduced leverage within firms. We focus on the cyclicality of leverage using non‐orthogonalized sentiment indices and find a st...

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Bibliographic Details
Published in:Abacus (Sydney) 2023-06, Vol.59 (2), p.570-605
Main Authors: Al‐Zoubi, Haitham A., O'Sullivan, Jennifer A., Al‐Maghyereh, Aktham I., Lambe, Brendan J.
Format: Article
Language:English
Subjects:
Capital structure
Financial leverage
Growth perception bias
Leverage
Managerial skills
Managerial traits
Market timing
Pecking order theory
Risk perception bias
Trade‐off theory
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Summary:This study examines the relationship between capital structure choices and investor and managerial sentiment, finding that periods of positive sentiment are associated with reduced leverage within firms. We focus on the cyclicality of leverage using non‐orthogonalized sentiment indices and find a strong negative relationship. Leverage, therefore, appears countercyclical, implying that the decision to take on debt is a consequence of either Admati et al.'s (2018) ratchet effect or a managerial attempt to time the market. Our findings lead us to question some fundamental capital structure theories, namely, trade‐off (Kraus and Litzenberger, 1973), and Hackbarth's (2008) managerial traits theory. Instead, we favour the idea that leverage is a consequence of countercyclical market timing behaviour.
ISSN:0001-3072
1467-6281
DOI:10.1111/abac.12274