Research Articles

Debt Capacity and Tests of Capital Structure Theories

Michael L. Lemmona1 and Jaime F. Zendera2

a1 Eccles School of Business, University of Utah, 1645 E. Campus Center Dr., Rm. 109, Salt Lake City, UT 84112.

a2 Leeds School of Business, University of Colorado at Boulder, UCB 419, Boulder, CO 80309.


We examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt capacity largely explain the use of new external equity financing by publicly traded firms. Finally, we present evidence that reconciles the frequent equity issues by small, high-growth firms with the pecking order. After accounting for debt capacity, the pecking order theory appears to give a good description of financing behavior for a large sample of firms examined over an extended time period.


We are grateful for comments from John Graham, Paul Malatesta (the editor), Robert McDonald, Roni Michaely, Ilya Strebulaev (the referee), and participants in seminars at the University of Colorado, Cornell University, Claremont McKenna College, University of Washington, and the Australian National University. We are solely responsible for any remaining errors.