The empirical implications of the trade-off theory, the market timing theory, and Welch's theory [Journal of Political Economy (in press)] of capital structure are examined using aggregate US data for 1952 to 2000. There is a long-run leverage ratio to which the system reverts. Deviations from that ratio help to predict debt adjustments, but not equity adjustments. A high market-to-book ratio is associated with subsequent debt reduction, but there is no effect in the equity market.
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We thank Vojislav Maksimovic and Toni Whited for helpful comments. We alone are responsible for any errors. Murray Frank thanks the BI Ghert Family Foundation and the SSHRC for financial support. Vidhan Goyal acknowledges research support from HKUST research Grant DAG03/04.BM46.